26 Mar 2014

Water Shortage and Rates in California

Chris Scott writes:*

The extreme water supply shortage in California has to be addressed by water managers and the rates need to reflect the current cost to supply the resource. The picture above of the Folsom Lake Reservoir, which provides water for nearly 500,000 people in California, illustrates the severity of the drought currently taking place. The picture on the left shows the reservoir on July 20, 2011 at 97% of its total capacity compared to the picture on the right of the reservoir just over a month ago at 17% of its total capacity. Folsom Lake and every other major water reservoir in California is currently significantly under their historical averages of water capacity for this time of year. With this trend showing up over the past few years, it has me wondering why the prices or rate structures have not changed drastically.

In California the two most popular water rate structures are “uniform rates” and “increasing block rates”. I agree that both of these structures are good in the sense that the people that are consuming the most water have the highest bills. What I disagree with is that in most cases in California it is the commercial and industrial customers, who use significantly more water than the residential customers, that pay the uniform rates and it is the residential customers that pay the increasing block rates. This means that for residential customers, who use far less compared to commercial customers, have increasing per unit costs, therefore decreasing demand for water the more they consume. Commercial customers on the other hand, have the same per unit cost no matter how much water they consume, therefore the same demand for water regardless of consumption level. This constant per unit cost for commercial customers gives no incentive to use less water during a drought because their variable costs remain the same regardless of consumption.

Bottom Line: Since water is a finite resource, especially in California, it only makes sense to have increasing block rates for everyone. Since the more water you consume the less is available for everyone else, your per unit rate for water should increase the more water you consume to reflect the water you are taking away from others consuming. If commercial customers see their variable costs going up and their margins going down, this gives them an incentive to be more efficient with their consumption or face diminishing returns.

* These guest posts are from students in my resource economics class at Simon Fraser University. Please leave feedback on their logic, ideas and style and suggestions of how to improve.