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Real Water Rates on the Rise

Fortnightly Magazine - July 15 1997

may reduce their water consumption through efficiency improvements or bypass the water supplier in favor of partial or complete self-supply. In extreme cases, they may seek to relocate. Whatever the reaction, the result for the water utility is revenue instability and revenue shortfalls. These problems are magnified when price elasticity estimates are excluded from the rate design process. The interaction between price elasticities and alternative rate structures must be considered carefully. %n5%n

Industry and Regulatory Restructuring

Increases in costs and real water prices most likely will constrain regulatory options in the short run. Regulators and legislatures historically have stood reluctant to decrease regulatory controls while real prices were increasing. Deregulation has primarily occurred when real prices were declining.

During the '70s, the twin shocks of rapidly increasing energy prices and higher rates of inflation changed the passive regulation of the electricity and natural gas sectors into an active and continuous review process. %n6%n Similarly, in the '90s, rising water costs will affect the water-supply sector and potentially could transform economic regulation.

Rising costs and prices, particularly in a more competitive water sector, ashould induce water utilities to mitigate costs. Water utilities have several cost-reduction options.

Water system consolidation can help utilities achieve much-needed economies of scale in source development, water treatment and utility management and operations. Regionalization of water utility service probably is the most promising means of reducing the unit cost of water production. Consolidation or regionalization also help achieve other policy goals, such as universal service and watershed

management. Besides regional utilities, wholesale water markets also could emerge. Smaller water utilities could become resellers and pass along to customers the savings from avoided treatment capacity. Privatization or public-private partnerships may help some municipal utilities realize substantial efficiency gains.

Water utilities can adopt efficiency improvements to reduce waste, conserve resources and lower production costs. Technological innovations in water treatment and other aspects of water utility operations likely will emerge. For large systems, innovation may include automation; for small systems, it may include point-of-entry or point-of-use treatment devices.

Market forces can lower costs by fostering competition for contracts and services between equipment vendors and other suppliers. In any sector of the economy where billions of investment dollars are at stake, the rivalry for profits will likely be intense. The recent EPA Drinking Water Infrastructure Needs Survey calls for $138.4 billion investment over the next 20 years.

Strategic management by water utilities can yield savings in such areas as financing, administration and purchasing. Water utilities must become smart buyers, which will include taking full advantage of competitive energy markets (water and wastewater utilities are energy customers). Integrated resource planning by water utilities, including a balanced consideration of supply-management and demand-management options, can promote least-cost planning options. Avoided-cost analysis can help utilities compare resource options and build a flexible resource portfolio.

Finally, innovative rate design can help mitigate against rate shock and revenue instability. Single-tariff pricing, for example, would allow regional utilities to spread costs across regional service territory and enhance affordability for the customers who reside in higher-cost areas.

Although daunting, increasing water