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Title: Conservation and drought water rates : state-of-the-art practices and their application
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Title: Conservation and drought water rates : state-of-the-art practices and their application
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Language: English
Creator: Rawls, Colin
Borisova, Tatiana
Publisher: Water Institute, University of Florida
Place of Publication: Gainesville, Fla.
Publication Date: April, 2009
Copyright Date: 2009
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UF UNIVERSITY of
WUFLORIDA
Water Institute


C
CONSERVE FLORIDA WATER
Promobng Conservatln in Our Pubhl Water SuppIes


Conservation and Drought Water Rates:


State-of-the-art practices and their application



April, 2009






Prepared by:

Colin Rawls, graduate student
Tatiana Borisova, assistant professor
Food and Resource Economics, IFAS, University of Florida








Prepared for:

Conserve Florida Water Clearinghouse Research*
UF Water Institute

*In partial fulfillment of DEP Contract No. WM925


pg. 1














Conservation and Drought Water Rates: State-of-the-art practices and

their application


Project developed for UF Water Institute and Conserve Florida Water Clearinghouse

Colin Rawls, graduate student, and Tatiana Borisova, assistant professor*1
Food and Resource Economics, IFAS, University of Florida


Table of Contents


I. Introduction........................ .......... .................................. ....3

II. Study O objectives ............... .................................................................. ..................... .. ..........................
Ill. M e th o d s ......................................................................................................................... ..... ...... . .......... 4

IV R e s u lts ..............................................................................................................................................4

A T y pe s o f W ate r Rate s ............................................................................................ ..............................

B. Conservation W after Rate Structures ........................................................................ .......................6

C D ro ug ht rate s ...................... .. .................. ............................. ..................... ...........................................2 1

D. International Rate Design Practices ....................................................................... ........................23

V Research N eeds ....................... ....................... ............................. .. ........ ..................... ............................ 25

V I. Conclusion ............................ ................................................... ............................................ .................. 28

So urces used in the study: .................. . .................................................................................................................30

A appendix A W after Rate D design in Florida .......................................................................... ..............................37

A ppend ix B. D ecisio n Suppo rt Too ls ................................................................................... ............................ 3 9

Appendix C. Legal aspects of defining conservation rates in Florida ................................... ....................... 40

Appendix D. Prototype matrix with water rate structure recommendations...................... ................... .... 41

Appendix E. Examples of Rate Design in Other Industries. ................................................. ....................... 42




1 We greatly appreciate review and valuable suggestions by Bruce Adams, Water Resource Manager, EMC
Engineers, Inc.; Damian Adams, assistant professor, Department of Agricultural Economics, Oklahoma State
University; Sandy Berg, Professor, Economics Department, University of Florida (UF); Dave Bracciano, Demand
Management Coordinator, Tampa Bay Water; Norman Davis, Water Conservation Program Technical Director,
Hillsborough County Water Resource Services; Suzanne Goss, Legislative Affairs Specialist, JEA; James Heaney,
Professor and Chair, Department of Environmental Engineering Science, UF; Rui Marques, Assistant Professor at
the Technical University of Lisbon and Visiting Scholar at Public Utilities Research Center, UF; and Lisette Staal,
Research Coordinator, Water Institute, UF.


pg. 2









I. Introduction
As Florida continues to balance the need for growth with protection of its natural resources,
scientists and policy makers look more closely at the problem of balancing water use and water
resources available. Two approaches can be used by water managers to achieve this balance.
The first is supply increase through the use of traditional or alternative water sources. However,
alternative water sources are often associated with high cost (such as desalination of ocean
water), low reliability (such as seasonal variations in surface water storage), water quality
concerns (reclaimed water), or environmental degradation (e.g., due to withdrawals of water
from surface water sources).

The second approach is water demand management, which focuses on increasing water use
efficiency and water conservation in the short and the long term (Baumann and Boland 1997).
Currently, water conservation is seen as "...the most important action we can take to sustain our
water supplies, meet future needs, and reduce demands on Florida's fragile water-dependent
ecosystems" (FDEP 2008). Demand management strategies include educational programs,
financial incentives for voluntary water use reduction (e.g., for installing water-efficient home
appliances and fixtures), mandatory restrictions in water use imposed by water agencies, leak
detection, and price incentives through conservation water pricing. This paper focuses on
conservation pricing, which is included in recommendations made for a drought resistant Florida
by Conserve Florida work groups (FDEP 2007), and suggested by the Florida Section of
American Water Works Association as a strategy to achieve the Florida 2030 vision of
elimination of the "...wasteful, uneconomical, impractical or unreasonable use of water
resources" (Section 373.227, F.S., cited by FSAWWA 2008).

II. Study Objectives
The overall purpose of this synthesis paper is to identify and summarize state of the art
conservation and drought pricing practices, and explore the challenges and opportunities
associated with conservation pricing. The paper is designed to be a contribution to the Conserve
Florida Collaborative Research Agenda. The paper is also meant to serve as a reference for
utilities and regulatory professionals. There two specific objectives are:

1) to review state of the art practices for conservation and drought rate design;
2) to identify research gaps and needs for future research.


pg. 3












III. Methods
The primary method used in this study is literature review. About 90 academic
publications, government reports, industry articles, and relevant privately or publicly funded
studies conducted in the various US states and in other countries have been reviewed for this
study. In addition, this study incorporates information obtained through informal contact with
utility and regulatory agency representatives.

IV. Results

A. Types of Water Rates
Water rates are the mechanism through which utilities generate revenue to cover economic
costs and finance expansion. In this document and in the literature analyzed, "water rate" usually
refers to the rate per unit of water (e.g., thousand gallons or cubic meter) charged by utilities.
"Rate structure" usually denotes the change in the water rates as water use increases. "Fee"
usually refers to a payment that is independent from the amount of water used, such as a
connection fee. However, many literature sources use the words "fee", "charge", "tariff", "price"
and "rate" interchangeably.

The most basic type of water charge is a fixed fee (sometime referred to as "fixed rate").
With fixed fees, users pay a set amount regardless of water usage. This is usually a monthly fee,
although it can be weekly, biweekly, bimonthly, or quarterly. The advantage of fixed fees is that
they are easy for utilities to administer and easy for customer to understand. Their disadvantage
is that they provide no incentive for customers to conserve water.

With volumetric rates (also referred to as "variable charges"), consumers are charged in
proportion to their water usage. For example, a volumetric rate for residential users might be $5
for every 1000 gallons. Volumetric rates are generally charged on a monthly basis, depending
on billing software and frequency of reading dates. The precondition for a utility to use a
volumetric rate is the ability to meter customer water usage.

Most utilities use a combination of fixed fees (also referred to as "base charges") and
volumetric rates. These "hybrid" charges are appealing to utilities because the fixed component
can be used to cover fixed costs, such as infrastructure costs and capital expenses, while the


pg. 4










volumetric component can be used to cover variable costs, such as labor and pumping costs. A

residential hybrid rate structure can, for example, charge each household $10 a month regardless

of usage and $5 for every 1,000 gallons used. Some utilities include a minimum amount of

water consumption with their base charge. That is, volumetric rates take effect only when a

customer uses more than the minimum included in the base charge. Table 1 lists different water

rate structures and briefly explains them.

Table 1. Summary of alternative water rate structures

Rate Definition
Fixed Each user pays a fixed fee each month that does not change with the volume
of water use
Declining block Unit price for the last unit of water used decreases as usage increases from
one water usage block to the next
Drought or Water Water rates are higher during the times of drought or water shortage
Shortage
Inclining Block Unit price for the last unit of water used increases as usage increases from
one water usage block to the next
Indoor-Outdoor Prices for indoor use are lower than prices for outdoor use (does require
separate metering)
Excess-Use Price are higher for above-average use
Hybrid Combination of several designs, most commonly inverted block and fixed;
some utilities employ a hybrid of increasing and decreasing blocks where
rates increase or decrease for specific targeted blocks of consumption
Marginal Cost Pricing Rates that represent the marginal cost of water production
Marginal Opportunity Rates that represent the marginal cost of water production, plus the expected
Cost Pricing cost of water supply capacity expansion
Penalties Charges customers pay for exceeding allowable limits of water use
Reclaimed Separate rate for reclaimed water
Seasonal Water rates are higher during the season of higher demand (usually during
peak outdoor usage) than during the off-peak season
Sliding-Scale Unit price for all water use increases as water usage increases
Spatial Pricing Users pay for the actual cost of supplying water to their establishment.
Customers "inside" a utility's political jurisdiction usually pay less.
Scarcity Pricing Cost of developing new supplies is paid by existing users
Time-of-Use Water rates are higher during peak hours or days of the week
Uniform A volumetric rate that is constant regardless of usage.
Water Budget Inverted block rate structure in which the blocks are defined uniquely for
each customer, based on an efficient level of water use for that customer
Source: Beecher et al. 1994; Mayer et al. 2008; Nida and Eskaf 2009; Raftelis 2005; Stallworth 2003


pg. 5









In addition to base and volumetric water charges, many utilities in Florida use separate base
and/or volumetric sewage/wastewater charges to cover those services. These charges are
different from water rates; however, they are often included on customer water bills based on
water usage.

B. Conservation Water Rate Structures

B1. Definition of "Conservation Water Rate Structure"
Generally, any rate structure that provides an economic incentive to conserve water is
considered a conservation rate structure. On a more technical level, studies present different
requirements to conservation rate structures, focusing on the following main characteristics: (1)
the structural form of the volumetric water rates; (2) the proportion of volumetric charge in the
total customer bill; (3) the proportion of utility revenues recovered through fixed fees versus
volumetric rates; (4) effective communication of the price signal through consumer billing (see,
for example, AWE 2008, Beecher et al. 1994, Minnesota DNR 2008, Whitcomb 1999).
Structural form of the volumetric rates. By their structural form, conservation rates are
usually associated with uniform, declining block, inclining block, and seasonal volumetric rate
structures (often referred to as uniform, declining block, inclining block, or seasonal rates) (see
Table 1). With a uniform rate, the user pays a set charge for each unit of water used. Uniform
rates have the advantage of being relatively simple to administer and easy for the customers to
understand. Uniform rates also send the customers a usage price signal, since the total water bill
increases with increase in water consumption (AWWA 2000).

With declining block rates (also known as descending or decreasing block rates), the
charge paid per unit of water decreases at certain usage thresholds. For example, the rate may be
$3.00 per 1000 gallons for the first 10,000 gallons used, and only $2.00 per 1000 gallons for all
additional usage. Usage volumes up to such threshold form a "price block" (also referred to as
"tier"). The declining block rate volumetric structures are often used by utilities that need to

develop a single rate schedule for various customer classes served. Such structure can allow
utilities take into account the different costs and usage characteristics of all customers while
remaining equitable to all of them. For example, an initial block can be designed to recover costs
associated with the volumetric use of residential and small commercial customers, and
subsequent blocks can be selected to encompass the water use and associated demand costs of


pg. 6










industrial customer class (AWWA 2000). Declining block rates can be used when utilities costs
decline with increasing water usage (due to economies of scale), and when it is important to
provide price incentives to encourage large-volume customers to remain on the system (instead

of developing their own source of supply by drilling a well, for example) (AWWA 2000).
Declining block rate may also be used by utilities that need to encourage economic development
(Childs and Kramer 2008).

With an inclining block volumetric rate structure (also known as increasing, inverted,
ascending block rates), price for additional units of water increases at certain water use
thresholds (Figure 1). For example, the rate may be $2.00 per 1000 gallons for the first 10,000

gallons used, and only $3.00 per 1000 gallons for all additional usage.

Figure 1. Example of an Inclining Block Rate Structure

Conservation rate for potable water

$5.00
0 $4.50
S$4.00
0 $3.50
$3.00
a $2.50
$2.00
j $1.50
$1.00
$0.50
$-_
0 5 10 15 20 25 30 35 40
Thousand gallons/month

Source: McLarty and Heaney (2008).

Inclining block volumetric rate structures provide stronger disincentive to use large
quantities of water in comparison with uniform and declining block rate structures, and as a

result, this structural form is most commonly presented as a "conservation rate structure".
However, inclining block rate structures are difficult to design and administer, since they require
analysis of the water volumes sold per price block and demand responses to price differentials
between the blocks (AWWA 2000). Utility-wide application of inclining block rate structures

can also result in "...cost-of-service inequities, especially to commercial and industrial


pg. 7









customers... These customers may not impose costs on a water system proportional to the costs
implied by increasing block rates" (AWWA 2000, p. 99-100). Furthermore, if significant cost-
recovery depends on those consuming in the higher blocks, changes in demand (due to unusual
weather patterns, changes in population demographics, or changes in income) can lead to
revenue shortfalls. Advantages and disadvantages of conservation water rates will be discussed
in more details in the following sections.

Economic incentives to conserve water created for the customers by an inclining block rate
structure depend on the size and the number of the price blocks. The literature provides limited
recommendations for the design of inclining block rate structures. Chestnutt and Beecher
(1998), focusing on efficiency as the focus of rate design, recommend selecting rate structure in
such a way that the price of the last unit of the water consumed is equal to the additional (i.e.
marginal) costs of new supplies. Minnesota DNR (2008) recommends the increase in price
between the price blocks to be 25% or more, with 50% increase between the last two blocks.
Alliance for Water Efficiency (2008) recommends selecting the first price block such that
minimum water usage is provided to a typical household at a minimum reasonable price, and
setting the price increase between the blocks to be greater than 50%. Further, "an effective rate
design will have more than half of residential customers exceeding the first tier when the new
rate structure is first implemented, and at least 30% and 10% of customers using water in the 3rd
or 4th tiers respectively (at least during seasonal peak demand)" (AWE 2008). However, Nida
and Eskaf (2009) examined the rate structures used by North Carolina utilities and showed that
for majority of utilities, the first price block exceeds typical residential use. That is, the rates are
effectively uniform for the water usage below 15,000 gallons per month, and majority of
customers are unaffected by the higher price blocks. Similarly, in Georgia, Environmental
Finance Center (2007) reports that "a customer that reduces their consumption by 40% from
10,000 to 6,000 gallons/month is likely to receive the same reward, both in terms of total bill
reduction and percent bill reduction, whether they are being charged increasing block or uniform
rates" (p. 3).

With respect to the number of price blocks, Alliance for Water Efficiency (2008) suggests
that 3 to 4 blocks are adequate for an effective residential rate design, and a nation-wide survey
of water utilities by AWWA and Raftelis (2006) shows that for the surveyed utilities that use


pg. 8









increasing block rate structures for residential water supply, the average number of blocks is 3.8.
In Florida, Post, Buckley, Schuh & Jernigan, Inc (1998) used a computer model to examine
demand of single-family households in service area of eight utilities, and showed that the water
use reductions of adding a fourth block to a three-block rate structure are small.

Nation-wide surveys of water utilities indicate the drop in the use of declining block rate
structures for residential water services, and an increase in the use of inclining and especially
uniform rates (Table 2). In Florida, out of 16 utilities surveyed by Whitcomb (2005), 6 utilities
used uniform and 10 used inclining block rates for residential customers in 1998 (Whitcomb
2005). In 2008, from the same sample of utilities, 3 used uniform, and 13 used inclining block
rate structures (see table Al in Appendix A).

Table 2. Water Rate Structures for Residential Water Services: Results from Nation-Wide Surveys.
1996 1998 2000 2002 2004 2006
Declining block 36% 35% 35% 31% 25% 24%
Uniform 32% 34% 36% 37% 39% 40%
Increasing block 32% 31% 29% 32% 36% 36%
Source: AWWA and Raftelis (2006).

In the 2006 survey conducted by AWWA and Raftelis (2006), over 73% of the responding
water utilities indicated that they have the same volumetric structure for residential and non-
residential customers. The authors note that even under the same volumetric rate structure, the
exact rates are not necessarily identical for residential and non-residential customers. Utilities
that reported different volumetric rate structures generally shift from an increasing block rate
structure for residential customers to a uniform or declining block rate structure for non-
residential customers. For example, 36% of utilities have an increasing block rate structure for
residential customers, but only 23% have an increasing block rate structure for non-residential
customers (AWWA and Raftelis 2006). Wang et al. (2005) describe two utilities that experiment
with conservation pricing for their non-residential customers. In Cleveland (OH), inclining block
rate structure is used for industrial consumers, nearly doubling the price from the first block to
the next. Louisville Water Company (KY) uses a "pyramid block structure" that includes a low
rate per thousand gallons for both relatively small customers and very large customers, while
intermittent heavy users (such as restaurants) face higher water rates. "It is likely not accurate,
however, to consider pyramid block rates to be water conservation-oriented rates, as they result


pg. 9









in the highest consumers within the commercial class paying less per unit that those who use
less" (Wang et al. 2005).

Some utilities increase their rates or implement a new rate structure during specific seasons
of peak use (seasonal rates) or times of droughts (drought tares), to provide additional incentives
for water conservation. Of the 231 utilities surveyed by AWWA and Raftelis (2006), 36 reported
that they use seasonal rates. More in-depth discussion of drought rates is presented in section 4.7.

Some utilities are also experimenting with rate structures based on individual household
water budgets. "Water budget-based rate structures are also very effective in promoting
conservation, though more difficult to implement. In this design, each residence has an inclining
block rate structure designed according to its individual needs. The tiers are usually set based
upon the quantity of occupants and the square footage of landscape; known to be the two most
significant factors in residential water use. The prices of the tiers increase significantly (greater
than 50%) after the base usage tier is established. This rate system requires a robust billing
system to accommodate the quantity of individual rate structures (possibly equal to the quantity
of customers); and the system requires a formal process to establish each homes base water
usage, and respond to the many customers likely to appeal their base tier allotment" (AWE
2008). Establishing base water usage requires a judgment on what is equitable for each
household, and how to define base tire allotment without "penalizing" customers who already
use low water volumes (due to investments into water efficient home fixtures or due to house
characteristics such as the lack of ground irrigation system) (source: based on D. Bracciano,
personal communications).

Publically available modeling tools are being used to help utilities make informed rate
design decisions. See "Decision Support Tools" in Appendix B for more information.

The proportion of volumetric water charges in the total customer bill. In addition to
volumetric rates, almost all utilities charge fixed fees (also referred to as base, minimum,
monthly, or meter fee or charge) that are the same each billing period regardless of usage. The
fixed fee is almost always based on meter reading, billing, and collection costs. Many utilities
also include meter repair and replacement costs and a capacity charge in their fixed fee (AWWA
and Raftelis 2006). The Alliance for Water Efficiency suggests that conservation rates should be


pg. 10









designed so that a large portion (two-thirds or more) of the water charges are based on the
quantity of water the customer consumes (AWE 2008). According to the data from the nation-
wide survey by AWWA and Raftelis (2006), the monthly fixed fee for the median customer
($5.84) comprises 29.3% of the total water bill (1000 cubic feet or 7.5 thousand gallon of water
usage).

In addition to water charges, many utilities include wastewater charges in the total
customer bill. Wastewater charges are typically based on a percentage of a customer's monthly
water use (AWWA and Raftelis 2006). As a result, wastewater charges make the customers pay
more for the non-discretionary water uses in comparison with the discretionary uses (effectively
converting an inclining block into a declining block rate structure), and distort the economic
incentives to conserve water created by conservation water rates. For example, Gainesville
Regional Utilities (Florida) assess residential customers a wastewater charge of $4.94 per
thousand gallons, based on average monthly water usage or winter maximum water use,
whichever is lower. Consider a hypothetical household that uses 6 thousand gallons per month
in winter. This household would pay $6.53 per thousand gallons for their first six thousand
gallons ($4.94 of wastewater charge plus $1.59 of water charge), and only $1.59 per thousand
gallons for any additional water use. If this household's consumption exceeds nine thousand
gallons, the water rate would still be only $3.11 per thousand gallons (up to twenty five thousand
gallons), much below the rate for the non-discretionary water use (GRU 2008a, GRU 2008b).
Post, Buckley, Schuh & Jernigan (1998) used a computer model to simulate effects of water rate
changes on utility revenues and water usage of single family households served by eight Florida
utilities. The authors showed that given utility revenue requirement and interrelation between
water and wastewater charges, the introduction of a conservation water rate structure can reduce
the water charges paid by customers, and hence increase households' water usage.

The proportion of utility revenues that is recovered through fixed versus volumetric
charges. In 2007, the California Urban Water Conservation Council established specific
guidelines for what constitutes a conservation rate (McLarty and Heaney 2008). To meet
California's conservation rate criteria, at least 70% of monthly utility revenue must come from
volumetric rates (McLarty and Heaney 2008). In Florida, Whitcomb (1999) suggest that a
conservation water rate structure should result in at least 75 percent of utility revenues collected


pg. 11









from volumetric charges. This revenue target can be reduced depending on the structural form of
water rate used by the utilities (characterized by a ratio of weighted marginal water price to
average water price) and the amount of information provided to the customers on the water bills.

Effective communication of the price signal through consumer billing. To influence
water demand, the conservation pricing must be understood by customers. Households should be
able to estimate changes in their water bills corresponding to increases (or decrease) in water
usage. The estimates of the effects of information campaign on consumer response to price
signal varies from study to study. For example, Gaudin (2006) report increase in consumer
responsiveness to price signals by up to 30%. In contrast, Carter and Milon (2005) found that the
knowledge of the rates for additional units of water (i.e., marginal price) result in the increase in
monthly water consumption. The authors hypothesize that the households tend to over-estimate
their marginal water rates, and hence, they increase water consumption in response to the
knowledge of the accurate marginal rates.

The survey of customers of sixteen Florida utilities conducted by Whitcomb (2005) showed
that 39% of respondents are not knowledgeable about water rate structures (i.e., number, size,
and prices of the blocks). At the time of the survey, only five of the sixteen participating utilities
printed their water rates on their bills; this practice partially explains this lack of customer
knowledge (Whitcomb 2005). Analysis of 1997 survey of customers of three North-Central
Florida utilities by Carter and Milon (2005) shows that higher monthly income, larger household
size, home ownership, larger lawn area, and awareness of nonprice conservation programs
increase the likelihood of knowing the marginal price. Households facing block rate structures,
however, are less likely to know the marginal price.

B2. Effectiveness of Conservation Rates
Price elasticity of demand. Responsiveness of the water use to rate is measured through
the price elasticity of demand. Price elasticity is defined as the percent change in water
consumption in response to the certain percent change in price (rate). "The most likely price
elasticity range for long-term overall (indoor and outdoor) residential demand is -0.10 to -0.30,
with price elasticity coefficients for long-term industrial and commercial demand ranging up to -
0.80" (AWWA 2000, p. 158). This means that for residential customers, a 10% increase in rate
(given current rate level) will most likely result in reductions in water usage within the range of


pg. 12









1% 3%. In Florida, estimated long-term price elasticities for single-family homes varies
between -0.39 and -0.84 depending on the home value and size (Whitcomb 2005). For ten
commercial customer classes in Southwest Florida Management District service area, Brown and
Caldwell (1993) estimated price elasticities vary from 0 to -0.70.

Price elasticity depends on a variety of factors, such as: the value of subsidies available to
consumers; the size of wastewater and fixed charges in customer bills; percent of total income
spent on water; price of water from alternative water sources (such as private wells); length of
time over which rates and water demands are evaluated; climate and weather events; initial water
rates against which the elasticity is measured; customer class (e.g., residential, commercial, or
industrial); type of water use (indoor vs. outdoor); season and time of the day (peak vs. off-peak
periods); geographical region; customers' knowledge of their water rates; presence of other
conservation programs; and customer education programs (AWWA 2000; Carter and Milon
2005; Cavanaugh, et al. 2002, Dalhuisen et al. 2003, Espey et al. 1997; Howe 2002; Howe and
Goemans 2002, Johns 2001, Wang et al. 2005). Price elasticity appears to rise with an increase in
rate levels (AWWA 2000). Also, water use is more responsive to the change in real prices
(adjusted for inflation), than in nominal prices (not adjusted for inflation) (AWWA 2000). The
rates for the additional unit of water (i.e., marginal water price) are low in US (e.g., Cavanagh et
al. (2002) cite the marginal price of $0.50 to $5.00 per thousand gallons). The average monthly
bill for an "average" US customer (with about 7500 gallons of monthly usage) is $20.24
(AWWA and Raftelis 2006), which is a small portion of average US household income. Such
low rates explain (at least partially) the small response in household water consumption to price
increase (Cavanagh et al. 2002). However, "price levels sufficient to induce significant water
savings are politically and socially controversial" (Cavanagh et al. 2002, p. 6).

Generally, water demand for outdoor discretionary uses (such as lawn watering, car
washing, and swimming pools) is more elastic than the demand for non-discretionary indoor
water uses. In Florida, there is less outdoor discretionary water use during late fall and winter
when water use for irrigation decreases and the demand for water may be less responsive to price
changes during that season. Further, "peak usage is more price-sensitive than off-peak usage"
(AWWA 2000, p. 159). Customers who know their marginal price are more responsive to
changes in prices (Carter and Milon 2005). Price elasticity is greater when measured over the


pg. 13









long period of time (more than 3 to 5 years) (e.g., Carter and Milon 2005). The presence of
marginal price information on the bill next to quantity consumed increases price elasticity (by a
factor of 1.4, according to Gaudin 2006). Further, when water restrictions are implemented,
consumers can be less responsive to rate changes (Kenney et al. 2008). High water users are
generally more responsive to price than low water users (Kenney et al. 2008). Low income
households are significantly more price responsive in comparison to the relatively wealthy
households reflecting the larger share of water bills in the low income household budget (Agthe
and Billings 1987, Dalhuisen et al. 2003, Renwick and Archibald 1998). Based on the analysis
of 64 studies and 314 price elasticities, Dalhuisen et al. (2003) shows that price elasticity
estimates vary depending on geographical regions of US, so that "price elasticities are greater in
absolute value in the arid West" (p. 306), which may be related to more significant water use for
discretionary purposes (irrigation).

Rate structures themselves can affect consumer responsiveness to rate changes (Kenny et
al. 2008). Cavanagh et al. (2002) and Nieswiadomy and Molina (1989, cited by Nauges and
Thomas 2000) found that price elasticity among households facing uniform marginal prices
appears to be significantly smaller than among households facing block structure. "If a
household knows that higher levels of use result in higher prices, it will be more sensitive to
price" (Cavanagh et al. 2002, p. 27).

The differences in price elasticity estimates reported in existing studies can also be partially
explained by the differences in the methodologies employed by the authors, specifically, the
spatial and temporal level of data aggregation, period of time over which the elasticity is
evaluated, price of water considered (average or marginal), and specific econometric estimation
procedures employed (Cavanagh et al. 2002, Dalhuisen et al. 2003; Espey et al. 1997;
Michelsen, et al. 1998). Studies also note that it is difficult for consumers to distinguish the
actual water rate from wastewater and fixed charges included in the water bills, which
complicates the estimation of price elasticity of water demand (e.g., Whitcomb 2005).

Empirical evaluation of the effectiveness of conservation pricing. Based on the
responses to the nation-wide survey of utilities conducted by Wang et al. (2005), many utilities
do not consider elasticities in designing water rates. An exception is Tucson (AZ), where utilities
believe that for some customers, a 10% increase in price will result in 4% reduction in water


pg. 14









usage (elasticity = -0.4), but more common response is 2% decrease in usage (elasticity = -0.2).
Further, San Antonio (TX) responded that it is difficult to isolate impacts of individual
conservation programs (focused on the Edwards Aquifer); however, it believes that water
conservation rates had the main impact on the 25% reduction in per capital consumption between
1998 and mid-1980s. El Paso (TX) reported that its water conservation rates, along with other
conservation programs, led to the drop in per capital consumption from 220 gallons to 165
gallons per day. This number would be even lower if non-residential consumers would have been
excluded from estimations. Corpus Christi (TX) reported low amount of per capital consumption
(130 gal per person per day) and attributed this record to education, planning, ordinances,
aggressively pursuing irrigation leaks, and conservation rates (Wang et al. 2005).

Clunie (2004) reports the results of two case studies from Hawaii. In Kauai County,
average monthly single-family residential water use (normalized for whether) dropped by 3.7%
in the year following the change in the water rate structure from uniform to inclining 3-block
(with an average 32% rate increase). In contrast, in Hawaii County, average monthly single-
family residential water use (normalized for whether) increased by 3.7% in the year following
the change in the water rate structure from inclining 3-block to inclining 4-block structure (with
an average 29% rate increase). The author suggests that increase in the number of blocks and the
steepness of rate blocks may have impacted relatively few customers. Also, "customers with
long-standing inverted block rates may have already changed their water use patterns" (Clunie
2004, p. 23), which may have reduced their ability to react to the higher water prices.




B3. Utilities' perspective: balancing competing objectives with rate design.
In addition to water conservation, the literature suggests the following criteria for rate
design and evaluation: revenue level and stability; equity, fairness, and impacts on customers;
economic efficiency; transparency; ease of understanding and implementation (simplicity);
accountability; and coordination (e.g., AWWA 2000, Raftelis 2005, Gaur 2007, Green and
Yingling 2007).

Utility revenue. While the objectives listed above are not mutually exclusive, they can
conflict with each other. The most common example is the potential tradeoff between water


pg. 15









conservation and utility revenue. Any program or pricing strategy that decreases water
consumption has the potential to decrease utility revenue. However, National Regulatory
Research Institute (NRRI 1994) concludes that conservation rates can be designed to avoid
revenue shortfalls. "The fact that water demand is relatively price inelastic means that price
increases do not necessarily decrease utility revenues. In fact, under certain circumstances, price
increases for conservation or other purposes can substantially increase utility revenues." (NRRI,
1994, p. 3). Among the 23 utilities nationwide responded to the survey by Wang et al. (2005),
9% of utilities responded that conservation rates increased their revenues, while 26% reported
that revenues decreased (30% considered conservation rates to be revenue-neutral, and 35% did
not know or gave no response).

The literature also discusses the potential for conservation rates to increase revenue
variability (AWWA 2000, Chestnutt 1993). "This revenue volatility is because an increasing
block rate anticipates recovering a proportionately greater percentage of the customer class's
revenue requirement at higher levels of consumption. These higher levels of consumption tend to
be more subject to variations in seasonal weather and, when coupled with a higher unit pricing,
customers tend to curtail consumption in these higher consumption blocks" (AWWA 2000, p.
100). Generally, revenue streams from inclining block structures are more variable than revenue
streams from declining block structures (AWWA, 2000, p. 100). Smaller utilities may be more
affected by revenue variability than larger utilities. In a survey of North Carolina utilities, Nida
and Eskaf (2009) observed larger fixed fees in smaller utilities and hypothesized that "smaller
utilities may, on average, have less stable customer consumption and therefore decide to shift
greater proportion of their operating costs into the base charge." (p. 5).

A revenue stabilization fund can be used to balance the need for conservation and the need
for revenue stability (AWWA, 2000, p. 100). A certain percentage of surplus revenue can be
allocated to the fund each month with surplus revenue; and the funds can be withdrawn from the
fund when revenues fall below projections. A number of utilities in Florida, including
Gainesville Regional Utilities, have adopted this strategy of revenue stabilization (GRU,
personal communications). Excess revenues can also be used to retire bonds in order to keep
future rates low, to improve infrastructure, or to educate public about water rates and water
conservation. Deficit in revenues can also be addressed through increase in rates or taxes,


pg. 16









through issuing bonds, inclusion of a risk margin in the calculation of revenue requirements, and
developing a mechanism for more frequent rate adjustments (Wang et al. 2005).

Economic efficiency. Economists have recommended that water prices should reflect the
marginal cost of providing water, i.e. the cost of providing the next additional unit of water
(AWWA 2000). Economic costs of water include utility's operation and maintenance costs,
costs of additional water supply to meet growing demands, and the social and environmental
opportunity costs of losing other benefits that the water can provide (such as ecological and
recreational values of water pumped for consumption from river basins) (Western Resource
Advocates et al. 2004). Economic efficiency requires setting rates to each customer according to
the customer's specific marginal costs, and adjusting rates as the opportunity costs or the water
infrastructure use change (OECD 2009). Even if true marginal cost pricing is impossible, the
literature strongly suggests that water rates reflect costs of water provision (Griffin 2001). When
water rates are used for alternative purposes, economic inefficiency and inequity are the likely
result, including underpricingg (requiring a transfer from the governing body), overpricing
(providing a transfer to the governing body), or subsidizing some customers at the expense of
others" (Griffin 2001, NRRI, 1994). In other words, water rates should be used to recover costs,
and not as a tool to redistribute wealth (like a progressive income tax), subsidize development, or
as source of additional city revenue.

Equity. fairness, and impacts on customers. Poorly designed conservation rate structures
can potentially lead to an inequitable billing of different customer groups (AWWA 2000).
Renwick and Archibald (1998) find that water use of low income customers is more responsive
to price increase than the water use of high income customers. "These results suggest that price
policy will achieve a larger reduction in residential demand in a lower income community than
in a higher income community, all other factors held constant. Results also suggest that if price
policy is the primary DSM [demand side management] instrument in a particular locale, lower
income households will bear a larger share of the conservation burden" (p. 357).

However, Agthe and Billings (1987) demonstrate that with proper design of the inclining
block rate structures, steeper price blocks will actually lead to greater distributional equity. The
authors show that by making price blocks steeper, a utility could increase the incentive to
conserve without adding any price burden to low income users. This conclusion is important; it


pg. 17









means that when equity is a high priority of rate design, steeper price blocks can be a better
option than increased fixed or uniform rates.

To address the impact of conservation rates on low-income / low use customers, several
utilities surveyed by Wang et al. (2005) charge minimum rates for the minimum amount of water
necessary to meet basic needs ("lifeline rate"), which often constitute the fist block in the
inclining block rate structures. The Kentucky Public Service Commission and several largest
utilities in Texas support a lifeline rate of 2,000 gal per household per month. San Antonio, TX,
uses the lifeline rate of 7,000 gal per month (Wang et al. 2000). Utilities focus on keeping the
rates for the lifeline rate low to avoid setting excessive burden on low-income customers. Some
utilities forgive service charge to low-income customers, offer fixing water leaks for free,
distribute free water-efficient home appliances, offer 50% discounts on the bills, or do not charge
for water consumption within the first price block (Wang et al. 2005).

To achieve utilities' financial objectives, "social tariffs" (i.e., low rates) for low income /
low use customers are often subsidized by other customer groups (e.g., by customers from other
regions, or by customers with other water use levels and/or higher income). Discussions of
affordability and social tariffs should be open to all the stakeholders. Also, social tariffs should
be based on precise definition of "affordability" and on reliable data on income distribution and
water use. "In the absence of such objective bases, there is a risk that the process be driven by
'political affordability'" (OECD 2009, p. 86).

Fairness is somewhat intangible, because it is related to public perception. An inequitable
rate structure will probably be viewed as "unfair" by the public. Also, rate changes should be
instituted in a proactive way, rather than in a way that could be viewed as punitive or
reactionary. For example, utilities can be proactive by making rate changes in anticipation of
future droughts rather than after a drought (source: personal communications).

Transparency and accountability. In Florida, there is no mandated rate design
methodology. As a result, each utility has the authority to decide which rate structure to use
based on its own criteria. This allows great flexibility in rate design across the state. But, it also
can present a public relations challenge. If the public does not consider the rate design process to
be transparent and accountable, rate hikes could lead to resentment among customers.


pg. 18









A rate process is transparent if the public understands why a rate change is necessary
before the change is implemented. Information about rate changes should be made available to
the public via meetings, workshops, websites, or other means. Further, public involvement in rate
design enhance public acceptance of the rates (AWWA 2000, Cuthbert and Lemoine 1996,
Saarinen 1993). For example, Saarinen (1993) suggested a "citizen's forum" to represent the
needs and concerns of the community. Such a forum could take place in the context of
government sponsored workshops, interactive websites, or civic group meetings. Wang et al.
(2005) reports that in Tucson AZ citizen advisory committees are set up to review rate design
that have memberships that are proportional to customer class (residential, commercial, and
industrial).

Coordination. Rate changes should be coordinated with other demand management efforts
and any supply expansion efforts. In several states surveyed by Wang et al. (2005), conservation
rates are supplemented by outreach programs such as conservation displays in schools,
demonstration of low flow water use landscaping, and public service announcements. For
example, in San Antonio (TX), the fee set to the fourth of the four residential rate blocks is used
to fund provision for low flow toilets and rebates for efficient washing machines, free repairs of
leaks for low-income customers, and outreach efforts (Wang et al. 2005).

B4. Benefits of conservation rates
Some key benefits of implementing conservation rates include (AWE 2008, AWWA 2000,
Cavanagh et al. 2002, Wang et al. 2005):
Communicating general water conservation need, rewarding efficient users that contain
water usage in the lower tiers, and penalizing non-efficient water use;

Reduction in operating costs and delay in the need for system expansion and acquiring
additional water supplies and storage capabilities. For example, Seattle Public Utilities
found that water conservation rates allowed it to defer the acquisition of its next source of
water supply by 10 years (Wang et al. 2005);

Drought preparedness Conservation programs that are implemented during periods of
normal conditions prepare public utilities and customers alike by forcing them to consider
consumption behavior and by conditioning them to be responsive to severe water scarcity;


pg. 19









Environmental benefits by reducing the amount of water that must be withdrawn from
watersheds and aquifers, more natural water is kept in-stream, and wastewater discharges
and thermal pollution are mitigated as ecosystems are buoyed.

Customers' flexibility to choose their own approach to increase water use efficiency and
conserve water. There can be a substantial difference in the costs of achieving greater water
use efficiency or water conservation among households, for example, depending on the age
and design of their houses. Traditional utilities' conservation programs target specific water
uses (such as irrigation or toilet flushing) and establish single water efficiency target for all
households, which is similar to "command and control approach". In contrast, price
increase and changes in price structure allow households to take into account the difference
in the costs of achieving water use efficiency target across households, and hence, "...may
be more cost-effective in practice ..." (Cavanagh et al. 2002, p. 34).

B5. Pitfalls of conservation rate design
There are a number of barriers to successful implementation of conservation water rates
(AWE 2008, AWWA 2000, SWFWMD 1991, Whitcomb 2005, Wang et al. 2005), many of
which are discussed below:

Possible effects of conservation rate on utility revenue (discussed in section 4.4 of this

paper).

Political considerations. When water rates are used to subsidize commercial development
or as a redistributive tax, conservation price signals will probably be missed by the
consumer.

Difficulty in implementation (for inclining block rate structures, as discussed above);

Possible reluctance on the users' side to accept increasing rates.

Source substitution by utility customers. For example, in Florida, homeowners in many
cities are legally allowed to dig their own irrigation wells. Substitution of well-supplied
water for tap water in response to introduction of conservation rate structure can reduce the
effectiveness of conservation rates.


pg. 20









C. Drought rates
Drought rates (or drought demand rates) are special surcharges that are implemented during
times of severe drought. They are often discussed in the same context as conservation rates, but
they differ from conservation rates in one important respect: they are temporary. While
conservation rates are typically in force all year long, drought rates are used to manage demand
before or during severe droughts and associated water shortages. Several communities in
Florida, including Hernando County, Punta Gordo, and Englewood, have applied drought rates in
recent years.

Drought rates are not as frequently used as inclining block rate structures. Drought rates
differ among states and utility companies. For example, the East Bay Municipal Utility District
(EBMUD), CA, imposes a 10 percent increase in volumetric rates for all customers and a $2
surcharge for each 100 cubic feet (748 gallons) of water used above individual customers'
allocations. "Residential customers using less than 100 gallons per day are exempt from the
increased rates and surcharges" (EBMUD 2009). Olivehain Municipal Water District (OMWD),
CA, proposes increase in water rate structure during the times of drought depending on the
drought alert level. For the drought alert level 1 ("drought watch"), no changes in water rates is
proposed to the first block of the inclining block rate structure for residential customers.
Increases in the second and third blocks are 5% and 15%. At the times of drought alert level 4
("emergency"), water rates are proposed to increase by 35%, 65%, and 75% for the first, second,
and third rate blocks respectively (in comparison with non-drought rates) (OMWD 2009).

Drought rates are often included into drought plans of state, regional, or local authorities.
The first step in initiation of drought rates is drought declaration. The authority and
responsibility to declare drought varies from state to state. Usually, the authority rests with
districts or municipalities. For example, in Connecticut and Kentucky, droughts are declared by
local governments (towns and municipalities) that may reflect spatial variation of physical
conditions throughout the state. In California and Florida, water districts have declaring
authority, and in Massachusetts, the state government declares a drought (Wang et al. 2005).

Drought is usually declared based on the results of monitoring of water resources. In
Arizona, drought restrictions can be declared when population growth exceeds water capacity in
an area. Wang et al. (2005) also report that there has been "some successes" using protection of


pg. 21









endangered species as a justification of drought rate application. In Texas, "pass-through rates"
can be used when a utility needs to purchase water from another utility, which can be the case in
the times of drought. Pass-through rate allows the purchaser to pass along aspects of the lending
utility's rate structure to avoid possible losses from obtaining water from the alternative source.
Utilities in Texas are also allowed to apply high "temporarily rates" if a court orders mandatory
reduction in pumping that result in losses of utilities' revenues (Wang et al. 2005).

Barriers to drought rates (Wang et al. 2005):

Higher rates during droughts may yield little change in these customers' water use due to
"demand hardening", which refers to the diminished capacity of some consumers to
reduce consumption during the course of drought because of the characteristics of their
demand (e.g., water use in hospitals) or past investments in water conservation that limit
opportunities for discretionary use reduction (e.g., low-flow shower heads).

The interface between drought, water use metering and water billing cycles create
problems for some consumers who receive a price signal out of sync with the onset of
drought. For example, if a drought where to only last one month while the billing cycle
is two months, customers may find themselves paying drought rates under normal
conditions.

Drought is not always caused by local hydrologic conditions, given cross-basin transfers
of water. In some areas, considering local conditions is no longer sufficient in the
drought analysis; however, implementing drought rates because of drought conditions
outside the locality is difficult to defend to customers. This can be true in Florida, where
many communities often rely on water supply from the same aquifer, and where water
use by one party can affect water availability to other users.

Differences in elasticities between various socio-economic groups of customers impact
the way in which people react to drought rates. Theoretically, less wealthy families may
already be consuming at or near minimum level, and despite conservation rates, have
little room to cut their consumption. And wealthier customers may regard landscaping
losses as more costly that higher water bills.


pg. 22









*It takes time for the consumers to adjust their water consumption in response to rate
increase. Droughts may last short time, and by the time consumers respond to drought
rate, hydrologic conditions may return to normal.

Customers' education is important for the success of drought rates. In the survey conducted
by Wang et al. (2005), utilities report putting advertisements in newspapers, notices in bills,
sending special mailing, conducting workshops and town-hall style meetings, and hiring field
consultants to educate customers about water rates. Effective communication strategies can help
public understand measurable social and ecological benefits of drought rates, and thus to help
promote customer support (Smith Jr. 2003 a, b, cited by Wang et al.).

D. International Rate Design Practices

D1. OECD Countries. This section is based on the publication by OECD (2009). The
Organization for Economic Cooperation and Development (OECD) includes 30 member
counties from North America (Canada, Mexico, and United States), Asia (Japan and Korea),
Europe, as well as Turkey, Australia and New Zealand. Overall, between 1999 and 2008, the use
of flat fees and declining block rates structures for residential customers decreased in OECD
countries, while the use of uniform and inclining block rate structures increased. For industrial
customers, only a few OECD counties used declining block rate structures. The Global Water
Intelligence survey of 184 utilities in OECD countries conducted in 2007-2008 showed that
about a half of utilities used uniform rate structure for residential water consumption (usually
coupled with fixed fees), and another half used increasing block rates (with only two utilities
coupling volumetric and fixed fees). Only seven utilities used declining block rate structures.
"The use of flat fees, however, is still reported in Canada, Mexico, New Zealand, Norway and
the United Kingdom" (p. 78). The number and size of blocks among the utilities using the
inclining block rate structures varies significantly. For example, in Mexico, water rate structure
is set by municipalities, and in most cases inclining block rate structures with large number of
blocks (more than five) are used. In the city of Monterrey, Mexico, different rates are set for each
cubic meter (264 gallons) used. In Mexico, industrial water rates are usually set higher than
residential rates.


pg. 23









Domestic prices for water and wastewater vary depending on costs of water supply, water
resources available and their quality, and percent of utilities' costs recovered through tariffs
(OECD 2009). Among the 21 OECD countries examined, two reported average domestic rates
for water and wastewater (including taxes) below US$3.8 per thousand gallon, eight countries
reported rates between US$3.8 and $7.6 per thousand gallon, nine were clustered around
US$11.4 per thousand gallon; while Denmark and Scotland reported even higher rates.

To address the concern of water affordability for low income customers, donors and
international financial institutions often define the benchmark of affordability as the water bill
equal to 3-5% of a household income. However, it is recommended to set the benchmark based
on local conditions. Also, several countries (such as Greece, Luxembourg, Portugal and Spain)
developed rate structures that take into the account the number of people in the household. Such
structures address the issue that low income households can consume more water than high
income households, just because of the larger household size. However, rate structures that take
into account the number of people in the household are very data-intensive and costly to
administer. Also, such structures require households to declare their destitution, and some
households may be reluctant to do that. Income support in the form of subsidies is suggested as a
mean to compensate low-income household for rate increases.

D2. Australia. Long term severe drought in Australia has forced policy makers to confront
the issue of water allocation among different users with a great sense of urgency. To do this,
institutional reform has been necessary (Dinar 2000). The national and regional governments in
Australia have adjusted prices to reflect the true cost of production and distribution. "Upper
bound pricing" have been defined as a maximum water rate level at which water utilities can
recover operational, maintenance and administrative costs, externalities, taxes, and cost of
capital, without deriving monopoly rents (NWC 2009). Also, regulators have made a
coordinated effort to eliminate cross subsidization in water pricing (Dinar 2000). For example,
in many areas residential and commercial users no longer subsidize the agricultural sector (Dinar
2000). These more efficient pricing strategies have helped regulators manage demand and
mitigate severe water shortages.


pg. 24









In general, residential water rates in Australia tend to be somewhat more conservation
oriented than American rates. For example, in Florida, monthly fixed fees vary between $2.00
and $14.00 (Rawls 2009); in Australia they tend to be comparable, often between $4.00 and
$12.00 (O'Dea and Cooper, 2008, p. 30). But, in Australia, volumetric fees are usually higher.
Average volumetric fees in Florida vary from about $1.00 to $3.00 per thousand gallons (Rawls
2009), while in Australia, they are usually between 3.50 and $5.00 per thousand gallons (O'Dea
and Cooper, 2008, p. 30). The higher volumetric fees are not surprising, given the country's
recent history of severe drought.

D3. Europe. Based on a review of existing studies, Dalhuisen et al. (2003) shows that
responsiveness of water consumption to price (i.e., price elasticity) tends to be smaller in Europe
in comparison with US. However, in Denmark, a survey-based study found that a water use tax
has resulted in 40 percent decline in water usage (ECOTEC 2001 cited by PRI 2005). EEA
(2009) reports that in Estonia, steady increases in water rates over time contributed to a
significant reduction in average household use. In England and Wales, widespread
implementation of water metering has also lead to decreased water use (EEA 2009). Currently,
in those two countries, metered households use, on average, 13% less water than non-metered
households (EEA 2009).

According to the European Union (EU) Water Framework Directive (Article 9), by 2010,
water rates in EU should cover the cost of water service, including financial cost of supply
(operational, maintenance, and capital cost), opportunity costs of losing other benefits that the
water can provide, as well as the costs to public or ecosystem "health" (OECD 2009). The
directive allows states "to diverge from full cost recovery after accounting for the social impacts
of cost recovery" (OECD 2009, p. 55). It is expected that the water rates will increase in many
European countries to meet the EU Directive requirements (Schleich and Hillenbrand 2009).

V. Research Needs
Based on the review of related studies, we identified the following gaps in the literature and
the following research needs:

Estimation of the effectiveness of conservation rate. For many utilities, strong evidence
may be needed to justify rate changes, especially in cases where drought rates or steeper


pg. 25









price blocks are politically controversial. Future studies need to provide empirical,
Florida-specific data to explore this issue. Currently, the only Florida study focused on
price elasticity of water demand is Whitcomb (2005).

* Analysis of the factors that determine effectiveness of conservation rates; developing
strategies to increase effectiveness. For example, survey-based studies may focus on
consumers' understanding of their bills and water rates. If the customers' understanding
is limited, then more effective billing procedure should be developed. Alternatively,
future studies can focus on effectiveness of different conservation rate structures. For
example, a working hypothesis for such a study could use a rate structure to separate
indoor and outdoor usage, utilities may become more successful at encouraging
conservation.

* Florida needs to adopt a consensus definition about what constitutes a conservation rate.
Currently, the regulatory concept of conservation rate structures is too vague for
consistently successful implementation. This is discussed further in the Appendix C.

* Further research is also needed to further explore the relationship between water
conservation and utility revenue. Although a fairly large body of literature already exists
on the topic, few Florida studies address the issue empirically. Negative revenue effects
are still cited as one of the major pitfalls of conservation oriented rate structures. Utility
managers must be confident that implementation of conservation or drought rates can be
"revenue neutral".

* Recommendations are needed on rate structures and other demand and supply
management strategies that can be used by utilities to achieve different objectives
(including water conservation, revenue generation, fairness, etc). Such recommendations
can be based on extensive consultations with policy makers and field professionals. An
prototype of recommendation matrix is presented in Appendix D.

* Analysis of institutional factors affecting rate design. More research is needed to examine

the decision-making process related to water rate design, and the role of politics, public
relations, local history and other factors in this process. For example, utility managers
may be under political pressure to keep rates low or uniform. Interest groups, such as


pg. 26









specific commercial sectors, may historically have preferential treatment, and may
oppose development of conservation rates. Utility ownership may also influence rate
design. Most Florida utilities are publicly owned, and may be under more pressure to
protect revenue and revenue stability, especially if the utility shares revenue with the city.
Utilities' management structure can also play a role in rate design.

* Analysis of the synergetic effects of price and nonprice programs on water usage. Some
researchers believe that a combination of price and nonprice programs can achieve the
goal of water conservation more effectively. For example, Moncur (1987) suggests that
the presence of nonprice programs enhances the price elasticity, thus lowering the price
increase necessary to induce the desired reduction in water use. It is difficult to deduce
the synergetic effects of price and nonprice programs, and there is little evidence to
support claims because information essential for an accurate assessment is typically not
available. Information about nonprice programs is often not recorded by utilities
(Michelsen et al. 1998).

* Effects of specific designs of conservation rates on customers' water usage. The literature
does not provide much guidance on the design on conservation rates. Utilities have the
freedom to experiment with different rate structures (inclining block, seasonal, drought,
water budgets, etc), different levels of inclining block rate structures, various price
differentials between price blocks, and different consumption breakpoints between price
blocks. Guidance is needed to lead water utilities through the process of conservation rate
design.

* Potential effect of conservation rates on water use in residential sector -other than single
family homes. For example, in most cases, water use by individual apartments in
apartment complexes is not metered. The possibility of metering water use and the
possible effects of conservation rates on residents of individual apartments needs to be
examined (Rui Marques personal communications).

* Relative costs and effectiveness of price and non-price conservation programs, as well as
leakage detection programs, in comparison with investment to increase supplies, or


pg. 27













Issues of cross-subsidization between tap water and reclaimed water, as well as and
reclaimed water ownership issued (Rui Marques personal communications).

Benchmarking of conservation programs implemented by various utilities in Florida, in
the US, and internationally (Rui Marques personal communications).

Additional information on the advantages and disadvantages of alternative rate structures.
Inclining block rates have been studied extensively, but others have not, including:
marginal cost pricing, spatial pricing, and marginal opportunity cost pricing. Rate
structures used in other industries and their applicability to water utilities can also be
examined (see Appendix E).




VI. Conclusion
This paper provides an overview of water rate design and "state-of-the-art" conservation
and drought rate practices. We conclude our literature analysis with two citations from Wang et
al. (2005):

Implementing conservation rates is a learning experience, which requires "finding
the appropriate tariff structure, creating a community education program that enables
users to make informed choices, and crafting the policy tools needed to address equity
concerns and real-time financial impacts" (Wang et al. 2005, p. 39).

"There are many conservation strategies available to water resource managers ...
the most successful long-term programs focus on building conservation as a viable choice
of informed customers. Those jurisdictions that have experienced the greatest success
have designed multifaceted programs with long-term visions. This includes water
resource education, taking into account equity and other socioeconomic considerations,
anticipating utility revenue impacts and addressing them in a positive way, and providing
users with ready access to practical and cost-effective technologies, as well as enlisting
the power of market signals to encourage conservation." (Wang et al. 2005, p. 40).


pg. 28









Conservation water rates do not represent a complete solution to Florida's water
allocation challenges. However, the results of this study strongly suggest that they will be part
of the solution in the future. The literature and the experiences of those in the industry indicate
that conservation rates are a useful tool for utilities and regulatory agencies. Where possible,
this tool can be part of a comprehensive, long-term planning approach. Conservation rate
design should also be an important subject for further study. Hopefully, the knowledge gaps
outlined in section 4.10 can be incorporated into the Conserve Florida research agenda.


pg. 29











Sources used in the study:


Agthe, Donald and Billings, Bruce. (1987). Equity, Price Elasticity, and Household Income Under Increasing Block
Rates for Water. American Journal ofEconomics and Sociology, vol. 36, number 3, 273-283.

Alliance for Water Efficiency (AWE). (2008). Conservation Oriented Rate Structures. Alliance for Water Ettic ienc
(AWE) Resource Library. available online at: http://www.allianceforwaterefficiency.org/lColumn.aspx?id=712

American Water Works Association (AWWA). (2000). Principles of Water Rates, Fees, and Charges. American
Water Works Association Manual of Water Supply Rates, Ml. (Fifth Edition). published by American Water Works
Association.

American Water Works Association (AWWA) and Raftelis Financial Consultants. (2006). Water and Wastewater
Rate Survey. published by American Water Works Association.

Arnold, Lee (chairman). (2003). Improving Florida's Water Supply Management Structure. Report for Florida
Council of 100. prepared by the Council Water Management Task Force. Tampa, FL.

Baumann, Duane D., and Boland, John. (1997). Urban Water Demand Management and Planning. New York, NY:
McGraw-Hill.

Beecher, Janice A., Landers, James R., and Mann, Patrick C. (1991). Integrated Resources Planning for Water
Utilities. Silver Spring, MD: The National Regulatory Research Institute.

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pg. 36









Appendix A. Water Rate Design in Florida
The water regulatory structure in Florida is unique. The Florida Department of
Environmental Protection cedes much authority to the five water management districts (WMDs).
WMDs manage the water resources on the regional level. However the WMDs do not have the
regulatory authority to dictate pricing schemes to utilities. Instead, they monitor and regulate
groundwater extraction through Consumptive Use Permits. All pricing authority is left to the
individual utility companies. The Florida Public Service Commission (PSC) monitors the profits
of the utility companies, since they exist as regulated monopolies. Still, the PSC does not
mandate how revenue is raised, as long as the revenue is not considered "excessive" based on
production costs.

Water rate design in Florida varies dramatically between individual cities and utilities.
Individual utilities have a fairly large degree of authority and flexibility to design rates for
commercial and residential users. When it comes to conservation rates, inclining block rates are
fairly popular, especially for larger utilities. (McLarty and Heany 2008). But, unlike California,
Florida utilities usually include relatively high fixed fees in their rate designs (McLarty and
Heany 2008). An exception is the Tampa Bay Water Department, which has no fixed charges at
all. This remarkable rate design practically ensures that users have an incentive to conserve
water.

In addition to variation in pricing strategy, Florida utilities developed more complex rates,
in which water is priced differently depending on its use. This is sometimes referred to as "price
specification." For example, some utilities have different rates established for indoor and
outdoor use. Others set different rates for the customers inside and outside the city limits. As
Florida utilities continue to experiment with more specified rates, they have an opportunity to
more specifically target price signals. This is important because sometimes the costs vary
dramatically across various factors. For example, even though reclaimed water is more
expensive to produce than purified groundwater, many utilities provide significant discounts for
reclaimed use. In this case, wastewater utilities save significant disposal costs if wastewater is
reused. There may be a risk of designing rates that are too complicated and confusing to
provide clear incentives. Nevertheless, price specification can be an effective way to distribute
costs more efficiently.


pg. 37










One type of price specification in Florida that is particularly promising is special pricing

for reclaimed water. A number of utilities charge a separate rate for reclaimed water use. In

most cases, a significant discount is offered for using reclaimed water. For example, the City of

Tallahassee offers a 70% discount for residential consumers willing to use reclaimed water.

A few Florida utilities have experimented with drought rates. Ft. Lauderdale, for example

has implemented them on a wide scale with measurable effectiveness. As droughts become

more common, drought rate designs like these will probably become more attractive.

In 2005, John Whitcomb published a report on water demand that was commissioned by

the water management districts. Whitcomb's sample included 16 utility companies. In 1998, the

first year data was collected, eight of the utilities had inclining block rates. Ten years later, in

2008, all but two of them had inclining block rates (Rawls 2009) which suggests that inclining

block structures are becoming more popular. The most common number of price blocks is three,

perhaps because more than three is too complicated. Almost all of them continue to have at least

some fixed charges.

Like much of the country, Florida utilities appear to be moving away from declining block

rates and uniform rates. Due to increased attention on conservation, inclining block rates are

becoming more popular. Table 3 illustrates the trend.

Table Al. Trends in Florida Rate Design based on a sample of 16 utilities
Utility 1998 Rate Structure 2003 Rate Structure 2008 Rate Structure
Escambia County Uniform Uniform Increasing with 2 blocks
City of Tallahasse Uniform Uniform Uniform
City of Melbourne Uniform Uniform Uniform
City of Ocoee Uniform Uniform Increasing with 6 blocks
City of Palm Coast Uniform Uniform Increasing with 4 blocks
Hemando County Uniform Uniform Increasing with 5 blocks
Palm Beach County Increasing with 3 blocks Increasing with 3 blocks Increasing with 4 blocks
City of Lakeland Increasing with 3 blocks Increasing with 3 blocks Uniform
Miami Dade Increasing with 5 blocks Increasing with 5 blocks Increasing with 4 blocks
Indian River County Increasing with 4 blocks Increasing with 4 blocks Increasing with 4 blocks
Hillsborough County Increasing with 5 blocks Increasing with 5 blocks Increasing with 4 blocks
City of St. Petersburg Increasing with 4 blocks Increasing with 4 blocks Increasing with 4 blocks
Toho Water (Osceola County) Increasing with 5 blocks Increasing with 5 blocks Increasing with 5 blocks
Sarasota County Increasing with 5 blocks Increasing with 5 blocks Increasing with 5 blocks
City of Tampa Increasing with 3 blocks Increasing with 5 blocks Increasing with 5 blocks
Seminole County Increasing with 5 blocks Increasing with 6 blocks Increasing with 6 blocks
Source: Rawls, 2009.


pg. 38









Appendix B. Decision Support Tools


Several studies focus on decision support tools to help utilities design water rates. For
example, the WateRate computer simulation model was developed by the five water
management districts, and allows utilities to simulate the effects of changes in their rate design
(SWFMD 2008). The model has four output tables, which include rate structure, bill
distribution, elasticity, and several others. It has four output tables, which include projected
usage and revenue up to five years in the future. The model also has default settings for data
gaps. In short, it is powerful tool for utilities interested in exploring demand management
options.

Another computer model is the University of Florida Simplified Aggregate Urban Water
Conservation Guide (UF 2008). This interactive program allows utilities to explore the cost
effectiveness of various conservation Best Management Practices. It also allows users to
conduct comprehensive water audits to identify problems and inefficiencies. Currently, the
Guide does not deal explicitly with rate design. However, future versions of the program
probably will.

Outside of Florida, other interactive tools have been developed to assist utilities in long term
planning. The publically available "Rate Dashboards", developed by the Environmental Finance
Center at the University of North Carolina, can be used to simulate the effect of various rate
structures by taking into account a variety of factors including utility finances and system
characteristics (EFC 2009).

Chesnutt (1996, cited by Wang et al. 2005) created a method of quantifying uncertainty of
utility revenues. His simulated water demand model "factors in parameters like season, climate,
and customer characteristics. This model is used to map the rate structure onto expected
revenues. The model also produces a measure of risk in future revenues. Given the estimate of
risk, utilities can design a number of revenue copying strategies" (Wang et al. 2005, p. 34).


pg. 39









Appendix C. Legal aspects of defining conservation rates in Florida
Currently, there is no consensus on what exactly constitutes a conservation rate in Florida.
The state government's only official definition is as follows: "conservation rate structure
means a schedule of utility water rates designed to promote efficient use of water using
economic incentives" (FDEP 2006, p.5). The Department of Environmental Protection states
that "a water management district will afford a utility wide latitude in adopting a rate structure,
and shall limit its review to whether the utility has provided reasonable assurance that the rate
structure contains schedule of rates designed to promote efficient use of water using economic
incentives" (FDEP 2006, p.5). In other words, the final decision rests with the Water
Management Districts. Without clear minimum standards, the precise definition of conservation
rates remains highly uncertain.

The South Florida Water Conservation District has taken steps establish minimum standards.
In District's Water Conservation Program Plan, Strategy 1-A includes the following action step:
"work with utilities and the Florida Chapter of the American Water Works Association
(AWWA) to define minimum standards in water use permit criteria for conservation rates"
(SFWMD 2008). These efforts to define and coordinate minimum standards should be
continued.


pg. 40











Appendix D. Prototype matrix for water rate structure recommendations
Type of Rate Structure Examples of Advantages Implementation Challenges Disadvantage mitigation strategies


Fixed Rates (base
charges)


Declining block rates









Uniform Rates




Inclining block rates






Drought Rates




Water Budget Rates


Highly predictable stable revenue stream; easy to
implement: easy for customers to understand




Can be used by utilities that need to develop a
single rate schedule for various customer classes;
can be used when utilities costs decline with
increasing water usage, and when it is important
to provide price incentives to encourage large-
volume customers to remain on the system; block
rate may also be used by utilities that need to
encourage economic development
Greater stability of stable revenue stream in
comparison with inclining block: easy to
implement: easy for customers to understand;
provides some incentive to conserve water
Provides strong incentive to conserve; may have
customer equity advantages- average and
marginal prices are higher for high-use customers




Provides strong incentive to conserve water in
times of drought



Provides very strong incentive to conserve; has
significant customer equity advantages; highly
flexible


No incentive to conserve
water: creates equity
issues- average prices are
higher for low use
customers
very weak incentive to
conserve water; may be
difficult for some customer
to understand; creates
equity issues- marginal and
average prices are higher
for low use customers

provides less incentive to
conserve water than
inclining block rates

may make revenue stream
more variable; may be
difficult for some customers
to understand; can be
difficult to administer

May be viewed as unfair or
punitive by customers



difficult to implement- has
high information
requirements; may make
revenue stream more
variable; may be difficult for
customers to understand


Can easily be used with non-price conservation measures;
despite equity issues, may be viewed as 'fair" because
everyone pays the same monthly bill


Can be used with non-price conservation measures;
transparent billing procedures and interactive tools such
as "rate calculators" may increase customer
understanding





Can easily be used with non-price conservation measures




Long term planning, revenue stabilization funds, and
small base charges can help utilities deal with revenue
variability; Transparent billing procedures and interactive
tools such as "rate calculators" may increase customer
understanding

By implementing drought rates before or during droughts
(rather than after the fact) utilities may increase
consumer acceptance; public awareness efforts can also
increase acceptance
Initial expenses can be offset by future rate precision and
water savings; Transparent billing procedures and
interactive tools such as "rate calculators" may increase
customer understanding; Long term planning, revenue
stabilization funds, and small base charges (in addition to
the uniform rate) can help utilities deal with revenue
variability


pg. 41









Appendix E. Examples of Rate Design in Other Industries.
Water regulators can also learn from other industries (NRRI,1991, p. iii). For example,
the electricity industry has dealt with some of the same pricing issues as water. In general, the
energy sector makes use of infrastructure with high fixed costs and large distribution
requirements. Some innovative conservation pricing strategies from the energy sector include:

Peak-Load Pricing: Different rates are charged for "peak" usage times. In other words,
consumers pay a premium during certain key hours when usage peaks. To be effective,
peak-load pricing schemes need to take capacity expansion costs and various time
horizons into account. (Lecing 1997).

Time of Use (TOU) Rates: Different rates are charged at specified time intervals on a
consistent basis (Barkett 2004).

Real Time Pricing (RTP): Different rates are charged based on wholesale prices and
infrastructure conditions (Barkett 2004). This pricing strategy allows for great
precision in cost allocation. Unfortunately though, it requires high frequency metering,
which is usually not available in the water industry.


pg. 42




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