From Regulation

Political Decoupling

A California Surprise, Part 2

More drought porn (this is used to be Folsom Lake)

How private implementation separates public policies from their political costs.

Warning: this post contains hardcore wonkery.

In 2015 the California State Water Resources Control Board (SWRCB) ordered drinking water utilities to reduce water usage by 25% statewide. As my last post described, something surprising happened: compared with local governments, the state’s private, investor-owned utilities imposed stricter water use regulations, were nearly twice as likely to comply with the state mandate, and conserved significantly more water overall.

Though counterintuitive, this difference in public and private sector water conservation follows rationally from the political institutions that govern water in America generally and California specifically. The keys to this conundrum are money and politics.

Financial risks of conservation

American water utilities operate on a fee-for-service basis; typically, customers pay a fixed monthly charge, plus a charge for each unit of water. Faced with resource scarcity or some other environmental problem, it may make sense to curb water consumption—say, in response to a drought. But reduced consumption reduces revenue. For utilities that rely on rate revenue to fund their operations (and, in the case, of private utilities, to pay their shareholders), conservation can be environmentally good but financially bad.

The financial risks of conservation are especially severe for utilities due to their very high fixed costs. As I’ve observed before, whether a utility delivers one gallon or ten million gallons, the costs of constructing, maintaining, and operating reservoirs, treatment plants, and distribution pipes are the same. A drop in water sales doesn’t bring a matching drop in costs to the utility, so reduced consumption threatens financial sustainability (for government utilities) and profitability (for investor-owned utilities).

Utilities are natural monopolies, and so could charge customers exorbitant prices if they were allowed to set prices any way they like. For that reason, utilities are subject to government price regulation. But the institutions that govern private and public utilities are different, and present them with very different incentives to comply with state conservation rules.

Price regulation & decoupling

Let’s start with private utilities.

Governments regulate private utility pricing through state Public Utilities Commissions (PUCs); in California the PUC is composed of five appointed commissioners. The PUC process is technocratic and legalistic, usually drawing scant media attention. PUC price regulation proceeds under the cost of service principle: companies are limited to recovering the actual cost of providing service, plus a legally-sanctioned rate of return.

It only looks Soviet

Decades ago, the conflict between conservation and profitability for private utilities led environmentalists to develop rate decoupling: the separation of a firm’s revenues from the volume of product it sells. If conservation causes revenue shortfalls, decoupling provides for automatic rate increases to make up the loss. In that way, decoupling shifts the financial risks of conservation from utilities’ investors to their customers, eliminating the incentive for utilities to sell more and more energy, water, or whatever. Decoupling can work in situations where private utilities operate under PUC regulation, and has generally been successful in stimulating conservation in the energy sector. Today about half of US states use rate decoupling for electrical utilities.

In 2008, California became one of just two states (the other is New York) to adopt decoupling for water utilities when it introduced the Water Revenue Adjustment Mechanism (WRAM). Private utilities take advantage of this provision when conservation causes a loss of sales revenue: financial losses associated with reduced sales volumes are recovered in future rate increases through WRAM. PUC records show that by Spring 2018, at least 39 of the 62 investor-owned utilities subject to California’s conservation mandate had invoked WRAM and raised rates following the drought. Decoupling irritates customers, who understandably grumble about paying more for water they didn’t use—the paradox of conservation. But those grumbles are largely impotent, as the PUC’s technocratic process allows WRAM under state law.

Water rate politics & the conservation paradox

And then there are local governments.

Governments (including counties, municipalities, and special districts) that own drinking water utilities are essentially self-regulated with respect to pricing; their rates are set by city councils and district boards. Public water rates are thus subject to the political calculations of local elected officials. Water customers are also voters who prefer lower rates, and so raising rates can have bad electoral consequences for politicians. Unlike the technocratic PUC process, rate-setting for government utilities can be a contentious affair. In California the political risks are especially pronounced, since public water rates are subject to Proposition 218.

California local government utilities can raise rates when conservation measures cause revenue shortfalls; they need not seek permission from the PUC. But raising rates is politically risky for local officials. Whatever their attitudes toward sustainability, citizen-customers of government utilities are just as irritated as customers of private utilities when they use less but pay more. Government managers and elected officials are wary of angering their voting water customers if revenue losses force rate increases.

Attendance at the Redlands city council meeting on water rates was robust. Photo: informedredlands.com

Consider the politics of water conservation in the City of Redlands. California’s 2015-2016 emergency rules assigned the city a 33% conservation standard. The city responded with a series of conservation measures, but met its conservation standard in just two out of twelve months and achieved only 11.3% conservation overall. Still, reduced water sales caused a city revenue loss of about $2 million. When utility staff recommended a 19% rate increase to cover the shortfall, more than 3,000 citizens filed protests against the increase in advance of a raucous, five-hour City Council meeting on the subject. Drought-related rate increases prompted similar protests and/or legal challenges in Alameda County Water District, East Bay MUD, Hillsborough, Los Angeles, Pleasanton, and Yorba Linda.

Political decoupling

When combined with rate decoupling, private water provision shifts to private firms the political risk that discourages conservation by governments. The unelected PUC absorbs those political risks instead. In this way, investor-owned water utilities provided a kind of political decoupling during California’s drought: private implementation of conservation rules separated a controversial environmental policy from its political costs, and helped make private firms more effective conduits of environmental policy than were government agencies. Youlang ZhangDavid Switzer, and I develop the idea of political decoupling and its broader implications in a forthcoming article.

Of course, decoupling conservation from its political costs does not eliminate those costs so much as place them beyond the reach of ordinary citizens. That might make for effective drought response, but it weakens democratic local governance.

 

A California Surprise, Part 3 will discuss what happened after the SWRCB dropped the conservation mandate.

Golden State Waterers

A California surprise, Part I

Drought porn

Something unexpected happened when California ordered its utilities to save water: the state’s investor-owned private utilities out-conserved local governments.

California’s long-term drought began as early as 2007, but intensified to crisis conditions by 2012. Conditions worsened, and in response 2015 Governor Jerry Brown and the California State Water Resources Control Board imposed restrictions on 408 drinking water utilities designed to reduce urban water usage by 25% statewide. The order required utilities to cut water use, but left individual utilities to choose the means by which to achieve conservation. The mandate assigned each utility its own conservation target, with standards ranging from 4-36% reductions relative to 2013 levels. These standards were formulaic, and varied based on utilities’ historical water consumption.

It was pretty bad

These conservation rules were in place for twelve months—June 2015 through May 2016—and applied to both local government utilities and private, investor-owned utilities. Conservation rules were assigned based on historical demand patterns and supply considerations only, not on ownership or governance.

Happily, the State of California has shared utility-level conservation data lavishly—a boon to water policy researchers! Over the past year, I’ve been sifting through that mountain of data with Youlang Zhang and David Switzer to see how California’s conservation efforts have fared. We’re discovering some fascinating things. The first of our studies is now forthcoming in Policy Studies Journal.

Restricting the flow

Faced with water scarcity, communities frequently restrict residential outdoor water use, such as car washing and especially lawn/garden irrigation. These water restrictions are effective in driving immediate reductions in water consumption. In California those restrictions typically take the form of limiting the number of days when outdoor irrigation is allowed each week. The graph below shows how public and private utilities regulated outdoor irrigation during the drought.

Eyeballing that graph, there doesn’t appear to be much difference between public and private utilities. But after adjusting statistically for a host of factors like utility size, demographic composition, and hydrological conditions, it turns out that private, profit-seeking, investor-owned utilities restricted irrigation about 4% more than public, local government utilities. That may not seem like much, as we’ll see it’s actually huge.

Meeting the mandate

We were also interested in what made utilities more or less likely to comply with the state’s conservation rules. Overall compliance was about 53%–that is, on average 53% of utilities reached their conservation targets each month. We modeled compliance statistically, and found a number of interesting correlates of success and failure. But most notable was a yawning gap between public and private sector: after adjusting for other factors, private utilities were nearly twice as likely as similar public utilities to meet the state’s conservation standards.

Conservation achievements

Finally, we analyzed overall conservation during the mandatory conservation period. And again, we found that, after accounting for other factors, private utilities conserved an average of 3% more water each month than their public counterparts during the mandatory restriction period. Although this difference is small in percentage terms, it reflects an enormous difference in absolute volume of water. This plot presents the distributions of conservation results from June 2015-May 2016 for local government utilities (green), and what it would have been if each utility had saved 3% more:

Monthly conservation relative to same month in 2013

The areas within the white bars on the right side of the distribution represent the conservation that didn’t happen due to differences in ownership. Three percent greater conservation would have boosted public utilities’ restriction compliance rate from 51 to 62 percent.

In substantive terms, three percent greater conservation by California’s local government utilities during the mandate period would have reduced the state’s water consumption by 54.6 billion gallons—enough to supply the City of San Francisco for more than two years.

Well that was unexpected

So what happened?

California is once again in the midst of a hot, dry summer; other parts of the world are, too. So it’s worth trying to figure out what’s behind the public-private disparity in drought response. Although it’s surprising at first blush, it’s actually a logical result of the institutions that govern water in America generally and California specifically.  My next post will explain why.*

 

 

 

*Spoiler: as usual, it’s about money and politics. If you can’t wait for the next post, you can read the forthcoming article.

 

Water affordability as poetry and prose

Can declaring a human right to water help address affordability?

Something extraordinary is unfolding in California.

In 2012, to great fanfare, California governor Jerry Brown signed into law Assembly Bill 685, which amended the state’s water code to declare that: “every human being has the right to safe, clean, affordable, and accessible water adequate for human consumption, cooking, and sanitary purposes.” The move was lauded by environmental justice advocates. One United Nations official gushed that AB685 would “…be an inspiration not only for other states within the USA, but equally for many other countries in the world.”

The declaration drew little notice among America’s water utility managers.

Thing is, California isn’t the first state to declare a human right to water in law. Pennsylvania and Massachusetts enshrined a right to water in their state Constitutions—in 1971 and 1972, respectively. Those declarations of rights didn’t translate into safe, clean, and affordable water for all the citizens of those states.  I’ve always been a bit uneasy about declarations of a human right to water. That’s not because I have any philosophical objection to the idea, but because declaring rights is a lot easier than making those rights meaningful to real people in real communities.

Cheap talk

Game theorists sometimes use “signaling models” to describe political behavior. In these models, people signal their intentions to other people. When those signals are costless to send and non-binding to the sender, the signals are “cheap talk.” When players learn that political words are meaningless, they can fall into a babbling equilibrium, in which political actors simply talk past each other, knowing that no one else’s words mean anything.

The trouble with cheap talk is that it doesn’t advance constructive public policy. Worse yet, it breeds cynicism. Their constitutional right to “pure water” is little solace to the people of rural Pennsylvania whose drinking water has been contaminated by hydrofracking. Utility managers are unlikely to take seriously mere rhetorical flourishes.

Is there any reason to think things will be different in California? Maybe.

Costly signals

Game theory also hints at when political signals augur meaningful policy changes: when political signals are costly to send and are accompanied by binding conditions, they indicate that real changes are likely to follow. That’s why the really exciting development isn’t AB685’s declaration of a human right to water, but rather AB401. This decidedly less sexy 2015 law ordered the California State Water Resources Control Board (SWRCB) to craft a statewide water affordability rate assistance program. That’s a first step—but a meaningful one—on the road to a comprehensive affordability policy. It’s not an affordability solution, but it is a costly signal.

The magic combination of vision with resources recalls the 1972 Clean Water Act, which combined the lofty goal of fishable and swimmable American waters by 1983 with a comprehensive regulatory regime and tens of billions of dollars in federal funding to support construction of wastewater systems. While far from perfect, the Clean Water Act has been enormously successful in cleaning the nation’s waters—because Congressional aspirations were matched with administrative authority and ample funding. The Clean Water Act didn’t emerge fully-formed from Earth Day 1970; it was the culmination of years of development.

“Campaign in poetry, govern in prose.” –Mario Cuomo

The unglamorous task of making AB685’s rhetoric into reality falls to the bureaucracy. The SWRCB has been working to craft policies to assess and address water affordability pursuant to AB401. To that end, tomorrow I’ll be in Sacramento to participate in a SWRCB symposium on water affordability—an early step in the state’s effort to turn the poetry of rights into the prose of guidelines, analysis, rules, regulations, and programs. I’m excited to be a part of this extraordinary effort to put a compelling affordability plan in front of the legislature.

*This post was inspired in part by an interesting twitter exchange with Mike Antos, Laura Feinstein, and Mark Lubell.