THE U.S. WATER INDUSTRY: STRUCTURE, REGULATION, AND PRICING JANUARY 2009 ROME, ITALY

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1 THE U.S. WATER INDUSTRY: STRUCTURE, REGULATION, AND PRICING JANUARY 2009 ROME, ITALY Janice A. Beecher, Ph.D. (2009) Institute of Public Utilities Michigan State University Do not cite or distribute without permission MICHIGAN STATE UNIVERSITY

2 Public utilities as part of the U.S. economy (2002 census) $ Bil. revenues % GDP Telecom less cable $ % Electricity (G/T/D) Private $ % State and local $ % Natural gas distribution Private $ % State and local $ % Water and sewer Private $ % State and local $ % Total $ % rome09-2

3 Monopoly status of the utility sectors today Water Arguably most monopolistic due to persistent market failures; policy is fragmented Electricity Restructuring has introduced markets with mixed results; state policy varies Gas Development of competitive wholesale markets; policy roles are distinctive Telecom Arguably least monopolistic due to technologies; policy is relatively centralized rome09-3

4 Water industry structure The water industry is Fragmented (lots of systems resulting from unchecked development) Bifurcated (by size and by ownership) Concentrated (at the large end, both public and private) Pluralistic (many often competing interests) Structural character is defined in terms of Size of systems Ownership of assets Management of operations Interconnection (limited local and regional) A water system is not always a utility Utilities may own multiple systems Some systems are interconnected and purchase water on a wholesale basis (about 15%) rome09-4

5 Water: a $100+ billion industry Estimated size of the the water industry: $110 billion in 2006 Equipment and chemicals, $25.9 Engineering, consulting, and analysis, $12.0 Water utilities, $36.2 Wastewater utilities, $36.5 rome09-5

6 Water systems in the U.S. (2007) 300, , , , ,000 50,000 0 Systems Population served (mil.) Nontransient noncommunity 18,839 6,334 Transient noncommunity 84,744 13,752 Community water systems 52, ,451 rome09-6

7 Community systems by population served (2007): many systems serve few people 60% 56% 50% % systems % pop. served 45% 40% 37% 30% 27% 20% 10% 7% 9% 10% 7% 0% 2% Very small (pop. <501) Small (501-3,300) Medium (3,301-10,000) Large (10, ,000) 1% Very large (>100,000) rome09-7

8 Water systems by size and ownership (2000): many small systems are privately owned 100% 90% 2,734 Public Private % 70% 60% 22,632 50% 40% 11,282 4,315 2, % 20% 10% 6,487 0% Very small (pop. <501) Small (501-3,300) Medium (3,301-10,000) Large (10, ,000) Very large (>100,000) rome09-8

9 Privatization: two distinct models rome09-9

10 U.S. water industry concentration Company Stock ticker Sales revenues (2007 mil.) American Water AWK $ 2,214 Aqua America, Inc. WTR 603 United Water (Suez) na California Water Service CWT 367 American States Water AWR 301 SouthWest Water SWWC 217 San Jose Water SJW 207 Aquarion (Macquarie) na Middlesex Water MSEX 86 Utilities, Inc. (AIG) 63 Connecticut Water CTWS 59 Artesian Resources ARTNA 53 Baton Rouge Water 40 The York Water YORW 31 Pennichuck Corporation PNNW 30 rome09-10

11 Private share of the U.S. water market $40 $35 $30 $25 Private market share for the water industry Annual water utility revenues ($bil.) Private market share % (NAWC) Poly. (Annual water utility revenues ($bil.)) Poly. (Private market share % (NAWC)) 40% 35% 30% 25% $20 20% $15 15% $10 10% $5 5% $0 0% rome09-11

12 Structural change in the water sector Change drivers include concerns about Efficiency in pricing and resource allocation Infrastructure investment needs Environmental constraints Rising costs and prices and their impact Ownership and jurisdictional options Structural change includes Consolidation, holding companies, private equity, foreign Institutional contestability (public v, private ownership) Convergence and integrative solutions (water/wastewater/energy) Environmental and economic regulators provide some incentives for structural change(sdwa) Competition is limited, although market mechanisms (e.g., competitive bidding, contracts, and pricing) can be used rome09-12

13 Water federalism and jurisdiction Water quantity Water quality Water funding Water prices Federal Congress, EPA (CWA, SDWA) Interstate River basin agencies (varies) States (primacy) Resource agencies SDWA primacy agencies Revolving fund agencies PUCs (private systems) Sub-state Management districts (varies) Local Health departments Public ownership, other local controls rome09-13

14 PUC jurisdiction for water Economic regulation by the states is based on persistent market failure in the form of monopoly (private, some publics) Forty-five states regulate about 8,000 water utilities and about 1,000 sewer companies (including combos) Commission jurisdiction covers about 20% of all community water systems; some are multi-system About half are investor-owned (private); the rest are divided evenly between municipals, water districts or authorities, and nonprofits and cooperatives Many non-jurisdictional utilities (munis) follow regulatory accounting, ratemaking, and other practices Economic regulation focuses on prudence, profits, price but PUCs may also impose service-quality standards, including pressure and aesthetics (color, taste, odor) rome09-14

15 Economic regulation of water utilities Water/sewer utilities demonstrate significant and persistent market failure Strong tendency toward vertically integrated monopoly Cost structure High capital intensity even among utilities (ratio of assets to revenues) Long-life fixed assets and associated financing, depreciation, and intergenerational equity issues Economics of scale, scope, density, and integration Externalities (positive and negative) Characteristics (and perceptions) of public goods Other technical, economic, and policy limits to competition (e.g., entry) In the presence of market failure particularly monopoly economic regulation is a proxy for competition to prevent abuse of market power (i.e., undue price discrimination or degradation of service quality) Economic regulation involves standards, accountability, and incentives rome09-15

16 Household expenditures on utilities (U.S.) Consumer expenditures on utilities for a four-person household in 2006 [$4,347 and 6.8% of total expenditures] Natural gas ($644, 1% of expenditures) 15% Fuel oil and other fuels ($147,.2% of expenditures) 3% Water and other public services ($532,.8% of expenditures) 12% Telephone ($1,439; 2.3% of expenditures) 33% Electricity ($1,586; 2.5% of expenditures) 37% rome09-16

17 Utilities as a percentage of income (regressivity) $5,000 $4,500 $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0 Consumer expenditures on utilities by income quintile (all consumers $) $220 $87 $306 $634 $843 $307 $105 $426 $862 $383 $121 $477 $1,089 $1,083 $1,237 $467 $155 $575 $1,297 $1,407 $610 $223 $759 $1,551 $1,759 Lowest quintile 2nd quintile 3rd quintile 4th quintile Highest quintile Water and other public services Fuel oil and other fuels Natural gas Telephone Electricity 10% 9% 8% 7% 6% 5% 4% 3% 2% 1% 0% Consumer expenditures on utilities by income quintile (all consumers %) 1.1% 0.4% 1.5% 3.1% 4.1% 1.0% 0.3% 1.4% 2.9% 3.6% 0.9% 0.3% 1.2% 2.6% 3.0% 0.8% 0.3% 1.0% 2.3% 2.5% 0.6% 0.2% 0.8% 1.6% 1.9% Lowest quintile 2nd quintile 3rd quintile 4th quintile Highest quintile Water and other public services Fuel oil and other fuels Natural gas Telephone Electricity rome09-17

18 Consumer price trends for utilities (U.S.) Trends in the consumer prices (CPI) for utilities [1977 to 2007] 350 Cable/sat. television Difference between CPI for utilities and overall CPI ( =100) Cable/sat. television Water and sewer 300 Garbage Water and sewer Fuel oil Local phone Natural gas ALL ITEMS (CPI) 150 Postage Electricity 100 Internet (1997=100) Wireless (1997=100) 50 Interstate phone Local phone Natural gas Electricity Interstate phone = 100 except for cellular (1997=100) rome09-18

19 Water financing needs gap rates rome09-19

20 U.S. water withdrawals and population (USGS) Pop. rome09-20

21 Trend in residential water demand 120,000 Annual residential gallons sold per residential customer (NAWC) 115, , , ,000 95,000 90,000 5 per. Mov. Avg. (Series1) 85,000 80, rome09-21

22 Pressure on water prices Pressures Prices probably do not reflect true economic value (willingness to charge) Rising costs coupled with flat or declining demand Combined water, wastewater, stormwater costs Infrastructure replacement needs Depreciation expenses Regulatory compliance costs Impact of energy markets and costs Historic under-pricing (public systems) Incentives for conservation and efficiency Concerns Affordability, regressivity, subsidy, and intergenerational equity Rate shock and rate design options Still, tap water still compares favorably to other utilities and to bottled water rome09-22

23 Reasons for the public-private rate disparity Profits (return on equity) Taxes (all levels) Financing (including SRF) Intergovernmental transfers and subsidies (often hidden) Costing practices (depreciation expense) Rate practices (inside/outside rates) Special charges (system development) Investment deferral (by cities) Cost differentials, including scale (in some cases) Economic regulation (cost-of-service based ratemaking) rome09-23

24 Revenue requirements formula RR = r(rb) + O&M + D + T where: RR = annualized revenue requirements r = authorized rate of return RB = ratebase (original cost of utility plant in service net of accumulated depreciation) O&M = operation & maintenance expense D = depreciation expense T = taxes rome09-24

25 Components of revenue requirements Labor Revenue requirements Variable operating costs Fixed costs Capital recovery Cost of capital Energy Other inputs and variable operating costs Taxes, insurance, other fixed costs Depreciation Interest on debt Return on equity Above the line: ratepayers cover the prudent cost of service Below the line: ratepayers compensate debt holders and shareholders (net) rome09-25

26 Basic rate-design options (many variations) tier breakpoint Price/ unit Uniform and uniform by class increasingblock decreasingblock Quantity consumed rome09-26

27 Survey of water rates $200 $175 Monthly water bills based on usage (260 utilities, Raftelis survey, 2006) 0 gal 3,740 gal 7,480 gal 11,220 gal 22,440 gal Seattle,WA -summer $150 $125 $100 $75 $50 $25 $0 -$25 Monthly charge for 0 water Corona, CA Based on data from Raftelis (2006) rome09-27

28 Sample water bill rome09-28

29 Issues in water costs and prices Pricing is based on metered use; varies by customer class (meter size) Full-cost pricing and profiting from water are challenging Cost profile (high fixed costs) presents a dilemma for water High fixed charges = less incentive to sell but less conservation High variable charges = more conservation but more incentive to sell Rising costs, supply constraints, and climate change are bringing focus to Water system sustainability and efficiency Water-energy interdependencies Water availability and affordability Environmental externalities (+/-) Elasticity and pricing incentives Trends in water demand and financial effects New technologies and decentralized solutions rome09-29

30 ipu.msu.edu rome09-30