Years—even decades—into on-again, off-again drought planning and restrictions in the Western U.S. mean water utilities are looking beyond short-term fixes. Although water supply planning has been following this trajectory for years, financial strategies have been slower to follow this path. Many utilities have adopted “drought rates” and have them ready to go should they need to help curb consumption and pump-up revenue in the short-term. We sat down with two of our California utility financial consultants—Steve Gagnon in Los Angeles and Kevin Kostiuk in Santa Barbara—to talk about how they are now advising clients to look beyond drought rates toward long-term financial strategies that can help build financial resiliency that aligns with the integrated water resource planning we’re seeing now.
Steve Gagnon: As a drought looms, we see utilities seek assistance with drought rates. However, drought rates are a tough political sell and while they may be requested by staff, we often see elected officials hesitate to implement them. Two often overlooked ways to prepare for a drought are rate stabilization reserves and adjustments to fixed charges. A rate stabilization reserve is a bit more covert way to combat lost drought revenue.
Kevin Kostiuk: I see utilities looking at this as a spectrum. In the short-term we have drought rates for the crisis, but rate stabilization reserves and rate structures that have higher fixed charges in the medium-term, and water demand offsets land on the long-range planning part of the spectrum where development contributes to the new water sources required to meet future demands.
Steve: Rate stabilization reserves create funding that you can dip into when you need it instead of going to the Board to adjust rates. This means you can use these reserves discreetly to protect customers from sudden rate changes to fund a shortfall in revenue. One client we have in Southern California uses their reserve to hedge against cost increases from their water supplier. A portion of the rate revenue coming from customers is dedicated to that rate stabilization reserve, then if the water costs are higher than they planned they have the reserve to draw on and don’t have to go to their customers for a rate increase. It’s challenging to plan for a rate stabilization reserve however, when the goal is to always minimize rates.
Kevin: Communicating the benefits of rate stabilization reserves is important so that customers understand that they are there to protect them. To the utility it is easier to put money in reserves for future shortages. Without strong communication about the benefit of a rate stabilization reserve you risk creating the impression that you are just putting money away to put money away instead of proactively planning for the next inevitable drought and mitigating the impacts when it arrives. We have to communicate the benefit of this strategy to build trust with customers.
Steve: Some agencies are increasing their fixed charges. We are also seeing interest in collecting capital charges through the yearly county tax bill which may be a result of high bill delinquencies during the pandemic. Each of these has pros and cons associated with it. Increasing the fixed charge lowers affordability for customers with low water demand and collecting capital costs through tax rolls collects those costs differently than if collected through a combination of fixed charges and a volumetric rate. The upside is you might avoid having to rely on drought rates and have more secure revenue.
Kevin: The idea of growth paying for growth will always be popular, especially in the West where population growth in some areas continues to boom. One of my clients had an issue with wastewater discharges that required them to find a new way to look at this resource. That wastewater will now be indirect potable recycled water and this new water system will essentially reduce the pressure to build a new water supply, but the infrastructure required for this is extremely expensive for the community. Future development is expected to pay a large share of the cost of this new water system through a specific water supply impact fee.
Steve: The idea is if you have a new development, you can’t develop without bringing your own water to serve that development, so you must buy conservation offsets – think of it as a net zero fee to buy into the system. Water demand offsets fund new water whether that’s groundwater or imported water or it funds a conservation program to help free up current water demand for use elsewhere.
Steve: Drought rates remain politically unpopular when it comes to pushing “go.” Many of our utility clients tell us to calculate them, but then everyone gets a little squeamish to start charging them. Especially when you have a big conservation program in place and your customers have done their part. That’s why we remind people that there are other things we can do beyond drought rates.
Kevin: Through a deliberate process we can get to the same place without drought rates as we do with drought rates. Agencies across California have recently updated their Urban Water Management Plans (UWMP) as required by the state and have new guidelines on water shortage contingency planning. Overall, it calls for additional (sometimes significant) long-term reductions in per capita water demands. By adjusting our baseline demand expectations our standard rates account for a future of less demand through higher rates without having to “sell” another, often unpopular, rate component.
Kevin: In theory, drought rates are the easy button. The agency doesn’t have to propose them until they need to, then they can utilize them to deal with the crisis, and this type of rate change can be tied to an emergency, so it can quickly be rescinded when the emergency ends. So drought rates, I think, are here to stay. But it’s not people using water in that first tier that causes a utility to ask for demand reductions. In California, from a Proposition 218 standpoint we need to ensure rates are cost-justified and that we are not subsidizing one group of users by charging another. But I think there are ways we can tailor our approach to exempt that first tier, or first number of billing units, and make it defensible with our very strict cost of service requirements. That means those customers who have really taken conservation to heart to reduce their usage would be protected to some extent.
Steve: One thing people often forget is drought rates are not designed to increase a customer’s bill. If a customer reduces water use, they will pay either the same or less as their pre-drought bill. However, it is still a tough sell, to pay the same for less water. Drought rates should also follow cost of service principles, just like regular non-drought rates. What I’ve done for some utilities is apply drought rates in proportion to the rates in the current rate structure. That way the drought rates are applied similar to the overall cost of service.
Steve: In terms of labor and materials, there may be, but I often hear that cost may go up during a drought if an agency must hire more enforcement staff. In any case, it creates goodwill if an agency can show that the water agency has taken steps to take some of the pain away by reducing costs in some way.
Kevin: There’s one area that often goes overlooked when it comes to thinking about cutting costs, but we’re seeing more and more of it, and that’s regional collaboration and partnerships. We’re more likely to see this in water supply planning as agencies become more proactive. As they turn to brackish groundwater treatment, indirect potable reuse, and desalination the project costs can be so large that it only makes sense to spread the benefits to a region. Regional collaboration and shared services projects can have significant benefits in terms of keeping costs in check for operations as well. But this is very much a long-term strategy.
Steve: Communicating the value of the service they provide. Regardless of the financial strategies you use to overcome our frequent droughts you’ll need to gather support for what it is that you need to accomplish whether that’s a diversified water supply or infrastructure investment. We know that will go better if you have the community understanding and support. The best way to do that is to start communicating right from the beginning—don’t wait until you have the answer and just tell customers about it. Bring them along the journey with you.