Periodically, RFC receives questions regarding various aspects of utility finance. We welcome these inquiries and address them in the forum below. Please check back frequently for additions to list of topics.

If you would like to pose a question to one of our experts, please contact Peiffer Brandt (pbrandt@raftelis.com or 704-373-1199).

You may follow the link below to investigate the following topics:

• Conservation Rate Structures

What are the characteristics of different conservation rate structures?

Water is an increasingly valuable commodity.  As a result, more utilities are implementing programs to ensure that water is used as efficiently as possible.  Many of these utilities have found that conservation pricing is integral to the success of their overall conservation program.  The inclusion of a pricing component ensures that customers are receiving the appropriate financial signal — that discretionary water use comes at a higher unit price. There are a number of approaches to implementing a conservation rate structure.

Uniform Rate Structure
While not typically considered a conservation rate structure, uniform rates are often utilized as a transition structure from declining block rates, in which the volumetric rate decreases as consumption increases, to a more conservation-oriented structure.  This structure only promotes conservation for those customers whose true unit cost of service is below the uniform rate per unit.

Increasing Block Rates
Increasing or inclining block rate structures price water at increasingly higher per unit rates as consumption increases.  The price of water for essential use is less than discretionary use.  Typically, water for essential use is priced below cost of service to reward users that are responsive to conservation initiatives. 

Increasing block rates are the most common of the various conservation rate structures with approximately 36% of the 230 utilities that responded to the 2006 RFC/AWWA Water and Wastewater Rate Survey using some form of increasing block rate structure.  Increasing block rates are an effective conservation rate structure and send a clear message that excessive water use will result in a high water bill.  The strength of the conservation message can be impacted by the rate differential between blocks.

Seasonal Rates
Seasonal rates, or rates that fluctuate according to the time of year in which water is consumed, can have conservation benefits for utilities that have significant fluctuations in usage during different times of the year.  Since facilities are constructed to meet peak demand during the “season”, a large portion of the capacity remains idle during the “off-season.”  Peak demands are created through lawn irrigation, additional water usage for sanitary purposes, pool usage, seasonal industrial operations (canning, fishing, etc.), and tourist impacts in resort areas (skiing during the winter, water sports during the summer, etc.).  Higher rates during the peak season not only encourage conservation during the peak season, but they also allow the utility to recover the costs for the facilities needed to meet peak demand from the customers that cause the peak demand.

There are two types of seasonal rates.

• Specific seasonal rates where there are two distinct sets of rates or two rate structures, one for the “season” and one for the “off-season”.
• Surcharge rate approach where consumption above a threshold is charged a higher rate during the season.

Marginal Cost Rates
Marginal cost pricing involves setting rates equal to the cost of the next unit(s) of service, whether that next unit is provided using existing facilities (short-term marginal costs) or new facilities (long-term marginal costs).  This pricing approach is based on relatively complex economic theory and is only used by a few utilities in an effort to achieve specific demand management goals. 

Marginal cost pricing is a relatively new concept for the water industry, but theoretically it should be effective in managing demand.  In fact, it is more accurately characterized as a “demand management” rate as opposed to “conservation” rate because there are some circumstances in which marginal cost pricing may actually encourage increased consumption.  For instance, if a utility has significant capacity already available in its system, marginal cost pricing could result in rates that are below average cost thereby encouraging customers to consume water up to the available capacity.  However, once that capacity has been utilized, the next increment of capacity must be provided by new facilities at a much higher marginal cost, therefore the rates associated with that capacity would be significantly higher.  This differential between long-term and short-term marginal costs can lead to serious rate equity issues and makes the implementation of marginal cost rates very complex.

For more information regarding Conservation Rates and the advantages and disadvantages of each rate structure method, please contact Peiffer Brandt (pbrandt@raftelis.com or 704-373-1199).