Conservation Pricing

Strategy #1:

Price Water to Encourage Conservation

 

A basic principle of conservation pricing is to charge for water based on how much water is used. The more you use, the more you pay. Although this seems like common sense, there are water utilities in California today that charge a fixed rate for each customer— no matter how much water the customer uses. The advantage of fixed charges for the utility is a predictable and dependable revenue stream.

 

The City of Santa Cruz charges for the amount of water used—the volume charge portion of the water bill. The other portion of the bill is a fixed rate, called a readiness to serve charge. The fixed rate is the same for all customers of that class, (e.g., single family residential customers with a 5/8inch meter).

 

To further increase the incentive to conserve, the City’s charges single-family residential customers a base rate for the lowest volume of water used, and higher rates for higher levels of water used. This is called tiered pricing. Table 1 below shows the tiered price structure for single family customers within the City limits. Customers outside the City pay rates that are 27% higher.

 

Table 1: Current Single-Family Residential Monthly Rates

(includes apts with separate meters)

Block

Category

Units

Rate

1

Essential needs

1-4

$1.57

2

Average indoor needs

5-9

$4.00

3

Average outdoor needs

10-14

$5.14

4

High use

15-18

$7.05

5

Inefficient or excessive use

over 18

$8.79

 

All customer groups that are not single family residential pay for water at the Block 2 rate.  This includes businesses, apartment buildings with a single meter, dedicated landscape accounts, golf courses, etc.

 

Although the City’s tiered rate structure provides a price incentive to conserve water, the fixed charge on a customer’s bill does the opposite.  When the fixed charge is averaged in with the volume charge, customers who use low or moderate amounts of water pay more per unit of water than customers who use more water. [1]

 

The City’s proposed water rate increases will exacerbate this price penalty. If the new rates are approved by the City Council as planned, the lowest average price per unit will be paid by customers using 15 units per month, a “high use”. Customers who use less will pay more per unit.

 

There are many ways that Santa Cruz could eliminate the price penalty for conservation. They all involve shifting more of the Water Department’s revenue from the fixed charge towards volume pricing. That shift is needed to put the City back into compliance with the California Urban Water Conservation Council’s Best Management Practice (BMP) which states that revenue from fixed charges make up no more than 30% of a water agency’s monthly revenue. Although the City committed to this BMP in its General Plan, it has been out of compliance for the last several years.

 

The effect of any of one of the following reforms would be to encourage conservation and make the price of water more equitable for customers who use low and moderate amounts. The pricing reforms could be structured to provide the City with reliable revenue.

Recommendation:

1. Water budgets for all landscape accounts. Higher price tiers for exceeding the water budget. The City has issued water budgets for large landscape accounts. Other communities, e.g. Irvine Ranch Water District, have water budgets for all landscape accounts. For water budgets to work effectively, there must be a price signal for exceeding the water budget. As part of the drought Stage 3 Curtailment, Santa Cruz has a price penalty for landscapes that exceed the budget. The City needs to implement water budgets with price signals in normal years.

 

2. Price landscape water at Block 3 rates. Currently single-family residential customers pay Block 3 prices for “average outdoor needs”, while golf courses and dedicated landscape accounts pay Block 2 rates for landscape water. Charging the Block 3 rate for all landscape accounts would encourage conservation during the dry season—when we need it the most. The reform would also improve the City’s compliance with Proposition 218, which prohibits one class of users from subsidizing another class of users.

 

3. Tiered pricing for other customer classes besides single family residential.

 

4. Increase the price signal by making the tier steps steeper. (Increase the price increment for each tier.)

 

5. Implement tiers in the fixed charge.   A customer’s monthly fixed charge could be based on that customer’s highest month of usage during the previous year. This would allow capture of revenue from vacation homes. It would also encourage conservation during the peak season, as customers would have motivation to qualify for a lower tier.

 

6.  The marginal cost of new water supplies (or new conservation investments) should be charged to the highest tiers, since low water users are not driving the need for new water supplies. An article published by the American Water Works Association[2] states:

“When excess water consumption is priced to capture the costs associated with overuse, the rates more closely respect each customers’ proportionality requirement by ensuring that those customers who stay within reasonable use of water don’t pay for costs generated by those whose use is excessive.”

 

Criteria Analysis: Conservation Pricing

 

Effectiveness

Sue Holt is also submitting a proposal for demand reduction through water pricing.  See her analysis of demand reduction rates in response to price increases.

An argument that has questioned the effectiveness of conservation pricing (or other measures meant to influence water use behavior) is the concept of demand hardening. According to the concept, we are close to reaching the limit in elasticity in demand. Customers can’t or won’t reduce water use much further in normal years. And in drought years they aren’t able to either.

 

In 2001, the City commissioned Gary Fiske to conduct a Water Curtailment Study. In that report Fiske discusses the research on demand hardening. “Evidence of demand hardening is largely anecdotal. If anything, the literature suggests that demand hardening is largely a hypothetical issue….Survey research suggests that those making investments in long-term conservation also have the highest likelihood to reducing their demands during shortages.”

 

Fiske’s conclusion that demand hardening is not already occurring has been confirmed by experience in Australia, and also Santa Cruz customers’ response to drought curtailment.

 

Practicability

The principle disincentive for water utilities to adopt more robust conservation pricing is the tradeoff in revenue reliability.  With fixed rates, water utilities can reliably predict their revenue. Viewed from the utility perspective, conservation pricing can work too well, with customers responding to price signals by reducing water use more than expected. In that case water agencies need to cover their expenses by returning to their governing bodies with requests for further rate increases.

 

Conservation pricing can be accomplished along with revenue reliability by including a price buffer in case demand reduction exceeds utility estimates.

 

If in spite of the buffer the feared scenario occurs, and revenue from water use is lower than needed—and the agency needs to request a rate increase— it would be advantageous for customers to understand and support their agency’s revenue structure.  Water rates that rely more heavily on volume charges rather than fixed charges are more popular with customers. In June 2014, City of Davis voters overturned a new water rate structure due in part to the unpopularity of the high fixed charges. In July, 2016, the Davis City Council adopted a rate structure that reduces revenue from fixed charges to 13% of monthly revenue.

 

Revenue from fixed versus volume charges

The California Urban Water Conservation Council Best Management Practice calls for a maximum of 30% of revenue from fixed charges. As the chart below displays, San Luis Obispo gets 100% of revenue from volume charges.

 

 

Environmental and Community Impact

The benefit of all demand reduction measures is their ability to eliminate or reduce the need for new water supply projects (and their environmental and financial impacts). The Draft Desal EIR estimated that the cost of desalinated water for Santa Cruz is $10,750 per million gallons. Although some indications are that this figure underestimated lifecycle costs, it is still a very large amount compared to our existing water supplies. The Integrated Water Plan (2003) reported that the cost to transmit and treat 1 million gallons of water from Loch Lomond was $170.



[1] The lowest per-unit cost of water when the fixed charge is included is $4.88 per unit. That’s the price that is charged to single-family customers who use 10 units of water per month (250 gallons per day). A customer who uses 3 units of water per month (75 gallons per day) pays $7.37 per unit.

 

[2] Hildebrand et al, “Water conservation made legal: Water budgets and California law”

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