“Conserving water won’t necessarily save you money!” Appearing on a local news website last autumn in northern California this headline highlights an interesting situation when water utility customers – after engaging in a successful conservation effort – received the surprising gift of an 8% water rate increase. An inside analysis of how utilities typically must manage costs provides insight into how successful conservation programs may result in an increase to customer’s water rates. For those in Water Rate Consulting, this is nothing new.

Significant rate increases after a successful conservation effort at first glance, doesn’t seem natural. Customers generally believe that cutting back on their water use should result in a reduced bill for water service. If user’s charges are calculated on a cost per gallon or cost per unit of service, this may be true – at least in the short term. Using less water usually does result in lower customer charges for water service.

Consumer believe that utilities should also see its costs reduced since fewer units, or in this case, gallons, are sold. In the case of an effective conservation program where consumers reduce consumption, the theory holds that the provider should also see its costs reduced as well. And all should be equitable.

When water providers begin to understand and manage their actual costs, this model no longer holds true. Unfortunately, many provider costs can be characterized as “fixed” or set costs. These costs do not change in relation to the number of gallons provided or number of units sold. In the case of water providers, these costs generally include maintenance, insurance, debt service as well as payroll and other costs that won’t be reduced if customers consume fewer gallons of water. In short, fixed costs occur at steady levels without relationship to customer use and are required by the utility to provide ongoing service to existing customers.

However, there is a direct relationship between income and revenue to the utility as well as a relationship between consumption level and price per unit. In other words, it is a function of quantity times price per unit. As water consumers decrease use, the inevitable result is a corresponding decrease in revenue paid back to the provider. So although conservation efforts may benefit customers in the short term with reduced fees and charges, the decline in income to the utility leads to economic shortfall. A successful water conservation program by extension, reduces revenue to the provider. The difficulty then lies in the fact that water providers and water utilities need this revenue just to provide providing on-going water service.

At the point that income levels are insufficient to support expenses – the utility is naturally compelled to identify new sources of revenue. Most water utilities will then seek rate increases in an effort to cover their fixed costs. If fewer units of product or in this case, gallons of water are sold, the rate per unit or gallon is going to have to be higher to return the utility to its original revenue levels that covered ongoing expenses.

When utility expenses threaten to outpace revenues , the provider usually proceeds with a request for a rate hike. Increases in rates then erase any gain the customer conservation efforts produced. After all, if fewer units are sold, the rate per unit (gallon) is going to have to be raised to a level that provides enough revenue to support the providers’ ongoing operations. This results in a basic conflict between provider revenue requirements and efforts to reduce customer bills.

Avoiding this conflict requires utilities and customers to fully understand the tradeoffs between conservation and utility revenue prior to initiating any kind of conservation effort. Establishing a rate structure in advance of conservation programs can help offset some of the expected revenue reductions and provide some degree of stability to customer rates. Skilled water rate consultants can also help design these rate and fee structures in advance. And that is a better solution than facing down upset customers at the next public meeting.

Author Jason Mumm is a an experienced Utility Consultants and specializes in water and wastewater services. With many years of experience delivering finanical and operational counsel to water service providers, Jason assists client companies achieve financial success while managing consumer rates.