Title: Memorandum Re: Water Supply Funding Committee - Utility Rates and Charges
Full Citation
Permanent Link: http://ufdc.ufl.edu/WL00004606/00001
 Material Information
Title: Memorandum Re: Water Supply Funding Committee - Utility Rates and Charges
Physical Description: Book
Language: English
Spatial Coverage: North America -- United States of America -- Florida
Abstract: Jake Varn Collection - Memorandum Re: Water Supply Funding Committee - Utility Rates and Charges (JDV Box 70)
General Note: Box 24, Folder 3 ( Water Supply Development and Funding - 1996-1997 ), Item 8
Funding: Digitized by the Legal Technology Institute in the Levin College of Law at the University of Florida.
 Record Information
Bibliographic ID: WL00004606
Volume ID: VID00001
Source Institution: Levin College of Law, University of Florida
Holding Location: Levin College of Law, University of Florida
Rights Management: All rights reserved by the source institution and holding location.

Full Text

State of Florida

pubtli Serbte Commision


DATE: October 31, 1996
TO: Paula Allen, Governor's Office
FROM: John Williams, Public Service Commission '- l 4
RE: Water Supply Funding Committee Utility Rates and Charges

The following is a short write up on water pricing and some ideas and examples of

alternative conservation rate structures that will encourage water conservation and generate

excess revenues that could be used to fund water supply development.

Water Pricing Past and Future

Water agencies traditionally assumed consumer demand as a given, designed system

capacity to meet that demand, calculated the cost of building at capacity, and determined the

price required to cover that cost. The demand-capacity-cost-price planning process has been

like a treadmill, and artificially low prices have kept the treadmill running at a fast pace. In

the past, three possibilities for slowing the cycle were largely ignored: that water demand can

be altered, that prices alter demand, and that prices can be used intentionally to alter demand.

In most parts of the United States, water as a resource historically has been

underpriced, resulting in more water consumption than would be economically efficient. For

various reasons, water prices have not reflected the full cost of providing water service. In

the underpopulated and water-scarce areas of the Western United States, the federal

government subsidized water projects to encourage settlement and growth. Subsidizing water

resource development proved to be politically attractive, and many a politician has won votes

with a pork-barrel water project. In addition, many communities have tried to keep water

prices low in order to attract economic development opportunities. Finally, water utilities face

considerable political pressure from ratepayer constituents (and their advocates) whenever

water rates are increased. In this vein, water is not considered as a resource, but rather as a

"right" that deserves public subsidy. For this and other reasons, water utilities (both public

and private) have experienced less than full-cost recovery and low rates of return on capital


Backward looking prices: The traditional methods by which water prices are

determined have contributed to underpricing, particularly from an economic efficiency

standpoint. In traditional rate making, which is the method used to set water utility rates in

Florida, the price of water is based on an analysis of actual historical costs. Historical (or

embedded) costs represent the costs actually incurred by a utility in providing water service.

Prices based on historical costs send signals to consumers about the past cost consequences of

usage decisions. Pricing based on historical costs create the illusion that resources used in the

future to provide water service will cost the same as resources used in the past. While this

assumption may have been valid at some point in time, the cost of developing new water

sources today (as well as maintaining the water delivery infrastructure) often is much more

expensive that the historical cost of existing water sources. The use of historical cost in

setting prices can misinform customers about the value of the water they purchase.

Forward-looking prices: In contract to the historical or embedded-cost approach,

prices based on incremental or marginal costs provide signals to consumers about the future

cost consequences of their usage decisions. Incremental or marginal costs reflect an estimate

of the cost of developing the next increment of supply needed to satisfy an increase in water


usage. Marginal cost analysis also can be used to estimate the savings (or avoided cost) from

not developing new supply sources to meet additional usage. Marginal cost pricing explicitly

recognizes that future costs may be very different, and usually higher, than historical costs.

Economists and policy analysts generally agree that prices based on marginal costs

send better price signals in terms of achieving efficiency in supplying and using resources.

Although the concept of marginal cost is well developed, the process of actually estimating

marginal or incremental costs requires extra effort on the part of agencies and analysts.

Utilities must develop improved cost accounting capabilities and invest resources to get a

better understanding of future cost alternatives. Analysts, for their part, must stare uncertainty

in the face. Though a variety of approaches and methods are available, marginal cost

estimation still lacks the attractive precision of historical costs, which are known to the penny.

But as one proponent of the marginal-cost approach noted, "it is better to be approximately

right that precisely wrong." Marginal-cost pricing is a dynamic process in which agencies can

develop better estimates of incremental costs as cost accounting improves, as future cost

alternatives are better defined, and as the commitment to marginal cost pricing increases.

Pricing and demand management: Marginal-cost pricing can be viewed as an

important tool of water planning and management. Given resource constraints, prices based

on marginal costs will encourage conservation more than prices based on historical costs.

Without adequate pricing signals, customers cannot be expected to make informed choices in

how to use water efficiently. Deficiencies in pricing can also undermine the effectiveness of

other conservation programs. By contrast, effective price signals will induce water customers

to modify their water use in ways that reflect the actual value of water.




Uniform Rates

Inverted Block Rates
(Excess Use Rates)

Seasonal Rates

Marginal Cost Rates


Rates that are the same for
all customers and customer
classes, at all levels of

Rates that increase as
consumption increases.

Rates that vary during
different periods of the year.

Rates that are based upon
the cost of providing the
next unit(s) of service.

Alternate onservatio
Rate StructuresL CrJ

Umnifrm Rates

Single rate for all units of consumption for all
customers and customer classes; each unit of product
is valued and priced the same.


$1.50 -

$1.00 -I

$0.50 -



100 1,000
USAGE (In 1,000 Gallons)



Usage: All units of consumption
Rate: $1.50 per 1,000 gallons

I V I I/ I V I

Rates in which unit charges increase with usage.

$3.00 -

$2.50 -

$2.00 -

$1.50 -

$1.00 -

$0.50 -

(Essential Use)

Uniform Rates





USAGE (In 1,000 Gallons)

Inverted Block Rates




Usage: Rate:
First 10,000 gallons $1.25 per 1,000 gallons
Next 15,000 gallons $1.75 per 1,000 gallons
Over 25,000 gallons $3.00 per 1,000 gallons

Higher unit rates) for consumption during a peak
period than at other times during the year.

$3.00 -

$2.50 -

$2.00 -


$1.00 -

$0.50 -




I 11/1+ I




USAGE (In 1,000 Gallons)




Usage: Rate (per 1,000 gallons):
Specific Rate Approach Non-seasonal Seasonal
All units of consumption $0.80 $1.80

F- -I
L arinl os Rte

Unit rate equal to the cost of
providing the next unit(s) of service.

$3.00 -

$2.50 -

$2.00 -


$1.00 -

$0.50 -

Marginal Cost Rate

Average Cost of Service Rate

I F ,--A I I



USAGE (In 1,000 Gallons)





Usage: All units of consumption
Rate: $2.25 per 1,000 gallons

Advantages and Dsadanags*

Rate Structures



Are simply designed.

Are understandable and accepted
by most customers.

Can be useful as a transition to a more
aggressive conservation rate structure.

Are generally easy to implement,
administer, and update.

Are growing in popularity

Can be highly conservation oriented.

Are growing in popularity, particularly
in water scarce areas such as the
Southwest, Florida, and resort areas.

Can be structured to reflect attributes
of marginal cost pricing.

Are generally understandable by

Can generate surpluses of revenue as
a rate stabilization mechanism or
other funding source.


Mav be inconsistent with cost of
service characteristics among classes
of customer.

May only marginally achieve
conservation objectives.

May have substantial economic impact
on large volume users when changing
from a declining block rate structure.

May be inconsistent with cost of
service rates.

Are more apt to lead to revenue
instability than traditional

May be complicated to implement if
existing rate structure does not allow
for simple conversion to inverted rates.

May pose difficulties in developing
appropriate block cutoffs and
unit rates.

May not be legal in some states.

Mav have substantial impact on
high volume users when moving
from another rate structure.



(Excess Use Rates)

Advantages* andDisadvantages

of Alternative Conservation

^^^^^^^^^^Rate^^^^ Structu^VP^^^z^^resf^^^^^^^^^^^^^



Are strongly conservation oriented
by efficiently using facilities during
the season and non-season.
Are increasingly popular in areas
where the difference between
average and maximum day
demands are significant.
Are generally understandable and
accepted by customers.
Are based upon cost of service
allocation concepts.
Are generally consistent with legal
requirements in most jurisdictions.

Can be more financially sufficient
than "average cost" rates.
Can promote water conservation
efficiency objectives.
Can be designed to "reward"
efficient water users.
Can provide source of funding for
water conservation programs or
rate stabilization fund.
May be very simply designed.


Are sensitive to differences in
climatic conditions between the
season and non-season.
Are highly dependent upon
frequency of billing cycle.
May have less predictable impact on
demand and, therefore, revenue.
May have substantial impact on high
volume customers when moving
from another rate structure.

May have less predictable impact on
demand and, therefore, on revenue.
May be difficult to develop, explain,
and understand.
Are untested legally in many states.
May have significant impact on
high volume users within
customer classes.
May generate large surpluses which
may be legally disallowed.




University of Florida Home Page
© 2004 - 2010 University of Florida George A. Smathers Libraries.
All rights reserved.

Acceptable Use, Copyright, and Disclaimer Statement
Last updated October 10, 2010 - - mvs