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

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 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.

© 2019 Manny P. Teodoro