What Regulators Need to Know about Drought

1. What Regulators Need toKnow about Drought Janice A. Beecher, Ph.D. Director of the Institute of Public Utilities Michigan State University Summer 2002

3. Drought attention span drought rain Attention Time

4. Characteristics of water use • Per-capita water demand is flat • Significant weather-related variations • Opportunities for growth are limited • Fixed cost are high and rising • Pressure on rates is significant

5. Daily Per-Capita Withdrawals in the US:1950 to 1995 2,000 1,800 1,600 Total 1,400 withdrawals 1,200 Gallons per capita per day 1,000 Total freshwater 800 600 Consumptive 400 use 200 Public supply 0 1950 1955 1970 1975 1995 1960 1965 1980 1985 1990

6. Water and weather • Water is transient in time and space; droughts are inevitable • Mother nature controls supply and demand; supply is constrained just when we need it • Water quality and water quantity are related • Environmental externalities of water usage are exacerbated during drought • For utilities, rainy weather is a problem when sales are down (“excess inventory”) • Drought is a problem when the state imposes restrictions (artificial “demand repression”)

7. Rain Drought “Normal” Sales down Sales restricted Sales may be affected by conservation behavior Weather and water sales

8. Residential Water Use per Connection: American Water Works Service Company, Inc. (1980 to 1997) 220 212.9 215 208.7 208.6 208.2 210 207.2 206.1 204.9 203.9 205 202.4 201.2 201.8 200.7 200.0 199.6 199.5 Gallons per connection per day 200 194.3 194.0 195 190.1 190 185 180 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997

9. Water efficiency/conservation • Any beneficial reduction in water waste or water usage; emphasis on efficiency • Marginal benefit exceeds marginal cost • Broadly defined to include externalities • Should not imply an impairment of lifestyle or economic activity • Loss of “excess capacity” or “demand hardening” should not deter conservation

10. Benefits of conservation Supply without conservation Demand Supply Capacity and Supply with conservation Demand without conservation Demand with conservation 1 3 5 7 9 11 13 15 17 19 Planning Year

11. Conservation Long-term Choices are well informed Pricing plays a central role No impairment State role is less direct Drought Short-term Choices are constrained Price is necessary but insufficient May impair lifestyles State role is more direct Conservation v. drought management

12. Role of pricing • Pricing is a necessary but not always a sufficient tool of efficiency/conservation • Water use in generally price inelastic • Outdoor use > indoor use • Nonresidential use > residential use • Even small price responses can be meaningful in terms of revenues • Marginal-cost pricing principles should be applied • IOUs do not have clear incentives for efficiency pricing

13. Water rate design in the U.S. Uniform rate: 36% Increasing-block rate: 29% Decreasing-block rate: 36%

14. Efficiency pricing Efficient price Price/ unit Cost/ unit Under-pricing Cost-based pricing Over- pricing

15. Increasing-block rate Tier breakpoint Price/ unit Tier Quantity consumed

16. Seasonal rate Price/ unit Peak season Off-peak season Quantity consumed

17. Excess-use andwater-budget based Excess use/use above budget allotment Price/ unit Quantity consumed

18. Marginal-cost pricing Tail block S3 Price/ unit S2 S = supply option S1 Quantity consumed

19. Multi-objective rate (example) Location/season Hi cost Price/ unit Mid cost Low cost Consolidated rate Marginal cost Lifeline for eligible customers Quantity consumed Affordability >>>> Equity >>>>> Efficiency

20. Drought pricing • Short term implementation • Fines and penalties • Purpose is enforcement v. efficiency • Revenue effect may be negligible • May strain customer relations • Non-price options (restrictions) may be more effective and appropriate in severe drought conditions

21. Drought and revenues • In the long run, all costs variable; in the short run, many costs are fixed • Many water utilities rely on revenues from variable charges to cover fixed costs • Mandated curtailments can impair the utility’s ability to collect sufficient revenues to cover costs, make needed investments, and earn a fair return • Revenue-adjustment (demand-repression) mechanisms may be necessary

22. Demand-repression adjustment • May be needed to adjust rates and revenues to account for revenue effects of: • Conservation-oriented prices • Drought-management policies (force majeure?) • When water utility revenues are impaired by state-mandated restrictions on usage during drought, the state (PUC) also has a responsibility to consider measures for adjusting rates and revenues

23. Adjustment eligibility • Long-term water supply plan and compliance with all state requirements • Water-loss management (plug the leaks!!!) • Efficiency-oriented tariff based on normalized weather • Public education effort • Subject to proof of impact, audit, and reconciliation

24. Conclusions • Water utilities are unique in terms of drought impacts • Regulators must be aware of potential revenue effects • A carefully designed adjustment mechanism could address revenue issues and utility incentives for conservation and drought management

25. Some Publications • Compendium on Water Supply, Drought, and Conservation. (NARRI 1989). • Revenue Effects of Water Conservation and Conservation Pricing: Issues and Practices (NRRI 1994). • Handbook for Designing, Evaluating, and Implementing Conservation Rate Structures (California Urban Water Conservation Council, 1996).

26. www.ipu.msu.edu beecher@msu.edu