17 Jul 2014

Pricing tap water for efficiency and fairness

I've opposed increasing block rates for some time, but I don't think I've got a simple post on how I WOULD price water.

This is from Living with Water Scarcity:
Reliable service and fair pricing

Utilities should collect fixed and variable revenues in direct proportion to fixed and variable costs so their finances are stable. All customers should pay the same volumetric prices to be fair. A surcharge can be added when water is scarce and demand needs to fall. Excess revenue from that surcharge can be rebated to each household --- without respect to their water use --- to ensure that the utility uses higher prices only as a temporary means of preventing shortage.

These ideas are summarized on the next page below, which illustrates how utilities can price water services for fiscal and environmental stability. The figure shows how water costs usually arrive (left column), the way that water is typically mispriced (center column), and how to price water correctly (right column). The light grey areas show the lopsided impact of conservation: A 50 percent drop in use reduces variable costs and revenues by 50 percent each, but total costs fall by much less than total revenues because variable costs are a small share of total costs while variable revenues are a much larger share of total revenues.

Copy, snip and distribute this sheet [PDF] at your next cocktail party. People love talking about realistic ways to live with water scarcity.
Bottom Line: Forget fancy pricing structures with dozens of customers classes. Recover costs to protect the utility's financial stability. Raise prices when water -- the cost of which is usually zero -- is scarce.


Larry Farwell said...

The only customer class that receives a greatly reduced price for water is agriculture. This is a political decision reflecting that the farmers own the land and have tremendous influence. How do we deal with politics?

Eric Hahn said...

The concept of pricing structures that recognize the mismatch of variable costs incurred by utility service providers with respect to their variable revenues has merit. However, I think I'll need to see more data on what people love to talk about at cocktail parties before I can buy every assertion you've made in this posting...

David Zetland said...

@Larry -- this is for drinking (tap) water *services*. Farmers often self supply, but they are sometimes subsidized. Their "problem" is often lax restrictions on (over)use

@Eric -- Yes! More cocktail parties! In the meantime, implement this scheme as the best way to help managers protect their financial health AND encourage customers to conserve.

Lauren Steely said...

Hi David, a few questions for you:

1. Do you think the scarcity surcharge + rebate plan as you've described it above would pass muster under Prop 218 in California (which mandates cost recovery pricing and limits rate hikes)? We are already seeing lawsuits against agencies for implementing rationing plans in places like San Juan Capistrano.

2. Koichiro Ito (2013) has pointed out that consumers tend to respond to average price, not marginal price. i.e., they look at their bill and divide the total bill by the amount of water they used. When fixed costs are large relative to volumetric costs, most consumers will find themselves on the downward sloping part of the avg cost curve where using more water actually decreases their avg cost. Unless the scarcity surcharge is very large, it seems like that would be the case here. How big should the surcharge be, and should it be tied to any particular measure of scarcity (storage levels for example)?

2. Are there any examples of agencies who have implemented your plan? (I know you've written about Davis, but it seems they've left the most important part out).

David Zetland said...

@Lauren -- According to Richard McCann, it will not, but it depends on your lawyer. If not, then it would have to be approved in a Prop 218 vote (or "not disapproved"?). Thankfully, most states do not struggle under such a tangle of anti-tax/user fee regulations.

I don't agree with your AC analogy, as it implies that people would use huge volumes to reduce the AC per unit while ignoring their total (rising) bill. The surcharge would, e.g., be $1/ccf on $3/ccf (flat rate) volumetric pricing. A price elasticity of -0.5 on this 33% increase implies a drop in use of 16%. The IMPORTANT part is that the drop in use would NOT harm finances, since fixed revenues would not drop...

As an example, consider Santa Barbara, where the price of $27/ccf (top tier) was WAY above cost of supply but NOT opportunity cost. I'm sure there are more, but sometimes "scarcity charges" are buried in "new supply costs", "reliability charges" etc. that reflect the need to balance S&D.

aguayaseo said...

I do not share the vision of having high fixed charges supported by a large proportion of fixed costs. In practice all producers have fixed costs but because they do not have the market power of the utilites they can not charge fixed fees and all costs would be recovered through variable charges.

I just defend the existence of high fixed charges in the holiday village where a large number of users are seasonal. In these cases very low or no fixed charges generated an improper unit cost for permanent residents.

Regarding increasing block tariffs, I consider them appropriates because they give a very clear signal of higher cost of additional capacity and gives (as they have done in Colombia) a strong social awareness to reduce water consumption.

David Zetland said...

@aguayaseo -- I disagree with your points as follows:
(1) Utilities do not have the ability to "make profits" like other businesses with high fixed costs (oil/gas or mobile phones), so it helps -- IMO -- for them to have higher fixed charges.
(2) IBRs can send signals, but so can higher uniform charges (e.g., strawberries in winter) or information campaigns...

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