“The popular explanation for the water crisis –- lack of rain -– is clearly inadequate…. But why do Californian’s use so much water? An underappreciated explanation is simple: Water prices have been held down below cost by political forces and by past water infrastructure subsidies covered by taxpayers across the country….“A better solution than water policing? Raise water prices until they hurt (or at least go high enough that Californians notice) – and spur conservation.”
— Kathryn Shelton and Richard B. McKenzie, “The California Water Crisis: Policing or Pricing?”, September 1, 2014.
Water economists from both sides of the political spectrum are claiming that one reason California water use has actually increased one percent in a drought this year is that municipal water rates are too low. Free-market think-tank scribes and water economists, joining with those who advocate government solutions to drought, have called for higher water prices not by market but by government coercion.
Shelton and McKenzie don’t believe that urban water policing will work as well as would raising water rates in a drought. They see low urban water rates as the culprit:
How low are water prices? Very! In San Diego and Los Angeles, cities with arid climates in years with ‘normal’ rainfalls (10.34 and 14.93 inches, respectively), the price of water is significantly less than 0.7 cents per gallon (even after rising modestly 8-10 percent over last year). San Francisco, which gets almost twice the rainfall of San Diego and close to the average for the state (21 inches a year), has a slightly higher price but still below a penny a gallon. Such low prices hardly send a signal that water is as scarce, or valuable….
Water Bills to $23,040/Month?
Shelton and McKenzie imply, but do not directly state, that water should be priced at least as high as the average price of gasoline. Gasoline is running at $3.84 per gallon as of September 1 in California. At that price a family of four using 50 gallons of water per day would end up with a monthly water bill of $23,040! (50 gal. x 4 x 30 days x $3.84 per gallon). I don’t think this was the authors’ intent but it is sloppy to compare prices of public and private goods.
Nonetheless, are California’s municipal water rates too low? The table below summarizes municipal water rates for various cities taken from the Circle of Blue Retail Water Price Survey used by Shelton and McKenzie. Water rates are arrayed from low to high.
Circle of Blue Retail Water Pricing Survey 2014 – Monthly Water Rates (Low to High Rates)
| (a)City(Water Sources) | (b)Rate Structure | (c)50 gallons day x 4 persons/dayx 30 days6,000 gal. | (d)100 gallons day x 4 persons/dayx 30 days12,000 gal. | (e)150 gallons day x 4 persons/dayx 30 days18,000 gal. | (f)Equivalent Price per Acre Foot |
| Fresno(Groundwater &Federal) | Uniform Rate | $19.38$0.0032 gal. | $28.26$0.0024 gal. | $37.14$0.0024 gal. | $782 to $1,042 |
| San Jose(Hetch Hetchy, State & Local) | Increasing Block Rate | $32.20$0.054 gal. | $56.43$0.0047 gal. | $83.49$0.0046 gal. | $1,499 to $2,217 |
| Los Angeles(State & LA Aqueduct) | Seasonal Increasing Block Rate | $36.53$0.0061 gal. | $75.98$0.0063 gal. | $122.41$0.0068 gal. | $1,987 to$2,215 |
| San Diego(State & Colo. RiverAqueduct) | Increasing Block Rate | $49.77$0.0083 gal. | $89.37$0.0074 gal. | $150.15$0.0083 gal. | $2,411 to $2,704 |
| San Francisco(HetchHetchy) | Increasing Block Rate | $48.50$0.0081 gal. | $92.50$0.0077 gal. | $136.50$0.0076 gal. | $2,476 to $2,639 |
| Source: Circle of Blue Water Rate Survey 2014 |
In Table 1, retail water rates range from a low of $782 per acre-foot for city water in Fresno to a high of $2,411 per acre-foot for San Diego for a family of four each using 50-gallons of water per day. The reason that Fresno has lower rates is because it mostly depends on cheap, local groundwater and imported water from the Federal Central Valley Project.
In contrast, the reason that San Diego’s rates are higher is because they have to rely on almost 100 percent imported water that has to be conveyed hundreds of miles. Water rates are based on recovering fixed costs not on open market prices like gasoline or milk. Water is free but municipal water rates are a reflection of the fixed costs to capture, store, convey, treat, and distribute water to customers without profit.
Next, Shelton and McKenzie committed a mathematical error in their analysis of the retail price of water. They reported water rates in tenths of a cent per gallon instead of the thousandth of a penny used in the Circle of Blue survey. So ironically, their reported water rates, which they say are too low, are actually wildly inflated by a factor of 105 times the actual unit price.
For example, the authors say that the $1.48 for 780-gallons of water in Irvine reflects “0.2 cents per gallon” (2/tenths of a penny) when the correct number is $0.0019 per gallon, or 19/1000’s of a penny per gallon ($1.48/780 = $0.0019). Again, this error isn’t fatal to their argument but it is sloppy analysis.
Water rates per gallon are deceptive because a tiny water rate is multiplied by a large number of gallons of water used each year, typically one-half acre-foot of water or 162,926 gallons/year per urban household. So a rate of, say $0.002 per gallon (2/1000 of a penny) equates to about $27 per month water bill but an increase to just $0.008 (8/1000 of a penny) per gallon equals $109 per month. This is why water rates are often calculated on an acre-foot foot basis, which is an acre of land one foot high in water.
Municipal Water Rates Typically Rise in Advance
Like the stock market, local government typically adjusts retail water prices in advance of a water shortage, or directly thereafter, because public utilities can’t run operating budget deficits or use bonds to defray operational costs. So the scarcity of water due to drought and state and federal curtailments of water deliveries has already been internalized into municipal water rates.
For example, Los Angeles increased water rates 15 percent in 2009, cut back water deliveries, and consumption by customers was reduced 20 percent.
This also holds true for agricultural water rates. There is no need to artificially raise farm water rates in most cases because water auctions and water transfers during the drought have already increased water rates from a few hundred dollars an acre foot to over $1,000 per acre-foot. The market has already adjusted agricultural water prices for water auctions. Moreover, raw water rates cannot be compared with fully treated water rates in cities as Shelton and McKenzie improperly do.
Are Municipal Water Rates Politically Depressed?
The reason that water usage has increased 1 percent in a drought is because California is experiencing historic hotter temperatures and farmers and cities have both shifted to groundwater supplies. Thus, even with 10 to 20 percent reduction in urban water consumption total water usage is up but not because water rates are too low.
Setting different tiered rates for lower use ratepayers is the only way local politicians can lower water rates below costs. The water rates shown in the table above are regressive in Fresno, San Jose, and San Francisco and usage-neutral in Los Angeles and San Diego. Thus, relying on local government to set higher water rates would have to come to understand the brutal reality of city power structures and cost shifting to keep large industries and businesses from moving where water rates are more favorable.
Hypothetically raising water rates to market prices can be done at the wholesale level or in defined agricultural irrigation districts but not at the municipal retail level because there is no feasible market competition. This is why municipal water departments are “natural monopolies” that occur when one firm unavoidably dominates an industry. Introducing a competitor firm would create large inefficiencies of two sets of pipelines, water treatment plants, sewer plants, water tanks, redundant personnel costs, etc. Water transfers can help in a drought, but again prices are typically set by recovery of fixed costs plus conveyance costs. Auctions are often used in droughts but the resulting prices typically reflect “duress value” not Fair Market Value.
For the most part, municipal water systems are not under funded unless sometimes electricity rates are used to keep water rates low. 83 cities and 1 county in California tack a Utility User’s Tax on water from about 5 to 10 percent already to transfer into each city’s general fund. That tax hasn’t been known to spur conservation.
In an ideal water market, water from low agricultural users would be traded to higher paying urban users in a drought. Thus, the problem of drought would be a distribution problem not a scarcity problem. But California’s North Coast Hydrological Region gets about 27 percent of average rainfall and 37 percent of all unimpaired available water, but has no infrastructure to convey water from the Russian River to the Central Valley or Los Angeles (see Ellen Hanak, Managing California’s Water, 2011, p 72).
The same holds true for about most of all unregulated groundwater basins that are located in isolated areas with no way to transfer water to California’s huge hydraulic water system. Groundwater regulation won’t facilitate water markets but may lead to more political redistribution of water and thus more vulnerability to drought.
Raising water rates in a drought is a pseudo-market solution that would just lead to more divvying up of excess water revenues to free riding political constituencies such as commercial fishermen, Indian Tribes, environmental studies and monitoring, and water-oriented tourist real estate development. The more free riders, the more water is politically allocated and the more farms and cities are vulnerable to drought. Long-term studies indicate raising tiered water rates for higher usage doesn’t deter water usage anyway.
Arguably, loading “water conservation surcharges” into water rates, that are unconnected with recovering the cost of public utility operations, should not be called a rate increase but a “tax,” requiring voter approval under California Proposition 218.
Any notion of selling government wholesale water allocated to the environment back to farmers at duress draught water prices is fraught with double payment by farmers that have already paid for the water once to maintain California’s Central Valley Project. Such sales would not reflect fair market pricing and are probably illegal under the eminent domain “project influence rule.” You can’t take water from farmers for a public purpose to protect fish and thus create an artificial scarcity and then charge farmers the scarcity price.
Conclusion
What California needs are more private market solutions for adding to water supply, such as what the City of San Antonio, Texas is pursuing.
We should be skeptical of most calls for raising water rates for conservation purposes. Paraphrasing Chuck Reid, in theory there is no difference between water-market pricing theory and practice; but in practice there is.
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Wayne Lusvardi valued land and water rights for one of the largest water agencies in California for 20 years.
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