Pricing California’s Water During the Drought: Can Rate Structures Provide an Incentive for Conservation?

california drought image

By Jeff Hughes, Shadi Eskaf & Liz Harvell


The relationship between water pricing and water use is more nuanced than basic economic theory on supply and demand suggests. That’s what the Environmental Finance Center at the University of North Carolina at Chapel Hill (EFC) found in a recent study on water pricing during the California drought.

California’s severe drought and statewide conservation mandate provided an opportunity to analyze the effects of pricing strategies as a tool to prevent wasteful water use. In 2015, the State Water Resources Control Board was charged with implementing a reduction of 25 percent on the state’s local water supply agencies. One of the strategies the Board suggested to local agencies was to look at ways rate structures could provide a financial incentive, also known as a price signal, to customers to conserve water.

Did water agencies with higher price signals achieve greater water savings than others? In some cases, yes. But not always.

The EFC team analyzed data on hundreds of California water agencies’ water pricing, residential water use and production data from the mandatory conservation period (June 2015 to May 2016), resulting in one major conclusion: no single pricing strategy works for every agency in reducing use.

The drought and subsequent conservation period provided a rich source of data for researchers. Water agencies were required to make monthly reports to the water board on production, number of customers, enforcement metrics, number of days when outdoor watering was permissible, and annual reports on pricing, rate structure, and water usage data. A statewide study completed by one of the state’s largest water agencies around the same time provided further information on water rate structures.

With so much data available, a group of California water agencies asked the EFC to collect and analyze information that could provide insight on how pricing, conservation measures, and a range of other factors might have influenced customer water consumption behavior. As a result, the EFC 1) calculated the variation in water pricing signals from state water agencies before and during the mandatory conservation period; 2) assessed the relative impact of pricing and non-pricing strategies in reducing water use during the mandatory conservation period; and 3) assessed the relationship between water pricing and residential use at the end of the mandatory conservation period.

Statewide, No Single Pricing Strategy Outperformed Others in Achieving Conservation

Pricing varies across California water agencies, providing unique combinations of pricing signals to customers. In some cases, the rate structure design and the rates at one agency might offer different price signals altogether. For example, one-fourth of the surveyed agencies would have saved their residential customer more than $23 on their monthly water bill in 2015 if they reduced their water use from 12 ccf (hundred cubic feet) in one month to 6 ccf. Yet a different quarter of the surveyed agencies sent much lower price signals for conservation, saving their customers less than $9. Nearly half of the agencies that charged the lower prices actually had increasing block rate structures or budget-based rate structures, both types described as examples of conservation rate structures by the Board. Even though a rate structure might be designed in one way to encourage conservation, it may still provide a weaker incentive to conserve than another rate structure priced differently.

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The strength of pricing signals is influenced by more than just whether a rate structure is classified as a uniform structure, increasing block rates, or budget-based rates. Water agencies should be wary of narrowly defining conservation rates based on only one aspect of the rate structure design.

In fact, the analysis showed there was no statistically significant difference in the water savings achieved between different water rate structures; high production savings during the conservation period were achieved with all forms of rate structures, as illustrated in Figure 1. No specific rate structure type was the dominant predictor of water savings.

For example, when looking at just agencies using increasing block rates, it’s clear that some agencies achieved much higher water production savings (30 percent or higher) than others (less than 15 percent), demonstrating that one rate structure design does not achieve the same level of conservation across all agencies. Furthermore, several agencies with uniform rate structures achieved the same level of high savings that agencies with increasing block rates achieved.


 

Figure 1

Figure 1. High water production savings were achieved under all types of water rate structures. There was no statistically significant correlation between any rate structure type and the cumulative savings achieved between June 2015 and May 2016.


Increasing block rates or budget-based rates with steep differentials between blocks are often designed specifically to incentivize low water use. For example, one agency was charging $1.95/ccf in its lowest tier and $16.97/ccf in its highest tier (8.7 times higher). Indeed, the EFC analysis showed that agencies in California with higher rate differentials had, on average, lower average residential water use than agencies with lower rate differentials. However, during the mandatory conservation period, water agencies with higher differentials between tiered rates did not achieve greater levels of water savings than other agencies.

For many agencies, the decision to charge the full cost of water service may be as important to the pricing signal as whether to adopt an increasing block, budget-based, or uniform rate structure. Pricing signals vary, and water agencies that incur higher costs to acquire, treat, and supply water typically set higher prices regardless of the type of rate structure used. On average, agencies charging higher prices had lower average residential water use than agencies charging lower prices, as shown in Figure 2 below. Thus, agencies that charge the full cost of water service inherently send stronger pricing signals than if they underprice their services.


Figure 2

Figure 2. Water agencies that charged higher bills for 10 ccf of water use had lower average residential water use in 2016. Statistically significant at the 1% level.


This does not mean that raising rates will always result in achieving greater reductions in water use. Many water agencies raised rates at various levels in 2016, but EFC analysis did not find a correlation between the amount of a rate increase and how much water savings was achieved during the mandatory conservation period. Some agencies that raised their rates and some agencies that did not achieved the same levels of water savings. In fact, there was also no significant correlation between high prices and achieved water savings.

One reason this might be the case is that agencies that had higher pricing signals already had lower water use before the conservation period began. Thus, because of demand hardening, they were not able to achieve greater levels of conservation than agencies that had lower pricing signals and higher average use at the start. The EFC found that water agencies starting the conservation period with a higher level of average residential water use were able to achieve greater cumulative savings than water agencies with more efficient customers from the start.

Other Tools for Conservation

The analysis revealed that pricing does not appear to be the dominant tool that was used to generate short term curtailments. Yet high levels of conservation were achieved by many agencies during the 12-month period. The EFC analyzed the relationships between non-price conservation strategies and higher levels of short-term conservation.
One of the most successful strategies appeared to be strict local enforcement of conservation directives by issuing warnings to customers that violated them. Agencies that issued more warnings per 1,000 customers achieved, on average, a greater level of water savings than other agencies.

Media coverage of the drought also played an important role during the conservation period, as Quesnel and Ajami found in their study. The EFC also identified that weather patterns and household characteristics were external factors that were also correlated with water savings achieved among agencies in California.

Localization is Key

The study suggests a one-size-fits-all approach to pricing and conservation strategies across the state would not be successful for the diversity of local conditions and costs that water agencies incur. What is effective for one water agency may not be as effective for another water agency with different customer characteristics.

Some water agencies have high water rates and do not need complex rate structures to convey conservation price signals, while others might rely more on the rate structure design than high rates. Water agencies with inexpensive treatment and delivery costs, or those that have avoided rate increases to keep water rates low, will provide little incentive for customers to save water unless the rate structure has a design that signals an incentive to maintain low water use. These agencies likely will have to work harder with non-pricing conservation strategies to encourage water savings.

The EFC analysis found that there are alternative methods of sending pricing messages other than changing the underlying rate structure. For example, Figure 3 below displays rate structures of eight California water agencies. Even though all eight agencies used uniform rate structures, the prices charged to customers provided very different financial incentives to reduce water use, demonstrating the diversity of price signals that can be achieved from a single rate structure design.


Figure 3

Figure 3. Although these eight water agencies all used uniform water rate structures, the monthly prices charged to customers and their incentives to conserve water use varied significantly. One water agency applied a fixed surcharge at 8 ccf while another applied a volumetric surcharge for all use above 8.5 ccf during the drought period.


Furthermore, two water agencies in Figure 3 implemented temporary drought surcharges during the mandatory conservation period. Even without employing block pricing, these agencies were able to send very different price signals to their customers than the other agencies.

The agency with the orange line implemented a volumetric surcharge on water use above 8.5 ccf/month, thereby essentially creating a temporary increasing block rate structure. The other agency (blue line) implemented a drought surcharge of $0.50/ccf for all water use. However, customers under 200 gallons per day (gpd) were given a full refund on that surcharge on the same bill. This means that the next gallon used above 200 gpd was the most expensive gallon purchased, at a total of $4.00 (see price jump at the 8 ccf mark). The drought surcharge and credit were distinct line items on the water bill, communicating to the customer a clear message of incentivizing conservation below 200 gpd. These two different approaches to implementing temporary drought surcharges created different price signals to the customers.

Looking Ahead

As conservation efforts continue, water agencies should still focus on using pricing as a strategy and understand the signals their pricing structures send but should also consider pricing in the context of other measures.

While the study did not show that pricing was correlated with higher levels of short-term conservation, it did show that pricing was correlated with average water use, and that some agencies successfully employed pricing to achieve reductions. In order for pricing to be effective, both the rates and elements of the rate structure need to be designed intentionally to provide appropriate price signals to encourage conservation. However, there is no evidence to suggest that any single approach employed by any water agency was more effective than all others across California in achieving water savings, or that pricing was the sole factor in reaching conservation goals. In fact, this research supplements other studies that identified non-pricing conservation programs as effective mechanisms to achieve short-term reductions in water use.

Looking forward, water agencies should consider their demographic, geographic, and climate-related situations when making determinations about how to encourage conservation through pricing and non-pricing strategies.


*Editor’s Note: A variation of this article originally appeared in the International Water Association’s magazine The Source in October 2018.


Jeff Hughes is the director of the Environmental Finance Center (EFC) at the University of North Carolina at Chapel Hill and an associate teaching professor with the UNC School of Government. He brings more than 30 years of environmental finance experience as a researcher, policy analyst, consultant and practitioner.

Shadi Eskaf is a senior project director at the EFC at the University of North Carolina at Chapel Hill, where he conducts research on a range of topics, including water and wastewater rates and rate-setting, residential water consumption, infrastructure capital needs and funding, and water systems collaboration and regionalization.

Liz Harvell coordinates communications and outreach for the EFC as communications manager, helping to ensure that all of EFC services and resources are available to those seeking guidance in environmental finance.


 

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