Water Affordability | Part 3
More than just a drop in the bucket: Ensuring long-term water affordability
Declining water consumption, reduced revenue, and tighter budget constraints—this has become the new norm for many of the nation’s water utilities. As utilities seek to address these challenges, they face the daunting task of keeping pace with an aging infrastructure system. In the first two installments of our water affordability blog series, we discussed the current state of our nation’s infrastructure woes and highlighted strategies for enhancing financial stability. In the final part of this series, we focus on conservation and specific ways utilities can leverage conservation efforts to protect the affordability of this vital service.
The Conservation Conundrum
Conservation is an integral component to ensuring the long-term viability of our nation’s water supplies. Reducing overall demands on a water system can lead to more reliable delivery for current residents as well as additional capacity for future growth. As conservation efforts continue to reduce overall demands, however, less revenue is generated to support a utility’s bottom line—unfortunately, tomorrow’s savings do not pay for today’s costs. Over the short-term, utilities may have to increase their water rates to fill the gap caused by declining water sales.
When evaluating a utility’s financial stability over the long-term, the benefits of conservation, both to the utility and its customers, easily outweigh these short-term revenue impacts. Through reduced municipal demand, utilities can offset the need for costly infrastructure upgrades, including additional treatment capacity and water supplies. In doing so, utilities can ensure more affordable water services for their ratepayers over the long-term.
Case Study: Westminster, Colorado
A prime example of conservation's long-term benefits is the City of Westminster, Colorado, which took a look back on 30 years’ worth of data to determine what the city’s water and sewer rates would have been in the absence of its longstanding conservation efforts. Through their analysis of historic water usage and peak demand, the City estimated per capita water use had decreased by 21% from 1980 to 2010. Without this reduction, the City estimated it would have needed $592 million to cover the costs of new infrastructure necessary for supporting increased municipal demand.
By reducing both overall demand and daily peak demand, the City of Westminster was able to extend existing water supplies and delay the need for additional water and wastewater treatment capacity. Without conservation, the city also estimated increased demand would have cost the utility $1.2 million per year in additional operating expenses. To pay for all of these costs associated with additional demand, the city projected water and sewer rates for single family residents would have been 91% higher.
As the Westminster case study reveals, utilities can avoid significant rate impacts over the long-term by introducing conservation measures to reduce demand and thereby offset the need for additional supply capacity in the future. Although the reduced water sales tied to conservation may force utilities to raise their rates to make up for immediate revenue shortfalls, this rate increase is far less than what would be required to cover the future capital costs of new water supply and infrastructure—not to mention conservation is often the cheapest alternative to traditional supply-side strategies.
The Conservation Solution
Utilities can promote conservation across their customer base in a number of ways: rebates for water efficient fixtures, irrigation audits, landscape transformation, education/outreach, water budgeting, advanced metering infrastructure (AMI), and conservation pricing. In recent years, more and more utilities have turned to these latter two strategies—AMI and conservation pricing—to enhance their conservation portfolio. Together, utilities can use these strategies to bolster their long-term financial stability and maintain affordable water rates.
As we discussed in our last installment on water affordability, AMI deployment offers benefits going beyond just water loss reduction—it also helps cut down on operating expenses, boost revenue collection, and offset the need for capital improvements. This type of smart technology offers real-time water usage data and conveys this information to the utility at regular intervals via an electric signal. Because AMI has the capability to quickly and accurately send meter readings, utilities can continuously monitor this data to proactively identify and address leaks. Reducing these real water losses means utilities end up spending less money on chemicals, labor, and energy to produce water that would be otherwise lost in the distribution system. More than that, though, utilities can utilize water loss analytics to facilitate capital improvement planning and improve overall system performance by targeting areas across the distribution network most susceptible to water main breaks.
The constant flow of meter data provided by AMI can also help utilities tackle apparent water losses, such illegal water use and faulty meter readings. Unlike traditional water metering systems which require manual readings and are prone to reading errors, AMI offers enhanced meter accuracy and quick access to readings. These advantages allow utilities to more easily detect unauthorized consumption and ensure billing accounts are charged true volumetric rates, meaning utilities can begin capturing additional revenue as soon as AMI is deployed. In addition to this revenue boost, AMI also reduces the labors costs associated with meter readings since it eliminates the need for manual readings. All in all, utilities can reap a broad array of benefits by implementing AMI, from water loss reduction to increased revenue to reduced operating/labor costs, to more strategic capital improvement planning. The City of Kennedale, Texas, provides a good example of how AMI can be leveraged to improve a utility’s financial outlook.
In 2013, the City of Kennedale deployed an AMI project as a strategy for addressing the revenue impacts of drought-related water restrictions. To help balance budgetary constraints and reduced water demands, the city partnered with FATHOM to facilitate meter data management and provide a platform for customer engagement. Using customer communication tools, the City of Kennedale successfully reduced capita water demand by 17.5%. In spite these reduced water sales, the city was able to increase overall revenue by 5.8%. This financial outcome was the combined result of increased data granularity and accuracy, which translated into streamlined billing processes, increased revenue, and improved operational efficiencies. When paired with meter data management and a customer information system, AMI stands to offer utilities greater water and financial security through refined management tools, as the City of Kennedale illustrates. For more information on how both AMI and district meter areas can improve a utility’s financial health, check out our recent blog post on this topic.
Conservation-oriented rate structures
The way utilities structure water rates has a huge impact on not only expected revenue generation, but also on customer water use behavior as well as water affordability for lower-income residents. Water rates are traditionally informed by the costs required for sourcing, treating, and delivering water. To determine these costs of service, utilities project future demand based on historic water years and sales and set rates accordingly. The dynamics of water rate design, however, are cyclical in nature because rates directly impact demands; which in turn dictate system capacity requirements; which in turn feed into the costs of service. The Westminster case study does an excellent job of highlighting how demands influence supply and capacity needs and how system expansion drives the cost of service. Ultimately, as the City of Westminster demonstrated, reduced demand can translate into more affordable water rates over the long-term. Understanding these dynamics is critical to securing greater financial stability.
How can utilities design their water rates to encourage reduced demand, maintain affordability, and ensure their long-term financial health? Conservation-oriented rate structures have emerged as an optimal way to achieve these objectives. Using different pricing mechanisms, utilities can integrate conservation goals directly into their financial framework. For example, utilities can establish increasing volumetric block rates (i.e., customers using less water are charged a lower rate compared to those who use more), seasonal block rates (i.e., volumetric block rates are adjusted according to peak and off-peak seasons), and excess use rates (e.g., water budget rates—if customers go over their individualized water budget, they are charged a higher volumetric rate). These types of rate structures are designed to encourage more water efficient use by the customers via pricing signals, especially when it comes to more discretionary uses like outdoor watering.
Keep in mind, however, revenue from water sales is derived from both fixed and variable charges. Though fixed charges provide greater revenue stability, high fixed rates are more burdensome on lower income residents, whose water bills represent a larger share of their income. Because lower-income residents typically use less water (especially for non-essential purposes, such as outdoor watering) than other customers, these households have less flexibility to reduce their usage and lower their bill. On the other hand, through higher variable fees utilities can set more equitable water rates and also send more effective pricing signals to their customers. Ideally, as consumption increases, the corresponding volumetric rate is designed to reflect the marginal costs of water (i.e., the costs of developing the next unit of supply necessary for meeting increased demands) and thus the true costs of water services. Using pricing signals to account for these marginals costs is crucial to empowering customers with the flexibility to make informed decisions on their water usage. For a comprehensive list of tools and resources to assist in setting effective rate structures, check out Alliance for Water Efficiency’s Financing Sustainable Water Project.
Developing effective rate structures can be a challenge for utilities given the dynamics of price elasticity, uncertainty of future droughts, and variability in demand. Since the costs of providing service are fundamental to the rate-making process, a utility must set rates that accurately reflect these costs. If a utility fails to ensure this, they could open the door to ligation disputing the legality of the rates. A situation like this occurred in San Juan Capistrano, California, where a group of ratepayers brought a lawsuit upon the city alleging it did not provide sufficient financial justification for its tiered rate system. Ultimately, the court found the city had arbitrarily established rates based on an allocation of the utility’s budget requirements, rather than the true costs of providing service. To avoid these legal implications, utilities must thoroughly demonstrate that its conservation-based water rates are directly proportionate to the actual costs of service.
Another challenge utilities encounter when developing new rate structures is communicating the value of water to customers so that they fully understand the true costs of providing this fundamental service. Although conservation-oriented rate structures seek to make these connections more transparent, water prices can vary significantly from system to system. For that reason, conservation pricing signals may not be as effective in communities with lower water rates. How utilities interact with their customers and convey this message is integral to shaping more sustainable water usage behaviors.
Water utilities’ primary responsibility is the safe and reliable provision of water, but the vital role utilities play in ensuring quality of life and economic vitality in the communities they serve is often overlooked. To transform this perception, utilities must be actively engaged with their customers through multiple channels of communication. In addition to focusing on the fundamental role utilities play in their customers’ everyday lives, these outreach efforts should also underscore their customers’ contributions (in the form of rate payments) towards achieving water and financial security now and in the future. For any conservation strategy to be successful, whether it is efficiency-oriented rate structures, AMI, rebates, etc., it must be underpinned by an active public engagement component.
A prime example of these efforts to balance water conservation, affordability, and revenue stability is Cobb County Water System (Georgia). As part of a state-mandated conservation initiative, Cobb County Water System designed and implemented an efficiency-oriented rate structure in 2006. During the rate-making process, the utility identified excessive outdoor water use and increasing operating and maintenance costs as critical factors to consider in the new rate structure. For residential customers, Cobb County proposed a rate structure consisting of increasing-block rates divided across three tiers. Although the new rate design increased rates across the board, the impact was minimal for 80% of the utility’s residential customers, which saw a 5% increase in rates. For the remainder of the utility’s customer base, however, water bills were projected to jump by as much as 300%, especially for high outdoor water users. To help garner public support for the rate adjustments, Cobb County tasked its rate-setting team with developing an effective communications strategy prior to the new rates taking effect. Their efforts focused on comprehensive messaging, engagement with elected officials, proactive internal preparation, and targeted public outreach. Through these sound planning efforts, Cobb County was able to minimize public opposition to the new rate structure, ensure adherence to state requirements, and secure greater long-term financial stability.
As we have discussed at length in our 3-part blog series on water affordability, the capital investments necessary for repairing and replacing our nation’s deteriorating water infrastructure are at an all-time high. To address these needs, utilities often look towards rate increases to cover budgetary gaps, but an unintended consequence of these rate hikes is the growing unaffordability of water services. The complex challenge of balancing budgetary constraints, high capital expenditure requirements, and ratepayer impacts necessitates a multi-pronged approach to water utility management and financial planning. This includes innovative financial solutions to help spread the capital costs over time, opportunities to increase operational efficiencies, and tools to facilitate strategic asset management. To complement these strategies, conservation can also be leveraged to maintain the long-term affordability of water and offset the need for additional capacity and supply in the future. Together, these strategies can provide water utilities with a proactive, tactical approach to investing in water and financial security.