From Finance

Prevent Defense

Playing  to win  not to lose in water utility management

Nature's Prevent Defense

Warning: strained sports metaphor coming.

It’s late January, and the National Football League season soon reaches its climax with the Super Bowl. Both of last weekend’s conference championship games saw a high-octane home teams take the lead. By late in the game, the winning teams’ strategies shifted from trying to score to trying to run out the clock. That meant lots of prevent defense, a tactic familiar to any reasonably attentive American football fan.

Prevent defense is an ultra-conservative strategy, designed to use up time and avoid disastrous, long passing plays—the goal is not really to stop the opposing team, but rather to manage moderate losses. A coach who deploys a prevent defense isn’t so much trying to win as he is trying to avoid losing. That works fine when the team that’s ahead has a comfortable lead. But when the lead is tenuous, prevent defense courts disaster because it can allow a quarterback to lead a heroic comeback. Legendary NFL coach John Madden famously declared that: “All a prevent defense does is prevent you from winning.” 

This didn't end well for the Cleveland Browns

Naturally, all of this makes me think about water utility management.

Compliance as performance

A few years ago I took a water operator training class through Texas A&M Engineering Extension. The course covered principles of safe operations, along with the basic math, chemistry, and physics that operators need. What really stood out to me was how virtually everything about our training involved regulatory compliance. Treatment plant operations, distribution system maintenance, even safety protocols, were all framed in terms of following rules and avoiding violations.

Things don’t seem much different in utilities’ executive suites or board rooms. Although the rhetoric of excellence abounds in water management circles, real policy decisions and capital investments tend to follow regulatory requirements. Treatment plant upgrades happen when the EPA formulates a new rule. Sewer capacity expansions come when overflows become so frequent and egregious that regulators force a consent decree.

A water system’s strategic goal might be public health, environmental quality, citizen trust, and economic prosperity, but the utilities’ management tactics often boil down to regulatory compliance. The practical goal is not so much to achieve good things, but to avoid bad ones.

The main reason is money. One of the challenges of managing great water and sewer systems is that the price of a water is much more visible than quality of water. Customers—who are also voters—know for sure what they pay for it when they get the bill each month. Water systems are literally buried. Unless quality is egregiously awful, the only marker of a system’s quality is regulatory compliance. It’s hard for utilities to demonstrate their real value in terms of anything but monthly bills and disasters.

Utility leaders are thus stuck between a rate increase rock and a regulatory hard place. For many, “success” means avoiding rate increases and regulatory violations as long as possible. The folks who operate these essential systems don’t like running them to the brink of failure, but as one city utility executive told me: “It’s hard to get anything done without a regulatory boot to your backside.”

That’s a fundamentally negative way to think about performance. Is it any wonder that utility managers often run a prevent defense?

From loss avoidance to winning

There are some creative, dynamic, and courageous leaders in the water sector who have found ways to build achievement cultures in their utilities. But hoping for the serendipitous arrival of an exceptional leader isn’t really a strategy. What would it take to change the game? How can we get utility leaders to think about seeking success, rather than avoiding failure?

What’s needed is a comprehensive, independent, and visible system for monitoring and reporting water and sewer utility performance. What if there were monthly box scores for utilities? What if they received a report card and grade point average every year, with results reported publicly?

Would this report card be good enough for you?

Aquam cum laude

This isn’t really a radical idea; Congress had transparency in mind when it required utilities systems to provide water quality reports, and the State of New Jersey was thinking about political accountability when it launched the Water Quality Accountability Act. Too often we forget that public information about water system performance also creates a credit-claiming opportunity. But reporting under those laws is complicated and in many ways opaque.

​Anyone who has been to high school understands grades and GPAs. A simple, comprehensive report card would give a utility’s leaders a way to communicate progress. A new management team could set clear improvement targets and show how their efforts moved the system’s GPA from 2.7 to 3.5. Mayors and councilmembers could trumpet the improvements, helping to demonstrate the value of those unpleasant rate increases. Water systems that achieve and maintain consistent excellence across the board would qualify for the Dean’s List.

I’m a big believer in the power of measurement and incentives. If we keep score correctly, our utility leaders can do more than avoid disaster—they can play to win health, environmental quality, and economic prosperity for our communities.

Squeeze Play

U.S. water utilities are shifting costs to low-volume customers—good for revenue stability, but bad for affordability

Luke Skywalker & friends escaped this crunch thanks to everyone’s favorite droid, but R2D2 isn’t going to help utilities escape their financial problems

Rising water and sewer prices linked to increasing capital and operating costs are driving affordability concerns across the United States, and with good reason. Studies of water rates typically measure prices at benchmark volumes that are meant to reflect “average” residential customers.* But for purposes of low-income affordability, how a utility structures its prices across levels of demand is as important as what it charges an average customer or how much total revenue it pulls in.

Over the past year I’ve been working with Texas A&M graduate student Robin Saywitz to analyze 2019 water and sewer rates data.† Among other things, we’re comparing our recent dataset with similar data from 2017. Although it’s difficult to infer trends from just two time periods, we’re seeing a troubling pattern in U.S. water and sewer rates: not only are prices increasing overall, average prices are rising much faster for low volumes than for high volumes.

That’s very bad news for affordability. Why are utilities squeezing their low-volume customers with higher prices?

Colliding trends

The answer starts with two broad water sector trends that have converged to drive water prices to their present point. First, long-deferred capital maintenance and upgrade costs are finally coming due, and long-deferred water and sewer revenue needs are rising accordingly. Utilities need more money to pay for pipes and people. Emerging challenges like lead service line replacement and new contaminants like PFAS only make things more expensive.

At the same time, average urban water demands have been falling steadily over the past twenty years. Back in the 1990s when I first got into the water business it was an article of faith that long-term water demand increased with economic and demographic growth, and long-term supply adequacy was a paramount concern in many parts of the U.S. The water sector responded with a widespread push for conservation. Thanks to organizations like the Alliance for Water Efficiency, we’ve seen an astonishing decline in average water demand—especially for essential indoor use. For the first time, America has seen sustained urban growth with steady or even declining overall water consumption. That’s an extraordinary accomplishment, and it’s rightfully celebrated.

But the combination of rising costs with declining average demand creates a revenue problem for water utilities. Declining total demand means that the average price of water must increase steeply in order to generate needed revenue.

Perils of progressive pricing

For years, utilities have been pushing for progressive water rate structures to distribute costs equitably and to encourage conservation. Indeed, progressive pricing is part of why we’ve seen declining demand. As I’ve observed before, water service is unusual in that its use varies considerably at different levels of demand. For residential customers, low volumes reflect essential uses like drinking, cooking, cleaning, and sanitation. Higher volumes are typically associated with discretionary uses like car washing and outdoor lawn irrigation. So progressive rate structures that charge relatively low prices for low water use, steeply higher marginal prices for high volume use, and volumetric sewer charges generally result in better affordability. What’s more, good rate design helps affordability without the transaction costs, administrative burdens, and social stigma that come with means-tested assistance programs.

But progressive rate structures raise utilities’ revenue risk. Revenues from volumetric charges fluctuate vary seasonally and can skyrocket or plummet depending on the weather. A utility doesn’t sell much high-priced, high-volume water if it rains all summer and nobody waters their lawn. Even worse, sales can fall sharply during drought emergencies when customers conserve water. That can leave the utility in tough financial shape, because the utility’s capital and operating costs are mostly fixed. Progressive pricing can put the squeeze on utilities’ revenue needs.

The squeeze

So utilities are, in turn, putting the squeeze on their most conservative customers with more regressive pricing.

The first gallon price of water and sewer service is a useful touchstone to understand the real impact of rate structure changes. 

The squeeze bunt puts more pressure on the hitter than any other play in baseball. Utility financial managers can relate.

​The first gallon price is the price a customer pays for using any water at all: any fixed charges plus the price of the first unit of water or sewer service. For example, if there is a $20 monthly fixed charge for water service and the first thousand gallons of water is $2.00, then the first gallon price for water service is $22.00. Here are the weighted average prices of water and sewer service in 2017 and 2019 at one gallon, 6,000 gallons, 12,000 gallons, and 20,000 gallons:

​Unsurprisingly, the first gallon price increased from $35.80 to $40.89 over the two-year period, and average prices went up at each volume level. If prices were simply going up across-the-board, we’d see roughly equal increases in prices at every volume. But the 2019 data show that price increases were uneven in percentage terms:

At 20,000 gallons monthly, average prices went up by 8%, but the first gallon price increased by more than 14%. As prices have increased, low-volume customers have on average borne a much larger share of utilities’ rising revenue burdens than their more profligate neighbors.

Managing risk

The financial challenges associated with equitable, affordable, progressive pricing are real: utilities can’t survive without revenue, and falling or fluctuating demand creates real risks for sustainable utility management. But there are better ways to manage risk than squeezing the most conservative customers.

A rate structure that provides basic volume allowances at low fixed prices with steeply inclined prices at higher volumes is one good option. As I’ve observed before, consolidation can help maintain progressive pricing because larger customer bases can withstand revenue shocks more easily than small systems. Utilities should also use larger cash reserves to stabilize revenues across seasons and years—and governments should keep their hands off those reserves! More creative approaches could include regional water revenue banks or development of a secondary market for utility revenue risk.



*A lot of studies claim to measure “average bills,” but are really measuring bills at specific volumes that are assumed to reflect an average customer. Studying true average bills across large numbers of utilities is hard because there’s no reliable source of data on average consumption across utilities.

An initial working paper reports the full methodology and descriptive findings in detail.

Garden Badger

Water Sector Reform #2:
Regulatory Transparency & Fairness

Bringing together the best of both states

With a major federal investment in water infrastructure possibly on the horizon, the United States has a once-in-a-generation opportunity to leverage that money into transformational, institutional solutions for America’s water sector. This is the second in a series of five posts outlining five broad ideas to reform the management, governance, and regulation of U.S. drinking water, sewer, and stormwater systems. The first proposed reform was consolidation of water utilities.

The second proposed reform is an overhaul of the processes and institutions that regulate water system finance using regulatory models from New Jersey and Wisconsin. The goal of this reform is not to regulate water quality directly, but rather to change the incentives for the organizations that operate water systems.

The need for regulatory reforms follow from the ownership structure of the U.S. water sector.

Infrastructure ownership

Another important way in which water is different from energy and other utilities is ownership. The overwhelming majority of Americans get their electricity and/or gas from a private, investor-owned firm, with small minorities receiving service from government utilities. But water is a different story: about 88% of Americans get their drinking water service from a local government, with about 12% served by private firms.

Source: US Dept of Energy, US Dept of Transportation, US Environmental Protection Agency

Ownership is crucial because different institutions govern private and public systems, creating different incentives for infrastructure investment.

Public Utilities Commissions

Let’s start with the private sector. The profit motive, constrained by regulation, drives management of investor-owned utilities.

Private utilities of all kinds—water, energy, telecom, whatever—are operated by corporate managers in the interests of their shareholders. But utilities are natural monopolies, and so we can’t count on free markets to guide investment and pricing. Instead, prices are not set by the companies themselves, but rather by the state Public Utilities Commissions (PUCs). The PUCs require utilities to report publicly their asset management plans and financial records in order to justify their pricing. PUC-regulated systems must also report a variety of performance data, which commissioners scrutinize to ensure that utilities are maintaining adequate service.

PUCs allow private utilities to set prices based on the amount of capital they invest in the system: the more capital invested, the more revenue they earn. That can create an incentive for private utilities to over-invest in infrastructure because those investments allow them to raise rates—a problem known as the Averch-Johnson Effect. Much of what the PUCs do is scrutinize all those investments to ensure that they’re justified and that utilities aren’t gold-plating their systems. In other words, PUCs act to prevent over-investment in utility capital.

But remember, that’s only about 12% of the water sector.

Local governments

The overwhelming majority of water service is provided by local governments—usually cities, counties, towns, villages, authorities, and special districts. These systems are managed by local bureaucrats, with investment and pricing decisions made by local elected officials. For all the talk about federal funding, U.S. water infrastructure investment is mainly a function of local politics.

Local politics are unkind to water infrastructure because the price of water is much more visible than the quality of water. As in all things, people generally like high quality and low prices. Thing is, most contaminants in water are invisible. Unless my water is so bad that I can smell or taste it, unless there are frequent an ongoing outages and main breaks, I really have no idea how good my water system is. Unlike roads and bridges, water systems are literally buried.

But the price of water is easily observable. Voters may not know what contaminants are in the water, but they know for sure what they pay for it when they get the bill each month.

Now suppose I’m an elected official who wants to please my voters. If I make decisions that maintain or improve water quality, that’s good! Alas, my voters may not recognize the improvement. But quality improvement might cause prices to increase, which is bad because higher prices are immediately visible to voters.

No mayor wants to roll into the office & find these folks waiting

But blame avoidance isn’t good for infrastructure investment. That’s a big part of why all those facilities built back in the 1970s and 80s are crumbling today. Back when the CWA and SDWA sent hundreds of billions of dollars to local governments, the idea was never for the US government to own and operate water systems. The goal was for ​Uncle Sam to help get those systems up and running in compliance with the new environmental laws. Local governments were then supposed to take over responsibility for those systems. In too many cases political forces have led local officials to run those systems to failure. Local politicians don’t neglect water infrastructure because they’re stupid​; they do it because they’re responsive to voters.

Jersey to the Rescue?

In 2017 New Jersey passed the Water Quality Accountability Act (WQAA), which requires all water utilities—both government and investor-owned—to develop asset management plans, report on infrastructure conditions, and reinvest adequately in their systems. Rule-making to implement the new law is still under way, but what the WQAA requires of all water systems is similar to what PUCs already require of investor-owned utilities: transparency about infrastructure conditions, evidence that they are managing assets responsibly, and evidence of system performance.

Making all that system information transparent can make water’s quality as visible at its price. We can make water infrastructure a credit-claiming opportunity for local officials, not just a blame-avoidance game. Mayors seeking reelection should point at their cities’ water system performance with pride, not merely seek to duck responsibility for rate increases.

Meanwhile, in Madison…

A thousand miles away, Wisconsin employs a unique regulatory system that’s a perfect complement to New Jersey’s new law. All fifty states and the District of Columbia have Public Utilities Commissions, but Wisconsin is the only state where all systems—public and private—are subject to PUC financial regulation. That is, Wisconsin local governments must get approval of their rates from the PUC (or the Public Services Commission, as they call it there).

expected a cheesier logo

As with other utilities commissions, the traditional role of the Wisconsin PSC with respect to rates is to guard against over-pricing by private monopolies. But in the case of local government utilities, the PSC’s authority could include New Jersey-style asset management requirements and a guard against underpricing due to inadequate reinvestment. At the same time, the PSC provides something of a shield for local leaders. As a 2012 Alliance for Water Efficiency report observed:

“The Wisconsin Public Service Commission regulates both public and private water systems, and assumes the responsibility for approving all changes to water rate-making in the state. Thus, the political ‘heat’ is off at the local level and water systems can more easily approach the PSC for needed changes to their revenue structures.”

In theory, if a utility isn’t adequately investing in maintenance and upgrades, the Wisconsin PSC might actually be able to compel rate increases. (I’m not sure that’s ever actually happened).

Regulatory overhaul

Together, the Garden State’s new WQAA and the Badger State’s PSC authority over local governments would be a potent regulatory combination. So my second proposed reform is to require comprehensive asset management and performance reporting for all water utilities (as in New Jersey), and to extend PUC pricing regulation to government utilities (as in Wisconsin). The idea is broadly consistent with Australia’s model for urban water price regulation. As with my other proposed reforms, achieving such a significant overhaul to the nation’s regulatory institutions will require federal leverage.

The great promise of the regulatory regimes pioneered in New Jersey and Wisconsin is that transparency and fairness can make buried infrastructure more visible, and so shift the political incentives for sound management of water systems.