Understanding progressive & regressive water pricing
By Antonio & Manny Teodoro
How do utilities distribute the costs of drinking water systems to their customers in their rate structures?
The answer is surprisingly complicated, and water utility pricing is often weird. There are lots of other wrinkles and variations, but the vast majority of utilities use one of three basic rate structures:
- Uniform, where customers pay the same price for every unit of water that they consume;
- Inclining block, which charge higher prices as volume increases; and
- Declining block, which charge lower prices as volume increases.
It’s easy to see that these different rate structures distribute costs differently, but how much differently isn’t immediately obvious. How do a utility’s rates apply to low-volume customers compared with high-volume customers?
The answer is important because it carries significant implications for affordability and conservation. It also speaks to risk tolerance and questions about fairness. Water is an unusual consumer good because its use is very different at different volumes. For residential customers, low volumes are mostly used for basic needs like drinking, cooking, cleaning and sanitation. Higher volumes are usually for more discretionary uses like lawn irrigation and car washing.Studies of water rate structures typically put them into the three main categories (uniform, inclining, and declining), which is fine, but can mask some important variation within the inclining and declining blocks. Consider four imaginary rate structures:
A and B are both inclining block rates, but A is more progressive than B because prices increase sharply for A as volume increases. Similarly, C and D are both declining block structures, but C is more regressive than D because C discounts higher volumes much more than D.
David Switzer developed a way to measure water rate progressivity to reflect that variation, and published a paper last year that uses regression slopes to measure relative progressivity. It’s a creative, rigorous, and smart methodology, but it’s pretty sophisticated and not the easiest approach for communicating with the general public.
In search of a valid but more intuitive way to communicate the idea of progressivity, we struck upon the idea of comparing average unit costs of water at relatively conservative and very high benchmark volumes. What would be appropriate comparative volumes? And how could we frame the measurement in an engaging way?
Enter Amy Poehler
Amy Poehler was a particularly profligate water customer. In the summer of 2015, while drought ravaged the Golden State, the Parks & Recreation star’s Beverly Hills home used 85,000 gallons a month. Meanwhile, a family of four that is fairly conservative with water uses something like 6,000 gallons per month for drinking, cooking, and sanitation.* In other words, Poehler’s home consumed in about two days enough water to comfortably supply a family of four for a month.
Shaming celebrities for bad environmental behavior is now something of a ritual in America, and it’s not clear whether exposing excess actually helps. But Poehler’s water consumption provides a convenient benchmark for excess.
The Amy Poehler Index
So to measure progressivity we calculate the total monthly water and sewer bill—including both fixed and volumetric charges—for a customer at 6,000 gallons (a conservative family) and at 85,000 gallons (Amy Poehler’s family), then divide that price by each customer’s total volume. These are average unit costs. The ratio of the two unit prices is the Amy Poehler Index (API). A value of 1.0 means that Amy Poehler and the conservative family pay exactly the same unit price for water. Values less than 1.0 indicate regressive rates (Amy Poehler pays less than a conservative family), and values greater than 1.0 indicate progressive rates (Amy Poehler pays more than a conservative family).
Let’s look at how this works for a couple of large U.S. city water systems under their 2019 rates:
In 2019 Tampa’s fixed monthly charge for water was just $1.50, with no fixed charge at all for sewer. Under Tampa’s inclined five-block rate structure, Amy Poehler would pay $617.82 monthly, while our conservative family would pay just $19.29. On a unit cost basis, those prices equal $7.27 and $3.22 per thousand gallons, respectively. The resulting API is a progressive 2.26.Meanwhile, in 2019 Philadelphia charged its customers a fixed $5.12 for water and $7.04 for sewer each month. The City of Brotherly Love then applied declining block water rates that would have charged Amy Poehler $455.69 monthly, and the conservative household $41.10—more than twice the Tampa bill for the same volume. The resulting unit costs turn out to be $5.36 for Amy Poehler and $6.85 for our conservative family, for a regressive API of .78.
The National Progressivity Picture
We used data from the Teodoro & Saywitz 2019 affordability update to calculate API for a nationally representative sample of 399 U.S. water and sewer systems. Average combined water and sewer rates were slightly regressive at .88, but ranged widely from .07 in Anchorage, AK to 3.81 in Phoenix, AZ.
API isn’t as precise as Switzer’s progressivity coefficient, but in our national dataset the two metrics correlate pretty well (ρ=.71). More importantly, the API offers an easy way to understand and improve the ways that communities distribute costs through their rate structures. That seems like the sort of thing Leslie Knope would probably dig.
Important developments in California for utility affordability
California’s Public Utilities Commission (CPUC) is working on establishing methods to measure affordability for utility service. The CPUC governs ratemaking for the state’s investor-owned water, energy, and telecommunications utilities.* The idea behind the CPUC’s process is to craft sensible, valid metrics to gauge low-income households’ ability to pay for essential services.
As part of their efforts, CPUC has been reviewing the latest academic research on affordability measurement. I was involved in this process through a series of conversations with CPUC staff and a workshop in San Francisco earlier this year. It’s been fascinating to watch the CPUC grapple with this important issue, and gratifying to see principles that I’ve advanced take shape in policy.
I spend a lot of time thinking, researching, and writing about water affordability; other scholars think about energy and telecom—that’s how industries and disciplines are organized. But of course, the same people who use water utilities also use electricity, gas, telephones, and Internet service. The affordability of any one of these services depends in part on the prices of all the others. So a realistic picture of utility affordability has to include all of them.
What’s particularly exciting about the CPUC’s current work is that they’re crafting a single affordability metric to capture the cost of all these utility services. That requires defining essential service levels for each service, measuring the prices for those levels of service, and estimating the ability of low-income households to pay for that bundle of services in combination. It’s an analytically daunting task.
Principles in practice
The CPUC staff took up the challenge, and crafted a smart proposal for comprehensive affordability measurement. The proposal sets essential water supply at 50 gallons per person per day (gpcd), Essential energy is set at “baseline quantities,” with end use studies underway. Telecom essential services are defined as 20 Mbps, 1024 GB/month, and 100 minutes per month. The total price of essential service for all three is the real cost of utilities.
The proposal then uses a combination of three metrics to assess affordability: the Affordability Ratio (AR), Hours at Minimum Wage (HM), and the Ability to Pay Index (API). Each of the metrics offers a different but important perspective on affordability. Here’s how the CPUC report summarizes the three metrics:
The report describes each metric in detail and discusses the ways that they can complement each other. I won’t lie—I’m pretty geeked to see the first two of those, since I introduced and have been evangelizing for them in the water sector. CPUC staff have picked up these principles and run with them.
The CPUC affordability rulemaking process is ongoing, but this staff proposal is an exciting development in utility pricing.
*The CPUC’s efforts are running in parallel with similar work by the California State Water Resources Water Board, which regulates the state’s water utilities, public and private.
© 2019 Manny P. Teodoro
A decoupling drama plays out in San Jose
Over the past year I’ve blogged about my research with Youlang Zhang and David Switzer on public and private water utilities’ responses to the drought that gripped California from 2014-2017. One of our most interesting findings was that California’s private, investor-owned utilities conserved significantly more water than government utilities. We argued that a main reason for the difference was politics and California law, which allows rate decoupling for private water utilities.*
The timing of the San Jose story was uncanny: I wrote my 2018 water conservation update just as SJWC was filing its request for the rate increase. The story of conservation and rates in San Jose is a useful illustration of why decoupling is so economically effective but politically perilous.
One city, three water systems
San Jose is unusual among large American cities in that three separate utilities provide drinking water service to its residents. The San Jose Municipal Water System (SJ Muni) is governed by the San Jose City Council, which sets the utility’s investment, operating, and financial policies. Two private water systems also serve San Jose: Great Oaks Water Company and San Jose Water Company (SJWC). Corporate boards and executives make investment and management decisions for these systems. Serving a population of more than a million, SJWC is the giant of the trio; but SJ Muni and Great Oaks are also large, each serve populations of around 100,000.
Importantly, very different processes govern price-setting for the three systems. San Jose’s elected City Council sets rates for SJ Muni. As investor-owned systems, SJWC and Great Oaks set their rates through the California Public Utilities Commission, whose members are appointed by the governor. That means San Jose voters can influence SJ Muni’s rates through their elected councilmembers. Rate-setting for SJWC and Great Oaks is a more technocratic affair, with the process handled mostly by lawyers, engineers, and economists at the CPUC.
All three systems charge fixed monthly service fees plus volumetric prices. However, their volumetric rate structures differ in subtle but important ways. The two private utilities employ inclining block rates, which charge progressively higher unit prices as volume increases. For example, SJWC customers pay $3.20 per hundred cubic feet (ccf) for the first three ccf; prices jump to $4.80/ccf for the next 15 ccf, and then to $6.40/ccf for volume beyond 18 ccf per month. Great Oaks uses a similar three-block rate structure, although its rates are considerably less progressive. SJ Muni uses a flat rate: customers pay the same unit price for all water, regardless of how much they use.† Here’s how these prices translate into bills for demand ranging from 0-30 ccf per month:
Great Oaks’ prices are lowest overall. SJ Muni’s and SJWC’s prices are similar at low volumes, with the private company’s total prices about $7-10 higher through the first 15 ccf. Without detailed financial, operational, and customer data, it’s impossible to say whether that gap is justified. We can say that the gap widens at higher volumes due to SJWC’s more progressive pricing: at 40 ccf/month a SJWC customer pays $52.09 more than a SJ Muni customer. That means SJWC likely gets significantly more of its revenue from the high-volume customers who pay high prices for water.
Is water consumption in San Jose consistent with those differences in pricing? This chart shows SJ Muni’s water conservation from 2015-2018, and population-weighted conservation for SJWC and Great Oaks for the same period, compared with the same month in 2013:
Notice how the green (private) line is close to but usually slightly above the blue (SJ municipal) line? Overall conservation tracks pretty closely for public vs. private over the four-year period, but San Jose’s private systems have averaged about 1% more savings.
The difference in per capita water use is much more noticeable; here’s residential gallons per capita per day in 2018:
San Jose’s private utility customers are much more conservative with water than are SJ Muni’s customers, using about eight gallons per person less water on average. The disparity is greatest during the seasonal peak period when supply stresses are also greatest.
Decoupling to the (utility’s) rescue!
In 2018, SJWC’s water customers were so conservative that the utility had a $9 million shortfall in sales revenue. California’s policy of rate decoupling allows the company to make up that shortfall with a rate increase in 2019. San Jose residents and lawmakers are angry that their reward for conservation success is a rate hike. Flat rates help keep SJ Muni’s revenues steadier and so spare the city council from the citizen wrath that such a rate increase might unleash.
Lots of things cause people to use more or less water, and so we can’t say for certain that prices drove the conservation patterns we see in San Jose without detailed customer-level data and a carefully-designed study. But it’s fair to say that San Jose’s experience is consistent with the public-private differences we see in the rest of California. Without decoupling, it’s unlikely that private utilities would use progressive pricing and risk the kinds of revenue losses that they experienced in 2018.
Economics is supposed to be the dismal science and politics the art of the possible. But for California water, the opposite seems to hold: decoupling makes conservation economically viable for private firms, while politics forces governments into difficult choices that can mean financial success at an environmental cost.
† SJ Muni’s flat water rates vary by geographic zone. The graph here uses a simple average of those rates.