A California surprise: update
California has been enjoying a great deal of rain and snow over the past several months—a pleasant rebound in precipitation after the brutal drought that plagued the state from 2011-2017. It’s now early 2019, reservoirs are full, the mountain snowpack is deep, and water managers in the Golden State are breathing easier than they have in a long time. Though water use has crept up since the end of the drought, overall water consumption remains lower than its pre-drought levels.
A California surprise
A surprising finding emerged from my analysis of California’s drought data with Youlang Zhang and David Switzer: the state’s private, investor-owned utilities conserved significantly more water than did local government utilities during the crisis. We linked the difference in drought response to the institutions that govern water finance. Nerds interested readers can read the full study in Policy Studies Journal for the details.
In a blog post last summer, I observed that a public-private conservation gap of 2-3% persisted in 2017 even after the drought ended, and wrote that financial imperatives would likely cause the trend to continue:
This consistent public-private difference lends greater weight to the idea that rate decoupling facilitates water conservation for private utilities, and that political constraints hamper public sector conservation. If 2018 holds to form, public and private conservation will converge in the spring and diverge again in the summer and autumn.
If financial and political considerations are really behind the public-private differences in conservation, then it stands to reason that the greatest differences would come during summer months, when water demand–and therefore rate revenue–fluctuations are greatest.
Now that full 2018 data are posted, it’s time to revisit conservation performance for the Golden State’s water utilities. Was the forecast valid? Did private systems conserve more than public systems again last year?
Are my water conservation predictions any better than my NCAA Tournament picks?*
Overall urban water use remained significantly lower in 2018, with average monthly conservation of about 14% compared with 2013. The public-private disparity in overall conservation also persisted. This graph plots average conservation (relative to the same month in 2013) for public and private utilities from January-December 2018:
As you can see, public and private conservation moved in pretty close parallel through 2018, but private utility conservation was consistently higher than public. The difference was negligible during winter months, but during the May-September peak demand season, California’s investor-owned utilities saved an average of 2.3% more than their local government counterparts.
As always when discussing water, it’s important to give percentages some context. Had public utilities saved at the same rate as private utilities in 2018, the difference would have been about 27 billion gallons—more water than San Francisco uses in a year.
Decoupling, man. Decoupling.
The persistent seasonal swing in public-private water conservation suggests that the difference is due to differences in outdoor irrigation behavior. That the pattern is now consistent over three years adds to the mounting evidence that rate decoupling encourages conservation for investor-owned water systems.
This isn’t a story of environmental angels or devils, it’s about governance institutions and the incentives that they create. In light of the political challenges of managing local government water finance, it’s impressive that public utilities have continued to conserve as much as they have—a testament to local water managers’ commitment to efficiency in the face of political headwinds.
*They could hardly be worse. I didn’t get a single Final Four team right.
Devils (and angels) in the details, Part 2
In early January the California Water Board released its draft proposal for a statewide low-income water bill assistance program. My last post summarized the path-breaking proposal and its promise for addressing affordability in the Golden State. It’s an admirable piece of work on a challenging and complex issue. The next couple posts wade into the tall policy grass in search of snakes. This one looks at the volume of water to be subsidized under the proposal.
Assistance for how much water?
An assistance program for water implies that there is some level of water consumption that is socially important, and that without assistance, water consumption would either fall below that level or force households to sacrifice other essential goods in order to pay for water. What is that level of water consumption? How much water is so important that taxpayers should subsidize it?
For California’s draft assistance proposal, the answer is 12 ccf (about 9,000 gallons) monthly per household.
Consumption in context
Not all residential water use is the same. Public policy discussions of water affordability are mostly concerned with essential needs like drinking, cooking, cleaning, and sanitation. We’re not generally concerned with the affordability of watering lawns, washing cars, or filling swimming pools.
The proposal’s 12 ccf price guideline implies 75 gallons per capita per day (gpcd) for a family of four. To give some context, California utilities average about 100 gpcd, which makes 75 gpcd seem pretty low. But it’s much higher than California’s 55 gpcd water efficiency standard (set to drop to 50 gpcd by 2030), and higher than typical water use in many California communities today. My own past affordability analyses have assumed 50 gpcd for essential use*; conservative San Francisco already averages just 42.4 gpcd for overall demand (not just essential use).†
There’s nothing magic about any of these numbers; in the end, the level of water consumption that is deserving of public subsidy is a decision to be made through the democratic process. But 12 ccf is a lot of water if the policy’s aim is to provide for essential water use. The draft proposal notes that the 12 ccf level is intended to allow for larger households and “modest amounts of outdoor irrigation.”
A perverse incentive
Why does any of this matter? Beyond the normative question of whether taxpayers ought to subsidize outdoor irrigation, a 12ccf standard may have the unintended effect of pushing water utilities toward less affordable, less conservation-oriented pricing.
Low fixed rates and low prices for essential water use make water affordable for everyone, whether or not they participate in an assistance program. Coupled with progressively higher volumetric prices, such rate structures help keep water affordable and encourage conservation. Unfortunately, many utilities have recently responded to falling average demand and revenue volatility by raising fixed rates and imposing higher costs for low-volume use. That’s good for utility revenue, but bad for affordability.
That’s where the perverse incentives creep in. A 12 ccf standard for assistance is likely to exacerbate the trend toward utilities raising fixed charges and low-volume rates. With the state’s assistance program providing aid to low-income customers, utilities can raise rates on volumes below 12 ccf with less concern for affordability impacts. That will naturally dampen the conservation incentive, as higher priced water becomes less expensive. Less obviously, higher prices for lower volumes will exacerbate affordability problems for anyone who is not enrolled in the assistance program. The draft proposal assumes an 84% participation rate; for the 16% of households who don’t participate (for whatever reason), affordability will probably get worse.
A footnote acknowledges a danger of strategic rate-setting (told you I’d get into the weeds!), observing that systems could respond to the assistance program by “shifting the rate burden to consumption levels below 12 CCF, and thus elevate the benefit for eligible households.” Apparently the concern is that utilities will game the assistance program as a means of channeling more state money to local customers. But from an affordability perspective, the more worrisome prospect is that the state’s assistance program will incentivize regressive pricing that ironically makes water less affordable for many.
This perverse incentive will exist no matter what volume is subsidized, but the greater the volume subsidized, the more perverse the incentive will be. If an assistance program is supposed to support a human right to water, then a more modest 6-8 ccf standard for support is more defensible and less susceptible to rate design gamesmanship.
*My January 2018 article on affordability measurement prompted a grouchy email from a San Francisco official who complained that 50 gpcd was an unrealistically high essential volume for evaluating affordability
†I chuckled when typing: “conservative San Francisco.” Our language is funny, sometimes.
During California’s recent drought, the utilities that own their supply sources conserved more than the those that purchase water from wholesale suppliers
-Warning: this post contains hardcore wonkery-
A while ago I blogged about my ongoing work with Youlang Zhang and David Switzer on water conservation in California. The first of our studies is now published at Policy Studies Journal; more are on the way. There we saw that financial incentives and institutional politics led to the surprising result that private, for-profit companies out-conserved local government utilities during a recent drought.
But another interesting pattern emerged from that study: a significant difference in conservation between utilities that draw their water supplies from wholesale sources.
Where utilities get their water
The drinking water utilities that serve American communities get their water in one of three ways*:
1) Pumping groundwater from wells that tap underground aquifers;
2) Drawing surface water from lakes and rivers; or
3) Purchasing water from a wholesale water utility.
In the first two cases, local utilities own wells, surface water intakes, and treatment plants. About 29% of American utilities fall in the third category, getting their water through wholesalers. In these cases, the local utility owns a distribution and/or storage system, but the supply works and perhaps the treatment facilities belong to another utility. Sometimes these wholesale utilities have retail customers of their own, sometimes they are purely wholesale suppliers.
In California, more than a third (36%) of water systems get at least part of their water from a wholesale supplier. A handful of very large wholesale water suppliers like Metropolitan Water District, San Diego County Water Authority, and Santa Clara Valley Water District manage major supply works, and then sell water to cities, special districts, and investor-owned retail water utilities.
Spreading the risk
A major advantage of big wholesale water utilities is that they allow a region’s water supply to be managed holistically and comprehensively. Rather than individual communities competing and depleting water supplies, regional wholesalers can plan and balance water supply needs. From the local perspective, wholesale utilities help diversify supply and so guard against catastrophic supply shortages. They also allow communities across a region to pool their capital for greater efficiency. Together these features spread both supply risk and financial risk across many local utilities.
Sales agreements between retails and wholesalers vary widely across the country, so generalizing is difficult. But one common feature of wholesale contracts is the take-or-pay provision. Under take-or-pay arrangements, the wholesaler agrees to supply and the retailer agrees to purchase a fixed volume of water over a given period of time for a given price. If retail demand exceeds the contract volume, the retailer pays for more on a volumetric basis. If retailer demand falls short of the contracted volume, the take-or-pay provision requires the retailer to pay the wholesaler anyway, as if it had used the entire contract volume.†
In other words, under take-or-pay contracts, the retailer pays the wholesaler the same amount, even if the retailer uses far less water than the contracted volume.
Wholesale supply & the logic of conservation
Got all that? Still with me?
Here’s what it all means for conservation. Wholesale supply arrangements reduce supply risk and long-term financial risk to local utilities. Take-or-pay contracts make a lot of sense for long-term stability for supply systems that have high fixed costs.
But in the short-term, these wholesale arrangements create disincentives for retail conservation during a drought. Under wholesale agreements, short-term supply risk from drought is shifted from the local utility to the wholesaler: the wholesaler is legally responsible for maintaining adequate supply. Meanwhile, fixed take-or-pay contracts leave retailers on the hook for the same amount no matter how much water their customers actually buy. The retailer may suffer significant sales declines if it rains all summer, or if the state imposes drought restrictions, but the retailer still has to pay the wholesaler as if demand was normal.
Together, these factors create structural disincentives for emergency conservation for retail utilities under wholesale agreements.
Does diluting risk also dilute conservation? As I explained in an earlier post, the recent drought in California prompted that state to impose conservation rules on retail water utilities from June 2015-May 2016. Each utility was assigned a specific conservation target and the state recorded overall conservation by each utility.
Did utilities that operate under wholesale supply arrangements perform differently from utilities that own their own supplies?
Our analysis of data from the drought mandate period is pretty striking. After accounting for a host of organizational and environmental conditions, we found that water systems that rely on wholesale water supplies were 42% less likely to meet state conservation standards, compared with systems that own their own supplies.
We also found that, after accounting for other factors, utilities under wholesale contracts conserved an average of 2.6% less each month relative to systems that use their own wells or surface water sources. In a state as large as California, this small percentage difference equates to tens of billions of gallons.
Follow the money
These patterns don’t prove that wholesale contracts caused California utilities to slack on conservation. But the data certainly align with the short-term incentives that wholesale supply arrangements create, and there aren’t other obvious reasons for the disparity. The lesson here is to pay close attention to wholesale contracts when setting conservation rules, so that conservation and financial incentives work in concert.
*Technically there are other sources, too—desalination and water reuse, for example–but they’re so rare that they don’t allow for much meaningful analysis.
†”Take-or-pay” is a weird phrase, since there’s really no “or” to the arrangement. Seems like “fixed fee” is a more accurate label, but then I’m not a lawyer.