Pricing is a powerful tool for shaping behavior, including water use. Recognizing the power of pricing, more water utilities are adopting water rates designed to encourage customers to conserve. These so-called “conservation rates” vary in form, but generally they increase the price per gallon of water the more water a customer uses. Across the country, utilities can testify to the power of pricing by pointing to their decreased water sales. This is great news from a conservation standpoint, but the unintended result can be unexpected reductions in revenue.
The need for more reliable revenue is more important than ever, as water service providers contend with prolonged droughts and aging infrastructure. Unfortunately, this need for revenue can make conservation the unwanted stepchild of water utilities.
The good news is that there are more tools than ever to help water systems anticipate the potential volatility of future revenues. The Environmental Finance Center at University of North Carolina Chapel Hill developed one such tool, available for free.
This tool underpins the findings of a new report co-authored by Ceres and UNC EFC, which underscores the need for utilities to assess what might happen if customers respond too well to pricing or other conservation signals. Measuring and Mitigating Water Revenue Variability uses the financial data from three North American water utilities to explore how pricing structures interact with customers’ usage patterns to create revenue stability or volatility.
For example, if customers at all three utilities cut their water use by 15 percent, the resulting change in water revenue is by no means uniform. The Southeastern Coastal Utility fares fairly well, with only a seven percent reduction in revenue. The Mountain Resort Utility, on the other hand, would see a whopping 24 percent reduction in revenue. (See Figure 1: Revenue Variability Due to One-Time Significant Declines in Residential Demands)
Why is the Mountain Resort Utility so much more susceptible to revenue shocks? The main reason is how many customers are high-volume water users. Although most customers of the Mountain Resort Utility use less than 10,000 gallons each month, a full 14 percent of customers use more than 25,000 gallons each month. Remarkably, the Mountain Resort Utility’s customers using more than 25,000 gallons each month use an average of 73,100 gallons per month! (See Figure 2: Distributions of Residential Water Bills by Volume in 2013) When those high-volume customers who are paying a premium for their water curtail their use, the result is a big drop in revenue.
Conservation isn’t optional for many utilities, especially those in water-constrained regions such as the West and Southwest. Fortunately, there are several established approaches that can protect utilities from the impacts of revenue swings even under the most aggressive conservation pricing strategies. These include temporary drought surcharges to offset lost revenue during times of extraordinary shortages. Utilities can also put money aside for a rainy (or dry) day in the form of reserves. They can even explore hedging weather risk through weather risk insurance contracts like those used in the electric utility, agricultural and recreational sectors.
Aside from these risk-management strategies, water utilities can also explore new pricing structures that are designed to optimize revenue reliability while sending a strong conservation-pricing signal. Measuring and Mitigating Water Revenue Variability introduces some of these “Dream Date” pricing models that could help water utilities commit to conservation without breaking the bank.
One such theoretical pricing model is the “PeakSet Base” model. In today’s world, the base charges customers pay to connect to a water system are generally set based on service line or meter size under the assumption that this is an accurate method of predicting a customer’s potential cost burden on the water system.
Since most residential customers use the smallest meter size, they have no incentive to reduce their base charge. Yet peak monthly water usage, which can be the primary cost driver for utilities, varies considerably for residential accounts with the same meter size. Some customers with a 5/8” water meter may peak at over 100,000 gallons in a single month, while other customers never exceed 2,000 gallons/month. In short, meter size alone is likely a poor indicator of the peaking cost burden of individual customers.
If peak monthly use was used to set the base charge itself, such that each customer was charged a unique base charge calculated from his/her highest month of water use, then customers would have a price incentive to conserve.
Unfortunately one such pricing model proposed in Davis, CA was rejected by local voters. Hopefully more water utilities will take a run at adopting these next-generation pricing structures despite this precedent.
Long story short, while water utilities will never be able to overcome all uncertainty in their revenues, they can invest in robust modeling and financial practices to ensure that conservation is a better friend of revenue stability.
About the Authors
Sharlene Leurig is director of the Sustainable Water Infrastructure Program at Ceres and recently chaired the Austin Water Resource Planning Task Force in Texas. Follow her on Twitter @sleurig. Ceres is an advocate for sustainability leadership. Ceres mobilizes a powerful coalition of investors, companies and public interest groups to accelerate and expand the adoption of sustainable business practices and solutions to build a healthy global economy.
Jeff Hughes is the Director of The Environmental Finance Center (EFC) at the University of North Carolina, Chapel Hill, part of a network of university-based centers that work on a range of environmental issues, including water res.ources, solid waste management, clean energy and land conservation. For more information, visit efc.sog.unc.edu or follow EFC at UNC on Twitter: @EFCatUNC.