Cost Accounting in Local Government

Privatizing the Water Utility – Issues

A major challenge in local government finance is finding sufficient monies to pay for all the wonderful things our citizens want and/or need. One technique used by some cities, was to sell the water utility to a private company in order to get the up-front cash for major infrastructure construction. Although the cash was a major incentive, the side benefit was to remove the constant rate increases from the local political agenda. After all, a private company doesn’t need the approval of voters to raise rates. At least, that was the conventional wisdom on the subject.

Last week, on October 15, 2015, the Los Angeles Times ran an article on the front page of the Business section titled “Cities in a Water Fight.” The gist of the article was that residents in some cities with privatized water were mad that the water rates were increasing while they were trying to save water. The private company had the temerity to impose a surcharge because its customers were using less water.

In my article, “The Downside of Water Conservation” back in 2009, I discussed the need to adopt a flexible rate model that would quickly adapt to lower consumption. Water conservation requires that the water rate be increased. A water utility cannot cover its fixed costs by selling more water. It has to recover those costs over the water sold – the less the water sold, the higher the price. This is because a significant portion of a utility’s costs are in the infrastructure and staffing necessary to get the water to the customer, whether that customer uses 1,000 gallons or 100 gallons.

It would be ideal if a utility could separately charge for fixed costs (infrastructure repair and maintenance) and variable costs (water purchased for consumption). Unfortunately, the fixed costs are so significant that all water rate models bury some of that cost in the consumption charge. The private water company that was the focus of the above article, charged a 5% surcharge for using less water.

It was more interesting to me that the focus of the article was on the customer complaints and not on why municipal water utilities were not also charging a surcharge. The economics are the same, so why aren’t they? The logical answer from years of dealing with cities is that cities are cutting back on water infrastructure repairs or, are delaying the construction of new infrastructure or, are leaving staff positions unfilled or, a combination of the above.

The unintended consequences of this approach is to push infrastructure costs to the next generation and pander to the expectation of customers that everything can be changed by complaining. We need a vigorous public relations campaign to explain the economics of providing water and to show that the logical consequence of consuming less water is to pay more for what is consumed.

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