NAME/LOGO Session - 1 IPU - MSU What Regulators Need to Know about Drought Janice A. Beecher, Ph.D. Director of the Institute of Public Utilities Michigan State University Summer 2002

NAME/LOGO Session - 2 IPU - MSU

NAME/LOGO Session - 3 IPU - MSU Drought attention span Time Attention raindrought

NAME/LOGO Session - 4 IPU - MSU Characteristics of water use Per-capita water demand is flat Significant weather-related variations Opportunities for growth are limited Fixed cost are high and rising Pressure on rates is significant

NAME/LOGO Session - 5 IPU - MSU ,000 1,200 1,400 1,600 1,800 2, Gallons per capita per day Total withdrawals Total freshwater Consumptive use Public supply Daily Per-Capita Withdrawals in the US: 1950 to 1995

NAME/LOGO Session - 6 IPU - MSU Water and weather Water is transient in time and space; droughts are inevitable Mother nature controls supply and demand; supply is constrained just when we need it Water quality and water quantity are related Environmental externalities of water usage are exacerbated during drought For utilities, rainy weather is a problem when sales are down (excess inventory) Drought is a problem when the state imposes restrictions (artificial demand repression)

NAME/LOGO Session - 7 IPU - MSU Rain Drought Normal Weather and water sales

NAME/LOGO Session - 8 IPU - MSU Residential Water Use per Connection: American Water Works Service Company, Inc. (1980 to 1997) Gallons per connection per day

NAME/LOGO Session - 9 IPU - MSU Water efficiency/conservation Any beneficial reduction in water waste or water usage; emphasis on efficiency Marginal benefit exceeds marginal cost Broadly defined to include externalities Should not imply an impairment of lifestyle or economic activity Loss of excess capacity or demand hardening should not deter conservation

NAME/LOGO Session - 10 IPU - MSU Benefits of conservation Planning Year Supply Capacity and Demand Supply without conservation Supply with conservation Demand without conservation Demand with conservation

NAME/LOGO Session - 11 IPU - MSU Conservation v. drought management Conservation Long-term Choices are well informed Pricing plays a central role No impairment State role is less direct

NAME/LOGO Session - 12 IPU - MSU Role of pricing Pricing is a necessary but not always a sufficient tool of efficiency/conservation Water use in generally price inelastic Outdoor use > indoor use Nonresidential use > residential use Even small price responses can be meaningful in terms of revenues Marginal-cost pricing principles should be applied IOUs do not have clear incentives for efficiency pricing

NAME/LOGO Session - 13 IPU - MSU Water rate design in the U.S. Uniform rate: 36% Increasing-block rate: 29% Decreasing-block rate: 36%

NAME/LOGO Session - 14 IPU - MSU Cost/unit Under- pricing Cost- based pricing Over-pricing Price/unit Efficientprice Efficiency pricing

NAME/LOGO Session - 15 IPU - MSU Increasing-block ratePrice/unit Quantity consumed Tier Tier breakpoint

NAME/LOGO Session - 16 IPU - MSU Seasonal ratePrice/unit Quantity consumed Peak season Off-peak season

NAME/LOGO Session - 17 IPU - MSU Excess-use and water-budget based Price/unit Quantity consumed Excess use/use above budget allotment

NAME/LOGO Session - 18 IPU - MSU Marginal-cost pricingPrice/unit Quantity consumed S1 S3 S2 S = supply option Tail block

NAME/LOGO Session - 19 IPU - MSU Multi-objective rate (example)Price/unit Quantity consumed Marginal cost Hi cost Low cost Mid cost Lifeline for eligible customers Consolidated rate Affordability >>>> Equity >>>>> Efficiency Location/season

NAME/LOGO Session - 20 IPU - MSU Drought pricing Short term implementation Fines and penalties Purpose is enforcement v. efficiency Revenue effect may be negligible May strain customer relations Non-price options (restrictions) may be more effective and appropriate in severe drought conditions

NAME/LOGO Session - 21 IPU - MSU Drought and revenues In the long run, all costs variable; in the short run, many costs are fixed Many water utilities rely on revenues from variable charges to cover fixed costs Mandated curtailments can impair the utilitys ability to collect sufficient revenues to cover costs, make needed investments, and earn a fair return Revenue-adjustment (demand-repression) mechanisms may be necessary

NAME/LOGO Session - 22 IPU - MSU Demand-repression adjustment May be needed to adjust rates and revenues to account for revenue effects of: Conservation-oriented prices Drought-management policies (force majeure?) When water utility revenues are impaired by state-mandated restrictions on usage during drought, the state (PUC) also has a responsibility to consider measures for adjusting rates and revenues

NAME/LOGO Session - 23 IPU - MSU Adjustment eligibility Long-term water supply plan and compliance with all state requirements Water-loss management (plug the leaks!!!) Efficiency-oriented tariff based on normalized weather Public education effort Subject to proof of impact, audit, and reconciliation

NAME/LOGO Session - 24 IPU - MSU Conclusions Water utilities are unique in terms of drought impacts Regulators must be aware of potential revenue effects A carefully designed adjustment mechanism could address revenue issues and utility incentives for conservation and drought management

NAME/LOGO Session - 25 IPU - MSU Some Publications Compendium on Water Supply, Drought, and Conservation. (NARRI 1989). Revenue Effects of Water Conservation and Conservation Pricing: Issues and Practices (NRRI 1994). Handbook for Designing, Evaluating, and Implementing Conservation Rate Structures (California Urban Water Conservation Council, 1996).

NAME/LOGO Session - 26 IPU - MSU