This post was updated on June 20, 2016.
For those in the business of selling water, drought often brings financial strains. New research by the PPIC Water Policy Center found that more than 70% of California’s urban water suppliers experienced reduced revenues during the latest drought. We talked to David Mitchell—an economist specializing in water and a co-author of a new PPIC report on urban drought resilience—about the cost of water and drought.
PPIC: Why do customers’ water rates sometimes rise during drought—even after big jumps in water conservation?
David Mitchell: For urban water suppliers, most of their costs are fixed. They have to pay these costs whether they sell a gallon or a million gallons. Their infrastructure costs for treatment plants, reservoirs, canals, and other investments needed to get water to us don’t change with their water sales, at least in the short run. Some costs do drop with reduced water use—for example, energy used for pumping or treatment. But most facility costs don’t, and neither do most staffing costs. The bills for these fixed parts of the system still have to be paid.
There are instances in every drought where communities push back on price hikes. But customer backlash isn’t inevitable. Creating and empowering citizen advisory groups can help build understanding and consensus around water supply issues, for example. This is what the city of Santa Cruz did when it faced a backlash over its plans to invest in desalination for drought security. City leaders turned it into a win by listening carefully to the community. The advisory group met with city staff and outside consultants for more than a year. City staff were deliberative and respectful. Santa Cruz went from having little community support to significant support both in terms of a long-term plan for addressing drought and near-term changes to its rate structure.
PPIC: How does drought affect suppliers financially?
DM: It affects them in lots of ways. With rationing, the supplier will have an immediate revenue problem unless it adjusts rates or has significant financial reserves. They may have to defer capital investments. Droughts also drive up costs in various ways. Drought often degrades water quality, so treatment costs go up. A supplier may need to acquire supplemental water that is more expensive than usual supplies. Suppliers spend more repairing leaks to cut waste.
Drought also brings higher customer costs, through educational programs, rebates, and staffing to address concerns. For example, Metropolitan Water District of Southern California spent half a billion dollars on rebates to replace lawns, toilets, and other fixtures in 2015.
PPIC: What are other reasons that water suppliers need to raise rates?
DM: First of all, urban water rates have been outpacing inflation in most of California for a long time―the drought just put an exclamation point on it. It’s a trifecta of aging infrastructure, increasing regulation, and worsening scarcity. In some parts of California the cost for upgrading old infrastructure is particularly significant. For example, San Francisco is spending billions to renovate its Hetch Hetchy system.
PPIC: How can suppliers reduce the financial risks of drought?
DM: Rates have to adjust. That’s just simple math―if you sell less water but your costs are basically the same, you’re going to have to adjust your rates. Communicating to customers the reason for adjusting rates is key, though. Also, making these adjustments early is better than deferring them to the end of the drought, though this is something that many utilities still fail to do. Our new report recommends that utilities get pre-approvals for special surcharges that they can introduce during droughts—something very few utilities currently do. Cash reserves are also important since they help mitigate the need for large rate increases. Following a drought, utilities are sometimes tempted to change rates so that a larger portion of the bill is a fixed service charge, rather than a per gallon fee. Although this keeps revenues from falling as much when water sales decrease, it also weakens the price signal to encourage efficient water use—an important goal both during droughts and over the longer term.
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