What Regulators Need to
Know about Drought
Janice A. Beecher, Ph.D.
Director of the Institute of Public Utilities
Michigan State University
Summer 2002
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Session - 1
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Session - 2
Drought attention span
drought
rain
Attention
Time
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Session - 3
Characteristics of water use
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Per-capita water demand is flat
Significant weather-related variations
Opportunities for growth are limited
Fixed cost are high and rising
Pressure on rates is significant
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Session - 4
Daily Per-Capita Withdrawals in the US:
1950 to 1995
Gallons per capita per day
2,000
1,800
1,600
Total
withdrawals
1,400
1,200
1,000
Total
freshwater
800
600
Consumptive
use
400
200
Public supply
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1995
1990
1985
1980
1975
1970
1965
1960
1955
1950
0
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Session - 5
Water and weather
 Water is transient in time and space; droughts
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are inevitable
Mother nature controls supply and demand;
supply is constrained just when we need it
Water quality and water quantity are related
Environmental externalities of water usage are
exacerbated during drought
For utilities, rainy weather is a problem when
sales are down (“excess inventory”)
Drought is a problem when the state imposes
restrictions (artificial “demand repression”)
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Session - 6
Weather and water sales
 Rain
 Sales down
 Drought
 Sales restricted
 “Normal”
 Sales may be
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affected by
conservation
behavior
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Session - 7
220
212.9
215
208.7
207.2
210 208.2
206.1
203.9
202.4
201.8
199.5
205
200
208.6
204.9
200.7
201.2
200.0
199.6
194.3
195
194.0
190.1
190
185
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1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
180
1980
Gallons per connection per day
Residential Water Use per Connection:
American Water Works Service Company, Inc.
(1980 to 1997)
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Session - 8
Water efficiency/conservation
 Any beneficial reduction in water waste or
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water usage; emphasis on efficiency
Marginal benefit exceeds marginal cost
Broadly defined to include externalities
Should not imply an impairment of lifestyle
or economic activity
Loss of “excess capacity” or “demand
hardening” should not deter conservation
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Supply Capacity and
Demand
Benefits of conservation
Supply without
conservation
Supply with
conservation
Demand
without
conservation
Demand with
conservation
1
3
5
7
9
11
13
15
17
19
Planning Year
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Conservation v. drought management
Conservation
 Long-term
 Choices are well
informed
 Pricing plays a
central role
 No impairment
 State role is less
direct
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Drought
 Short-term
 Choices are
constrained
 Price is necessary
but insufficient
 May impair lifestyles
 State role is more
direct
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Session - 11
Role of pricing
 Pricing is a necessary but not always a sufficient
tool of efficiency/conservation
 Water use in generally price inelastic
 Outdoor use > indoor use
 Nonresidential use > residential use
 Even small price responses can be meaningful in
terms of revenues
 Marginal-cost pricing principles should be applied
 IOUs do not have clear incentives for efficiency
pricing
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Session - 12
Water rate design in the U.S.
Uniform rate: 36%
Increasing-block rate: 29%
Decreasing-block rate: 36%
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Session - 13
Efficiency pricing
Efficient
price
Price/
unit
Cost/
unit
Underpricing
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Costbased
pricing
Overpricing
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Session - 14
Increasing-block rate
Tier breakpoint
Price/
unit
Tier
Quantity consumed
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Session - 15
Seasonal rate
Price/
unit
Peak season
Off-peak season
Quantity consumed
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Session - 16
Excess-use and
water-budget based
Price/
unit
Excess use/use
above budget
allotment
Quantity consumed
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Session - 17
Marginal-cost pricing
Tail block
S3
Price/
unit
S2
S1
S = supply option
Quantity consumed
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Session - 18
Multi-objective rate (example)
Location/season
Hi cost
Mid cost
Low cost
Price/
unit
Consolidated
rate
Marginal
cost
Lifeline for
eligible
customers
Quantity consumed
Affordability >>>> Equity >>>>> Efficiency
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Drought pricing
 Short term implementation
 Fines and penalties
 Purpose is enforcement v. efficiency
 Revenue effect may be negligible
 May strain customer relations
 Non-price options (restrictions) may be
more effective and appropriate in severe
drought conditions
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Drought and revenues
 In the long run, all costs variable; in the short
run, many costs are fixed
 Many water utilities rely on revenues from
variable charges to cover fixed costs
 Mandated curtailments can impair the utility’s
ability to collect sufficient revenues to cover
costs, make needed investments, and earn a
fair return
 Revenue-adjustment (demand-repression)
mechanisms may be necessary
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Demand-repression adjustment
 May be needed to adjust rates and revenues
to account for revenue effects of:
 Conservation-oriented prices
 Drought-management policies (force majeure?)
 When water utility revenues are impaired by
state-mandated restrictions on usage during
drought, the state (PUC) also has a
responsibility to consider measures for
adjusting rates and revenues
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Adjustment eligibility
 Long-term water supply plan and
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compliance with all state requirements
Water-loss management (plug the leaks!!!)
Efficiency-oriented tariff based on
normalized weather
Public education effort
Subject to proof of impact, audit, and
reconciliation
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Conclusions
 Water utilities are unique in terms of
drought impacts
 Regulators must be aware of potential
revenue effects
 A carefully designed adjustment
mechanism could address revenue issues
and utility incentives for conservation and
drought management
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Some Publications
 Compendium on Water Supply, Drought,
and Conservation. (NARRI 1989).
 Revenue Effects of Water Conservation
and Conservation Pricing: Issues and
Practices (NRRI 1994).
 Handbook for Designing, Evaluating, and
Implementing Conservation Rate
Structures (California Urban Water
Conservation Council, 1996).
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www.ipu.msu.edu
beecher@msu.edu
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