Luke Eastman, Consultant (Email)
The magnitude of this pandemic is unprecedented, causing unexpected, abrupt changes to water utility consumption and revenues. But this is not unfamiliar territory for utilities. The severe drought of the mid-2010s and lessons learned from that crisis can shed light on how utilities can respond effectively to this pandemic today.
At the start of 2015, nearly 30% of the western United States was in moderate to severe drought1, putting tremendous pressure on utilities to protect their vulnerable water supplies. In response, California Governor Jerry Brown imposed a 25% reduction in total water use for 400 water supply agencies in the state.2 In a remarkable show of action, most utilities met the reduction goals, with some agencies reducing consumption as much as 36%. However, the collateral effects of this order on utilities soon became clear – they saw their primary source of revenue – the sale of potable water – reduced dramatically and for an uncertain amount of time. In addition to the drop in revenues, many utilities experienced increased costs related to drought mitigation measures. Decreased revenues and increased costs created a communications difficulty – utilities found themselves thanking the public for using less water, then asking for a rate increase to recover revenue lost from conservation.
Industry experts predict that COVID-19 will also produce shocks to consumption, revenues, and operations. In areas with stay-at-home advisories for non-essential workers, residential water use is expected to increase while commercial and industrial consumption is expected to drop precipitously. The uptick in residential consumption from increased washing and cooking is unlikely to replace the consumption by large commercial and industrial operations. Additionally, utilities will find that their largely fixed costs have not relented, and that some budget items will increase, such as overtime for operators and technology investments.
Western utilities that successfully faced the drought can show us the way forward for COVID-19. Some of the key lessons of the drought are described below.
Lesson 1 – Now is the time to use reserve funds
Many utilities have cash on hand in reserve funds designated for rate stabilization, operating emergencies, capital expenditures, or other uses. Unexpected expenses or drops in revenue because of COVID-19 could easily justify use of reserve funds until the pandemic is managed. Though the financial impacts of COVID-19 may be swift, utilities would do well to cushion customers from the impacts when possible. Just as well-managed utilities were able to survive the drought by drawing upon reserves, the same should apply in the face of COVID-19. Better times in the coming months will allow for those reserves to be restored.
Lesson 2 – Understand your worst-case scenario
Uncertainty about what the future holds is another similarity between COVID-19 and the western drought. In times of great uncertainty, it is necessary to define the worst-case scenario and what that means for your utility. Now is the time for utility managers to consider scenarios such as: what would happen to my utility’s finances if commercial and industrial water consumption dropped 90% for three months? One Raftelis client in California has assumed this to be the case and is adjusting operations accordingly.
Doing stress-testing can help a utility understand how sensitive it is to the effects of COVID-19 and can “bracket” the future. This helps prepare for the worst, but hope for the best. Raftelis recently wrote a report for the American Water Works Association and the Association of Metropolitan Water Agencies modeling the financial impacts of the COVID-19 crisis on water utilities. The report estimated that on average, water utilities will see a reduction of water revenues by 17%. However, utilities would be wise to assume a much worse scenario than the average to assure the future viability of their finances.
Lesson 3 – Communicate utility needs to customers
Some utilities may understandably find themselves with operational and financial problems now, just as with a drought. If the utility has already used reserve funds (or perhaps never had any) and explored external grant and debt funding, a rate increase may be necessary. No utility manager wants to communicate a rate increase to customers during economically challenging times such as these, but if the situation is unavoidable, it is best to be honest and upfront with customers. If a rate increase must be implemented, utilities should consider restructuring rates to provide essential service at the lowest possible cost, such as with a “lifeline” rate for residential customers.3 Additionally, utilities could consider a bill round-up program to eliminate past-due charges for needy customers. In any case, if the utility is not proactively communicating the challenges it is facing, it is unlikely to find public support when it is most needed.
The water industry is scrambling for a playbook to confront COVID-19. Unfortunately, there isn’t one. Though uncertainty remains, practical experience can offer a guide. We would be wise to learn from other disasters such as drought that our industry has faced before. Drought taught us that now is the time to use reserves, prepare for the worst-case scenario, and communicate to customers. The water industry has beaten severe drought before using these strategies; it is now the time to consider using them against COVID-19.
2 Nagourney, Adam. California Imposes First Mandatory Water Restrictions to Deal With Drought. New York Times. April 1st, 2015. https://www.nytimes.com/2015/04/02/us/california-imposes-first-ever-water-restrictions-to-deal-with-drought.html