Water Pricing

 

Water Conservation / Revenue Loss Conundrum 

Programs aimed at reducing demand can sound like a losing proposition.  How can a utility thrive by working to sell less of its own product?  The answer lies in rate structures that recover costs through the portion of their demand that represents efficient, base-line use – in other words, the portion of your demand you can always count on.  Then, price signals and other conservation programming can aim to reduce inefficient and more discretionary uses, without suffering revenue shortfalls.  This is easier said than done, but the guidelines and resources in this section are intended to help.

Fixed Costs / Variable Revenue Conundrum 

In Massachusetts, suppliers’ short-term fixed costs often represent 90% or more of total costs.  These costs (such as infrastructure maintenance, debt service, regulatory compliance, administration, and source protection) stay approximately the same no matter how much water is sold.  However, most suppliers collect most or all revenues on a volumetric basis (charge-per-unit-sold).  As a result, demand reduction can reduce revenues far more than costs, exacerbating financial gaps.  

Download the Fixed Costs Variable Revenue Conundrum graph above

This conundrum, too, can be addressed with rate structures that recover fixed costs through the portion of demand that represents stable, baseline use (that is, the portion of your demand you can always count on) in combination with some amount of fixed fees.  Then, sudden drops in discretionary use arising from a wet year or successful conservation programming, for example, don’t leave suppliers deep in the red.  Establishing such a rate structure requires a solid understanding of your customer base’s water use patterns.  For guidance on customer use data management and analyses, click here.

 

Key Concepts

• Full-Cost Recovery
• Long-Term Planning and Budgeting

Rates should reflect the true cost of providing safe, reliable water service into the future. Revenues should be high enough to cover the full cost of operating, maintaining, and protecting the water supply system, with a minimum of a 10-year planning horizon. 

A planning horizon of ten or more years helps:

1) educate customers and decision makers about the water system’s financial needs

2) build in revenue to cover longer-term capital needs

3) justify debt acquisition; and

4) avoid high costs of deferred maintenance by budgeting for regular infrastructure upkeep.

In assessing full costs, consider at a minimum:

1. Pumping equipment and distribution system operation, repair, and maintenance;
2. Water quality program, treatment, and treatment plant costs;
3. Electricity and energy costs;
4. Capital needs, including planning, design, and construction;
5. Watershed land purchase/protection, well site purchase/protection, aquifer land purchase/protection;
6. Debt service;
7. Administration (including management, billing, customer service, cost of service studies, rate analyses, and long-range planning efforts);
8. Regulatory compliance, permitting, and reporting expenses;
9. Staff salaries, pensions, benefits, training, and professional development.
10. A water conservation program that includes some or all of the following:
    • Water audits (utility audits and individual facility audits, including voluntary customer audits);
    • Leak detection equipment and services;
    • Meter replacement/repair program;
    • Automated meter reading equipment, including installation and maintenance;
    • Purchase of free or subsidized water conservation devices for customers (such as low-flow faucet devices, toilet leak-detection kits, etc.);
    • Customer rebate programs for water efficient fixtures and appliances, weather-based irrigation controllers, rainwater collection systems, etc.;
    • A public education program including educational components of water bills, school partnership programs, public workshops, etc., including related staff time;

Key Concepts

• Price Signals
• Effective Billing Practices

 

Price signals

Rates should be easy to interpret and send strong price signals to use water efficiently. The most common way to send a conservation price signal is to charge more per unit for inefficient and discretionary water use.  This requires:

1. A way to distinguish water being used efficiently for essential purposes from water being used excessively, for discretionary purposes, or at times that burden the system or environment.  This distinction can be based on customer use analysis (see the “Data Management and Analysis” section for more details on this) and/or efficiency benchmarks in the literature.
2. Charging a significantly higher per-unit cost for water in the categories targeted for reduction.  At least a 50% increase in unit cost between tiers is advisable.

Some common examples of these types of rate structure are as follows (some of which can be used in combination):

• Seasonal Rates – unit charges increase during seasonal peak demands and/or seasonal source strain.
• Tiered Rates – unit charges increase as a customer’s usage crosses set volume thresholds within a billing period.  

Tiered rates are more effective and more equitable when they account for differences in customer type, like single-family vs. multi-family units, or household size.  Since determining every household size is often not practical, a supplier can create default tiers for single-family customers that presume a given household size (e.g. 4 people) and allow larger households to apply for adjusted tiers based on actual household size.  Another approach sets per-household tier thresholds based on each household’s average winter water use, and percentages thereof.  A simpler approach assigns system-wide residential tiers based on system-wide average winter water use per household, and percentages thereof. 

There is generally a trade-off between maximizing fairness of a tiered approach and minimizing administrative complexity.  Each system must strike a reasonable balance based on its resources and goals. 

• Drought or Scarcity Rates - unit charges increase based on drought triggers or other specific indicators of source stress, like deteriorating water quality or low streamflows, groundwater levels, or reservoir levels.

You can also send a strong price signal with high uniform water rates.  In this case, you charge the same per-unit cost regardless of how much, or how little, a customer uses.  This is administratively simple; but may cause affordability concerns for customers even when they’re using water efficiently.  For high uniform rates, affordability protections should be used. (click here for more information on protecting affordability) 

Billing Practices

Price signals only work when customers understand how their use impacts their bill and receive bills often enough to make timely adjustments in their use or investigate potential leaks.  The following billing strategies work hand-in-hand with price signals to help change customer behavior. 

• Bill monthly or bi-monthly.  This is especially important for reducing seasonal use, like irrigation, and fixing leaks quickly. 
• Explain the rate structure on the bill.  This helps customers to understand how their behavior can affect their bill.
• Use gallons as a billing unit.  This helps customers visualize their use in familiar terms and make adjustments that could impact their rates.  Tables can help customers calculate their per person per day use.
• Chart trends for customers of their individual water use and compare their use to others in their customer class.  This motivates people to match their own periods of lower use or their neighbors’.  Secure websites can give customers a way to track their use in more detail if you have Advanced Metering Infrastructure (AMI).
• Educate customers.  Customers may need tips on how to conserve water; you can provide these with bill inserts.  You can also inform them of available rebate or home water audit programs and share information on large capital projects and the costs associated with providing reliable service.  (Click here for water conservation tips and educational materials for customers.)

Direct billing with customer autopay is very convenient for customers, but reduces customers’ awareness of their bills and exposure to price signals.  It also limits chances to deliver educational materials.  If you offer the convenience of auto-pay billing, consider communicating with customers by email, social media, and direct mail to maintain good communication and information flow.

Key Concepts

• Fixed Fees
• Reserve Funds
• Enterprise Accounting

Rate structures should include mechanisms to stabilize revenue in the face of reduced demand.

Fixed Fees - One primary strategy for addressing revenue instability is to incorporate or raise the component of billing that is independent of usage.  This fee can be based on meter size, relative burden on infrastructure costs (such as a portion of the system that requires significant pressure management), or other factors.  Fixed fees also help customers understand their water bill more as a charge for a reliable service than the price of a commodity, which more closely reflects the reality of water utilities in Massachusetts.

However, fixed fees reduce a customers’ financial incentive to use water efficiently.  To avoid weakening incentives to conserve, rate structures that include fixed charges should be combined with steep per-unit charges for discretionary or excessive use.  If a fixed charge is being newly introduced or increased as a percentage of revenue recovery, volumetric charges should be simultaneously re-evaluated and adjusted to ensure conservation signals for discretionary and inefficient use are not weakened.

Reserve Funds - Another useful strategy for revenue stability is a reserve fund that smooths over revenue surpluses and deficits year-to-year.  In dry years, when customers may increase discretionary use, by increased lawn watering, for example, revenue from this bump in use should be excess relative to underlying costs and can help build the reserve fund (or build up a long-term capital account). (For more, see “Water Conservation / Revenue Loss Conundrum” and “Fixed Costs / Variable Revenue Conundrum")

Enterprise Accounting – Control over your budget is an essential mechanism for sound financial planning.  For municipally-owned suppliers, the most common mechanism for such control is an Enterprise Account (See Massachusetts General Law Chapter 44, Section 53F 1/2 for enabling legislation.)  However, other financial mechanisms may be used if they effectively segregate water supply accounting from the municipal general fund and other government activities.  Such a fund allows the water supplier to account for the total costs of operating and maintaining the supply system and ensures all revenues from water supply activities are retained and applied to water supply costs.

Key Concepts

• Cost Allocation
• Affordability Protections
• Public Engagement

Rates should reflect fair distribution of costs and protect affordability of water for basic needs.

Costs Allocation

Water rates are a way to recuperate costs.  But who should pay for what component of a utility’s costs?  The answer is unique to each system, but in all cases cost allocations should be fair and should protect basic health and safety.

One common approach to fairness is to generate revenue from each class of customer in proportion to the utility’s costs to serve that class.  Such classes are often defined on the basis of type of infrastructure (single-family homes, commercial properties, institutions/large facilities, etc.).  Other options may be to categorize the customers on the basis of geography (remote spurs of the system, pressure-boosted zones, etc.), on the basis of system capacity (new development that requires expansion of treatment or storage capacity), or other unique factors that impact underlying costs. 

Cost allocations could also be thought of in terms of times of use. It may make sense to apply “peak use charges” during times of day when supplemental sources or treatment facilities are needed to meet peak demands.  It may be fair to apply “excess use charges” for extremely high usage to help recover costs of (or better yet, ward off the need for) developing new sources to meet such demands.

Some classes or users may need to subsidize others for reasons of practicality or other considerations. But making decisions about cost allocations in an informed, clear-eyed manner is what matters.

Affordability

Protecting the affordability of water for basic needs is an important component of rate-setting.  This can be accomplished with discount or “lifeline” rates for customers qualifying on the basis of income.  Other suppliers protect affordability by setting artificially low per-unit charges (i.e. below the cost to provide that water) for the first tier of use to cover water use for essential needs.  This approach is only compatible with full cost recovery if there is stable, reliable usage in higher tiers that can subsidize the lower tier. (See more on this here.)

Public Engagement

Decisions of fairness, practicality, and financial soundness are difficult.  Strong, consistent public engagement has been shown time and again to make the critical difference in setting effective water rates that rate payers and community decision-makers alike support, especially when substantial rate restructuring is needed.  Some tips to keep in mind:

• Data is a powerful engagement tool.  Rate payers and political leaders alike need to understand their water supply system’s challenges and costs.  Once these are understood, modeling the impact of various rate structures on different user groups can help the public evaluate trade-offs and hone in on solutions that fit the community’s needs. (See section on Data Management and Analysis)
• Incorporate broad community representation.  Community surveys and well-balanced advisory committees can help ensure inclusion of the full range of perspectives.
• While the initial groundwork to set up public engagement structures takes time and effort, once developed, these structures can be used to evaluate progress, make course corrections, and engage on new emerging issues.

 

Key Concepts

• Incremental/Phased Change
• Anticipating Trends

Rates should be reviewed frequently and adjusted as needed. While addressing all the principles associated with sustainable rate setting would require radical rate restructuring for some suppliers, change can be achieved in phases.  Using data to help understand long-term trends (see Data Management and Analysis section), establishing clear financial targets, and engaging the community and elected officials regularly in a transition plan toward sustainability seems to be the recipe for success. 

Once a sustainable rate structure is in place, the actual rates may need to be tweaked on a fairly regular basis to correct for under or overestimates or respond to new trends and needs.  Analyzing your water rates regularly and making the necessary adjustments can help avoid the need for radical restructures in the future.  

Resources

What are the experiences of Massachusetts suppliers with rate setting?

• Survey of 114 Massachusetts Water Suppliers –key successes and challenges in rate setting

What are the important lessons learned about rate setting from MA water suppliers?

• Summary of Key Lessons Learned from 7 Massachusetts Rate-Setting Case Studies
• Full Report of Key lessons Learned from 7 Massachusetts Rate-Setting Case Studies 

What Detailed Guidance is Available on Water Rate Setting?

• The American Water Works Association’s Principles of Water Rates, Fees, and Charges (AWWA M1, most recent edition)
• The American Water Works Association’s Developing Rates for Small Systems (AWWA M54, most recent edition)
• Building Better Water Rates for an Uncertain World:  Balancing Revenue Management, Resource Efficiency, and Fiscal Sustainability.  Alliance for Water Efficiency (2014).
• Water Conservation-Oriented Rates: Strategies to Extend Supply, Promote Equity, and Meet Minimum Flow Levels. Wang et al., American Water Works Association (2005)

What Rate-Setting Tools are Available to Help me with Rate Setting?

• AWE Sales Forecasting and Rate Model
• MA Water and Wastewater Rates Dashboard

 

More content for Water Suppliers and Municipal Officials

Toolkit - Site Map  > Municipalities  > Suppliers and Water Commissioners

Toolkit - Site Map  > Municipalities  > Suppliers and Water Commissioners