With the future of the drought uncertain, the State Water Resources Control Board extending the emergency conservation regulation, and the legal environment for rate setting still evolving, many water utilities are left short on revenue and wondering what to do. We are working with a number of water agencies who are grappling with these issues to jointly develop some creative solutions.

The appellate court ruling on the City of San Juan Capistrano’s water rates set a new standard that requires agencies to clearly demonstrate the cost basis for their tiered water rates. Facing the uncertainty of exactly how this should be done, many agencies are choosing to roll back their tiered rates and adopt a uniform (single-tier) volumetric rate in an effort to better comply with the requirements of Proposition 218. Other agencies who have tiered rates (and want to keep them) are seeing a “flattening” of their tiers as a result of more closely tying these rates to their cost basis. This takes the form of reducing the number of tiers and/or having smaller cost differentials between tiers.

Additional consequences of taking a more “cost-based” approach to rate setting include collecting a greater percentage of rate revenue from fixed charges. This provides more revenue stability and safeguards against significant decreases in revenue in uncertain drought conditions. Also, more closely pegging volumetric rates to the marginal cost of water helps ensure sufficient revenue for the utility at various levels of water consumption. As a further safeguard, developing drought rates that align with varying levels of conservation allow a utility to adjust the price of water, as conservation increases or decreases, thereby providing a backup plan that maintains revenue stability independent of the amount of water sold.

Creative water pricing methodologies such as these can allow water utilities to mitigate the risk of decreasing revenues during changing and uncertain water conservation levels, and help meet Proposition 218 requirements at a time when uncertainty is the only certainty.

On the legal front, efforts to “de-publish” the San Juan Capistrano ruling have not fared well to date. However, the Association of California Water Agencies (ACWA), the League of Cities, and the California State Association of Counties are working with the State legislature to provide more flexibility in rate setting.

Late in 2015, the California Water Conservation, Flood Control and Stormwater Management Act was introduced (see page 3 for more details), and more recently on March 9, 2016, water industry leaders met in Sacramento to discuss efforts to amend Article X of the California Constitution to provide water agencies an alternative process which allows: (1) more flexibility in adopting conservation-based rate structures; (2) the freedom to implement lifeline rates for low-income households that could be subsidized by other ratepayers; and (3) more flexible financing options for storm water and flood control projects.

We will continue to provide updates on these important issues as they evolve.