23 May 2012

Water pricing and metering

I wrote this for a website two years ago, but it was never posted. Sound right?
"Water is a gift from God." ---Argentine State's Attorney

"Yes, but he forgot to lay the pipes." ---Olivier Barbaroux of Vivendi
If you drink water from your own well or divert it from a neighboring river, then you can stop reading.

Everyone else should read on.

We pay for our water because we need to cover the cost of getting that water to our taps.

Those costs are fixed and variable.

Fixed costs are the costs of building dams, aqueducts, treatment plants and pipes. They are the salaries of the people who install and maintain equipment, answer the phones and make sure that you are paying your bill. For most water agencies, 70-80 percent of total costs are fixed. That means that they do not go up or down with the volume of water sold.

Variable costs do fluctuate with delivery volumes. There are costs from the energy it takes to run pumps and machines, the chemicals that go into water treatment and the costs of some staff.

The interesting thing is that there is not often a cost of water. That's because many water agencies have the right to divert water from a river or lake or pump it from underground. San Francisco doesn't pay a penny for the water it gets from Hetch Hetchy reservoir. It has the right to export that water from the Sierra Nevada because it has an agreement with the Department of the Interior.

So these costs need to get paid.

Our water bills used to be simple. We paid a flat charge, per month or quarter, and used as much water as we wanted. The goal was cost recovery, not water conservation. There was plenty of water, and revenue paid for fixed and variable costs.

Meters made an appearance when water conservation started to matter, and we wanted to do two things: Charge people for what they used and encourage people to use less.

Water meters always reduce water use.

People also like them because heavy water users (water hogs) use more.

Meters also made it possible to charge people in two parts: a fixed charge per meter and variable charge for the volume of water used.

There are three ways to charge for water volume:
  1. Uniform pricing charges people the same price per unit, regardless of how many units they use. This pricing is similar to the price we pay for gasoline.

  2. Decreasing block rates mean that people pay less per unit, the more units they use. This =pricing is similar to the price we pay for cellular phone plans. Buy more minutes, pay less per minute.

  3. Increasing block rates mean that people pay more per unit, the more units they use. Ironically, we do not see this kind of pricing outside regulated (water, gas, electric) utilities.
There's lots of economic theory behind these pricing regimes, but the basic idea is to encourage use with decreasing block rates and discourage it with decreasing block rates. Those incentives generally work, but they can be weakened by:
  • Blocks that are "too wide," so that people do not face a higher or lower price point when they are deciding how much to use.
  • Blocks that do not "step far," so that the change in price is too small to notice.
Now here's the tricky part. In systems without meters, the flat monthly charge would cover both fixed and variable costs. When meters were introduced, it was easier to match fixed costs to fixed revenues, and variable costs to variable revenues. That would ensure that the utility would break even as consumption (or costs) rose and fell.

Note that municipal water agencies decide how much they want to charge. Investor owned private companies have their prices regulated by a Public [sic] Utilities Commission that's part of the state government.

Unfortunately, lots of people wanted to use variable prices to influence water use. That meant that the share of variable revenue had to rise, so that, for example, a utility may get 80 percent of its revenue from variable charges.

It's not hard to see that these weights would lead to mismatches between costs and revenues.

Let's say that a family pays $100 per month for water: $20 fixed and $80 variable. If they use 50 percent less water, then their bill falls to $20 + $40 = $60. Unfortunately, the utilities costs fall by $10, from $80 fixed and $20 variable to $10 variable. So the utility has a revenue shortage and then -- often -- asks for price increases. This often annoys customers, since they end up facing higher prices after using less.

But this is the water business, and nothing is ever as straightforward as it seems.

I suggest that you get your water bill and try to understand what you are paying for, why it is that amount and how those costs may change -- or not -- with your behavior.


Susan Hollingsworth said...

Thank you. Simple explanation of water usage appreciated. As a renter, I've always paid into utilities without seeing usage until only a few months ago. I found the bill as confusing and not informative at all, as if I was encouraged to not understand it and simply write a check. I look forward to speaking with someone in city hall next time I drop it off to learn more.

Tim said...

Hi Dawid, could you outline or link to a reference of the economic theories of pricing regimes you would refer to in particular? Many thanks

David Zetland said...

@Susan -- tell me what happens :)
@Tim -- "demand slopes down" -- the rest is complications of accounting (i.e., who ends up in what block). Also note that I NOW advocate uniform blocks (same price per unit of water) as easy and fair.

Mr. Kurtz said...

There are two other functions that water infrastructure often (but not always) provides: flood control and sewage disposal. The former has no relation to volumes consumed, and the latter a tenuous one (a house with a big garden uses a lot of water, an apartment uses much less, but both can produce the same amount of human waste). Insurance companies get a free ride on flood control; property owners typically pay a small surcharge in their property tax bill to fund the local levee district, but not the giant dam upstream. As for sewage, I would love to have a system that measured the amount of shit people produce generally, and fined them on that basis, but until I am King...
Anyway, meters (or other accurate measuring systems for big users like agriculture) make sense for a ton of reasons. They just don't measure everything.

Anonymous said...

"Water meters always reduce water use" I stopped reading ater that...

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