Fair Water Pricing

April 5, 2012
Establishing water and sewer rates that charge for the full cost of services provided

About the author: Jason Mumm is president of StepWise Utility Advisors. Mumm can be reached at [email protected].

One of my favorite clauses in the English language is “in the grand scheme of things ...” Usually when hearing about the grand scheme of things, you are about to be told just how irrelevant something is within the larger context of every other single thing—from the composition of insect hair to the gravitational force of distant solar systems. Nothing in particular seems to matter in the grand scheme of things.

By this standard, water and sewer utilities have not measured very well historically. In the grand scheme of things, the notion of immediate access to clean drinking water and working sewer systems are things that, while once luxuries for Americans, now are thought of as basic services. When something is labeled a basic service, that means it is expected to be provided as a given. Put another way, so-called basic services are taken for granted.

Once things are taken for granted, they quickly become small in the grand scheme of things. That brings us to another truism: Things that are taken for granted also are expected to be cheap.

What We Pay

As a nation, we do not pay very much for our water and sewer services. We have not paid much historically, and we do not pay very much now. Ten years ago, the average water and sewer bill in the U.S. was about $450 per year, or about $1.23 a day. The average now is about $720 a year, or $1.97 a day. Whether we are talking about $1.23 per day in Y2K dollars, or water $1.97 per day in 2012, it ought to be self-evident that the average American pays less for instant, on-demand water and sewer service in a day than he or she does for a single cup of coffee from any popular coffee shop.

To say that water and sewer services are dirt- cheap would be an insult to dirt. A ton of water— about 250 gal (enough to fill an SUV’s gas tank about 10 times)—costs approximately $1 to $2, and it is delivered to your faucet every time you feel like turning the knob. A ton of dirt, on the other hand, will run you about $20 without a delivery charge. Hooray for dirt!

Utilities in the Red

In the grand scheme of things, utility rates have long been ignored. If anything, the rates charged for those basic water and sewer services have been nothing short of a nuisance for utility managers and their elected officials. Raising rates is viewed by too many communities as a fiscal failure and a sign of mismanagement. Elected officials respond to community perception by resisting those increases.

That is a shame, because while rates may seem irrelevant, in the grand scheme of things they are an essential business requirement. A business requirement is not a goal or an objective, but rather a necessity for ensuring that a business model can succeed. The utility business model is not complex: it is to acquire assets and operate them in order to provide drinking water and sewer service to customers in exchange for a fee. That is all: Acquire assets, operate them, pro- vide service, get paid. Fail to do any one of these things, and your business will fail.

Most government-owned water and sewer utilities have failed in the getting-paid category. The latest Community Water System Survey conducted by the U.S. Environmental Protection Agency collected data from the nation’s water utilities in 2006 (the results were published in 2009). The report showed, among other things, that government utilities, on average, were in the red on an operating basis. “In the red” is a not-so-technical accounting term that means the utilities were losing money—that it cost them more to operate their systems than they received in payments from customers’ bills.

The ‘True Value of Water’

The low price of water and sewer service has prompted many in our industry to champion a slogan (one that I personally dislike) called “the true value of water.” If only we could charge customers for the so-called true value of water, the argument goes, we could fix our ailing infrastructure, have no problems meeting all those regulations and, depending with whom you speak, save the world from water shortages while curing any other social and economic evils created by the collective anti-wisdom of utility bills past.

I would settle for just charging for the actual costs. Presumably, the “true value of water” is something higher than the actual cost. But because not enough utilities are recovering even those costs, a debate over charging more would seem to be, well, kind of silly ... in the grand scheme of things.

After all, if communities are loath to pay even enough to recover the costs, what exactly is going to moti- vate them to suddenly start paying for the “true value” instead?

Cost-of-Service Rate-Making

There are plenty of reasons—too many to discuss here—why we do not want utilities, public or private, to determine the value of their services. As monopolies, utilities are in a special category of business—one that as a society we have come to learn through economic theory and in actual practice is not self-regulated by the market powers that apply to other types of commerce. Instead, we have reached a compromise with utilities that allows them to recover their costs. The normal process for determining utility rates commonly is referred to as “cost-of-service rate making” for this reason.

Utilities have cost-of-service rate-setting methods at their disposal. The American Water Works Assn. publishes generally accepted methods for drinking water utilities, and the Water Environment Federation publishes a similar guide for wastewater utilities. While those resources are helpful, the legal doctrine for cost-of-service rate-making predates those publications by decades. In the grand scheme of things, cost-of-service rate-making has been around in the U.S. since the 19th century and the creation of the country’s first public utilities. Cost-of-service is nothing new or special; it is not that difficult, and it can be implemented effectively in every case.

The failure of water and sewer rates in America is front and center in the industry’s great issues, although one would not know it in the grand scheme of things. As an industry, we do not believe we have enough money to deal with things like a major gap in funding the replacement of aging infrastructure. The U.S. Conference of Mayors estimates that gap to be at $3 trillion over the next 20 years. The seemingly insurmountable mountain of cash required has led many to advocate for increased government grants; new banks cap- italized and run by the Treasury Department for making loans to local water and sewer agencies; and still other expansion and/or creation of government programs to pick up the slack.

Virtually nowhere are solutions proposed encouraging utilities to charge for the full cost of the services they provide. Dr. Janice Beecher of the Institute of Public Utilities at Michigan State University recently wrote in “Primer on Water Pricing” that “Translating costs into rates requires a willingness to charge on the part of utilities.” So true.

In the grand scheme of things, what really ails the industry is not lack of access to financing, or any kind of funding gap for aging infrastructure. Why do those issues exist in the first place? They exist because of broken utility business models, made so by unsustainably low prices for service. But if rates have been a lingering weakness, they also can be one of the industry’s most important strengths, if only we are willing.

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About the Author

Jason Mumm

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