Analysis: Conventional Rate Structures Punish Low End Users

Matt Williams and Donna Lemongello listen to URAC discuss their proposal the meeting before last week..
Matt Williams and Donna Lemongello listen to URAC discuss their proposal the meeting before last week..

We have heard much about the inadequacies of CBFR. The look-back is considered unfair. The public does not understand the rates. CBFR was said to punish people who chose to have water and summer intensive outdoor uses.

But the bottom line is that CBFR equalized a very inequitable situation where the reliance on 40% fixed costs meant that low end users paid more – a lot more proportionally per unit – than high end users.

Matt Williams and Donna Lemongello have offered a system that can fix that. But it is clear that neither the city, especially Herb Niederberger, nor a working majority of the URAC are in favor of such a system.

Cost-per-ccf-across-conventional-rate-systems

This graphic re-structures the city’s sample bill comparison for single family residential billing under the various rate scenarios that the WAC was asked to look at – without the Williams-Lemongello rates.

Except, instead of raw billing, we look at cost per ccf and this is what illustrates most clearly the problem with all of these rates.

The lowest user spends TWICE per CCF what the middle tier users at 11 CCF spend. And they spend THREE TIMES the amount that the highest end users use. They are effectively subsidizing the water usage of the top end users. As Matt Williams would state a few meetings ago, “That is not fair.”

The critical issue facing the council is the seeming tradeoff between social equity versus the need for revenue certainty and drought resilience.

At the URAC meeting, Elaine Roberts Musser would argue that these differences are not necessarily that great. She argued that the cost differences across all schemes is only $9.

Greg Clumpner, a URAC member, argued in his synopsis that he submitted to the Vanguard, “Ideally, fixed costs are recovered through fixed charges and variable costs are collected through volumetric rates. The higher the percentage of rate revenue collected from volumetric rates (i.e., above variable costs), the greater the revenue instability.”

He argues, “The perception that the ‘social-equity bar charts’ presented numerous times fairly represent social equity presumes that all costs are variable. This is just not true, and I believe this is a poor measure of the fairness and social equity of rate structures.”

On Tuesday, the city’s financial advisor, Mark Northcross, discussed the implications of the 87-13 structure.

Any rate structure you can bond against, that’s not the question,” he stated. “The question is what’s the cost of bonding. The more different it is, the more uncertainty there is which means volumetric, the more likely the rating will be adversely impacted.”

He talked about a revenue stabilization reserve fund as a mechanism to protect the bond rating. “The way this thing is set up, my instinct is that I would want to see cash deposited in the vat from day one and restricted,” he said. “I want to see money in there from day one.”

“I said $4 million as a ballpark figure for how much cash would need to be in there,” he said.

He would add, “The reason you want cash upfront is that promising to deposit cash after everything goes bad is something that the ratings services have finally figured out doesn’t always work. Because after everything goes bad you may not have the cash.” He added, “They want to see it restricted… Once it goes in there, you’re pregnant, it’s there.”

He noted that drought recovery fees should be on the fixed, not the volumetric charge, because in a drought, the uncertainty is on the volumetric side, “you don’t know how far down its going to go. So putting your drought recovery fee on the volumetric is like a dog chasing its tail.”

Mr. Northcross added, “The way out of that particular bind in a drought situation is to put your drought recovery fee… put it all on the fixed… so whatever you have to cut on the consumption, it’s all coming back.”

While Greg Clumpner argued that any CBFR was “opposed by much of the public (via Measure P), and is difficult for the general public to understand,” Matt Williams believes otherwise.

“I believe this proposal honors both the spirit and intent of Measure P,” he would write. “It has eliminated the 6-month weighting.  It does not shift the costs to summer irrigators.  “

He argues, “The bill that consumers receive each month under our proposal will be familiar, simple and easy to understand.  It will have two parts just like the bills today do, and it will only include charges for the current period’s water usage.”

He added, “There is a good argument that Revenue Stabilization Reserve Fund provisions should be included in any rate that Davis adopts. Mother Nature doesn’t modulate her drought effects on the basis of what water rate structure a city has put in place. All rate structures are subject to the revenue erosion risks associated with drought. 60-40 isn’t a magic bullet. It too is vulnerable. If having a reserve fund and Stage 3 and Stage 4 surcharge provisions allows Davis to get lower interest rates, then all the ratepayers benefit from the lower borrowing costs. It is really a very simple mathematics problem … one that should be central to Davis’ presentation to bond rating agencies like Standard and Poors.”

He and Donna Lemongello believe they have addressed the rate-stabilization issues. Here is what they presented to the URAC on Friday.

Rate and Fee Increases

The City of Davis is proposing to increase the rates and water service and establish a new rate structure.  The new water fees would be imposed on all properties in Davis receiving water service.

Two-Part Structure

The rate structure has two components, 1) revenues from rates and 2) a revenue stabilization reserve fund

Traditional Fixed Volumetric Rate

Revenues from rates are derived from two components:  A) a monthly fixed fee and B) a monthly volumetric water use fee.  Those components are:

  •  A Fixed Fee, which for a 3/4-inch meter is $8.25 per month, to pay for billing costs, fire fighting infrastructure and readiness to serve infrastructure costs.
  •  A Volumetric Use Fee that has two tiers, specifically $3.14 per ccf for the first 20 ccf each month and $4.54 per ccf for all water usage above 20 ccf each month.  This fee pays for the costs of wells, above ground water storage, the surface water plant, water pumping electricity and water treatment chemicals.

Revenue Stabilization Reserve Fund

Smooth Cash Flows for Debt Coverage

The revenue stabilization reserve fund supports the smoothing of monthly cash flows each fiscal year. During low revenue winter months, the revenue stabilization reserve fund will be used as revenues of the water utility for the calculation of adequate ongoing debt service coverage to comply with bond covenants.

Annual Reserve Fund Balance Target

The June 30th end-of-year target balance for the revenue stabilization reserve fund is 25% of the annual revenue requirements.

Reduced Consumption Revenue Protection

The revenue stabilization reserve fund will also be a core component of the City’s response in times of substantially reduced consumption (whether from cumulative conservation or as a result of drought), which is outlined in the City’s Urban Water management Plan (see http://water.cityofdavis.org/water-conservation/drought).

Reduced Consumption Provisions

Stage 1 and Stage 2

In order to keep the water utility financially stable through the circumstances of reduced consumption, the revenue stabilization reserve fund will be available for use as revenues during Stage 1 and Stage 2 shortages (a 10% reduction and a 20% reduction respectively).

Stage 3

When aggregate system-wide consumption reaches a Stage 3 shortage (a 30% reduction), the cost of the volumetric portion of each customer’s monthly water usage shall have an extra 15% of that cost added to the bill.

Stage 4

When aggregate system-wide consumption reaches a Stage 4 shortage (a 50% reduction), the cost of the volumetric portion of each customer’s monthly water usage shall have an extra 43.75% of that cost added to the bill.

Duration of Temporary Rate Adjustment

A Stage 4 rate adjustment will continue in effect until the reduced consumption stage has been reduced to Stage 3. A temporary Stage 3 rate adjustment will last until the drought stage has either been reduced to Stage 2 or increased to Stage 4.  During a Stage 4 shortage the Stage 3 cost provisions do not apply.

Does this do enough to quell the concerns raised by both the council last week and the URAC? Hard to know. But given the distribution of cost per ccf for the conventional rates, I suspect that a rate challenge like Measure P could prove effective if the council cannot find a more equitable means to create the revenue stability needed for the bonding agencies.

—David M. Greenwald reporting

About The Author

David Greenwald is the founder, editor, and executive director of the Davis Vanguard. He founded the Vanguard in 2006. David Greenwald moved to Davis in 1996 to attend Graduate School at UC Davis in Political Science. He lives in South Davis with his wife Cecilia Escamilla Greenwald and three children.

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29 Comments

  1. South of Davis

    David wrote:

    > Conventional Rate Structures Punish Low End Users

    I think it comes down to what different people think is “fair”. Is it “fair” to charge the owner of the DAC (who’s pool is getting more use and having more water splash out since the city is closing public pools and who has 100 people take a shower every day) the same price per gallon (or CCF to make Matt happy) as the grad student that lives in a studio condo (and only showers the two days a week he is teaching and not sitting at his desk trying to finish his thesis)?

    In the private sector most people think it is “fair” that people who use more pay less and I’m sure no one would be surprised that if Teichert sends a 4,000 gallon water sprayer truck to keep the dust down at the Canary site the cost per gallon will be a lot less than if the grad student logs on to Safeway.com and buys a gallon of spring water to drink while working on his thesis. Does Safeway (or restaurants) “punish” low end users when they charge MUCH MUCH more for water than the high end user that buys it by the 4,000 gallons at a time?

    1. Frankly

      Nice points SOD.

      There is that social justice mindset again. Some people just cannot help themselves. As you point out in your examples, the ratcheting of fairness based on assessment of economic class is a slippery slope and impossible to implement on a macro scale.

      I guess there are people that never got the “life is not fair” explanation from their parents.

      But in terms of public policy, the most “fair” is always going to be a penny spent for a penny of service used.

      We all pay the same price per gallon for gasoline. But of course, I’m sure there are those social justice do-gooders scheming right now for a special GASNSAP card for those low income people that can no longer afford the gas prices made high from all the taxes added by the social justice do-gooders.

      1. Davis Progressive

        it’s not a social justice issue, it’s a matter that people are being charged for service costs that they are either not contributing to or not contributing as much to.

    2. Davis Progressive

      your water analogy at safeway doesn’t hold water. in that case you don’t have low end user subsidizing high end users. instead, you have low end users paying more because the fixed costs – in that case the cost of the containers make up a disproportionate part of the cost. whereas in this situation, the main problem is that the fixed costs of meter size really do not correlate with the fixed costs in the system. this has been explained over and over again that the fixed costs really measure capacity and the low end users contribute far less to the peak output need than the high end users.

    3. Matt Williams

      SOD, I am glad that you have brought up the DAC example. The problem you raise is one that exists in all rate structures everywhere. To address this problem the state’s Department of Water Resources convened a COMMERCIAL, INDUSTRIAL, and INSTITUTIONAL (CII) TASK FORCE PROJECT in March 2011 under the auspices of The Water Conservation Act of 2009. The report for this project, known as the U1 CII Task Force for short, is available at http://www.water.ca.gov/wateruseefficiency/sb7/committees/urban/u1/

      One of the key provisions of the CII report/recommendations is how to set the tier break for Commercial/Industrial/Institutional customers. Our proposal recommends following those CII Task Force guidelines for Davis’ Commercial user class. The focus of the community discussion has been on residential, but Donna and I have dotted our i’s and crossed our t’s in the Commercial/Industrial/Institutional area as well.

  2. dlemongello

    SOD, guess what, DAC (where I work, full disclosure) and all commercial users are going to get the amount of water they used historically per year at tier 1 rates in our structure. It is the family user class (single and multi) that will pay the same price per gallon as each other. But yes, if you have a big luscious lawn you want to keep, or you are just an inefficient water user, the other guy is not going to subsidize you. But even then, tier 1 is set quite high, you really have to use a lot of water (21ccf or more per month to be exact) to end up in tier 2.

    1. South of Davis

      Donna wrote:

      > It is the family user class (single and multi) that will pay the
      > same price per gallon as each other. But yes, if you have a big
      > luscious lawn you want to keep, or you are just an inefficient
      > water user, the other guy is not going to subsidize you

      I think we need to get away from words like (David’s) “punish” and (Donna’s) “subsidize” since every house using a lot of water does not have a “big luscious lawn” and in most cases (in Davis) will have a lot of students crammed in to a little house because they are trying to save money on rent (or they are an older newspaper columnist who still has a lot of kids at home).

      Is it “fair” to give the same “punishment” to a single guy with an acre of lawn in North Davis Farms as you give to a poor family with six kids who have a set of the kids grandparents living with them since they can’t afford daycare even though both parents work?

  3. dlemongello

    20 ccf is plenty of water to address all of those users without “punishment” (your word), ask the “older newspaper columnist who still has a lot of kids at home”. And my rental with 4-5 tenants uses 6-11 ccf/month.

      1. dlemongello

        But SOD, you are still only going to pay tier 1 rates if you use all the way up through 20 ccf and if you use 11 or less you will pay less than any of the consultant’s structures and up to 16 for at least one of their structures. From that target I would guess you have 2 people living there, or at least that is what the city “thinks”. The personal use target is 55 gallons per day.

    1. paul Brady

      In Willowbank we exceed 40 ccf every month in the summer!

      The larger users are paying for the large system they require, and it will provide “cheaper” water for all. They pay for it by the large volume of water they purchase, and none of it runs down the street I can assure you! Drip and mulch is used, but with the hot summers, the huge lots with so many trees, so much greenery and plantings there is no option. About 90% of these large lots is planted – much more than on smaller lots. The small users have access to this cheap water, so who is subsidizing whom! The rates the City seeks are much higher than needed. Little effort is being made or planned by the City to economize. eg, the savings from the shut-down of most of the intermediate wells

      Water costs here in WB will approach $4000/yr, so you can understand why we seek to revive our old shallow- well system for irrigation.

    1. Davis Progressive

      i don’t know that there is a set definition, but it seems to be used in this context to refer to a rate structure with 40 fixed rate, 60 percent variable rate.

      1. dlemongello

        I am going to stick my neck out here, because actually I believe any structure with a fixed and variable component is considered “conventional” and that David could have distinguished things better here, but I am sure he only wrote it that way because he did not know the full nuances of the term. Of course what distinguishes the 2 sets of structures is ours in 87 Var/13 Fixed, the consultant’s are 60% Var/40% Fixed. The other thing that is very conventional is any structure, all these included, need to be looked at on an approximately annual basis, and readjusted if necessary, for generating the right revenue.

      2. Matt Williams

        DV and DP, “a rate structure with a fixed fee component and a variable/volumetric fee component” is probably the highest level definition of “conventional.” The percentage proportions of the two components varies considerably. The state Department of Water Resources (DWR) and the California Urban Water Concervation Council have come up with Best Management Practice 1.4 that sets the numbers at 70% volumetric and 30% fixed. Some of the DWR grants deny an application if it doesn’t comply with BMP 1.4.

  4. Alan Miller

    Again, I ask all to eliminate the word “fair” from all water discussions. When all sides think “their” scheme is “fair”, the word has no meaning.

    The more I read, the less I am convinced by the social equity arguments. The person who said that the fixed costs should cover the fixed infrastructure makes the most sense. I’m sure what that covers exactly could be argued, but I’m sure a range could be defined. There just plain is a charge just to access the system. The fact that overall the fixed plus variable means low end users pay more per gallon is a non-argument in my view. If you are covering the fixed cost of entering the system, that is fixed no matter what you use. To the degree the city goes up on fixed to value lawns, large families, trees, gardens, leaking toilets, then the fixed should go up from there; to the degree the city values conservation, cactus and spreading more fixed costs to higher-end users, the fixed should go down from there.

    I am not sure how everyone seems to not differentiate between rate structures and rate values. In my opinion the URAC should recommend several rate structures along with their pluses and minuses for the City Council to evaluate. Then the City Council should decide on the variation from the fixed value to cover fixed costs based on a city value POLICY decision as to how the city values the balance between the various values higher or lower fixed values should be such as those examples mentioned above.

    If truly a lower fixed cost means higher bond costs which means higher overall costs, then if as a whole Davis is paying more that hardly helps low-end users to the degree they may be paying a lower per-gallon but everyone including them is paying more overall. That is not a logical end game.

    1. Matt Williams

      The person who said that the fixed costs should cover the fixed infrastructure makes the most sense. I’m sure what that covers exactly could be argued, but I’m sure a range could be defined. There just plain is a charge just to access the system.

      I agree 100% Alan. The Bartle Wells Cost of Service Study pegged those fixed costs at 13% of the total (6% for Fire Readiness, 4.5% for what you called “just plain access to the system” and they call Readiness to Serve, 2.5% for Billing, Administration, Compliance and Meter Replacement costs. Covering those fixed costs is what the “13” is in 87/13 … fixed fees to pay for fixed costs.

      1. Alan Miller

        Well, that’s the most succinct and clear thing I’ve read in all the water arguments, short and source cited. If that is the whole of it, I’ll bite.

    2. dlemongello

      Alan, we have no intention of trying to get the city to adopt our structure if it costs more overall because of higher interest rates, we have stated this publicly numerous times. We are in the process of getting the best answer to that question we possibly can.

      I will try not to use the word again since it can be determined based on several differently interpreted criteria. I happen to be in the camp where I see logic for people paying for a fixed cost by the proportion of that amenity that benefitted them personally. But I also can see the logic in saying if a cost is fixed and not determined by use, in this case volume, there is also a reasonable argument that can be made to not therefore charge on proportion to use. But there is one more point to consider, and that is the infrastructure had to be “big” enough to accommodate aggregate use, and everyone has a share of that. So that is my reasoning.

  5. Frankly

    We need to set the fixed rate aside in determination of the total cost per CCF.

    The argument that higher water users must pay a greater fixed cost is severely flawed. That is where the social justice mindset goes off the rails.

    Each property is connected to the water delivery infrastructure. That connection should be represented in the fixed cost that represents the debt service on the total investment in that infrastructure.. And meter size should be a factor in a differentiation of that fixed cost. But neighbor A in a smaller house filled with retired empty nesters should pay the same fixed cpst for their 1/2″ meter as should neighbor B with a larger house full of thirsty and dirty kids.

    Variable rate should be based on ongoing operational expenses less the debt service… including maintenance costs of the infrastructure. It should also include some operational reserve to cover unforeseeable changes in consumption that might cause total variable rate revenues to be inadequate or too-high.

    Now each should pay the same variable rate based on usage. And if we remove the fixed cost component from the social equity consideration, both families will be paying exactly the same per gallon/CCF.

    It is a disingenuous argument to claim unfairness using both fixed and variable costs to derive a total cost per gallon/CCF. Using this argument those that ride a bike and not drive a car should be given a discount on their property tax bill for road maintenance. It does not work that way. If we live here, we have to share equally in the cost of infrastructure.

    1. Matt Williams

      We need to set the fixed rate aside in determination of the total cost per CCF.

      Frankly, that is exactly what we are doing in the 87-13 proposal. There is nowhere in the proposal where higher water users are expected to pay a greater fixed cost. John Munn in his Sunday article in the Enterprise and the Vanguard backed off from a 100% Volumetric approach when he said, “I have since learned that a small fixed charge should be included for expenses, such as fire hydrants, providing benefits that are not proportional to water use.”

  6. Alan Miller

    “It is a disingenuous argument to claim unfairness using both fixed and variable costs to derive a total cost per gallon/CCF.”

    Yes, I agree.

    Do you know if the claims made above by W&L — that 13% covers the fixed costs — agrees with your interpretation of fixed costs? I’m not saying who is right, just trying to make sense of something beyond my understanding.

    You said the variable cost should fund the operational reserve . . . is that not what someone else called the rate “chasing its tail”? Maybe I have that wrong.

    1. dlemongello

      The chasing the tail analogy was referring to using a surcharge on the variable/volumetric charge to compensate for loss of revenue due to loss of consumption. So of course if your consumption keeps dropping your surcharge has to get higher and the implication was the higher the surcharge got it would drive consumption down further. But I do think there is a limit to how much consumption can drop and we have compensated for it in our structure all the way down to 50%.

    2. Don Shor

      So, to summarize:
      There are suggestions for water rates that are 17/83 fixed/variable, or rates such as 30/70, or 40/60.
      The higher the variable rate, the more it costs high water users.
      The higher the fixed rate, the more it costs (proportionally) low water users.
      Tiers increase the variable rate for higher water users.
      Current proposal has the variable rate a little higher (surcharge) because we need to build up a surplus for periods when revenues might drop.
      Optionally, the council could decide to make the fixed rate a little higher for that purpose instead.
      Basically, what the council has to decide is:
      — which amount for fixed, which for variable?
      — where to set the tiers?
      — how much surcharge to create the reserve?
      — whether to attach the surcharge to the fixed or the variable rates?

      1. Matt Williams

        That is a good summary Don. The one omission is that Bartle Wells in its March 2013 Rate Study recommended the creation of a Rate Stabilization Reserve Fund with a target balance of $5 million, and on Thursday they indicated that the $16,214,000 Revenue Requirement for 2015 contains costs for the funding of that Reserve. So the 40/60 rate alternatives also “have the variable rate a little higher (surcharge) because we need to build up a surplus for periods when revenues might drop.”

      2. dlemongello

        Don, ours is 13% fixed/87% variable
        -The higher the variable portion (such as 87%) means the more you use, the more what you pay is closer to the proportion of use
        -The higher the fixed portion, the less you use, the more you pay per ccf, and the more you use the less you pay per ccf unless this is rebalanced with tiers
        -Tiers, via the variable portion, increase the overall rate for high users, which is proportional to the higher costs associated with peaking
        -The surcharge is separate and would only kick in if consumption were to drop to a level where more revenue was needed from the variable portion, and only would be used to generate more revenue in that case. Generating the surplus we need is within the variable portion of the rates if consumption stays at an anticipated level. Optionally, the council could decide to make the fixed rate a little higher for that purpose instead.
        Basically, what the council has to decide is:
        – which portion for fixed, which for variable?
        – where to set the tiers, possibly different for different classes of users?
        – how much surcharge to generate the revenue if it is not generated by the rate itself due to loss of consumption?
        – whether to attach the surcharge to the fixed or the variable rates so if it were to kick in it would have the desired effect?

  7. Michael Harrington

    Had no idea that forcing the weird August 2011 rates onto a ballot would end up with all of these articles and posts. There is a very high public awareness of these water supply and ratestructure issues, and I think that is a very good thing.

    I’m not sure how this will all end, but the discussion is fascinating.

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