The document discusses how declining water demand is driving increases in water prices rather than the other way around, as many assume, due to water utilities having large fixed costs. It also critiques increasing block rate structures, arguing they are inequitable, inconsistent with cost of service principles, and do not effectively encourage conservation as intended because customers respond more to average price than marginal price. The author concludes rate structures need to be rethought to better align with costs of service and address the challenges of declining demand.

1. Rate Structures, Fixed Costs, Declining
Demand, Reduced Revenues:
What Really Determines
the Price of Water?
Arizona Water Annual Conference
4 May 2017, Phoenix, AZ
Gary Woodard, JD MPP
Montgomery & Associates

2. Brief Bio: Gary Woodard, Montgomery & Associates
Gary Woodard is Senior Water Policy and Economics Consultant with
Montgomery & Associates. Prior to that, he was with the University
of Arizona. He has addressed water resources issues as both
academic and consultant for 35 years.
Woodard works on a range of policy issues, with an emphasis on
municipal water demand, conservation, and pricing. His areas of
expertise include modeling water demand, evaluating utility assets,
forecasting trends, designing water rate structures, and assessing
water quality impacts.
He has chaired a water district, founded a water conservation
alliance, and worked with UNESCO in arid lands globally.

3. Supply-demand curves are endemic
in economics and public policy
…but not in this
presentation.

4. Debate over the key drivers of municipal demand
 Economists – it’s the price, stupid!
 Conservation professionals – our customers are
conserving for altruistic reasons
 Fence straddlers – there are synergies between price
increases and conservation programs
 Engineers – didn’t trust either camp (especially
conservationists), better to have excess capacity and
grow into it

5. Is water different? Does economics not apply?
Municipal water seems different in that:
• The price is not set by a free market but rather by
elected bodies or utility regulators
• It is extremely heavy and therefore expensive to
move uphill or over great distances
• There are many quality dimensions to municipal
water service
• Some minimum water supply is necessary to
maintain life and meet basic sanitary needs
• It is not destroyed by use; water used indoors can
be reclaimed and re-used

6. Water is different – it’s a human right
The Human Right to Water and Sanitation
On 28 July 2010, through Resolution 64/292, the United
Nations General Assembly explicitly recognized the human
right to water and sanitation and acknowledged that clean
drinking water and sanitation are essential to the realization of
all human rights.
To meet the goal of universal access, the water
supply must be:
• Sufficient
• Safe
• Acceptable
• Physically accessible
• Affordable

7. Increasing block rates (IBRs) became popular…
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2000 2002 2004 2006 2008 2010 2012 2014
% Utilities with commodity charges that are:
Decreasing Uniform Increasing

8. …and many utilities with IBRs intensified them…
Over time, the rates have been modified to:
 Increase the number of blocks
 Steepen the differential between blocks
 Reduce the fixed portion of the water bill and increase
the commodity charge

9. …but IBRs are particularly problematic
 They are inequitable, assuming that households that
use more water are being wasteful
 They are inconsistent with cost of service principles
 They destabilize utility revenues
 They don’t work as advertised to encourage
conservation

10. Increasing block rates are often inequitable
IBRs target and punish large water users, assumed to be
water wasters with large amounts of outdoor usage.
Unfortunately, IBRs are a blunt policy tool that also hit:
large families with greater levels of indoor demand
low-income households with older, less-efficient fixtures
and appliances and a greater incidence of leaks
The big winners under IBRs are households in newer
homes with modern appliances and fixtures and little if any
turf. These households tend to have higher incomes.

11. IBRs are not aligned with cost of service principles
Households that use more water are often more cost-
effective to serve, but under increasing block rates, they
fall in higher rate blocks.
Because it was not aligned with costs of service, a
California court recently found that an aggressive IBR
violates California’s state constitution.
Rate structures can be designed to provide strong
conservation signals without the equity and cost of service
issues of IBRs.

12. Why aren’t IBRs effective conservation tools?
 Rate schedules are complex, may adjust seasonally, and are
frequently changed
 Water bills typically include sewer charges and other costs
 Water bills generally are among the smaller of household utility
bills
As a result, consumers do not respond to marginal price.
The underlying theory of IBRs is deeply flawed.

13. Sewer, other fees often dominate “water” bill
So-called “water bills” in
Pima County and many other
places have been increasing
largely as a result of sewer
fees.
Tucson Water’s new bill is
designed to highlight the
non-water portions of the
water/sewer/environmental
services bill.

14. Do customers react to MP or AP lagged?
Demand for water by well-informed, rational consumers:
Q = B0 + B1(I + D) +B2MP + B3Z
Demand for water by uninformed, rational consumers:
Q = B0 + B1I +B2APL + B3Z
Demand for water by a mix of informed and uninformed consumers:
Q = B0 + B1(I + αD) +B2[APL + α (MP - APL)] + B3Z
α varies from 0 to 1 and represents the fraction of consumers who are
aware of the rate structure details and react to marginal price.

15. Analysis was consistent with uninformed customers
0.7
0.71
0.72
0.73
0.74
0.75
0.76
0.77
0.78
0.79
0.8
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1
R2Value
Assumed level of rate comprehension
Separate research projects
by Woodard and by
Opaluch in the 1980s
established that consumers
who face complex,
frequently changing rate
structures react to lagged
average price.
Research reported in 2014
reached the same
conclusion.
If most consumers are
reacting to average price,
then IBRs are ineffective.

16. What are the consequences of customers reacting to AP?
Decreasing AP Increasing AP
In the cases analyzed,
most customers had water
demand levels that
resulted in them facing
declining average price.
In other words, the more
water they used, the lower
their average price of
water.

17. The real cost of indoor water uses - showers
QUANTITY COST PERCENT TOTAL COST
SHOWER-maximum products
Water 15.8 gal $0.063 5.0
Sewer 15.8 gal $0.108 8.5
Energy 2.06 kWh $0.211 16.6
Shampoo 0.6 fl oz $0.450 35.4
Conditioner 0.3 fl oz $0.225 17.7
Body Wash 0.3 fl oz $0.096 7.6
Moisturizer 0.2 fl oz $0.118 9.3
Water
Sewer
Energy
PCPs, Cleaners
Water
Sewer
Energy
PCPs, Cleaners
Between 6% & 14% of indoor water use costs are for the water

18. Similar findings for swimming pools
Pecuniary benefits of removing an
unused pool include lower:
• water and sewer bills
• electric bills
• homeowner’s insurance
• property taxes
• chemicals costs
• pool service company expenses
• maintenance and repairs

19. Annual total costs of maintaining a pool
Costs by Category
Water/Sewer
Electricity
Insurance
Property Taxes
Chemicals
Pool Company
Maintenance
Costs are dominated by electricity, chemicals,
and often, a pool service company.
Water is a much smaller expense.

20. Observed Declines in Demand
0
50
100
150
200
250
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
AverageWaterDeliveriesperHousehold(Kgal/year)

21. Three factors driving down
residential water demand:
• Active conservation efforts – program-related
• Passive conservation driven by more efficient
appliances & fixtures and changing tastes &
preferences – remodeling kitchens and bathrooms
• New more water-efficient houses are being added to
the housing stock

22. What are the limits to efficiency?
 Toilets – from 5 gpf to 3.5 to 1.6 to 1.28
 Shower heads – from 4 gpm to 2.5 to 2.0 to 1.5
 Dishwashers – from 6 gal/load to <4 to 2 zones
 Clothes washers – from 40 gals/load to 27 to 23
 Commercial washers – from 2 gal/lb to 0.7 gal/lb
 Cooling towers – from 2 cycles to 3 to 4
Can we really go much lower?

23. What are the limits to efficiency?
 Toilets – from 5 gpf to 3.5 to 1.6 to 1.28 to 1 to 0.8
 Shower heads – from 4 gpm to 2.5 to 2.0 to 1.5 to 0.75
 Dishwashers – from 6 gal/load to <4 to 2 zones
 Clothes washers – from 40 gals/load to 27 to 23 to 8
 Commercial washers – from 2 gal/lb to 0.7 to 0.5 gal/lb.
 Cooling towers – from 2 cycles to 3 to 4 to 0 (geothermal)
Can we really go much lower? YES.

24. Decreasing demand forces rate increases
 Water utilities have large fixed costs, typically over 85%
 Energy and chemicals account for most of the variable
costs
 When demand falls, revenues fall far more than costs
 This problem is exacerbated by IBRs
 The response is continually rising water (and sewer) rates

25. Actual relationship of price, costs, and demand
Price increases Demand falls
Changing technologies,
tastes, and demographics
Revenue
falls

26. Actual relationship of price, costs, and demand
Price increases Demand falls
Changing technologies,
tastes, and demographics
Revenue
falls

27. Cost of water, sewer began deviating from
all other goods and services post-2000
0.000
50.000
100.000
150.000
200.000
250.000
300.000
91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Water & Sewer
CPI-Urban –water & sewer vs. All Items, January 1987 – March 2016

28. The mystery of CPI-water – solved?
Why have water & sewer rates grown more than twice
as fast as other prices since 2000?
Possible explanations:
• Maybe municipal water providers have been beefing up their
staff?
• Possibly water professionals have seen their incomes increase
far faster than the national average?
• Or perhaps water/sewer rates accelerated around 2000
because that is the time that gpcd rates began their long
downward trend?
More evidence consistent with the hypothesis that declines in
demand are driving rate increases, not vice versa.

29. Providers are starting to re-think IBRs
Over the past couple years,
rates are being quietly
modified to:
 Decrease the number of
blocks
 Lessen the differential
between blocks
 increase the fixed portion of
the water bill

30. So are regulators
Last year, the Arizona Corporation approved
new rates for Community Water of Green
Valley that assumed their long-term declines
in demand would continue.
This was accepted by ACC staff,
recommended by the administrative law
judge, and unanimously approved by the
commissioners.

31. Conclusions:
 The theory of consumer price perception does not hold for
water utilities
 IBRs cause more problems than they solve
 The costs of most “water uses” is mostly for items other
than water
 The price of water and water demand are correlated, but
the impact of price on demand is modest
 The impact of demand on price is much larger - cause and
effect are largely reversed
 This may be reflected in inflation rates post-2000

32. “Statements of fact and opinion expressed are those of
the author/presenter.
AZ Water, AZAWWA, and AZWEA assume no
responsibility for the content, nor do these statements
represent official policy of the Association.”

33. If you have questions or would like more
information…
Gary C. Woodard, JD, MPP
Senior Water Policy & Economics Consultant
Montgomery & Associates
Office: 520.881.4912
Cell: 520.850.4249
gwoodard@elmontgomery.com