FIXING RATES TO RECOVER FIXED COSTS WHEN WATER USAGE IS DECLINING

Historically, public utilities--particularly water utilities--have designed rates to recover most, if not all, their costs of service through volumetric usage charges. Under such a rate structure, for example, customers pay a rate per 1,000 gallons, or per 100 cubic feet, of water delivered. Some water utilities also impose a fixed flat rate called a customer charge, designed to recover meter reading and billing costs. Except for the customer charge, which typically is quite small, all costs of service are sought to be recovered under rates which vary with usage.

This historical rate design can be problematic today. First, it assumes that almost all of the costs of water service are variable costs and that fixed costs are minor. In a water utility rate case before a state regulatory commission, the president of the company testified that 90% of the utility's costs actually were fixed costs, not variable costs. He said that variable costs were only such items as power, chemicals and possibly some labor and maintenance. Therefore, he argued for a larger customer charge to recover fixed costs. Regulatory staff in the room laughed and opposed any increase in the fixed rate. Was he correct? Are not depreciation, debt service, return on rate base and some labor and maintenance incurred regardless of the volume of water delivered?

A second issue with the historical rate design is declining revenue due to conservation,more efficient water appliances and usage restrictions. If most of the costs of water service are designed to be recovered from usage charges, and usage has declined, then revenue necessary to recover costs of service has declined as well.

Recently, the Wall Street Journal reported that electric utilities across the country are experiencing these issues and are seeking to resolve them by substantially increasing their fixed customer charges.* Regarding customer charges, "the utilities argue that the fees should cover a bigger proportion of the fixed costs of the electric grid, including maintenance and repairs." One utility official is quoted as saying "Since our cost to provide service is mostly fixed, we think our rate design ought to reflect that more accurately"

The Journal article stated "The problem for utilities is that many consumers are using less power these days, in large part because appliances and equipment are getting more energy efficient....The rise of rooftop solar power in some parts of the country also is chipping away at power sales."

The article cites an opposing view that a higher customer charge to recover fixed costs would be a disincentive to customers embracing rooftop solar power or cutting down on their usage of electricity. This assertion, however, would seem to beg the question as to the adequate recovery of fixed costs of service in view of declining revenue. Water rates, as well as electric rates, should be designed to enable recovery of all costs of service, not to satisfy social or political agendas. Substantial fixed costs are incurred by water utilities to enable them to provide water service to customers on demand.
Fair rate design should reflect that reality and obligation.

_________________________________________

*Rebecca Smith,"Electric Utilities Seek
To Raise Fees As Usage Declines", Wall
Street Journal, October 20,2015,p.B5