24 June 2014

Stabilizing water utility finances in Germany

Siegfried Gendries (German blog) wrote this on the balance between fiscal stability and conservation incentives (my post on implementing the same idea in Davis, California*):

The water industry in Germany is facing more and more challenges due to decreasing water consumption from both, the household sector and the commercial and industrial sector. Since the majority of the water supplier charge an high degree of volumetric price elements, the turnover in the industry is decreasing nearly simultaneously. Due to the inverse cost structure in the asset heavy industry this leads to significant problems for the water companies. As an answer, the regional water company RWW Rheinisch-Westfälische Wasserwerksgesellschaft, a subsidiary of RWE, developed and introduced a new pricing system which is based on a weighted consideration of fixed and volumetric price elements in order to stabilize the turnover and therefore not at least the cost coverage.

The water price and water saving challenge
In the eighties of the last century the water demand projections of scientific institutes targeted on 250 liters per capita and more. Therefore the water testament plants and pipes constructed afterwards especially in the Eastern regions of the former GDR considered these numbers. Also the industrial and commercial water consumption patterns were estimated at a significantly higher level than today's reality. Regarding households, the assumptions failed by more than 50 %. Today the numbers are at 121 liters and less (incl. commercial and mid/small industries). The Eastern regions of Germany are below 90 liters per capita at present.

Under these circumstances it would be nightmare to assume that the water supply in Germany could be stabilized on the satisfactory level. Since with each cubic meter consumed less, the cost coverage failed by 60 percent and more. The usual reflex are price increases. This can't be recognized as a sustainable solution due to the more intensified focus of anti trust authorities on one hand and price elasticity effects of those consumers which have the opportunity to react on the other hand. The latter one must result in a price spiral.

Reasons for water demand decreases
The consumption levels are recognized by four effects:
  1. Autonomic effect: technological changes lead to less water consumption (incl. energy nexus),
  2. Ecological behavioral effect: people want to save water since there is water stress in some regions in the world or due to their ecological attitudes
  3. Economical behavioral effect: people want to save money by saving water (a target which is supported by the volumetric price)
  4. Demographic changes: the population in many regions in Germany is decreasing, which lead to less consumer.
With regard to a price adjustment process we analyzed the impacts of the four effects. The first one explains 60% reduction in our supply region, the two behavioral aspects 20% and the demographic change 20%. Therefore it can be stated, that the room for influencing the water consumption behavior in order to reduce the economical impact is quite small. That means on the other hand a price increase will not have the impact as usually assumed.

New water price system to stabilize service and quality levels by ensuring cost coverage
As a water company with nine small and larger water works, 2,900 km pipes and mains serving 800,000 people and 10,000 commercial and industrial customer RWW had to find a solution to react on a 1.5% y/y water demand decrease. Although the price structure was already 20% fix and 80% variable, we had to find a economic solution accepted by both, the customers and the shareholders.

One problem had to be solved at first: the structural difference between costs and prices. The objective was to rise the fixed price element on a 50% level and to reduce the variable price element at 50% as a countermove. Although it seemed to be easy at the first view, it was impossible to adhere at the usual water meter as the base for charging, since the group of one-family houses would have been burden unacceptable. In order to reduce the viable unfairness the „size of the meter“ was replaced by the number of „housing units“.

The next challenge was to avoid the unfairness deriving from the fact that a linear price system would multiply the fixed prices depending on the number of units in a house. Households in multifamily-house would have been discriminated against those in smaller houses. The solution was a regressive fixed price algorithm per housing unit.

In order to stabilize the total turnover and to avoid profit by the introduction, we reduced the volumetric price from 1.62 Euro per cubic meter to 1.21 by 40%. Therefore the price system change became neutral for the totality of the customers.

With regard to the communication strategy we anchored the fix price element at the water supply system in order to convince people that they are paying for pipes and water works. Consequently we called that element "system price," therefor we consequently named the tariff the "System Price Model for Drinking Water."

Two years after introduction there is an increasing interest in the German water sector to introduce a comparable price system for water. Meanwhile two companies changed their water prices according to system price model and six water companies are in preparation of the same step advised by RWW.
* Addendum: Wow. There's an amazingly weird discussion of "wet fixed costs" justifying higher water charges (and lower fixed charges) in Davis. I left this response:
Fixed costs include current spending and debt repayment that does NOT change with daily volumes of delivered water. They average 80 percent at most utilities. Taking 87 percent of revenues from water sales is ASKING for financial instability. It also does nothing extra to reduce use, versus CFPR.

@Matt — you’re proposing that people pay for 87% of their driving with gas, with the other 13% coming from the cost of buying the new car. This is silly.
On the one hand, I think it's really annoying to have to fight with these funny interpretations. On the other, it's great to get a public debate on how water pricing works.

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