The Economic Quandary of Water

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Written by: Robin Gilthorpe

The economics of the water industry are well represented by Churchill’s famous description of Russia: “a riddle, wrapped in a mystery, inside an enigma.” It’s genuinely difficult to deconstruct the underlying economics of so many elements of the industry: Costs for variant supply sources, treatment chemicals and pumping energy, as well as subsidies, rate structures, infrastructure amortization, bond financing and many other financial factors. However, it’s clear that the status quo isn’t sustainable. We can’t keep water this cheap and still maintain safety and abundance. But there’s a path out if we base decisions on complete data and communicate clearly and accurately with consumers.

Water utilities have done an amazing job of ensuring reliable and safe water service, to the point where it has become a figure of speech. No Silicon Valley fundraising pitch passes without the inevitable Uber reference, and their mission statement is: “Transportation as reliable as running water, everywhere for everyone.” That’s a great vote of confidence for an entire industry, but it’s built on a series of misunderstandings:

  1. As a consumer, you don’t pay for water.  You essentially pay for the power, chemicals and labor required for treatment and conveyance.
  2. In many cases, your water bill didn’t pay for the infrastructure of water delivery. Much of the distribution network was built with taxpayer money, most of it at the federal level, for projects by the Bureau of Reclamation or the Army Corps of Engineers. Very few of those projects make economic sense.
  3. Water isn’t a commodity. It’s a precious, limited resource. Some is renewable (surface water, recycled water, desalination, etc.) and some isn’t (this applies to significant amounts of groundwater). Using “fossil water” for ongoing needs is like going to the loan shark for grocery money – it’s going to end badly.
  4. Utilities don’t price water at the true marginal cost of procurement. Price controls destroy willingness and ability for producers to supply resources, like in Venezuela for example. Net investment in water infrastructure barely keeps up with depreciation; the clue is the recent spikes in water main breaks and water quality alerts.

While there’s no quick fix, the first rule when you’re in a hole is to stop digging; we can get water infrastructure financing back on a sound foundation to attract new capital and improve the productivity of existing investments. This requires fundamental, but achievable changes in the industry:

  1. Utilities need better tools to prioritize project investments. Supply-side projects take years (or decades) and often cost hundreds of millions of dollars, but support systems to model future demand and cash flows aren’t robust. This puts utilities at a disadvantage in funding projects through retained earnings or debt financing.
  2. Utility pricing for consumers needs to change.  Fixed costs dominate expenses, but most utilities generate the majority of revenue through volumetric fees. Rebalancing towards a higher fixed charge isn’t a panacea, but it would improve revenue predictability and more accurately reflect the underlying economics of supply, similar to your monthly cell-phone bill. Improved analysis across the whole service area of a utility, with an ability to dive into specific cohorts and benchmark against comparable utilities nationally, would facilitate this transition. More realistic accounting for total costs would also put utilities on a more secure foundation, without necessarily requiring mass consolidations.
  3. The rate making process should be more nimble and robust. New price schemes are submitted for review and approval on a multi-year cycle. Approvals or rejections are most often based on political expediency rather than underlying economics. Even annual reviews seem quaint to generations raised on real-time financial platforms such as eBay and Priceline. Requiring dynamic modeling of 10-year impacts would be an additional step toward long-term accountability.
  4. Social equity needs to be accounted for. One of the problems with higher fixed fees is how they may affect disadvantaged communities, where there may be genuine obstacles to bill payment. A combination of measures including accurately targeted “lifeline” rate programs, assistance with conservation behaviors, and rebates for more efficient fixtures can help prevent an unreasonable burden on the least fortunate.
  5. Customer engagement needs to be a priority. Water utilities have a tradition of “silent service” that’s noble and well intended, yet counterproductive. If you only hear from your utility when there’s bad news then you’ll avoid future contact. That’s a terrible basis for a relationship and makes it harder to navigate some of the other necessary changes discussed here.  Water utilities can borrow from experiences of other industries to engage in more cost-effective targeted communications (and more robust proof of viewership) than traditional “billboard & bill insert” one-to-many approaches.

 

 

Churchill may have found Russia puzzling, but Lenin demonstrated his understanding that the existence of entrenched interests means change happens imperceptibly at first and then suddenly, when he stated, “there are decades when nothing happens, then weeks when decades happen.” This also applies to the water industry; it’s incumbent on this generation of policy-makers and influencers to ensure that we help all stakeholders navigate these waters successfully.

Editorial economics of water industry rate making process utility pricing customer engagement