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.
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.
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.