From Rates

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.

Water & Sewer Affordability in America, 2019

An update on what low-income U.S. households must pay for essential service

It’s hard to come up with amusing images for this topic

About a year ago I also published the results of a national study of affordability using these new metrics using data from a nationally-representative sample of utilities in 2017. This year, I’ve been working with Texas A&M graduate student Robin Saywitz to update that study for 2019 with fresh data and an expanded sample of utilities. A working paper details the full methodology and results for the 2019 update; this post reports the main findings.

Water and sewer affordability remain at the forefront of discussions among utility policymakers, managers, and regulators as communities across the country face rapidly rising capital, maintenance, and replacement costs. Since good policy requires good measurement, I’ve spent a lot of time in recent years evangelizing for a new, double-barreled measurement approach published early in 2018: the Affordability Ratio and Hours at Minimum Wage. These metrics are designed to capture the sacrifices and trade-offs that low-income households face when paying for these essential services.

Sample & data

There’s no central repository for water and sewer service rates in the United States, so valid depictions of affordability requires gathering data directly from utilities. We drew our sample from the EPA’s Safe Drinking Water Information System (SDWIS), which contains basic system information for the country’s nearly 50,000 water systems. To get a representative picture of the nation’s affordability we stratified the sample and then randomly selected systems. Our analysis then adjusted mathematically for the sampling procedure to make sure we get representative results.

We collected rates data during the summer of 2019 with an active survey—that is, we gathered rates information directly from utilities rather than relying on responses to questionnaires. The final dataset included full water and sewer rates data for 399 utilities—an increase of 70 systems compared with the first study.*

Basic water & sewer share of disposable income

The first main metric is the Affordability Ratio at the 20th income percentile (AR20), which estimates basic water and sewer prices as a share of disposable income, which for present purposes is total income minus other essential living costs (including taxes, housing, food, health care, and home energy), estimated using Consumer Expenditure Survey data.

In 2017 AR20 averaged 9.7 in the United States; we found that average AR20 is up sharply since 2017, with the national average now at 12.4. In substantive terms, that means that in the average U.S. utility, basic water and sewer service prices for a four-person household consume about 12.4 percent of disposable income for a household at the 20th income percentile. Here are the distributions of AR20 for 2017 and 2019:

As the figure shows, the overall distribution has shifted markedly since 2017, especially at the high end. AR20 is less than ten for about 60% of systems, but we found a troubling growth in very high values of AR20.

Basic water & sewer in hours at minimum wage

The other way I like to measure affordability is to convert basic monthly water/sewer prices into Hours’ Labor at Minimum Wage (HM). It’s not a precise way to measure affordability, but it’s intuitively meaningful.

The overall HM distribution also shifted up overall, with an average HM of 10.1 in 2019. In other words, the average monthly price of basic water and sewer service for a four-person household in the United States requires about 10.1 hours of labor at minimum wage. Average HM was 9.5 in 2017, so we see an increase in 2019, but the change in average HM is not as dramatic as the change in AR20. Here’s affordability in the United States measured in terms of local minimum wage, again with 2017 and 2019 side-by-side:

So what’s going on with affordability?

Trying to infer trends from just two time periods is tough, but some important patterns are evident in the 2019 update. The most striking result overall is the sharp increase in AR20, which reflects increases in water and sewer prices, increases in essential expenditures, and stagnant or even declining 20th percentile incomes.

The more modest increase in average HM is consistent with nominal inflation, but in terms of minimum wage labor the increase of +36 minutes is noteworthy as minimum wages have not increased in many parts of the country.

We’re still unpacking what it all means, and I’ll have more to say about what the 2019 data show. For now, these figures offer another snapshot of water and sewer affordability in the United States to help frame discussion over improvements and structural reforms to the American water sector.

 

 

*399 might not seem like a very large sample for a country with 50,000 water systems, but the sample is much larger than most studies of water rates, it’s representative, and we’re highly confident in the validity of the data because we gathered the data ourselves. It’s also 70 more systems than we sampled in 2017.

The Plan

A five-point proposal to transform the U.S. water sector

As daunting as the challenges in the U.S. water sector are, solutions are possible and within our grasp. Thanks to legions of smart, creative scientists and engineers, we know a lot about the threats to environmental quality and health, and we’re pretty good at finding ways to address them. Today the principal barriers to progress in the water sector are not environmental or technological; they are social, economic, and political.

Fixing the water sector—really fixing the water sectormeans more than government money for pipes. The crazy quilt of institutions that govern, regulate, and manage water in the United States hinders effective, lasting solutions. Fortunately, institutions are human creations, which means we can do something about them. There’s nothing wrong with water governance in America that can’t be solved.

Over the past few months I’ve written a series advancing five broad institutional reforms to the U.S. water sector that ought to accompany any big federal investment.* This post summarizes them. They’re a package deal: each reform complements the others, and each is unlikely to be successful without the others. It’s an ambitious plan, but it’s rooted in empirical research, and together the five parts are technically and politically feasible. Here they are (click each heading for the full post on each):

1. Consolidation

There are more than 50,000 community water systems and 15,000 sanitary sewer systems in the United States. Virtually every aspect of America’s water sector is worse because there are so many systems. Let’s reduce the number of water systems to fewer than 5,000 by 2030. Consolidation can happen by merging neighboring systems into a regional utility, creating new authorities or nonprofit organizations, or when an investor-owned firm purchases small systems. To make it happen:

  • Federal funding for water, sewer, and stormwater systems must be contingent on small system consolidation.
  • Laws governing utility mergers and acquisitions should remove barriers to and create incentives for consolidation. Consolidation laws should ensure that struggling systems are consolidated and guard against “cherry-picking.”
  • All systems must be held to the same environmental standards. Exemptions and waivers for small systems should be eliminated and regulators should be empowered to force condemnation and consolidation for perennially failing systems.
  • State and federal agencies should provide technical and legal assistance to facilitate the consolidation process.

Reducing the number of water and sewer utilities through consolidation is the single best thing we can do to improve water utilities in the United States.

2.Regulatory reform

​Let’s follow regulatory regimes used in New Jersey and Wisconsin to change the incentives for utility leaders to invest in their systems adequately and manage them responsibly.

Specifically:

​Best of Both Worlds

  • Regulatory authorities should collect and publicly report performance metrics for each water and sewer system,
  • Water, sewer, and stormwater systems must develop comprehensive asset management plans, and demonstrate that capital assets are adequately maintained.
  • Public Utilities Commission pricing and service quality regulation should be extended to all utilities, not just investor-owned systems.

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 and economic incentives for sound management of water systems.

3. Technological transformation

America’s water systems need a technological leap forward with comprehensive deployment of information technology. Let’s get our systems out of the 19th and 20th centuries and into the 21st and 22nd. Funding for water, sewer, and stormwater systems should support data collection and analytical capacity for more effective and efficient investment and operations.

4. Human capital

The water sector needs a stronger supply of human capital, and we need to streamline the labor market. To that end, let’s:

  • Invest in the next generation of water professionals with new and rejuvenated educational and training programs.
  • Create national standards for operator licensing and certification.
  • Build a body of rigorous, data-driven social science research on effective utility management, leadership, and organizations.

5. Environmental justice

Let’s build environmental justice into water, sewer, and stormwater policy. Specifically:

  • Federal and state authorities must establish standard metrics to assess racial, ethnic, and socioeconomic equity in environmental conditions and infrastructure investments.
  • Utilities must collect and publicly report data on service shutoffs and restorations, and work toward an end to shutoffs.
  • Regulators must demonstrate equity in inspections and enforcement actions.
  • Eligibility for federal infrastructure funds must be contingent on utilities demonstrating equity or progress toward equity.
  • Channel extra funding and technical assistance to communities that suffer from significant disparities due to historical or structural disadvantages.

The way forward

Just over a year from now Americans will head to the polls for a pivotal federal election. With water on the national political agenda in a way it hasn’t been since the 1970s, we are, perhaps, an election away from a major federal investment in infrastructure, and with it an opportunity to reimagine water governance. Let’s use that opportunity do more than rebuild pipes; let’s rebuild institutions. If we do it right, those institutions will keep the pipes working for generations to come, and our legacy will be a cleaner environment and healthier, more prosperous people.

*The five-part plan debuted in a talk I gave at as part of the University of Rhode Island’s Metcalf Institute public lecture series last summer. You can catch the whole talk here if you’re so inclined.