Inclining block rates can be an important component of a multi-faceted conservation plan. In recent years, many water utilities in our region have moved away from declining block and uniform block rates to an inclining block rate structure. If you are contemplating the benefits of such a change, there are some considerations to be taken into account.
Part I of this article appeared in the Third Quarter 2010 edition ofThe Source and addressed the prevalence of inclining block structures in our region and general application of such structures. For a copy of Part I, click here. Part II, contained below, addresses inclining block rate design considerations and design characteristics of such structures currently in use in the North Central Region.
Inclining Block Rate Design Considerations
Rate design is as much an art as it is a mathematical exercise, often requiring equal consideration of policy preferences and financial implications. Regardless, two objectives must be met when designing a conservation water rate structure:
- Generate revenue sufficient to cover costs, and
- Provide customers with incentive to conserve water.
Other considerations such as equitability and affordability come into play. Although it may be assumed that reduced water use will result in decreased utility costs, most times the cost savings associated with reduced electricity and chemical needs are not enough to offset the decrease in revenue resulting from reduced sales. Many utility costs are fixed and independent of the amount of water treated. In addition, a utility must always consider the cost of meeting the peak day needs and of obtaining the next increment of water beyond the existing capacity. As a result, the challenge of devising a rate plan that does not result in lost revenue in the face of decreased water sales is real. When designing rate blocks, consideration of the average cost of water as well as the marginal cost of water, or the cost of the next increment of supply, is required. Pricing too close to the average cost may result in the generation of insufficient revenues, while pricing too close to the marginal cost may result in excess revenues. The goal is to find the most reasonable and responsible balance based on the best estimates of future costs and water sales.
If the consumer’s response to price increases could be accurately predicted, meeting the revenue versus water use reduction challenge would be a lot easier. Many variables affect price elasticity, or the percent change in water use in response to a percent change in price, including weather, customer demographics, percent of income spent on water bill, size of fixed charges in customer bills, geographic region, availability of alternate supply, and customer knowledge of water rates. Few studies have been completed that address water price elasticity, and those studies have been conducted primarily in Florida, North Carolina, and the southwestern United States. Studies have verified what would be intuitive – that residential indoor water use is relatively “inelastic”, while outdoor (irrigation) water use is “elastic”. That is, indoor water use is generally representative of essential use, and outdoor water use is based on consumer choice.
As a general rule, American Water Works Association (AWWA) has indicated that for a 10 percent increase in the water rate, a decreased residential total (indoor and outdoor) water sales of one to three percent can be expected (AWWA, 2000). So when setting up an inclining block water rate structure, consideration of many qualitative factors, such as some of those named above, needs to occur when projecting future water sales.
Effective Inclining Block Rate Design
There is little hard and fast data available from which to draw specific guidelines for the design of inclining blocks. The research is inconclusive as to whether inclining block structures are the most effective structure in achieving reduced water demand. The research does indicate, however, that the price incentive for conservation appears to be strongest for inclining block structures with more than three price blocks. That is not to say, however, that appropriately designed uniform block rate plans or inclining block rate structures with three or less tiers cannot be successful. The appropriate configuration for your system will depend upon your users and their associated average and peak day usage patterns. In addition, it should be noted that appropriate block structures for residential, commercial, and industrial customers are likely not the same.
For detailed information about usage blocks or tiers and the thresholds between tiers, click here.
Inclining Block Structure Pricing from our Region
To illustrate the design of existing inclining block rate structures in our region, inclining block rate structure data from the 2010 North Central Region Utility Rate Survey was evaluated in terms of the difference between charges for the rate blocks. Of data from 213 systems reviewed, approximately 30 percent indicated the use of an inclining block rate structure. Of these, 67 percent reported a structure consisting of three or more tiers, while the remainder reported two tiers.
Figures 1 and 2 illustrate the variation in the percent differences between the rates for the first and
second tiers and the second and third tiers, respectively, for respondents to the 2010 North Central Region Utility Rate Survey. A difference between the first and second tier rates as high as 133 percent was reported, and a value as small as 3.1 percent was reported. The average percent difference between the first and second tier rates was 23.6 percent, and the median was 13.5 percent. Making similar comparisons between the second and third tier rates, it was found that the average difference was 21.4 percent and the median was 15.7 percent. The maximum difference between the second and third tier rates was 86.5 percent, and the minimum difference was 3.7 percent. The wide range in differences in inclining block rate design used in our region suggests that the need to create an incentive to reduce water use in communities varies greatly.
Where Do We Go From Here?
Whether you are considering a change to your rate structure based on conservation goals or for other reasons, there are several things that a utility should consider:
- Educate the public and governing body on the purpose of conservation rates, how they will be applied, how they will affect billing, etc.
- Identify non-economic goals to consider throughout the rate design process and to convey to the public/elected officials in conjunction with rate recommendations (e.g. resource conservation, growth management, etc.)
- Understand the patterns of use and associated costs of service for each user class. It is important to be aware of these in order to avoid setting rates that will undermine the ability of all users to obtain affordable water service.
- Identify and understand the future costs associated with obtaining additional supply and treatment capacity.
- Assess whether the availability of source substitutes (e.g. private wells, recycled wastewater for irrigation, etc.) may significantly impact water sales. It has been shown that a lack of source substitutes measurably decreases price elasticity.
- Evaluate existing metering and billing practices. It is most effective to bill based on actual use rather than estimated, and monthly billing practices will deliver the price signal more quickly than quarterly or semi-annual billing.
- Consider the formation of a rate stabilization fund to assist in the implementation stage of a new structure, during which revenues are often difficult to predict.
In conclusion, a properly structured inclining block water rate structure can be an effective tool as part of a broader conservation plan. If you have any questions or would like further information on this topic, please feel free to email AE2S at TheSource@ae2s.com.
Alliance for Water Efficiency (AWE). (2008). Conservation Oriented Rate Structures. Alliance for Water Efficiency (AWE) Resource Library.
American Water Works Association , 2000. AWWA Manual of Water Supply Practices – M1, Fifth Edition, Principles of Water Rates, Fees, and Charges.
American Water Works Association Research Foundation, 2008. Water Budgets and Rate Structures: Innovative Management Tools.
Georgia Environmental Protection Division, 2007. Conservation-Oriented Rate Structures, EPD Guidance.
Minnesota Statues, Section 103G.291, amended in 2008.
Rawls and Borisova, 2009. Conservation and Drought Water Rates: State-of-the-Art Practices and Their Application, University of Florida Water Institute.
Rawls, Borisova, Berg, and Burkhardt, 2010. Incentives for Residential Water Conservation: Water Price, Revenue, and Consumer Equity in Florida.
Whitcomb, John B. 2005. Florida Water Rates Evaluation of Single-Family Homes. Florida Water Management Districts.
Minnesota Statues, Section 103G.291, amended in 2008.