United States
Environmental Protection
Agency
Office of Water (4606)
EPA816-R-99-009
September 1999
Consolidated Water Rates:
Issues and Practices in Single-Tariff
Pricing
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USEPA-NARUC
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Acknowledgment and Disclaimer
This document is a collaborative effort of the United States Environmental Protection
Agency (USEPA) and the National Association of Regulatory Utilities Commissioners
(NARUC). USEPA is responsible for the implementation of Safe Drinking Water Act
provisions. NARUC represents state public utility commissions that have jurisdiction for
investor-owned and other water utilities.
This report does not constitute polices, positions, or views of the USEPA, NARUC, or
NARUC-member commissions.
The report was prepared by Janice A. Beecher, Ph.D., Beecher Policy Research, Inc., who
conducted an independent survey of commission staff members in 1996 on behalf of the
staff of the Florida Public Service Commission and subsequent verifications and updates
through contacts with the commissions.
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Contents
1. Introduction 1
Definition 1
Key Advantages and Disadvantages 4
Single-Tariff Pricing as a Policy Issue 6
The Regulatory Context .6
2. Background . . 9
The Municipal-Unit Doctrine 9
Spatial Pricing 13
Spatial Pricing and the Telephone Industry 16
Counterpoint 17
3. Spatial Pricing and Ratemaking Theory 18
Theoretical Issues 18
Evaluation Issues 19
Ratemaking Criteria 20
The Efficiency Criterion 22
Other Criteria 23
Pricing in Practice 24
4. Structural Issues in the Water Industry 26
Systems v. Utilities 26
Multi-System Water Utilities 27
Pricing and Structural Change 28
Incentives for Restructuring 28
5. Cost Profile of the Water Industry 31
Trends in Water Costs 31
Economies of Scale 32
Capacity Development 34
Consumer Affordability 35
6. Examples of Single-Tariff Pricing 37
Basic Single-Tariff Pricing 37
Variations of Single-Tariff Pricing 39
Two Recent Cases 41
Single-Tariff Pricing in Great Britain 45
7. The Public Utility Commission Role 48
Number of Regulated Utilities 48
Capacity-Development Policies 50
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8. Commission Survey 52
Relevance of Single-Tariff Pricing 52
General Findings. 53
Specific Findings 54
Characteristics of Single-Tariff Utilities 55
9. Arguments in Favor and Against Rate Consolidation 57
Arguments in Favor of Single-Tariff Pricing 57
Arguments Against Single-Tariff Pricing 58
10. Commission Policies on Rate Consolidation 59
Commission Decisions 59
Implementation Strategies 67
Related Strategies 68
Commission Authority 68
Appendix A
Glossary of Terms 73
Appendix B.
Select Commission Orders on Single-Tariff Pricing 76
Appendix C
Detailed Example of Single-Tariff Pricing 78
Appendix D
Commission Survey on Single-Tariff Pricing 80
Appendix E
Detailed Findings from Commission Survey on Single-Tariff Pricing 83,
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Tables and Figures
Tables
Table 1. Cost Allocation under Zonal Pricing 14
Table 2. Example of Municipal Zonal Rates for Residential Water Customers 15
Table 3. Consistency of Single-Tariff Pricing with Ratemaking Criteria 21
Table 4. Monthly Water Bills by System Size and Customer Class 34
Table 5. Sample Calculation of Single-Tariff Pricing...., 38
Table 6. Pricing Variations for Fixed and Variable Water Charges 40
Table 7. Phase-In Approach to Single-Tariff Pricing 41
Table 8. Metered Water Tariffs for British Water Companies, 1995-1996
(Household Customers) 47
Table 9. Commission-Regulated Water and Wastewater Utilities 49
table 10. Relevant Sample of State Public Utility Commissions
Regarding the Issue of Single-Tariff Pricing Policy 53
Table 11. Comparative Analysis of Multi-System Utilities
With and Without Single-Tariff Pricing 56
Table 12. Summary of State Public Utility Commission Policies on
Single-Tariff Pricing for Water Utilities 60
Table 13. Pennsylvania Public Utility Commission Policy Statement on
Acquisition Incentives 70
Table Cl. Cost-of-Capital Determination 78
Table C2. Allocation of Expenses by District and Under Single-Tariff Pricing 78
Table C3. District Revenue Requirements and
Effect on Average Residential Water Bill 79
Table C4. Comparison of Tariffs for Selected Districts Before and
After Implementation of Single-Tariff Pricing 79
Table El. Commission Policies on Single-Tariff Priding for Water Utilities
(1996 Survey) ....84
Table E2. Multi-System Water Utilities and Single-Tariff Pricing (1996 Survey) 91
Table E3. Arguments in Favor of Single-Tariff Pricing (1996 Survey) 105
Table E4. Arguments Against Single-Tariff Pricing (1996 Survey) 108
Figures
Figure 1. Water Systems without Physical Interconnection 2
Figure 2. Water Systems with Physical Interconnection 2
Figure 3. Water Systems with Stand-Alone Pricing 3
Figure 4. Water Systems with Single-Tariff Pricing 3
Figure 5. Illustration of Pricing Practices by Firms 12
Figure 6. Revenue Requirements per Equivalent Residential Customers for
Stand-Alone Costs, Common-Management Costs, and
Single-Tariff Pricing 42
Figure 7. Forecast Revenue Requirements per Equivalent Residential Customers Including
Capitallmprovements 42
Figure 8. Stand-Alone and Consolidated Rates for
Pennicuck Water, New Hampshire 44
Figure 9. Regional Water Utilities in Great Britain 46
Figure 10. Summary of Commission Policies on Rate Consolidation 61
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VI
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Consolidated Water Rates: Summary
Purpose
Consolidated rates or single-tariff pricing is the use of a unified rate structure for multiple
water (or other) utility systems that are owned and operated by a single utility, but that
may or may not be contiguous or physically interconnected. The purpose of this report is
to provide policymakers and other stakeholders with an overview of consolidated
ratemaking and an appreciation of the complex trade-offs involved in its implementation.
The report provides a review of historical, theoretical, and practical issues related to
consolidated ratemaking, implementation data, and key decisions by the state public utility
commissions. A detailed survey of state public utility commission staff regarding single-
tariff pricing is presented. General commission policies are summarized, along with
citations of specific regulatory decisions concerning single-tariff pricing.
How Consolidated Pricing Works
Under consolidated pricing, all customers of the corporate utility pay the same rate for the
same service, even though the individual systems providing service may vary in terms of
operating characteristics and stand-alone costs. In many respects, consolidated rates are
the conceptual opposite of "zonal" or spatially differentiated rates.
Single-tariff pricing is used by many investor-owned water utilities, with the approval of
state regulators, but it also can be implemented by publicly owned utilities. Single-tariff
pricing can be an incentive for larger water utilities to acquire small water systems that
lack capacity because it makes it possible to spread costs over a larger service population
and maintain more stable and affordable rates for customers of some smaller and more
expensive systems. Single-tariff pricing can be used by publicly owned or nonprofit water
utilities that operate satellite systems, but few examples are readily available.
Unfortunately, the literature on utility ratemaking, which leans heavily toward the
conditions and experiences of the energy and telecommunications industries, yields little
theoretical insight or empirical evidence on the implications of single-tariff pricing. Much
of the understanding of this issue is derived from case-specific regulatory proceedings.
However, an analysis of historical and theoretical perspectives suggests that single-tariff
pricing is not necessarily inconsistent with the prevailing principles of ratemaking.
The Tradeoffs
Single-tariff pricing is a provocative issue precisely because of the tradeoffs involved in
its application, including possible tradeoffs among different types of efficiency. Single-
tariff pricing might lessen some kinds of efficiency (such as those related to spatial
allocation of costs and price signals to customers), while improving other kinds of
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efficiency (such as those related to management and innovation). Of particular
importance, but hardest to gauge, is whether single-tariff pricing and related restructuring
can lead to long-run efficiency improvements in the water industry. Water utilities and
policymakers must consider and weigh the evidence and trade-offs prior to implementing
or approving single-tariff pricing.
A variety of theoretical and practical arguments in favor and against the use of single-
tariff pricing can be made. Single-tariff pricing tends to stabilize rates and revenues,
mitigate rate shock, and make rates more affordable for the customers of the smallest and
more expensive systems. While achieving certain capacity-development, affordability,
and operation efficiency goals, however, single-tariff pricing also might trade a degree of
economic efficiency by ignoring spatial differences in costs and diluting price signals. A
1996 survey of commission staff members identified several arguments in favor of and
against single-tariff pricing were identified.
Summary of Select Arguments in Favor and Against
Single-Tariff Pricing
Select Arguments in Favor of
Single-Tariff Pricing
Select Arguments Against
Single-Tariff Pricing
O Mitigates rate shock to utility customers (17)
a Lowers administrative costs to the utilities (16)
O Provides incentives for utility regionalization and
consolidation (15)
a Physical interconnection is not considered a
prerequisite (13)
D Addresses small-system viability issues (13)
a Improves service affordability for customers (12)
O Provides ratemaking treatment similar to that for
other utilities (10)
O Facilitates compliance with drinking water
standards (9)
D Overall benefits outweigh overall costs (9)
O Promotes universal service for utility customers (8)
D Lowers administrative cost to the commission (8)
D Promotes ratepayer equity on a regional basis (6)
D Encourages investment in the water supply
infrastructure (5)
O Promotes regional economic development (3)
D Encourages further private involvement in the water
sector (2)
D Other: Can be consistent with cost-of-service
principles (1) and found to be in the public interest
(1)
n Conflicts with cost-of-service principles (14)
a Provides subsidies to high-cost customers (12)
a Not acceptable to all affected customers (10)
n Considered inappropriate without physical
interconnection (8)
O Distorts price signals to customers (7)
D Fails to account for variations in customer
contributions (6)
D Justification has not been adequate in a
specific case (or cases) (6)
a Discourages efficient water use and
conservation (4)
a Encourages growth and development in high-
cost areas (4)
O Undermines economic efficiency (3)
D Provides unnecessary incentives to utilities (2)
n Not acceptable to other agencies or
governments (2)
n Insufficient statutory or regulatory basis or
precedents (2)
D Overall costs outweigh overall benefits (2)
n Encourages overinvestment in infrastructure
0)
Source: Author's construct. See Tables E3 and E4. Numbers in parentheses represent number of mentions
(out of 21 applicable survey responses).
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State Commission Policies
The public utility commissions have provide the central forum in which single-tariff
pricing has been evaluated. Single-tariff pricing is a relevant regulatory policy issue only
for the thirty (30) state public utility commissions with jurisdiction for multi-system
utilities. Given this context, a clear majority of affected state commissions have allowed
regulated water utilities to implement single-tariff pricing (22 state commissions).
Based on the commission survey and subsequent updates, single-tariff pricing is generally
accepted in eight (8) states. A few states (such as Connecticut, Pennsylvania, and Texas)
have recognized single-tariff pricing as a policy tool. Staff members at seventeen (17)
commissions characterized the policies of their commissions as "case-by-case," indicating
that the single-tariff pricing must be justified for every specific application (even when the
policy is "generally accepted"). Numerous exemplary decisions can be cited.
Summary of State Public Utility Commission Policies on
Single-Tariff Pricing for Water Utilities
. 2 SZU.
Commission Policy
Generally Accepted (8)
Case-By-Case (17)
Never Considered (5)
Not Applicable — No Multi-
System Water Utilities (15)
No Jurisdiction for Water
Utilities (6)
State Commissions
Connecticut
Missouri
North Carolina
Oregon
Single-Tariff Pricing Has
Arizona
Delaware (a)
Florida
Idaho (not an issue)
Illinois
Indiana (b) (f)
Massachusetts (c) (f)
Pennsylvania
South Carolina
Texas
Washington
Been Approved (14)
••
New Hampshire (d) (f)
New York
New Jersey (e) (f)
Ohio
Vermont
Virginia
West Virginia
Single-Tariff Pricing Has Not Been Approved (3)
California (g)
Maryland (not an issue)
Mississippi (not an issue)
Iowa
Kentucky
Louisiana
Alabama
Alaska
Arkansas
Colorado
Hawaii
Kansas
Montana
Nebraska
Georgia
Michigan
Minnesota
Maine
Wisconsin
Nevada
New Mexico
Oklahoma
Rhode Island
Tennessee
Utah
Wyoming
North Dakota
South Dakota
Washington, D
.C.
Source: Author's construct. See Table 12 for notes.
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Guide for Readers
1. Introduction. The introductory section defines consolidated ratemaking, discusses
general advantages and disadvantages of this approach, and provides the policy and
regulatory context in which rate consolidation is considered.
2. Background. This section contemplates single-tariff pricing in light of an historical
perspective and the prevailing economic regulatory literature. The concept of spatially
differentiated pricing (or "zonal rates") also is considered.
3. Spatial Pricing and Ratemaking Theory. Principles of ratemaking and tradeoffs
among efficiency, equity, and other policy goals, are considered. Goals unique to the
water industry are identified. The section also contrasts pricing in theory with pricing in
practice.
4. Structural Issues in the Water Industry. This section identifies ways in which
pricing policies will shape the structural character of the water industry and the future of
small water systems.
5. Cost Profile of the Water Industry. This section considers the cost profile of the
water industry, including the relevance of economies of scale, the challenge of
maintaining affordable water service for consumers, and the means to enhancing water
system capacity.
6. Examples of Single Tariff Pricing. Numerical illustrations of rate consolidation are
provided here, including examples from two recent cases in Indiana and New Hampshire.
7. Public Utility Commission Role. The role of the state public utility commissions is
reviewed in this section, with an emphasis on how commission policies will affect the
structure of the industry through consolidation.
8. Commission Survey. Results of a 1996 survey of commission staff members are
presented. Based on a database derived from the survey, this section also identifies the
characteristics of utilities that have implemented consolidated rates.
9. Arguments in Favor and Against Rate Consolidation. Commission staff views
about the advantages and disadvantages of single-tariff pricing are presented.
10. Commission Policies on Rate Consolidation, This final section summarizes
commission policies on rate consolidation and provides an overview of several key cases,
including regulatory decisions from West Virginia, Pennsylvania, Massachusetts, Florida,
Illinois, New Jersey, Missouri, Indiana, New York, and Connecticut. This section also
considers legal challenges to the authority of regulators to approve consolidated rates.
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1. Introduction
Definition
Consolidated rates or single-tariff pricing is the use of a unified rate structure for multiple
water (or other) utility systems that are owned and operated by a single utility, but that
may or may not be contiguous systems"~0r physically interconnected. Under a system of
single-tariff pricing, all customers of the utility pay the same rate for service, even though
the individual systems providing service may vary in terms of the number of customers
served, operating characteristics, and stand-alone costs. Single-tariff pricing essentially
allows for allocating the average costs of combined systems in the course of ratemaking.
In addition to the term "consolidated rates," the terms "single-rate structure," "uniform
rates," "standard-tariff rates," "unified rates," and "rate equalization" sometimes are used
in connection with the concept of single-tariff pricing.1 For the purposes of this report,
the terms consolidated rates and single-tariff pricing are used interchangeably.
Single-tariff pricing cfe-emphasizes spatial distinctions in costs. One of the best examples
of a single tariff across an expansive and multicentric "service territory" is the single rate
used in the United States for first-class postage. Indeed, consolidated rates sometimes are
called "postage-stamp" rates. Conventional wisdom holds that uniform postal rates
historically facilitated the extension of service to rural areas and that they continue to
serve the national interest, provide equity and accessibility, and lower transaction costs.2
Examples of uniform pricing also can be found in the other public utility sectors. Long-
distance, cellular-phone, and cable television services typically are priced according to the
single-tariff concept (although the same terminology might not be used). Historically, at
least, energy prices were established for a regional enfranchised service territory,
regardless of the physical proximity of customers to specific utility facilities.3 The other
public utility sectors generally price across larger regional territories than water utilities,
although facilities in the other sectors tend to be physically interconnected through
transmission and distribution networks.
Use of single-tariff pricing by U.S. water utilities continues to be debated in regulatory
policy circles, although many states have approved consolidated rates for one or more
jurisdictional utilities and a few states have actively promoted the use of single-tariff
pricing. A very prominent example of single-tariff pricing in the water sector comes from
"across the pond." All of Great Britain's privatized regional water and wastewater
1 The concept of uniformity is useful, but the term "uniform rates" probably should be reserved for rate
structures that do not vary usage (or volumetric) charges by quantities (or blocks) of water usage.
2 For a provocative discussion of both sides of the issue, see Ronald H. Coase, "The Economics of Uniform
Pricing Systems," Manchester School of Economics and Social Studies Vol. 15 (May 1947): 139-56.
3 In the context of restructuring and partial deregulation, methods for aggregating customers, allocating
costs, and setting prices are changing dramatically. Spatial considerations might become less important in
some instances, as in the purchase of electricity from a far-away generating facility. But market forces
might also tend to group customers with similar cost profiles and undermine the goals of cost averaging.
1
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utilities, and most of the smaller water companies, impose uniform rates for measured
(metered) service, for both household and nonhousehold customers. A summary of recent
British water tariffs is provided later in this report.
Single-tariff pricing can be absolute, applicable to all of the systems comprising the water
utility. However, utilities also sometimes establish rates for regional zones consisting of
subsets of water systems within the larger service territory. Rate consolidation sometimes
is used for water systems that are contiguous but not interconnected, as well as
noncontiguous noninterconnected systems, based on various criteria. Partial rate
consolidation can be a compromise between individualized tariffs and complete single-
tariff pricing, or part of a phase-in plan leading ultimately to a single tariff for the entire
utility and all of its service territories. Figures 1 through 4 provide simple illustrations of
the basic issues involved in rate consolidation for water utilities. A glossary of terms
appears in Appendix A of this report.
Figure 1. Water Systems without Physical Interconnection
Figure 2. Water Systems with Physical Interconnection
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Figure 3. Water Systems with Stand-Alone Pricing
Figure 4. Water Systems with Consolidated Pricing
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Key Advantages and Disadvantages
The primary advantages of single-tariff pricing are that it can lower administrative and
regulatory costs, enhance financial capacity and capital deployment, achieve rate and
revenue stability, and improve service affordability for customers of very small (or
extremely small) water systems. The water industry's rising investment needs correlate
with the interest in rate consolidation. A leading argument for single-tariff pricing made
by multi-system water utilities is that each individual system eventually will require an
infusion of capital for renovations and improvements; only the timing varies. Equalizing
rates smoothes the effect of discrete cost spikes across systems and over time, much like
insurance pooling. Single-tariff pricing also achieves equity to the extent that all
customers of a given utility company pay the same price for comparable service.
Importantly, single-tariff pricing is ^pricing strategy, not a costing strategy. Single-tariff
pricing can appear to lower costs when in reality it simply allocates costs differently. In
fact, one of the chief benefits of single-tariff pricing is that it greatly simplifies the
allocation of common costs across separate facilities. Many water utilities believe that
single-tariff pricing is more reflective of the consolidated cost of service. By itself, single-
tariff pricing may not provide significant economies of scale because only the costs
associated with the pricing process itself (including analytical, administrative, and
regulatory costs) can be considered. Economies of scale in water production and
management are achievable, irrespective of the rate structure implemented by the utility.
Separating the cost side from the price side is crucial to understanding the true nature of
the single-tariff pricing issue.
However, single-tariff pricing can lead to economies of scale in the water industry through
secondary benefits. The secondary advantages are that single-tariff pricing can encourage
industry consolidation, common management of smaller systems, and overall technical,
financial, and managerial capacity. If regionalization eventually includes physical
interconnection among some or all systems managed by a utility, more significant
economies of scale can be realized. Larger utilities view consolidated rates as an incentive
to engage in acquisitions because it can expedite the process and simplify ratemaking.
The single-tariff price also can provide a powerful incentive for small communities as they
contemplate selling their systems to larger utilities.
Other secondary advantages of consolidated rates include improved regulatory compliance
by water utilities, the provision of universal service to customers who desire and need
water service, and coordinated water resource protection, management, and planning.
Even without physical interconnection, regional utilities can play a role in defining
regional communities within which environmental services are provided. A consolidated
rate for a larger community of customers will be more sustainable over time than stand-
alone rates for smaller communities.
Consolidated rates also can improve the overall operational efficiency of a utility. Absent
single-tariff pricing, the utility might be induced to invest in the system facing the highest
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rates, even if this is a suboptimal choice from the standpoint of total system operations and
economic value to the customer base as a whole. In other words, the utility might feel
pressure to lower prices instead of lowering total system costs. With single-tariff pricing,
utilities are induced to invest their available resources in the functional areas where the
greatest improvement can be achieved at the lowest cost, to the benefit of all customers.
The primary disadvantages of single-tariff pricing are that it appears to undermine
economic efficiency, distort price signals to customers, and manifest an inconsistency with
traditional cost-of-service principles.4 Although subsidies through some societal policy
instruments (namely, taxes) are widely accepted, subsidies through utility rates generally
are not.5 Another potentially important equity concern is whether consolidated rates result
in subsidies from the low-income customers in the low-cost area to higher-income
customers in a high-cost area. This effect is mitigated to the extent that water use by low-
income customers tends to be relatively low. Various aspects of the rate design also can
lessen this type of subsidy.
Some communities and large-volume water users have opposed single-tariff pricing
because they believe it is merely a means of subsidizing high-cost users at the expense of
low-cost users. For this reason, single-tariff pricing also seems to be at odds with water
conservation, in that it appears to weaken price signals and thus undermine efficient
production and consumption. If rate consolidation involves a price decrease for some
customers, one concern is that water consumption could increase.6
Secondary disadvantages are that—absent other incentives or safeguards— single-tariff
pricing can provide some water utilities with incentives to overinvest in individual
systems, disincentives for cost control, and a competitive advantage in the course of
acquisitions. The latter concern applies only if one potential acquirer can offer
consolidated rates and another cannot.7
These concerns are fundamental to utility economics, pricing, and regulation. However,
any differences between single-tariff pricing and spatial pricing in terms of efficiency and
other effects have not been well established from either a theoretical or empirical
standpoint. Evaluating the net efficiency effects is especially difficult. Single-tariff
pricing might lessen some kinds of efficiency (such as those related to spatial allocation of
costs and price signals to customers), while improving other kinds of efficiency (such as
those related to management and innovation). Of particular importance, but hardest to
gauge, is whether single-tariff pricing and related restructuring can lead to long-run
4 Steve H. Hanke, "On Water Tariff Equalization Policies," Water Engineering and Management 128
(August 1981): 33-34.
5 The appropriateness of rate differentiation continues to be debated today in the context of both regulation
and deregulation of public utility industries. The potential movement away from cost averaging for some
services will affect customers, as well as the utilities that serve them.
6 The price elasticity literature, however, is clearer about the usage effects of price increases than the usage
effects of price decreases.
7 In realty, competition for acquisitions is less a problem in the water industry than finding a single capable
and willing buyer.
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efficiency improvements in the water industry. Single-tariff pricing also has been
underevaluated in terms of ratemaking criteria other than economic efficiency.
Single-Tariff Pricing as a Policy Issue
Single-tariff pricing is a public policy issue because it involves tradeoffs among
competing policy objectives. Traditional cost-of-service principles and economic
efficiency arguments, adhered to in the U.S. model of economic regulation as applied by
the states to public utility monopolies, can lead to the conclusion that spatially-
differentiated (or allocated) costs should be used as the basis for pricing utility services.
Single-tariff pricing as a matter of public policy in this context requires an explicit
recognition of the tradeoffs involved.
Specifically, single-tariff pricing involves a tradeoff between conventional ideas about
cost-based rates, economic efficiency, and other legitimate ratemaking goals. These other
goals include, for example, small-system capacity, rate and revenue stability, universal
service, and compliance with environmental standards. A fine-tuned price signal that
appears to be economically efficient, for example, can result in considerably less rate and
revenue stability. Likewise, a conservation-oriented rate may not be affordable to
customers. Evaluating ratemaking trade-offs can be complex. The decisionniaking
process can be greatly enhanced by information and analysis, and decisions can be made
more rational, but a certain degree of judgment ultimately is required in determining
whether a particular option is in the public interest.
The short-term goals of single-tariff pricing tend to focus on enhancing the financial
capacity of water systems and making rates more affordable for water customers. The
long-term goals, however, are related to structural change in the water industry.
Specifically, single-tariff pricing is regarded as a means to consolidating the management
and operation of water systems, or "regionalization," to achieve multiple policy goals.
The Regulatory Context
Single-tariff pricing has received more attention in the context of economic regulation by
the state public utility commissions than in context of public ownership (where regulation
is limited or nonexistent). A compilation of citations to selected commission orders on the
issue can be found in Appendix B of this report. As discussed later in this report, the issue
is not equally relevant in every jurisdiction. Not all states regulate water utilities, and for
those that have jurisdiction, multi-system water utilities may not be present. Single-tariff
pricing also has not been raised as an issue for every multi-system water utility.
Single-tariff pricing was placed on the regulatory policy agenda by the investor-owned
water industry. Some water industry officials have made a strong case for single-tariff
pricing before regulators. Several of the regional affiliates of the American Water Works
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Company have taken the lead in advocating this method of pricing before the state public
utility commissions, including the commissions in Illinois, Indiana, New Jersey, and
Pennsylvania. However, other multi-system utilities (not affiliated with American Water
Works), commission staff members, and other stakeholders also have raised the potential
use of single-tariff pricing.
The many proceedings (and sequences of proceedings within certain jurisdictions) in
which the issue of single-tariff pricing has been raised is suggestive of the case-by-case
manner by which single-tariff pricing policy has largely developed. This is due in part to
the nature of commission decisionmaking: regulators must rule on the record of evidence
put before them in a given proceeding and each individual utility generally must make its
own case for implementation. However, some commissions have explicitly encouraged
the movement toward single-tariff pricing and a few have incorporated this approach into
general policies and specific policies dealing with acquisitions of smaller systems.
Opponents have argued forcefully before the commissions that single-tariff pricing
contradicts fundamental regulatory principles and conventions, as well as undermines the
commission oversight responsibility:
Tariff consolidation, sometimes called Single Tariff Pricing (STP), breaks the
connection between costs and rates. It is a fundamental tenet of utility ratemaking
policy that the cost causer should also be the cost payer. STP runs counter to this
principle. Under and STP scheme, customers who receive no service from the core
system would receive a considerable subsidy. Likewise, customers who do not
impose a load on the [noncore systems] would be forced to pay a portion of the
cost of providing that service indefinitely. A customer located in the core system
would be encouraged to conserve water to an excessive degree. Conversely, a
[noncore customer] would bear a smaller economic penalty for using more water
than necessary.
It is also important to note that once a regime of subsidies has been initiated, it is
very difficult to discontinue this practice due to customer impact considerations,
even if it has been found to create undesirable consequences. Subsidies are
understandably popular among those who receive them, and it is equally
understandable that they will resist their being terminated. Conversely, subsidies
are understandably unpopular among those who pay them....
If rates were to be consolidated, there would be no reason to maintain separate
books and records for each of the [systems].. .8 However, this loss of operating
and financial data would destroy the ability to evaluate the effectiveness and
efficiency of the Company' s operation of the [systems]. As a result, the [public
8 This point seems somewhat overstated. Most consolidated utilities maintain detailed cost and other data
on their operating units for planning and management purposes. Under single-tariff pricing, the need for an
acceptable method to allocate common costs across distinct systems for ratemaking purposes is lessened or
eliminated.
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utility commission] would lose its ability to exercise regulatory oversight and
control as it pertains to these systems.9
Most of the commissions historically shared this predilection for "cost-based" rates. In
numerous recent decisions involving a variety of utilities and issues, however, many of the
state public utility commissions have found that single-tariff pricing is in the public
interest and that it comports with prevailing standards concerning just, reasonable, and
nondiscriminatory rates. Some commissions have found that single-tariff pricing is not
inconsistent with cost-of-service principles or with commission ratemaking authority.
A variety of specific rationales (or combinations thereof) have been put forth by some of
the commissions to justify approval of single-tariff pricing: it addresses pragmatic
concerns affecting utilities and customers (namely, revenue stability and mitigation of rate
shock); it is consistent with consolidated management, operations, financing, and
corporate structures; it reduces regulatory caseload and costs; and it results in comparable
prices for comparable services produced from comparable facilities. Many investor-
owned utilities have strongly urged regulators to recognize that these companies provide
all of their customers the same brand-name product (a safe and reliable supply of potable
water) and that single-tariff pricing will also make the product more affordable.
Essentially, single-tariff pricing makes it possible for all customers to share in the total
economies of scale and scope achieved by the utility corporation.
Asserting regulatory authority to approve single-tariff pricing in some jurisdictions has not
been an easy task. The issue often arises in the context of other complex regulatory issues
related to water utility rates, management, operations, and acquisition practices.
Regulatory rulings must be within the scope of commission authority and the boundaries
set by state legislatures and the courts; if not, commission decisions can be legally
challenged. Nevertheless, as explored later in this report, the state public utility
commissions have approved the use of single-tariff pricing for many multi-system water
utilities. Several specific regulatory determinations involving single-tariff pricing are
reviewed later in this report.
9 Ernest Harwig, Direct Testimony before the New Hampshire Public Utilities Commission in DR 97-058,
Pennichuck Water Works, Inc. (1997).
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2. Background
With few exceptions, the literature on public utility economics and ratemaking-including
ratemaking for the water industry-sheds little direct light on the issue of single-tariff
pricing. The leading scholarly work on utility economics mainly considers the economic
characteristics of telecommunications and energy industries, where private ownership
prevails, regionalization is pervasive, physical interconnection is the norm, and costs of
transmission are low.10 The leading manuals on water utility ratemaking published by the
American Water Works Association convey little (if any) information about the single-
tariff pricing method, a fact that probably undermines the method's institutional
acceptance.11 A cursory review of other promising bodies of literature, such as economic
geography, does not readily yield information on this apparently understudied issue.
The limited discussion of the spatial dimension of utility ratemaking appears mainly
within the literature on legal doctrine and in the consideration of zonal pricing.
The Municipal-Unit Doctrine
In the adolescent years of the public utility industries, legal scholars debated whether costs
of providing service should be allocated spatially. Specifically, the debate centered on the
cost differences associated with providing service to urban and rural areas, the latter of
which can be more expensive to serve because of the cost of service-line extensions and
lack of economies of scale (for example, numerous users at the end of the line). The
known result of strictly cost-based pricing would have been to discourage the extension of
"modern" services to rural areas. Based on the essential nature of utility services, the
consequence would have been marked differences in the quality of life between urban and
rural dwellers, as well as underdevelopment of rural communities.
A series of legal precedents seemed to establish municipalities as ratemaking units for
utilities serving multiple cities. The "municipal-unit doctrine" refers to the treatment of a
municipality as a distinct service territory and unit for cost allocation and ratemaking
purposes (that is, "city-based" rates). In a 1934 review, however, Robert D. Armstrong
passionately rejected the "municipal-unit doctrine," primarily on economic-development
grounds:
System utilities have made service available to the entire public, both urban
and rural, within large areas. This development serves a sound social policy.
Any regulatory policy or rule of law which would curtail it or rob it of its just
reward would be unfortunate and unwise. If each locality were required to
10 See Charles F. Phillips, Jr., The Regulation of Public Utilities (Arlington, VA: Public Utilities Reports,
Inc., 1993).
1' American Water Works Association, Water Rates (Ml), Water Rates and Related Charges (M26), and
Alternative Rates (M34) (Denver, CO: American Water Works Association, 1983,1983, and 1992,
respectively).
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stand upon its own bottom, so to speak, rural and village extension and
development would be discouraged, and in many cases existing service
abandoned.
This would hurt the larger communities as well as the rural localities. It would
tend to eliminate the rural and village patrons, who now contribute something
to system overhead and return, and thus lessen its burden upon city and town
patrons. It would reverse the process by which large scale production and
distribution have been made possible, with more dependable service and lower
rates for all. It might ultimately require higher rates within the larger
municipalities in order to produce a reasonable unit return.
Moreover, anything that would discourage the development and prosperity of
the tributary rural and village territory would react unfavorably on its economic
center and business capital.12
Armstrong also cites addresses by Governor (and President-to-be) Franklin D. Roosevelt
in 1929 and Harvard Professor Philip Cabot in 1932, both of whom advocated "greater
uniformity in public utility rates despite differences in cost on broad grounds of public
policy."13 At the 1929 State Fair, Roosevelt "attacked the inequality and lack of
standardization" of utility rates and declared the situation "manifestly unfair":
Now, I am sorry to say that the principle of reasonably equal service at reasonably
equal cost to all the people of the State has not been carried out with regard to the
two latest forms of public service—the telephone and electricity. For some reason
(the history of which it is unnecessary to go into) the original telephone companies
were allowed to charge different kinds of rates, and now, when practically all
telephones are controlled by the greatest of all American mergers, we do not insist
on either uniform service or uniform rate...
The other example, and one which is even more glaring in its unfairness, is that of
the use of electricity in the homes. The railroad principle of fairly uniform rates
has been thrown to the winds even by the public regulating body known as the
Public Service Commission. Is it [now] time to stop and ask the question: "Why
does electricity in the home, the electric lights, electric refrigerator, electric sewing
machine, the home machinery, cost as high as from 15 to 20 cents per kilowatt
hour in some localities and as low as from 4 to 6 cents per kilowatt hour in other
localities." Why should families in one section be so grossly penalized over
families in another section?
Robert D. Armstrong, "The Municipality as a Unit in Ratemaking and Confiscation Cases, Michigan Law
Review 32 No. 3 (January 1934), footnotes omitted. Armstrong served as a hearing examiner with the
Indiana Commission and thereafter with the Interstate Commerce Commission.
13 Armstrong (1934), 292n.
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This difference in charges is true not merely in its application to regions as large as
counties, but is true in respect to towns adjoining each other and houses separated
only by a mile or two. This is perhaps one reason why even today nearly two-
thirds of all the farm houses in the State of New York have no electricity. I am
wondering whether it is not time for the people of this State to ask for the
application of a more uniform rate and a more uniform system of charging for
installation.14
Utility regulators have a considerable degree of discretion in ratemaking, but their
authority is derived from state legislatures and checked routinely by the courts. In 1933,
for example, the Supreme Court upheld a decision by the Indiana commission to treat
municipalities as separate ratemaking units pursuant to state law. hi response, however,
the legislature expressly authorized the commission to prescribe uniform rates on a
regional basis. This section continues to hold a place in the Indiana Code:
Every public utility is required to furnish reasonably adequate service and
facilities. The charge made by any public utility for any service rendered or to be
rendered either directly or in connection therewith shall be reasonable and just, and
every unjust or unreasonable charge for such service is prohibited and declared
unlawful. The commission, in order to expedite the determination of rate
questions, or to avoid unnecessary and unreasonable expense, or to avoid
discrimination in rates between classes of customers, or, whenever in the judgment
of the commission public interest so requires, may, for ratemaking and accounting
purposes, or either of them, consider a single municipality and/or two (2) or more
municipalities and/or the adjacent and/or intervening rural territory as a regional
unit where the same utility serves such region, and may within such region
prescribe uniform rates for consumers or patrons of the same class...
The policy theory deployed to reject the municipal-unit doctrine accepts a fairly sizable
subsidy of rural services in the interest of achieving societal policy goals. Historically,
and for public policy reasons, rural utility services also were subsidized through
governmental grant and loan programs. In the public sector, local governmental subsidies
related to water and wastewater services are relatively common.16
Following the apparent demise of the municipal-unit doctrine, most investor-owned
telecommunications and energy services seemed to price their products on a service-
territory basis. Today, this issue has been eclipsed by the trend toward competitive
pricing. Price theory suggests that competitive firms will offer the same price, based on
marginal cost, at all locations. Unregulated monopolists will maximize profits by
engaging in price discrimination among markets. According to B. Peter Pashigian, the net
14 Ibid.
15
Indiana Code §8-1-2-4 Sec. 4.
16 Another violation of efficiency occurs when subsidies flow from the water system to the municipal budget.
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H Local market
121 Distant market
Price-discriminating Competitive firm Regulated
monopoly (price = marginal monopoly
cost)
Figure 5. Illustration of Pricing Practices by Firms
Source: Adapted from B. Peter Pashigian, Price Theory and Applications
(New York: McGraw Hill, 1994), 467.
price will be lower in the distant market under geographic price discrimination because the
price-discriminating monopolist absorbs the freight costs associated with distant sales.17
Of course, economic regulation tends to reverse this finding, resulting in higher prices to
higher cost areas (namely, distant or rural markets). Pricing theory suggests, however, that
consolidated rates may be consistent with the behavior of competitive firms. The
generalized disparity in pricing among different types of firms is illustrated in Figure 5.
Competition places a greater emphasis on overall efficiency as a determinant of price
levels, rather than on allocating costs according to space or other criteria used in monopoly
ratemaking. Competitive pricing also shifts some attention away from the cost of service
toward the value of service. Pricing flexibility can help firms respond to competitive
forces, focus on service, and improve overall efficiency. When left to their discretion,
many multisystem utilities will opt for the competitive advantage of a consolidated rate.
Absent competition, however, the rate will not achieve efficiency.
17 B. Peter Pashigian, Price Theory and Applications (New York: McGraw Hill, 1994), 467.
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Spatial Pricing
Analysts seem to agree that utility costs vary spatially; that is, the cost of serving one area
generally is not matched by the cost of serving another area. For water utilities,
differences in elevation, climate, physical terrain, the age of the infrastructure, the density
of the service population, and a host of other factors will tend to affect costs even for
service territories that otherwise appear similar. Differences in the proximity to water
sources, the type of source (surface water versus groundwater), the quality of source water,
and implemented treatment methods will tend to produce substantial cost differences.
Assumptions about efficiency and concerns about equity in cost allocation also can lead to
zonal pricing, by which utilities vary prices according to spatial variations in costs among
customer groups that are grouped into zones, districts, or service areas. Zonal pricing
recognizes that the location of consumers within a larger service area can affect the cost of
providing service.18
With zonal pricing, rates are differentiated according to substantial differences in the cost
of serving different areas. Zones generally are defined in spatial terms and represent
geographic clusters of customers with similar cost characteristics. Differences in costs
among zones may be attributed to differences in distribution system costs, which may be
due to differences in the physical plant serving the zones (including age). A more
frequently cited reason for spatially differentiated pricing, however, is the variation in
pumping costs caused by differences in the proximity to facilities, density of the service
population, and particularly elevation. For practical purposes, and as used in this report,
zonal pricing is essentially the same as spatially differentiated pricing.
The zonal price can reflect not only the proximity of groups to source and treatment
facilities, and differences in terrain, but also the different peaking characteristics that
service areas might present. Economist Robert Greene describes a situation in which three
zones present alternative distance and peaking characteristics that can be used to guide the
efficient allocation of capacity costs for each zone.19 In this case, customers assume a
greater cost burden when they are further from the treatment plant and when they
contribute to the peak period of water usage. Greene's example of the cost allocation
based on zonal differences appears in Table 1. The cost allocation reflects the fact that
users impose different capacity costs on water systems based on their location, well as
their contribution to the system's peak loads.
According to Greene:
18 Janice A. Beecher, Patrick C. Mann, and John D. Stanford, Meeting Water Utility Revenue Requirements:
Financing and Ratemaking Alternatives (Columbus, OH: The National Regulatory Research Institute, 1993).
19 Robert Lee Greene, Welfare Economics and Peak Load Pricing (Gainesville, FL: University of Florida
Press, 1970).
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Table 1
Cost Allocation Under Zonal Pricing
Zone
Zone A
ZoneB
ZoneC
Distance from the
Treatment Plant
1 mile
1-2 miles
2-3 miles
Peak Period
of Usage
Period I
Period II
Period I
Efficient Allocation of the Zone's
Capacity Costs
All users in Zones A, B, and C
All Period II users in Zones B and C
Period I users in Zone C
Source: Adapted from Robert Lee Greene, Welfare Economics and Peak Load Pricing (Gainesville, FL:
University of Florida Press, 1970), 60.
The importance of zone pricing rests not only in the proper allocation of
resources in water use. There is considerable significance with respect to land
use and other objectives, hi a discussion of improper pricing policies tied to
marginal rents and the constraints imposed by these rents... A zone pricing
solution can be used for rate differentials in both seasonal and daily peak load
problems... Zone pricing can also be used to adjust rates hi accordance with
cost differentials arising from such factors as geographical characteristics and
population density.. .20
The key issue in implementing zonal rates is one of cost justification. If substantial cost
differences exist within a service area, then zonal rates may be an appropriate form of rate
unbundling that ostensibly attains more efficient water rates.
The efficiency gain assumes that the zonal rate is cost-based and that the transaction costs
associated with unbundling are justified by the efficiency gains. Zonal rates that are
arbitrary (for example, rates that bear no relationship to cost variations or rates that are
based solely on geopolitical boundaries) will introduce inefficiencies. The expense of
developing zonal cost data probably has limited the application of zonal pricing. A
prerequisite to efficient zonal pricing is the capability to accurately calculate the cost
differences associated with providing service to different zones within a utility's service
territory.
Economic and engineering arguments against zonal pricing can be made.21 Capital-
intensive utility systems should be designed for optimal performance of all utility
functions (supply, treatment, distribution, and so on) within a service territory. Spatial
differentiation within the service territory might subvert this general optimum. In other
Ibid., 61-62.
Beecher, etal. (1993).
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words, the utility does not deploy resources in the most economically beneficial manner.
Another potential disadvantage of zonal pricing is that it can accentuate the problem of
localized cost and rate shock associated with infrastructure replacements. By broadening
the customer base, a uniform or average rate will cushion the shock and temper its adverse
effects (such as revenue instability).
Zonal rates also raise concerns about equity and perceptions of equity. Obviously, zonal
rates usually will be met with considerable resistance from the groups of consumers asked
to pay higher water rates. In some contexts, zonal pricing might constitute an undesirable
form of price discrimination.
Zonal pricing is used by the water industry to some degree, although not necessarily by
that name. Wholesale water rates might qualify as an example because they typically
reflect spatial differences in costs. Utilities that set different retail prices for districts
served include the California-American Water Company and the Los Angeles Suburban
Water Company.22 A more common form of zonal pricing used by publicly owned
utilities is the rate differentiation for service inside and outside municipal boundaries.
Fairfield, California provides an example of spatially differentiated pricing, both within
the city and between residents and nonresidents (see Table 2). As a generalization,
municipal utilities are more likely to use inside-city/outside-city pricing and investor-
owned utilities are more likely to seek approval for rate uniformity across service
territories.
Table 2
Example of Municipal Zonal Rates for Residential Water Customers
Residential Water Charges
Service charge
Water-use charge
Zone 3 (200 feet and over)
Zone 5 (400 feet and over)
Pneumatic Pump Zones
Zones 1 and 2
Zones 3 and 4
Zone 5
Outside City Charge
Service charge
Water-use charge
Rate
$0.50 per day
$1.3 5 per 100 cubic feet
$1.67 per 100 cubic feet
$2.00 per 100 cubic feet
$ 1 .57 per 1 00 cubic feet
$1.89 per 100 cubic feet
$2.22 per 100 cubic feet
$0.75 per day
$2.02 per 100 cubic feet
Source: City of Fairfield California Utility Rates, as of January 1, 1999. 100 cubic feet = 748 gallons.
(http://www-e-v.com/fairfield/government/public_works/rates.htm).
22 Raftelis Environmental Consulting Group, 1996 Water and Wastewater Rate Survey (Charlotte, NC:
Raftelis Environmental Consulting Group, 1996).
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For a variety of reasons, zonal pricing does not appear to be the prevailing model for retail
water pricing. Importantly, costs can vary within physically interconnected service
territories by magnitudes as great as they might vary between noninterconnected systems.
By and large, many cost differentials associated with spatial considerations are essentially
disregarded in the ratemaking process for public utility systems.
Spatial Pricing and the Telephone Industry
The rejection of zonal pricing in the debate over statewide telephone rates seems to come
closest to providing a rationale for single-tariff pricing by multi-system water utilities.
According to Charles Phillips:
While each exchange is a distinct unit for rate-quoting purposes, the former Bell
System companies have generally established rates on a statewide basis.
Essentially, the statewide basis provides that the total costs of furnishing telephone
service and the resulting revenue requirements are considered for the state as a
unit. This practice recognizes that telephone service, both exchange and intrastate
toll, furnished by a given company through a state, is, in reality, an integrated
whole, all portions of which are interdependent. The objective is to apply
throughout the state a well-balanced and coordinated pattern of rate treatment,
providing rates that are uniform under substantially like conditions and producing,
hi the aggregate, reasonable earnings on the company's total telephone operations
within the state.
The statewide basis has five important advantages over consideration of individual
exchanges. First, the statewide basis permits more people to have better service at
a reasonable price. Some small areas, if forced to pay their own way, might have
no service at all. Needed plant replacements or additions might be postponed if
local customers had to cover their full costs, resulting in deterioration of local
service within the exchange and of toll service to and from it. Second, on the
statewide basis, customers pay like charges for like amounts of service. If each
exchange had to stand on its own feet, customers' charges would vary with
physical characteristics of the exchange areas, age of plant, type of equipment and
other factors affecting costs, but not necessarily affecting the service rendered.
The statewide basis averages out such factors.
Third, customers seem better satisfied with statewide rates, since the application of
uniform schedules avoids any questions of discrimination or unfair advantage to
pressure groups in individual exchanges. Fourth, the statewide basis tends to
stabilize rate levels by providing a broad rate basis. Risks are shared so that a
community suffering from flood, storm or other natural disaster or from some local
economic difficulty (e.g., the removal of a major industry) need not pay higher
telephone rates such as would be required if telephone operations in that exchange
had to meet these conditions single-handedly. Finally, the statewide basis is more
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workable and makes the regulatory process less cumbersome and expensive to
both the public and the company involved. It avoids multiplicity of rate cases for
each individual exchange. It simplifies handling of questions and complaints by
the regulatory commissions and administration by the companies.
At the same time, it should be pointed out that the statewide basis results in some
subscribers subsidizing other subscribers. Because exchange telephone service is
more valuable to customers irTthe larger service areas, they are willing to pay more
for their service. Since their average cash incomes are greater, they are able to pay
more. Lower rates in the small towns and rural areas, where average money
incomes are relatively low, encourage telephone use and development in these
places. Once again, this is an example of how rate discrimination has been used to
achieve a socially desirable objective, in this case the widespread development of
telephone usage through the country.23
Phillips also discusses how "nationwide averaging has been used in establishing interstate
toll rates, under which toll rates are the same for equal distances throughout the
continental United States, despite differences in the costs involved"24 A nationwide rate,
he acknowledges, has "all of the advantages of statewide rates, but it results in internal
subsidization" and raises a variety of competitive issues as well.
Counterpoint
In a direct and provocative treatment of the "uniform pricing" issue, economist Ronald
Coase acknowledged that the key arguments favoring uniformity are founded on the view
that certain services (namely, utility services) are considered essential and that the
undertaking as a whole can be "self-supporting."25 However, Coase notes the intellectual
disagreement among early postmasters (also economists) over whether postage stamp
rates actually served the interests of rural communities.
Absent a governmental subsidy, according to Coase, a uniform price actually might cause
a provider to avoid or delay extending service to high-cost areas, even if the customers in
high-cost areas are -willing to cover the additional costs through rates (or surcharges).
Adding high-cost customers to the mix increases the average cost of production and
decreases the eeonomic well-being of the utility. The magnitude of this effect depends on
the relative mix of high-cost and low-cost service. Coase makes, and then relaxes, a
number of assumptions that may or may not be valid but he does not consider the role of
economic regulation. In practice, a forward-looking ratesetting process that accounts for
the total cost of service throughout the consolidated service territory neutralizes the is
incentive Coase identifies. Indeed, the primary and practical purpose of rate consolidation
had been to extend service while maintaining the utility's financial health.
23 Phillips (1993), 517-518.
24 Phillips (1993), 522.
25 Coase, "The Economics of Uniform Pricing Systems."
• 17
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3. Spatial Pricing and Ratemaking Theory
Theoretical Issues
The defining engineering, economic, structural, and institutional characteristics of the
water industry generally are not contemplated in the literature establishing the basic
principles of utility ratemaking. The central issue of whether physical interconnection
should be required for single-tariff pricing by multi-system water utilities is not well
addressed. Because other utility infrastructures—electricity, electricity, natural gas,
telecommunications—have a high degree of interconnection through transmission grids,
the acceptability of cost averaging for non-interconnected systems is a theoretical problem
unique to the water and wastewater industries. Although energy and telecommunications
providers experience spatial differences in cost, these differences are generally not
reflected in prices.
In the prevailing theories used in ratemaking and regulation, the concepts of "due" (or just
and reasonable) and "undue" (or unjust and unreasonable) price discrimination are
contemplated with regard to customers classes but not with regard to spatially defined
systems. Separate prices for separate systems owned by a common entity reflect
assumptions about the implications of the cost allocation for efficiency. It can be argued
that water costs are allocated (and prices are charged) on a spatial basis primarily because
they can be, rather than that they should be for unequivocal theoretical or empirical
reasons. In other words, the costs of providing utility service can be approximated for
individual operations (with corporate common costs allocated among them), but the
benefits and desirability of doing so are contingent on other considerations.
A logical (if not well documented) argument can be made that spatial pricing comports
with cost-of-service principles and enhances allocative efficiency: customers of systems
with higher costs pay higher rates and customers of systems with lower costs pay lower
rates. The degree of subsidy or inefficiency introduced with single-tariff pricing, and
whether or not it is acceptable, depends in part on the differential in costs among systems.
A small differential with a minimal rate impact will be less controversial than a large
differential with a substantial rate impact. Little guidance is available on to what extent of
cost averaging through single-tariff pricing would constitute an inappropriate level of
subsidy, undue price discrimination, or more generally an abuse of monopoly power.
However, with or without single-tariff pricing, utility rates can be more or less efficient
depending on other features of the rate (such as the mix of fixed and variable charges, the
number of rate blocks, rate-block differentials, and seasonal differentials). These features
can promote efficient water use and can do so when used in conjunction with single-tariff
pricing. Moreover, and perhaps more importantly, the cost of service is not the only
guiding principle and efficiency is not the only goal of public utility ratemaking and
policymaking, as discussed later in this report.
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In reality, virtually all methods of utility rate design require a considerable degree of cost
averaging. The obvious example is in the establishment of rates by customer classes (for
example, residential, commercial, industrial, and wholesale). But many utility costs are
associated with common operational and management functions. Common costs are
allocated to customer groups according to one of several available methodologies. For
multi-system utilities that do not use single-tariff pricing, common costs must be allocated
spatially as well. Allocating common costs requires the analyst to make assumptions
about underlying cost drivers and establish yet another layer of averaging. The entire
process of cost allocation and rate design is as much art as it is science, and has at least as
much to do with equity as it does efficiency.
In many jurisdictions, the status quo presents a challenge for utilities. Based on the
prevailing theoretical assumptions, the burden of proof has rested on water utilities
to justify the use of single-tariff pricing. In other words, the prevailing assumption
is that deviations from spatial allocation of costs (such as the movement toward
consolidated rates) must be justified. An alternative approach would be to begin
with a single tariff and specify the circumstances under which spatial allocation of
costs is justified because of concerns about efficiency, equity, subsidies, undue
discrimination, or other ratemaking or policy concerns. This might shift attention to
the use of extra-tariff instruments, such as surcharges, to make price adjustments
needed to encourage efficiency and accomplish other purposes.
Evaluation Issues
The appropriateness of reflecting spatial differences in cost in prices can be
evaluated according to traditional and modern ratemaking criteria. The general
criteria for many public policies, and for utility ratemaking, often emphasize
competing goals. Although it always seems desirable to achieve public policy goals
efficiently, efficiency itself is not the only goal of policymaking:
Of course, efficiency is not the only societal value. Human dignity,
economic opportunity, and political participation are values that deserve
consideration along with efficiency. On occasion, public decision makers or
ourselves, as members of society, may wish to give up some economic
efficiency to protect human life, make the final distribution of goods more
equitable, or promote fairness in the distribution process. As analysts we
have a responsibility to confront these multiple values and the potential
conflicts among them.26
The emphasis on, concept of, and assumptions about efficiency shape views about
what is just, fair, or equitable. Political philosophers offer alternative perspectives.
The Rawlsian theory of justice, which holds that public policies should be used to
26 David L Weimer and Aidan R. Vining, Policy Analysis: Concepts and Practice (Englewood Cliffs, NJ:
Prentice-Hall, 1989), 31.
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provide the greatest benefit to society's least advantaged, is perhaps the best
example of a countervailing philosophy.27
Ratemaking Criteria
Ratemaking and rate design are guided by certain fundamental principles that are well
established and well accepted in the regulatory community. These principles provide
guidance, but are not decisive because each involves a degree of subjectivity and some
principle might directly clash with others.
Most ratemaking analysts rely substantially on James Bonbright's eight criteria for a sound
or desirable rate structure:
1 .
2.
4.
5.
7.
The related, "practical" attributes of simplicity, understandability, public
acceptability, and feasibility of application.
Freedom from controversies as to proper interpretation.
Effectiveness in yielding total revenue requirements under the fair-return
standard.
Revenue stability from year to year.
Stability of the rates themselves, with a minimum of unexpected changes
seriously adverse to existing customers.
Fairness of the specific rates in the appointment of total costs of service
among the different consumers.
Avoidance of "undue discrimination" in rate relationships.
Efficiency of the rate classes and rate blocks in discouraging wasteful use
of service while promoting all justified types and amounts of use:
(a) in the control of the total amounts of service supplied by the company;
(b) in the control of the relative uses of alternative types of service (on-
peak versus off-peak electricity, Pullman travel versus coach travel, single-
party telephone service versus service from a multi-party line, etc.28
As indicated by check mark (/), Bonbright considered three criteria — revenue sufficiency,
fairness, and efficiency — to be especially important.29 Despite the passage of time,
Bonbright's criteria remain quintessential. Table 3 presents a qualitative analysis of the
consistency of single-tariff pricing with Bonbright's traditional criteria (items 1 though 8).
Five additional policy criteria that are especially relevant to modern water pricing also are
presented (items a through e).
Consolidated rates generally seem to meet the test of Bonbright's first five criteria. If
practicality depends in part on customer acceptance, then acceptance becomes a
" John Rawls, A Theory of Justice (Cambridge, MA: Belknap Press of Harvard University Press, 1971).
28 Phillips (1993), 434-435. Based on James C. Bonbright, Principles of Public Utility Rates (New York:
Columbia University Press, 1961).
29 Phillips (1993), 434-435.
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determinant. Other aspects of practicality, namely simplicity, understandability, and
feasibility of application (or implementation) seem very compatible with single-tariff
pricing. The last three criteria are labeled as indeterminate because their compatibility
with rate consolidation depends on other policies or practices, or on the subjective
judgment of the evaluator. While single-tariff pricing is not necessarily consistent with
these criteria, neither is it clearly inconsistent. On the issue of fairness, single-tariff
pricing might be considered unfair on the basis of subsidization,,but fair on the basis of
sharing burdens at a reasonable cost. On the issue of efficiency, other features of a tariff
also affect the accuracy of price signals.
The five additional criteria included represent a select group of other potentially relevant
policy goals in relation to single-tariff pricing for the water industry. Resource planning is
considered indeterminate because planning incentives and outcomes probably are more
heavily influenced by the structural character of the water industry than by rate design.
However, single-tariff pricing seems rather consistent with four other criteria—standards
compliance, customer affordability, industry restructuring, and institutional legitimacy.
The last criterion, institutional legitimacy, is somewhat of a composite indicator. The
assertion of consistency reflects the generally positive support for single-tariff pricing by
the state public utility commissions and the courts.
Table3
Consistency of Single-Tariff Pricing
With Ratemaking Criteria
Criterion
Consistency of Single-Tariff Pricing
with Criterion
Bonbright Criteria
1. Practicality
2. Interpretability
3. Revenue recovery
4. Revenue stability
5. Rate stability
6. Fair cost allocation/equity
7. Discrimination avoidance
8. Efficient resource use
Generally consistent (if accepted)
Generally consistent
Generally consistent
Generally consistent
Generally consistent
Indeterminate
Indeterminate
Indeterminate
Additional Criteria
a. Resource planning
b. Standards compliance
c. Customer affordability
d. Industry restructuring
e. Institutional legitimacy
Indeterminate
Generally consistent
Generally consistent
Generally consistent
Generally consistent
Source: Author's construct. Criteria 1 through
Rates (New York: Columbia University Press,
8 are from James C. Bonbright, Principles of Public Utility
1961).
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Directly or indirectly, these criteria figure prominently in the consideration of rate
consolidation. Other analysts surely could raise other relevant considerations. No attempt
is made here to weight the criteria according to perceived importance; this is a task left to
policymakers. In reality, the efficiency criterion is assigned considerable weight in
ratemaking, as well as in policymaking in general. In other words, divergence from
efficient solutions (or solutions that are perceived to be efficient) must be well justified.
The Efficiency Criterion
Economic theory argues for utility pricing that promotes overall efficiency for society. An
efficient price signal leads consumers to consume, and producers to produce, an
appropriate amount of a good or service. Prices that are too low can lead to
overconsumption (and underproduction); prices that are too high can lead to
underconsumption (and overproduction). The mismatch of supply and demand, and the
"welfare loss" associated with it, has rippling effects throughout the economy because in
using excessive resources to produce a good, or spending too much for that good, society
foregoes opportunities to use those resources or make those expenditures elsewhere.
Economic theory also argues for utility pricing that is equitable in terms of allocating costs
to those responsible for those costs.30 In this conception, equity essentially serves
efficiency goals. Three kinds of equity can be considered. Horizontal equity suggests that
those who impose similar costs should pay the same rate. A related ratemaking principle
is that rates should be "nondiscriminatory." Vertical equity suggests that those who
impose different costs should pay different rates that reflect those cost differences.
Ratemaking allows for "due discrimination" when costs among customer groups vary
substantially. Finally, intergenerational equity considers equity along a temporal
dimension, suggesting that one generation of customers should not be forced to cover
costs imposed by another generation of customers.
Economists long have argued for prices that reflect costs and against subsidies that distort
price signals. Modern pricing theory more specifically calls for pricing based on marginal
costs; that is, prices should reflect the incremental cost of producing an additional
increment of a good. Prices based on long-term marginal costs will help achieve long-
term efficiency in deploying resources. Efficiency is a fundamental goal but it is not the
only goal of utility pricing. Pricing also must help achieve a delicate balance between the
interests of the utility and the interests of ratepayers, and in doing so satisfy the public
interest standard.
30 Of course, other theoretical perspectives will argue for different kinds of equity, such as social and
political equity.
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Other Criteria
Another vitally important ratemaking principle centers on the avoidance of "undue" price
discrimination. An important issue for regulators is whether the level of price
discrimination under either single-tariff pricing or stand-alone pricing is "due or undue,"
that is, whether or not it is justified. According to Charles Phillips:
Price discrimination occurs when a seller establishes for the same product or
service different rates that are not justified entirely by differences in cost, or the
same rate where differences in cost would justify differences in price... [I]t would
be theoretically possible for a firm to charge each customer a different rate.. .31
The often-cited legal standard of "undue discrimination" does not point regulators or the
courts to particular solutions, as articulated by Richard J. Pierce:
Most regulatory statutes forbid "undue discrimination" in the relationship among
the rates charged different customers or classes of customers. This statutory
standard is almost completely devoid of meaning, however. By using the adjective
"undue," the standard obviously authorizes some forms of price discrimination, but
it says nothing that would help an agency or a court distinguish between
permissible and impermissible rate differentials.
Much of the case law purporting to distinguish between due and undue
discrimination is affirmatively misleading...
[The Supreme] Court's holding in Hope applies with equal force to rate design
decisions. An agency's decision has a "presumption of validity," and anyone
seeking to overturn it has "the heavy burden of showing that it is invalid." The
agency is "not bound to the use of any single formulae in determining rates."32
A closely related and equally complex regulatory standard is whether resulting rates are
"just and reasonable." Phillips explains:
[Discrimination is accepted in the rate structures of public utilities, but... such
discrimination must be "just and reasonable." Discrimination is both unintentional
and purposeful. It is unintentional in that some discrimination results from the
efforts of utilities and commissions to simplify the rate structures by grouping
customers into a limited number of classifications. It is purposeful in that
discrimination may be the only way in which service can be provided to some
customers. Low-density routes may be subsidized by high-density routes (even
under competition), small towns by large cities. Rather than preventing
31 Phillips (1993), 69-70.
32 Richard J. Pierce, Economic Regulation: Cases and Materials (Cincinnati: Anderson Publishing Co.,
1994), 122.
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discrimination, regulation merely seeks to control what discrimination takes
place.33
In sum, regulatory agencies have considerable discretionary authority, and have exercised
that authority, to determine whether rates and rate structures are within acceptable
boundaries. Many state public utility commissions have found that rate consolidation by
multi-system water utilities is within these boundaries.
Pricing in Practice
Despite the hallowed status of economic efficiency in ratemaking, pricing in practice often
violates pricing in theory. Many sources of distortion (governmental grants and subsidies,
differences in ownership, ill-defined markets for alternative water uses, and a variety of
past public policies) distort price signals for water. The considerable "noise" in the real
world of assigning monetary values to water undermines the efficiency of the price signal
sent by utilities. Practical applications of marginal-cost pricing, when used at all, deviate
substantially from the theoretical construct. One key reason is that strict adherence to the
marginal-cost model could allow utility monopolies to receive excess revenues and earn
excess profits (in the case of investor-owned utilities).
Averaging costs to one degree or another is an accepted practice in utility ratemaking. For
example, rate regulators generally do not accept "vintage" rates that distinguish "old"
customers from "new" customers even though old and new customers impose different
costs on the utility system.34 Ratemaking also tends to ignore the reality that older and
newer parts of a water system will require capital investments at different times and at
different costs; these improvement costs instead are averaged across the entire system and
all of the utility's customers.35
In rate design, economic theory often gives way—at least somewhat—to practical and
public policy concerns. An example that has some relevance for the single-tariff pricing
debate is the provision of budget-payment plans for customers that equalize payments over
a year, making the utility bill during the peak period of use (such as the winter heating bill
or the summer cooling bill) more affordable. A disadvantage of the budget plan in terms
of economic efficiency is that it undermines the price signal to customers, which may lead
them to overconsume (and pay a higher annual bill than they otherwise would pay). But
the advantages of convenience and affordability for customers, as well as avoidance of
costly and potentially dangerous disconnections, generally outweigh these theoretical
considerations.
33 Phillips (1993), 70, footnotes omitted.
34 John Guastella, "Single Tariff Pricing and Conservation Rates," a discussion paper prepared for the Rates
and Revenue Committee of the National Association of Water Companies (1994).
35 Guastella (1994).
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The budget-payment plan is an imperfect analogy to single-tariff pricing, however, in that
it is customer-specific and does not involve subsidization from one customer to another.
Subsidization will occur, however, with lifeline rates that provide a minimal block of
usage at a price below the cost of service and lenient disconnection practices. Such
policies introduce equity and fairness considerations beyond those narrowly defined by
economic theory.
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4. Structural Issues in the Water Industry
The U.S. water industry is complex and diverse. The U.S. Environmental Protection
Agency and the state primacy agencies, count noncommunity and community water
systems. According to the EPA's Community Water System Survey (1997), about 50,289
community water systems operate in the United States. A community water system is a
system serving a population of 25 or more people with at least 15 service connections.
The data confirm both the large number of water systems in the United States, as well as
the large proportion of smaller systems within that total. Relatively small systems, defined
as systems serving communities with a population under 3,300 persons, comprise about 85
percent of total systems and provide water to approximately 12 percent of the connections
served by community systems. Conversely, about 15 percent of community water systems
are larger in size and provide water to approximately 88 percent of connections.
Systems v. Utilities
Community water systems, which the EPA inventories, can be distinguished from water
utilities. Water utilities are governmental, nonprofit, or private corporate entities engaged
in providing water service to one or more service territories. Water utilities can operate
more than one water system. Multi-system utilities are particularly apparent in the private
segment of the water industry. Many of the larger investor-owned utilities actually
operated several distinct water systems'. In some cases, none of the systems operated by
the utility are physically interconnected; in other cases, two or more of the systems may be
connected to common water source, transmission, or treatment facilities.
The state public utility commissions typically count the number of regulated water utilities
but not necessarily water systems. In 1995, the number of commission-regulated water
utilities was about 8,537 and the number of commission-regulated water systems was
about 11,064.36 Thus, the commissions regulate approximately 20 percent of all water
systems, although the number and percentage of commission-regulated systems probably
is somewhat underestimated because of the difficulty in counting regulated systems.
In some states, the number of regulated utilities is equivalent to the number of regulated
systems. However, the distinction between utilities and systems is important in that many
jurisdictional water utilities encompass multiple community water systems. The presence
of numerous multi-system utilities is, and will continue to be, an important feature of the
U.S. water industry.
36 Janice A. Beecher, 1995 Inventory of Commission-Regulated Water and Wastewater Utilities.
(Indianapolis, IN: Center for Urban Policy and the Environment, 1995).
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Multi-System Water Utilities
A multi-system water utility is a utility comprised of several distinct water systems.
Physical interconnection among systems can help utilities achieve economies of scale in
production and enhance service reliability. Common management of physically separate
systems, however, also can help systems realize operational, management, and financing
(cost-of-capital) savings.
Even without physical interconnection, the utility still can achieve economies of scale and
scope through certain operational and administrative functions. Operating multiple
noninterconnected systems within close physical proximity, for example, might allow the
utility to save labor costs by using a circuit rider approach to system operations. A
specialized maintenance team might also be used to address ongoing programs for
maintenance, replacements, and improvements. Shared operations and management also
can enhance the ability of water systems to respond to water emergencies. Consolidated
meter reading, billing, and customer relations functions also can produce savings.
At the management level, planning, financing, regulatory relations, and other areas of
decisionmaking can be consolidated on a utility-wide basis. Managers with greater
expertise can be retained at the utility level than at the smaller system level. While
managers with greater expertise will command higher salary and benefit packages, the
investment in their expertise can yield savings that individual systems could not otherwise
achieve. Ample anecdotal evidence supports the assertion that smaller systems benefit
from access to expert technical knowledge. Using this expertise, multi-system utilities can
exploit efficiencies and improve effectiveness by deploying a unified workforce, rather
than having each individual utility maintain separate capability for various utility
functions.
The potential advantages of utility-wide management may extend beyond the immediate
efficiency payoffs. Planning for multiple systems, as compared to individual systems,
allows for a more comprehensive approach. Better planning, in turn, should enhance the
utility's capacity to respond to regional economic and environmental issues. Effective
watershed management and source-water protection programs, for example, require a
regional perspective that is not easily achieved by isolated systems.
Another appreciable benefit of common management is lowering the cost of capital. A
consolidated utility with a broader customer and revenue base is expected to pay lower
financing costs than individualized systems. This is a particularly important benefit for
very small water systems.
Multi-system utility operations can be linked to the broader and more long-term policy
concerns related to structural change in the water industry through regionalization. Multi-
system utilities generally serve regional areas. Many have the potential to combine
operations, with or without physical interconnection, with other nearby water systems
(many of which are small in size). Water utility mergers and acquisitions reflect a very
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gradual trend toward regionalization and, in some cases, privatization of water services.
Existing utilities also can be used to provide service as an alternative to the creation of
new water utilities. Indeed, many states will not certify a new water system if service
from an existing provider is feasible. In addition to expanding regional water operations,
some water utilities have diversified by entering the wastewater industry. Likewise, some
private energy utilities providing electricity and natural gas have ventured into the water
business. The formation and expansion of multi-system utilities and multi-sector utilities
are part of potentially fundamental structural changes occurring in the water industry.
Pricing and Structural Change
Pricing is intrinsically related to structural change in the water industry. For example, a
utility's level of interest in a merger or acquisition opportunity may depend on anticipated
price effects. A negotiated sale of a utility might include limitations on near-term pricing
practices or even price caps or freezes for a fixed period of time. Larger utilities often are
reluctant to consider acquiring smaller, nonviable systems unless reliable means of cost
recovery can be identified and secured. An acquisition candidate often presents
substantial infrastructure needs but its service community lacks the ability to pay for
improvements through higher rates. As mentioned already, the acquisition will yield some
economies but not usually economies of~a magnitude great enough to offset the
diseconomies associated with the smaller system's operations. Some argue that more
acquisitions would occur if acquiring companies were provided incentives, including the
ability to spread costs throughout the utility's multiple service territories.
Although the dilemmas of small water systems have been extensively studied, the issue of
pricing probably has received considerably less attention than viability assessment,
capacity building, and related approaches. Pricing policies ultimately will play a role in
shaping the future structure of the water industry, including but not limited to the future of
small water systems.
Incentives for Restructuring
Single-tariff pricing has the potential to encourage economic industry consolidation and
regionalization, as well as privatization.37 Averaging costs mitigates rate shock for
customers and enhances revenue stability for utilities; it also is relatively simple to
administer. Some investor-owned utilities have sought rate equalization in direct
connection with small system acquisitions.38 According to one industry representative,
37 Janice A. Beecher, G. Richard Dreese and John D. Stanford, Regulatory Implications of Water and
Waste\vater Utility Privatization (Columbus, OH: The National Regulatory Research Institute, 1995), 141.
38 Patrick Mann, G. Richard Dreese, and Miriam A. Tucker, Commission Regulation of Small Water
Utilities: Mergers and Acquisitions (Columbus, OH: The National Regulatory Research Institute, 1986);
Raymond W. Lawton and Vivian Witkind Davis, Commission Regulation of Small Water Utilities: Some
Issues and Solutions (Columbus, OH: The National Regulatory Research Institute, 1983).
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single-tariff pricing "could help solve the dilemma of other nonintegrated small water
systems."39
The focus of this report is on single-tariff pricing by regulated investor-owned utilities
because the issue has emerged primarily within these parameters. Rate consolidation can
be used as easily by publicly owned utilities as by investor-owned utilities.40 Many of the
larger metropolitan water systems could acquire numerous contiguous small systems and
employ single-tariff pricing with a negligible customer-bill impact.41 In the context of
public utility regulation and mandated takeovers, it appears that the burden of acquiring
troubled systems seems has fallen more to privately owned than to publicly owned water
utilities. This is because many small systems are privately owned and regulated, the larger
investor-owned systems do not confine their service territories to local political boundaries
and regulators can provide acquisition incentives to jurisdictional utilities. In the few
states where a takeover can be mandated, it may be easier to impose this responsibility on
a private system.
Unfortunately, little systematic evidence on the use of single-tariff pricing in the public
sector is available. Also, most municipal utilities and many public authorities appear to
operate single water systems only. However, one example of the use of single tariff
pricing in the nonprofit context can be found in Clark County, Washington. Clark Public
Utilities is a customer-owned district that provides water service (and other services) to
24,000 customers throughout Clark County and also operates several small "satellite"
systems for small groups of homes throughout the county.42 All customers pay the same
monthly customer charge and uniform volume rate.
Some municipalities do impose zonal rates that reflect differences in elevation and
pumping costs. Generally, however, municipal water utilities impose a single pricing
structure for all citizen-ratepayers served within municipal boundaries; ratepayers outside
of municipal boundaries often pay a higher rate.43 Higher "outside" rates are justified on
the grounds that "inside" customers bear more risks and burdens associated with financing
capital improvements through municipal funding instruments. However, the rate
differential often appears to be somewhat arbitrary, hi a few states, charging a different
rate to outside customers can trigger economic regulation by the state (Pennsylvania is an
example).
Some insights can be gained from two states where state economic regulation applies both
the privately and publicly owned water systems, hi Wisconsin, state law mandates single-
39 Edward M. Limbach, "Single Tariff Pricing," Journal American Water Works Association 75 no. 9
(September 1984): 52.
40 Limbach (1984).
41 Cities may lack adequate incentives or opportunities or acquisitions. In contrast, regulatory agencies can
offer investor-owned utilities with rate-of-return and other incentives. Some commissions have the authority
to mandate takeovers of smaller, nonviable water systems.
42 Clark Public Utilities (http://clarkpud.com/Default.htmX
43 The interest of many investor-owned utilities in single-tariff pricing clearly stands in contrast to the
apparent interest of many municipally owned utilities in spatially differentiated pricing.
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tariff pricing for municipalities.44 In West Virginia, where economic regulation applies to
public service districts, as well as investor-owned utilities, single-tariff pricing has been an
issue because of the needs of the state's rural areas. Single-tariff pricing is approved on a
case-by-case basis and both single tariffs and multiple tariffs are used throughout the state.
Many of the state commissions have broadly supported the idea of consolidating water
utilities and specifically approved valuation, costing, and pricing practices that encourage
larger and healthier utilities to acquire smaller and less healthy utilities. The Pennsylvania
Public Utility Commission, hi its policy statement regarding acquisitions, explicitly
mentions single-tariff pricing. These regulatory policies are being adopted within the
larger context of structural change in the water industry. These structural changes may
include reconsideration of traditional methods of regulation and ratemaking, as is taking
place in many jurisdictions for the other utility industries.45
44 Wisconsin S. 66.069 (1) (a) (1971).
In the increasingly competitive electric and natural gas industries, for example, the interest in regulatory
alternatives is high. These alternatives include price caps and flexible rates, which essentially deregulate rate
design by giving utilities greater discretion in setting rates within broad parameters.
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5. Cost Profile of the Water Industry
Water utilities remain one of the more tried and true monopolies in terms of basic
economic characteristics. In general, water service can be provided efficiently by a
vertically integrated supplier; two or more suppliers (or redundant distribution systems) in
the same service area would greatly increase costs and rates. The technology of water
supply clearly demonstrates economies of scale, meaning that average unit costs decrease
with the quantity of water provided. The prevalence of many small utilities undermines
the industries' overall efficiency in terms of achieving economies of scale.
Even in comparison to other fixed utilities, water utilities require substantial investment in
fixed assets relative to the variable costs of production (including the cost of raw water,
energy, and treatment chemicals).46 Using the standard of capital investment per revenue
dollar, water supply is among the most capital-intensive of all utility sectors. Capital
investment in water supply mainly is a function of the need to establish production
capacity; maintain a complex storage, transmission, and distribution network; and meet
both fire-protection specifications and peak demands. In general, the water supply
industry has high fixed costs and low capital-turnover rates. However, the capital intensity
of the water supply industry also can be explained by the industry's relatively low variable
(operating) costs, which translate into relatively low operating revenues.
Reflecting these cost characteristics, water rates typically take the form of a fixed charge
that does not vary with usage and a variable charge that varies with usage. Traditional
cost-of-service principles can lead to very high fixed charges and very low variable
charges for water utilities. Efficiency-oriented rates, however, tend to accentuate the
variable component of the water bill in order to affect consumption behavior.
Trends in Water Costs
Water supply clearly is a rising-cost industry. Water supply utilities, and their regulators
at the federal, state, and local levels, are increasingly aware of the water supply industry's
changing revenue requirements. Three key forces affecting the industry's costs are (1) the
need to comply with regulatory provisions of the Safe Drinking Water Act (SDWA), (2)
the need to replace and upgrade an aging water delivery infrastructure, and (3) the need to
meet population growth and promote economic development. In addition, water utilities
face a variety of secondary cost forces. These include the often high cost of borrowing to
finance capital projects (especially for small systems) and the shift to nonsubsidized,
self-sustaining operations (especially for publicly owned systems).
46 For a comparison of the water industry to the electric, natural gas, and telecommunications industries, see
Janice A. Beecher, The Water Industry Compared: Structural, Regulatory, and Strategic Issues for Utilities
in a Changing Context (Washington, DC: National Association of Water Companies, 1998).
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The concurrent and mutually reinforcing impact of these forces on many water utilities
presents a substantial pressure on both capital and operating costs, a pressure not
previously experienced by the water supply industry, hi response, water utilities are
reexamining their cost allocation and rate design practices. The interest in alternative
ratemaking methods for the water sector is on the rise.
Rising costs, along with structural and regulatory changes in this industry is placing new
demands on utility regulators. However, rising costs should not be taken for granted but
closely scrutinized. Moreover, the water supply industry must be held accountable for
making prudent decisions in response to its changing cost profile. The industry must be
able to fully justify the use of alternative approaches to meeting revenue requirements
(including automatic cost-adjustment mechanisms, pass-throughs, and special surcharges,
as well as cost-allocation and rate-design methods).
Water utility regulators generally are open to the consideration of policy alternatives but
also vigilant about whether these alternatives are within the scope of regulatory authority
and consistent with accepted regulatory principles. Regulators will want to be especially
cautious about affecting the incentives that determine whether utility costs are effectively
managed. Thus, the industry perspective on rising costs and how to address them should
be tempered by a reasoned regulatory perspective.
Economies of Scale
Although an arbitrary threshold, water systems serving under 3,300 (or approximately
1,000 service connections) generally lack economies of scale in production and other
aspects of service.47 As a result, many small water systems are prone to capacity problems
and difficult to sustain over time.
Economies of scale in water supply, particularly in the areas of source development and
treatment, make it difficult for smaller water utilities to perform as well as larger water
utilities. Declining unit costs of production indicate scale economies; as the volume of
water "produced" (that is, withdrawn and treated) increases, the cost per gallon or cubic
foot decreases. At lower unit costs, production is less costly in the aggregate and more
efficient at the margin.
Very small water systems underperform primarily because they simply are not large
enough to achieve economics of scale. Scale economies in the water sector explain why
smaller utilities tend to have less capacity in financial, managerial, and technical terms.48
47 U.S. Environmental Protection Agency, Affordability of the 1986 SDWA Amendments to Community
Water Systems (Washington, DC: U.S. Environmental Protection Agency, 1993).
4S Janice A. Beecher, G. Richard Dreese, and James R. Landers. Viability Policies and Assessment Methods
for Water Utilities (Columbus, OH: The National Regulatory Research Institute, 1992).
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49
Rising costs over the past decade have exacerbated the condition of smaller systems.
Capacity-development problems often are manifested in higher rates for water service.
Scale economies (or lack thereof), thus become an important determinant of how much
people pay for water service. As a generalization, assuming comparable system
characteristics and cost-based pricing, larger systems should be able to provide service at a
lower price than smaller systems. In reality, of course, many factors other than system size
(such as the quality of source water and treatment methods required) influence ultimate
water costs and prices. But as a generalization, it is widely held that smaller water
systems rnustcharge customers much higher rates for water service comparable to service
provided by larger water systems.
Importantly, the economies of scale in water production are associated with the volume of
water produced (not simply the number of service connections). Even smaller systems
that are fortunate enough to have one or two large-volume customers will enjoy some
economies of scale. Two utilities can have a comparable level of investment per customer
and cost-of-service for the same number of residential customers, but if one also serves a
large industrial firm and economies of scale are achieved, everyone in that community will
enjoy lower water bills. In other words, when controlling for large-volume use, the level
of investment and the cost of service can be quite comparable from system to system. One
of the arguments in favor of single-tariff pricing is that it allows all customers to benefit
from the location of large customers anywhere in the composite service territory.'
. 50
Some evidence about the effect of utility size on water prices is available. A 1996 survey,
summarized in Table 4, found that median prices decline as system size increases for
different classes of customers served (residential, commercial, and industrial). The
implication is that small-systems customers pay more for roughly the same level of service
as large-system customers. As a consequence, the affordability of water service is a
greater threat for small systems. "Rate shock" is another problem for many smaller
systems because increasing costs must be spread over a smaller customer base.
49 Janice A. Beecher, Patrick C. Mann, and John D. Stanford, Meeting Water Utility Revenue Requirements
(Columbus, OH: The National Regulatory Research Institute, 1993).
50 Conversely, large-volume users in the larger service territory might complain that single-tariff pricing
forces them to subsidi/e customers in outlying areas..
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Table 4
Monthly Water Bills by System Size and Customer Class
Customer Class
Group A Systems
Producing >75
MGD (n=34)
Group B Systems
Producing 15 to
75 MGD (n=61)
Group C
Systems
Producing < 15
MGD (n=47)
Residential
Median monthly charge for 1,000
cubic feet (7,480 gallons)
$13.19
$14.64
$15.61
Commercial
Median monthly charge for 50,000
cubic feet (374,000 gallons)
$486.82
$530.92
$578.96
Industrial
Median monthly charge for
1,000,000 cubic feet (7,480,000
gallons)
$7,926.97
$8,747.06
$10,292.34
Source: Raftelis Environmental Consulting Group, 1996 Water and Wastewater Rate Survey (Charlotte,
NC: Raftelis Environmental Consulting Group, 1996), Exhibit 2.
MGD = million gallons daily, n = number of systems in the sample.
Capacity Development
Federal policymakers and state regulators, including both drinking water primacy agencies
and public utility commissions, have long been concerned about how to check the
emergence of new nonviable water systems, how to improve the performance capacity of
existing systems, and how to maintain safe and affordable water service.51 The 1986 Safe
Drinking Water Act triggered substantial attention to small-system issues and the problem
of keeping rates affordable in light of the newly enacted standards.
Regulators continue to seek out ways to balance the equally legitimate fiscal concerns of
water utilities (that is, financial capacity) and utility customers (that is, affordability). The
1996 Safe Drinking Water Act codified capacity-development policies for new and
existing water systems and elevated the capacity-affordability conundrum to a higher place
on the policy agenda.
Capacity in this context is defined in terms of a utility's financial, managerial, and
technical well being. Financial capacity carries particular importance because a
financially healthy utility will have the resources needed for professional management and
technically appropriate operations. Many (but not all) small water systems struggle with
significant capacity problems. These problems are manifested by the small water utility's
poor performance hi many areas, including regulatory compliance.
51
Beecher, Dreese, and Landers (1992).
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Traditionally, both economic and public health regulators have been very focused on
small-system capacity issues. Policymakers have paid considerable attention to smaller
water systems and the tradeoffs between ensuring a financially healthy system and
maintaining affordable rates for safe and reliable water service. One manifestation of
capacity problems is noncompliance with drinking water standards. For small systems,
these violations often include failure to meet monitoring and reporting requirements.
Small systems also have difficulty complying with public utility commission regulations.
For very small systems, meeting the procedural mandates of economic regulation (such as
rate filing requirements) can be difficult.
Small water systems have long troubled state economic regulators. Many (but certainly
not all) of the commission-regulated water systems are small in size, which poses certain
public policy problems. Particularly problematic are the very small systems that were the
product of unchecked real estate development and lax local zoning policies. Many of
these systems are geographically isolated, which often precludes interconnection with
another system. Lacking economies of scale, smaller water systems typically must charge
a much higher rate for service than larger systems. Higher rates make water service less
affordable for customers of smaller water systems.
As a utility monopoly, water supply demonstrates substantial economies of scale. Larger
water systems enjoy these economies, meaning that they can spread certain costs over a
larger customer base. Lower production costs are reflected in lower prices to customers.
Smaller systems must recover revenue requirements over a smaller customer base. In
general, smaller systems are more likely to encounter capacity and affordability problems.
Consumer Affordability
Economic theory argues strongly for cost-based utility rates, that is, rates based on the true
cost of providing a service. An efficient (cost-based) rate should sustain the water system;
however, if the rate is unaffordable to the service population and customers cease to pay
for and/or receive the service, the water system itself may cease to exist. This solution
may achieve a degree of economic efficiency, while sacrificing other fundamental public
health, safety, and quality-of-life purposes.
For many water customers, the affordability of water service is a growing problem. The
problem of affordability affects customers in terms of increased arrearages, late payments,
disconnection notices, and actual service terminations. Affordability affects utilities in
terms of expenses associated with credit, collection, and disconnection activities; revenue
stability and working capital needs, and bad debt or uncollectible accounts that other
customers must cover.
Other ramifications of the affordability issue also are becoming apparent. If a customer
base cannot support the cost of water service, potential lenders may be concerned about
the utility's financial health and ability to meet debt obligations. Moreover, disconnecting
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residential water customers can present a public relations nightmare for utilities,
particularly because essential services are involved. Increasingly, problems of bad debt
also extend to nonresidential utility customers. Financial distress and bankruptcies in the
commercial and industrial sectors can leave utilities holding the bag. However, the larger
issue of affordability is primarily a concern with respect to low-income residential
consumers.
For low-income customers, who have little choice but to buy service from the local utility,
paying more for basic water service means going without less essential and more
discretionary products and services. Thus, rising water prices can contribute to
deterioration in the quality of life for low-income utility customers. While larger systems
can spread the cost of providing assistance to low-income customers, a small system with
an impoverished customer base has no opportunities for even limited subsidization.
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6. Examples of Single-Tariff Pricing
All utility pricing involves some form of averaging. Utility systems do not establish a rate
for Customer A based on the cost of serving Customer A, a rate for Customer B based on
serving Customer B, and so on. Doing so might be considered efficient and equitable, but
it also would be extraordinarily costly from an administrative standpoint (that is, the
transaction costs would be astronomical)- Instead, utility systems tend to group customers
into customer classes—residential, commercial, and industrial—based on similarities in
the cost of serving customers in those categories. Occasionally, a unique customer (often
a large-volume customer, such as a food-processing plant) might be able to negotiate a
special rate based on unique cost-of-service characteristics, but most customers pay a rate
based on cost averaging.
Basic Single-Tariff Pricing
Single-tariff pricing basically is the conceptual "opposite" of zonal or spatially
differentiated pricing. Single-tariff pricing suggests that ratemakers should de-emphasize
spatial differences in costs; costs are aggregated rather than disaggregated. One of the
chief advantages of single-tariff pricing, from the utility's standpoint, is simplification.
Single-tariff pricing does not negate the need to determine the revenue requirement and to
allocate the revenue requirement among customer classes. It may still be necessary for the
utility to maintain cost data for separate facilities and services in accordance with accepted
accounting practices and regulatory reporting standards. Once revenue requirements are
established, however, the allocation process is greatly simplified because it is unnecessary
to spatially allocate common costs (that is, costs that are not site-specific). Total costs
simply are spread over the consolidated customer base and only one rate is designed for
each class of customers or service.
A sample calculation of a single-tariff price is provided in Table 5. In this very simple
illustration, the cost of service and total water sales are varied for three separate service
territories (A, B, and C). A relatively modest amount of water usage (5,000 gallons per
month or 60,000 gallons per year) is assumed. The number of residential connections and
the annual cost of service are varied to reflect differences in costs and economies of scale.
For simplicity, only residential customers are considered.
Service Territory A is in the most favorable position, in terms of economies of scale
(number of customers and sales volume); Service Territory C is in the least favorable
position, which accounts for the higher costs per connection and per sales. A stand-alone
tariff results in a cost of service equivalent to $1.94, $2.0&, and $2.78 per 1,000 gallons of
water service in the three respective service territories. The transition to single-tariff
pricing would result in a rate of $2.11 per 1,000 gallons for all customers in all three
service territories.
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The illustration reveals the resulting shift in cost responsibility from the customers in the
larger Service Territory A to the smaller Service Territory C. However, the decrease in
rates to customers in Service Territory C of 67 cents per 1,000 gallons (24.1%) is offset
Table 5
Sample Calculation of Single-Tariff Pricing
Service Territory A
Total residential connections
Total annual water use per connection
Total annual water sales (gallons)
Total annual cost of service
Annual cost per connection
Cost per 1,000 gallons sold
6,000
60,000
360,000,000
700,000
$116.67
$1.94
Service Territory B
Total residential connections
Total annual water use per connection
Total annual water sales (gallons)
Total annual cost of service
Annual cost per connection
Cost per 1,000 gallons sold
2,000
60,000
120,000,000
250,000
$125.00
$2.08
Service Territory C
Total residential connections
Total annual water use per connection
Total annual water sales (gallons)
Total annual cost of service
Annual cost per connection
Cost per 1,000 gallons sold
1,500
60,000
90,000,000
250,000
$166.67
$2.78
Combined Service Territory
Total residential connections
Total annual water use per connection
Total annual water sales (gallons)
Total annual cost of service
Annual cost per connection
Cost per 1,000 gallons sold
9,500
60,000
570,000,000
1,200,000
$126.32
$2.11
Per 1,000 Percentage
Rate Impact of Single Tariff Gallons Change
Service Territory A
Service Territory B
Service Territory C
+17 cents
+3 cents
-67 cents
+8.8%
+1.4%
-24.1%
Source: Author's construct. For simplicity, only residential customers are
adjustment (that is, a usage response to the change in price) is not included
considered and a price-elasticity
in the illustration.
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primarily by the relatively smaller increase in rates to customers in Service Territory A of
17 cents per 1,000 gallons (8.8%). The larger number of customers in Service Territory A
lessens the impact of the rate adjustment on a per customer basis. Customers in Service
Territory B are least affected, experiencing an increase of 3 cents per 1,000 gallons (1.4%)
in rates. The lower cost-of-service in Service Territory B (relative to the number of
connections served) in comparison to Service Territory C accounts for the difference in the
rate impact.
In practice, rate design for public utilities is far more complex.52 (See Appendix C.)
Utilities must analyze the cost of service, including the cost of capital, and determine
revenue requirements for the period over which rates will be set (the "test year"). A
utility's costs will be allocated according to customer groups (or classes) and the demand
characteristics of those groups. Typically, residential customers are distinguished from
nonresidential customers, the latter of which are further divided into commercial and
industrial classes.
Variations of Single-Tariff Pricing
Utility tariffs, or rate structures, actually have various components. These components
make it possible for utilities to approach single-tariff pricing in different ways depending
on system cost characteristics and the nature of the current rate structure. Table 6
illustrates three variations. In the first, uniformity is established only for the fixed charge
portion of the utility bill. In the second variation, fixed charges vary and uniformity is
established for the variable portion of the utility bill. The third variation is the more
complete example of single-tariff pricing, where both fixed and variable charges are made
uniform.
These variations can be used to phase-in single-tariff pricing over time, as illustrated in
Table 7. A phase-in plan reflects the principle of gradualism in ratemaking. A significant
change in rate levels or rate design can be implemented in phases, rather than at once, in
order to reduce rate shock to customers and revenue instability to the utility. In this
example, the utility first consolidates fixed charges and gradually consolidates the variable
rate. Many utilities have used a phased approach to implementing single-tariff pricing,
with the encouragement and approval of regulators.
At least three other variations of single-tariff pricing can be identified. First the utility can
retain current rate differentials and equalize future rate increases. This addresses the rate
shock issue while maintaining rate differences based on historical differences in costs.
Second, the utility can use rate "bands" to establish tariffs for groups of systems with
similar cost characteristics. Third, the utility can combine rate equalization with the
strategic use of short-term or mid-term surcharges to pay for extraordinary costs associated
with blending the operations of multiple systems. Each of these methods has been
implemented on at least one occasion.
52 Beecher and Mann (1990).
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Because of rising costs, and the need for rate customers to gradually become accustomed
to higher rates, it may not be desirable to lower rates at all for any customer group.
Rather, it may be advisable to "cap" higher rates in the higher-cost areas and gradually
increase rates in the lower cost areas. Although customers should be educated about
changes in the rate structure, a phased approach and a price-cap approach might help
mitigate complaints about cost shifting.
Table 6
Pricing Variations for Fixed and
Variable Water Charges
Before Implementation
Fixed
Charge
Variable
Rate
After Implementation
Fixed
Charge
Variable
Rate
Variation 1:
Change to Single Fixed Charge Only
Service Territory A
Service Territory B
$6.00 per '
•month-''''
;'••;.;..;• ;xx>^M
;;;£'# '?###;
/ $9.00: per
/i'y month, ''*f':-
•V'y,'''-yy^/''^yf ,
^^mje^
.-',-/:-vx'i ''•'.',/ . :'/,'
>xf^mpnm-.":;v'."c
- ''-'• ''••.•'•• .•'-'• '/, 'y//s'.
/'•••/>•,/,•//,'////..'.',
$1.95 per
1,000 gallons
$2. 15 per
1,000 gallons
Variation 2:
Change to Single Variable Rate Only
Service Territory A
Service Territory B
$6.00 per
month
$9.00 per
month
.y,^ ;•-•;.; ;,<;>•; i;^.;^;.;-;
'•'+#$.$$$&£; f
ItllSftl
', '•• •'•'///, :'j/////y /.'s '//.•
M|?2:ijf eri I
f ifilii 1
$6.00 per
month
$9.00 per
month
' ^ ^j- ' '
$2,P5 per ^
1 000 gallcms , '
'
, - $ii)5 per x
f?000 gallons:
'^ /
Variation 3:
Change to Single Tariff for Fixed Charges and Variable Rates
Service Territory A
Service Territory B
$6.00 per
month
$9.00 per
month
f 7,
$1.95 per '
1,000 gallon's"
• / ^
' '•,, , y
$2.1-5 per
1,000 gallons
/• V fj
' '$7,5aper'
month
f s
s
- ^50 per
„ month
/
/ f / '"//'/,
S2.05-per '
,1,000 gallops
' ',', SS / ,
f < '•'"',,'///
' /'ft,
' / '
$2.05'pef - -'
1,000 gallons
s /
Source: Author's construct.
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Table 7
Phase-In Approach to Single-Tariff Pricing
Before Implementation
Fixed
Charge
Variable
Rate
After Implementation
Fixed
Charge
Variable
Rate
Phase 1:
Change to Single Fixed Charge
Service Territory A
$1.95 per
1,000 gallons
$1.95 per
1,000 gallons
Service Territory B
$2.15 per
1,000 gallons
$2.15 per
1,000 gallons
Phase 2:
Adjust Variable Rates
Service Territory A
$7.50 per
month
'//Si-'/**//.-
!ei>; >;:
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Consolidated Water Rates
f $2,500
'§•«
of E $2,000
L_ O
«l $1,500
§ $1,000 -
S S
^ S
2 BJ
te
£
CD S
in_ CM_
m" co" of i-"
10 to ^" o> co co o
o o co co o co ^*
l^ h^ co co v- in ^
g O Q LU
SEES
co co
T- CM
0 Stand-alone
m Common-
management
D Single-tariff
u- O I -
co
S
S
5S.
co
•S S
E E E
&
0)
c?1 ^ w w <5T
z
S
§,
w
Community (Equivalent Residential Customers)
Figure 6. Revenue Requirements per Equivalent Residential
Customers for Stand-Alone Costs, Common-Management Costs, and
Single-Tariff Pricing
$2,000
« =$1,500
S "
£3 .^
•| S
S"! $1.000
$500
$0
CD
U>
CM
CO
—•— System A
^— System B
— System C
—— System D
— System E
—--— System N
—•— System H
—>— System I
—~- System G
~™o— Single-tariff
- -«• - System K
- — - System L
- — - System J
- — - System M
- — - System F
Figure 7. Forecast Revenue Requirements per Equivalent Residential
Customers Including Capital Improvements
Source: John F. Guastella, Testimony in Cause No. 40703 before the Indiana Utilities Regulatory
Commission, Indiana-American Water Company (1997), Exhibits JFG-5, JFG-R-1, and JFG-R-3.
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For each community served, the economies of scale and scope achieved by common
management are obvious. Left to their own devices, none of the communities could
replicate the same level of service at the same cost. In other words, each community's
true stand-alone cost would be much higher than their share of costs under consolidated
operations. These cost savings are achieved independent of the pricing structure.
The additional benefits of single-tariff pricing are fairly obvious. The smaller, very high
cost systems at the low end of the spectrum clearly have much to gain through rate
consolidation. Both common-management and consolidated rates are a fraction of what
the system would pay on a stand-alone basis. The impact of the single-tariff price on
customers at the middle and higher end of the spectrum is not necessarily substantial.
The rate stabilizing effect of single-tariff pricing is illustrated by the revenue requirements
forecast for the same group of utilities (Figure 7). Over time, the single-tariff provides
considerable rate (and revenue) stability and, once again, the benefits for the smaller
systems are clear. In this particular case, substantial rate hikes associated with planned
capital improvements for four systems can be mitigated. The timing of capital
expenditures will play a role in determining perceptions about the benefits of single-tariff
pricing to individual communities. The obvious affordability benefits to small systems, as
well as the general "smoothing" effect on revenue requirements, are among the leading
rationales for single-tariff pricing.
Similar results were achieved in another recent case involving a New Hampshire utility,
Pennichuck Water Works, Inc. Without rate consolidation, some water customers would
face annual water bills as high as $1,200, as illustrated in Figure 8. In its decision, the
New Hampshire commission directly addressed subsidy and affordability issues, as well as
the anticipated benefits of adopting the single tariff:
We do not believe it would be in the public interest to impose annual rates in the
range of $800 to $1200, as would be the case here, when a reasonable alternative is
available. By consolidating the community systems with the core system for
ratemaking purposes, all customers would face a uniform tariff which, for the
average residential customer, would be approximately $253 per year. The rates for
the average residential customer in the core system would increase less than $1.00
per month, for a total of $8 per year, under the rate consolidation proposal which,
in light of the alternative, we find to be acceptable. We consider a single tariff rate
of approximately $253 per year for the core residential customer to be just and
reasonable. A consolidated rate will ensure affordability and the continued
viability of many of Pennichuck's community systems. It will also enable
Pennichuck to operate in a more administratively efficient manner by eliminating
separate general ledgers for each system, thereby reducing administrative costs.54
54 New Hampshire Public Utilities Commission, Order in Docket DR 97-058, Pennichuck Water Works, Inc.
(1998).
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$1,200
1 $1,000
fc $800
l
0 Current rate
H Stand-alone rate
D Consolidated rate
CO CM
r- co
co co co CM in co
10 co co o h- CD
co
CO O Q til
i E E E
a) CD a)
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USEPA-NARUC
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Single-Tariff Pricing in Great Britain
Great Britain provides a "real life" example of the use of single-tariff pricing on a very
large scale. In 1989, Great Britain's ten large regional water, wastewater, and stormwater
service providers (shown in Figure 9) were transformed from nationalized to investor-
owned utilities. Since privatization, the tariffs established for measured (metered) service
within each of the regional systems have been uniform. In other words, single-tariff
pricing is implemented along with metering. Each of the water utilities provides *a
metering option, although a large proportion of British households is not metered. For
unmeasured service, standing charges are uniform. However, variable charges are based
not on water volumes but on the "rateable" value of properties served. These charges vary
according to geographic zones for the Severn Trent and Thames water utilities, but not for,
the other utilities.
Tariffs for residential water service for 1995-1996 are reported in Table 8. Metered rates
for large users are comprised of standing (fixed) charges that vary by meter size, plus a
volumetric charge. Standing and volumetric charges are uniform for large-volume
customers throughout the company service territories.
In addition to the larger privatized utilities, another twenty-one water service companies
also serve somewhat smaller service territories in Great Britain, although in terms of
population served almost all seem quite substantial in size when compared to many U.S.
water systems. For the most part, these companies also employ single-tariff pricing. All
of the twenty-one companies use a uniform standing (or fixed) charge; four have different
volumetric rates for different geographic areas served.55
55 For one of these companies (Three Valleys), two of three areas have comparable metered rates, suggesting
a gradual move toward uniform pricing. A fifth water company (North East) adopted single-tariff pricing in
the 1993-94 rate period for its two areas (each of which also is subdivided).
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WATER AUTHORITY BOUNDARIES
Areas in England within
Welsh National Water
Development Authority
Areas in Wales within
Severn Trent Water Authority
WELSH
NATIONAL
WATER
DEVELOPMENT
AUTHORITY
The ten Water Authorities in England and Wales
(reproduced by permission of the Controller of Her Majesty's Stationery Office)
Figure 9. Regional Water Utilities in Great Britain.
Source: Daniel A. Okun, Regionalization of Water Management: A Revolution in England and Wales
(London: Applied Science Publishers, 1977).
46
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Consolidated Water Rates
7. The Public Utility Commission Role
Regulation of the water industry, like the water industry itself, is fragmented and
pluralistic. All community water systems, regardless of their ownership, are subject to
federal and state drinking water regulations pursuant to the federal Safe Drinking Water
Act. Drinking water standards focus on public health concerns. Water systems in many
states also are subject to water quantity regulations, meaning that water withdrawals are
regulated through registration or permitting mechanisms. Economic regulation of water
utility prices and rates of return is the domain of the state public utility commissions. The
commissions play a quasi-administrative, quasi-legislative, and quasi-judicial role in terms
of overseeing the utility industries.
Although their jurisdiction for the water industry is not comprehensive, and generally
applies only to investor-owned water systems, the state public utility commissions have
specific authority and expertise in the area of pricing. Moreover, many commission-
regulated systems are small in size. Thus, pricing practices in general, and commission
policies in particular, are worth considering when crafting solutions for small systems.
Forty-five commissions presently have authority to regulate investor-owned water utilities.
In some of the states, commission regulation extends to other types of water utilities under
certain circumstances. For example, some states regulate municipal water utilities if they
provide service outside of municipal boundaries. In Florida, counties can opt to regulate
water systems; in Indiana, municipal water utilities can opt to be regulated. In terms of
commission jurisdiction and authority, many variations among the states can be found.
Not all water utilities are subject to commission regulation. Most water utilities in the
United States are publicly owned and not subject to state economic regulation. The state
public utility commissions do not regulate water utilities in Georgia, Michigan,
Minnesota, North Dakota, South Dakota, or Washington, D.C.
Number of Regulated Utilities
Periodic surveys have been conducted for the purpose of counting the number of regulated
water and wastewater systems. As noted earlier, for 1995 the total number of
commission-regulated water utilities in the United States was approximately 8,537.56
Approximately 4,095 regulated water utilities are classified as investor-owned water
utilities.57 Table 9 summarizes the 1995 inventory of commission-regulated water and
wastewater utilities.
56
Beecher(1995).
These data include 15 investor-owned utilities and 3 homeowners' associations thatno longer are
regulated in Michigan.
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Table 9
Commission-Regulated Water and Wastewater Utilities
Utility Ownership
Investor-owned or private
Municipally-owned
Districts
Cooperatives
Homeowners' associations
Nonprofits
Other
Totals
Water Utilities
Number of
Commissions
46
11
7
4
6
1
1
46
Number of
Utilities
4,095
1,547
1,300
1,436
85
73
1
8,537
Wastewater Utilities
Number of
Commissions
28
6
4
2
1
1
0
28
Number of
Utilities
1,233
649
205
50
0
15
0
2,152
Source: Janice A. Beecher, 1995 Inventory of Commission-Regulated Water and Wastewater Utilities
(Indianapolis, IN: Center for Urban Policy and the Environment, 1995). Includes data for Michigan, which
ceased regulating 18 systems in 1996.
Leading states in terms of the number of regulated water utilities are Texas (3,300),
Mississippi (740), Wisconsin (573), West Virginia (421), Arizona (354), and New York
(354). For investor-owned water utilities, leading state jurisdictions are Texas (1,200),
Arizona (354), New York (334), North Carolina (226), Florida (210), California (199),
and Pennsylvania (190).
Between the 1989 and 1995 surveys, the number of regulated investor-owned utilities
declined by 445 utilities (10 percent); the total number of regulated utilities declined by
1,398 utilities (14 percent).
States in which the number of regulated water utilities (including investor-owned utilities)
declined by a substantial amount include Arizona, Connecticut, Indiana, New York, North
Carolina, Pennsylvania, and Texas. Commission sources suggest that mergers and
acquisitions were the leading cause of the decline. Systems rarely cease operations
altogether. However, transfers to unregulated ownership forms and changes in
commission jurisdiction also can contribute to the decline in the number of regulated
utilities. A few states, including Mississippi and Oregon, had substantial increases in the
number of utilities under their jurisdiction. Nebraska's gain is noteworthy because
jurisdiction for the water industry was initiated in 1994.
The decline in the number of regulated utilities is consistent with an anticipated trend in
industry consolidation. Mergers and acquisitions within both the public and private
segments of the industry will gradually reduce the number of regulated utilities. However,
the population served by regulated utilities will not necessarily decline as a result of
reductions in the total number of regulated utilities.
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Despite the decline in the number of regulated water utilities, water utility regulation
continues to rise in importance on the agendas of many state commissions.58 Economic
regulation of water utilities is important given monopoly power, rising costs, structural
change, and a degree of uncertainty about the industry's future.
Capacity-Development Policies
The commissions, which are well aware of the precarious condition of many small water
systems, can and have addressed capacity development through three basic strategies. The
first strategy involves slowing the creation of new water systems. State regulations can
create substantial barriers to entry for new water systems. Many of the state commissions,
as well as the state drinking water agencies, are tightening the certification process and
more carefully scrutinizing the financial, managerial, and technical competencies of
proposed new systems.
The second strategy involves procedural simplification for small water systems to lower
the administrative cost of regulation and enhance regulatory compliance. This strategy
includes simplifying filing and reporting procedures. In some cases, commission staff
members directly assist managers of small water utilities in meeting procedural
requirements. Some of the commissions have used alternative regulatory methods, such as
operating ratios, to further simplify the process and address the unique needs of small
systems. Regulatory simplification treats one of the primary symptoms of small-system
capacity problems (that is, regulatory compliance), but it does not necessarily treat the
underlying capacity problem (that is, lacking economies of scale).
The third strategy involves structural change in the water supply industry. As noted in a
report of the National Regulatory Research Institute, the least-cost solution to regulatory
compliance and other problems for many systems can be found only through structural
change, namely consolidation.59 The downward trend in the number of water systems
suggests that ownership consolidation may be occurring in the industry. Consolidated
systems may or may not be physically interconnected. While physical interconnection
yields significant economies of scale, common management of noninterconnected systems
directly addresses financial, managerial, and technical capacity issues and can yield
significant economies.
Many of the commissions have played an active role in this area by encouraging and
approving mergers and acquisitions. Some of the commissions provide specific
incentives, such as acquisition adjustments. Certain ratemaking practices, including
single-tariff pricing, also can provide incentives for acquisitions and, perhaps, the
formation of regional water systems. Larger systems interested in acquiring smaller
systems tend to favor rate consolidation (sometimes with surcharges).
ss In the late 1990s, however, water issues must compete for the attention of regulators with major
restructuring issues in the energy and telecommunications sectors.
59 Beecher, Dreese, and Landers (1992).
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In general, modern public policies affecting the water-supply industry, including
regulatory policies, appear to support the consideration of structural options (including
consolidation) that will help water systems achieve economies of scale. The emphasis on
water system capacity at the federal, state and local levels will make it harder for providers
to get operating certificates, water-supply permits, and special financing. Explicitly or
implicitly, growth management policies in some states are calling for consolidation of
water supply through interconnection with existing systems. Public policy also appears to
emphasize the importance of establishing and maintaining water systems for which the
population served can support the cost of water service. Thus, institutional factors also are
playing a role in reducing the number of water systems.
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8. Commission Survey
State public utility staff members at all of the state public utility commissions with
jurisdiction for water utilities (that is, forty-five state commissions), were surveyed about
the issue of single-tariff pricing in early 1996. This research was conducted by Dr. Janice
Beecher on behalf of the Florida Public Service Commission. The survey was first sent by
telefax in January and follow-up telephone calls were made in late January and early
February to ensure the completeness and accuracy of the survey. The commission staff
members who completed the survey are knowledgeable about water utility regulation and
competent to complete this particular questionnaire. A copy of the survey questionnaire is
attached as Appendix D. Detailed findings can be found in Appendix E.
Additional follow-up contacts were made in 1997 and 1998 to update findings on specific
cases that were pending at the time of the original survey, as well as to check for any
major shifts in regulatory policy. Although no significant changes were detected, updated
information is noted throughout the findings.
Relevance of Single-Tariff Pricing
Single-tariff pricing for water utilities is not necessarily a policy issue for every state
public utility commission. Jurisdiction for water utilities and the presence of multi-system
utilities are necessary but not sufficient conditions for consolidated rates to be an issue for
a given commission. Single-tariff pricing does not become an issue until a utility or the
commission initiates the use of this method. Utilities with systems that are viable on a
stand-alone basis, by virtue of size and other factors, may not need or want single-tariff
pricing. Even when considered or implemented, single-tariff pricing may not be
considered "an issue" if it is noncontroversial.
The consideration of single-tariff pricing policy can benefit from the perspective provided
in Table 10. The relevant sample for considering commission policy with regard to
single-tariff pricing is comprised not of all fifty-one public utility commissions (including
the District of Columbia). It is more accurate and reasonable to evaluate commission
policies with regard to this issue in the context of the twenty-five commissions where
multi-system water utilities operate and where the issue has been considered (including the
states where single-tariff pricing had been rejected or considered but not approved).
Given this context, a clear majority of affected state commissions have allowed regulated
water utilities to implement single-tariff pricing (22 state commissions).
Of the remainder, the California commission has allowed partial rate consolidation. For
two commissions (Maryland and Mississippi), single-tariff pricing had not been an issue
but staff characterized commission policy as "case-by-case." It also is noteworthy that in
one of the state's approving a single-tariff pricing structure (Idaho), the matter was "not an
issue when proposed." No regulatory commission has steadfastly opposed single-tariff
pricing, although many continue to review the merits on case-by-case basis.
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TABLE 10
RELEVANT SAMPLE OF STATE PUBLIC UTILITY COMMISSIONS
REGARDING THE ISSUE OF SINGLE-TARIFF PRICING POLICY
All state public utility commissions:
Commissions without jurisdiction for water utilities:
Subtotal
Commissions without multi-system water utilities:
Subtotal
Commissions for which single-tariff pricing has never been considered:
Total
51
-A
45
ill
30
-5
25
Source: Author's construct. Includes reclassification of Delaware as having a multi-system utility based on a
1999 survey. The total number of commissions includes the District of Columbia.
Pending cases at the time of the original survey in Massachusetts and New Jersey were
decided in favor of single-tariff pricing. Soon after, in two significant cases, the Indiana
and New Hampshire commissions approved rate consolidation proposals (in 1997 and
1998 respectively). Since the original survey, the Delaware commission approved single-
tariff pricing in conjunction with an acquisition that created the state's only multi-system
utility (as reflected in Table 10 and elsewhere).
General Findings
The detailed results of the original survey are reported in Appendix E (Tables El through
E4). The data are reasonably complete for all fifty-one public utility commissions
(including the District of Columbia commission). Detailed data on specific utilities are
incomplete from a few states because of the difficulty in compiling these data.
As noted in the tables, six public utility commissions do not have jurisdiction for water
utilities ("NJ"). In sixteen (16) of the states with jurisdiction for water utilities, staff had
observed that no multi-system water utilities were in operation (including Delaware at the
time of the original survey). This finding also was established in the 1995 Inventory
Report, which was used to supplement this survey. For the remainder of the survey,
responses for these sixteen states were recorded as "NA," or "not applicable."
Thirty (30) state commissions regulate multi-system water utilities, where single-tariff
pricing is a potential issue. Of the thirty (30) commissions with multi-system water
utilities, twenty-two (22) have approved single-tariff pricing for one or more utilities,
including partial consolidation. California regulators have allowed partial consolidation
subject to further deliberations. Seven commissions (7) have not directly addressed this
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issue. As already noted, these findings have been revised since the original survey to
update the findings for five states (Delaware, Indiana, Massachusetts, New Hampshire,
and New Jersey) where pending and recent cases have been decided in favor of single-
tariff pricing (in Massachusetts, partial consolidation already had occurred).
Of the twelve (12) commissions that had not approved single-tariff pricing at the time of
the original survey, three explanations were provided: single-tariff pricing had not been
an issue (7 commissions), a proposal for single-tariff pricing was rejected (1 commission),
and single-tariff pricing had been considered but not specifically approved (4
commissions). The Indiana commission reportedly rejected single-tariff pricing because
of cost-of-service concerns. No commission staff member reported that a statute or policy
expressly prohibited single-tariff pricing. However, the Florida survey response indicated
that legislation had been proposed to limit the use of rate consolidation to interconnected
systems; the legislation was not adopted.
Specific Findings
Data were provided for 213 multi-system utilities, of which 129 had implemented a full
version of single-tariff pricing and 20 had implemented partial rate consolidation (that is,
single-tariff pricing for all but a few systems or single-tariff pricing for groups of systems
within the utility but not for the utility as a whole). Partial rate consolidation in some
cases is used to phase-in the single tariff. The survey does not include the multi-system
utilities in Texas (estimated at 200 to 300 utilities) or all of the multi-system utilities in
Florida (estimated at 60 to 70 utilities) because these data were not readily available.
Other states also may have some additional multi-system utilities for which data were not
reported. The survey also excludes publicly owned water utilities, with the exception of
West Virginia for which data were available for commission-regulated public service
districts.
Several states have jurisdiction for only one multi-system water utility. States with more
than ten multi-system utilities are Connecticut, Florida, Louisiana, North Carolina, Texas,
Washington, and West Virginia. Of these states, only Louisiana has not approved single-
tariff pricing.
Based on the available data from the original survey, the number of systems managed by
the multi-system utilities ranges from 2 to 201. The average number of systems reported
is 11; the median number of systems was 4. The number of connections for the smallest
system ranged from 2 to 30,000 with a mean value of 751 and a median value of 30 (based
on data for 115 systems). The number of connections for the largest system ranged from
18 to 329,000, with a mean value of 11,615 and median value of 257 (based on data for
115 utilities). The earliest date reported for adopting single-tariff pricing was 1958; the
most recent date was 1995 (disregarding the pending or subsequent cases). The average
and median time frame for adopting single-tariff pricing was the early 1980s.
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At the time of the survey, rate consolidation had been partially implemented for several
utilities. In some cases, all but a few systems had been placed under a single tariff; in
other cases, the single tariff was being phased-in gradually over time. Only one
commission reported that monitoring and evaluation of single-tariff pricing had occurred
in the form of reexamining past rate cases (West Virginia).
Characteristics of Single-Tariff Utilities
Single-tariff utilities appear to have some distinguishing features in comparison to multi-
system utilities that do not use single-tariff pricing. Data were provided for 213 utilities,
of which 129 implemented single-tariff pricing or partial rate consolidation. Data on the
approximate number of systems were provided for 203 utilities (149 single-tariff utilities
and 54 multi-system utilities without single-tariff pricing). Data on the smallest and
largest systems in terms of service connections were available for 115 utilities (81 single-
tariff utilities and 34 multi-system utilities without single-tariff pricing). All available
data were used to preserve as much information as possible for the analysis. For data
reported as a range of values, an average was used (for example, "8 to 9" was replaced
with 8.5). For data reported as "<5," a value of 4.5 was used.
The sample is incomplete and nonrandom, so findings based on the available data are not
generalizable. Substantial missing data will affect the results of any analysis. However,
the data represent a sizable portion of the multi-system utilities regulated by the state
commissions. Also, many states reported a mixture of systems with and without single-
tariff pricing. Certain observations can be drawn from the data that should lead to further
consideration and analysis.
As reported in Table 11 (and Table E2), single-tariff systems and multi-system utilities
appear to differ in terms of the number of systems that comprise them, smallest
connections, and largest connections. For single-tariff systems, the median number of
systems was 5 (average value of 13); for multi-system utilities without single-tariff pricing
the median number of systems was 4 (average value of 6). The connection data reveal
more striking patterns. Along every measurement (except for the minimum of 2
connections for the smallest systems for both utility types), single-tariff utilities appear to
be much smaller in terms of both smallest and largest systems based on connections.
This finding is very consistent with the perception that single-tariff pricing is most needed,
and perhaps most justified, when numerous very small water systems are involved. These
data may indicate that commission approval of single-tariff pricing takes into account
these basic descriptive characteristics. This is not to suggest, however, that single-tariff
pricing only has been (or should be) approved for utilities made up of very small systems.
In fact, some of the more recent decisions affirming single-tariff pricing have involved
utilities with systems that are fairly substantial in size.
55
-------
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Source: Table El . Not adjusted for cases pending at the time of the survey or subsequent cases in which cor
were approved for individual utilities in Delaware, Indiana, Massachusetts, New Hampshire, and New Jersey
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USEPA-NARUC
Consolidated Water Rates
Arguments in Favor of Single-Tariff Pricing
In the course of the survey, regulatory commission staff members were asked to consider
key arguments for and against the adoption of single-tariff pricing. Various reasons for
commission approval of rate consolidation were provided in the survey. Table El
provides the primary reasons for approval. Cost savings were frequently mentioned. As
reported in Table E3, commission staff members also were asked to identify the arguments
that influenced their commissions' deliberations or policies regarding rate consolidation.
These data reflect only staff member views, not necessarily the views or policies of the
commissions. Twenty-one (21) commission staff members responded to this portion of
the survey. The data exclude thirty commissions where, at the time of the survey, single-
tariff pricing had not been an issue and staff views were not elicited.60 Staff could cite
more than one argument and no weighting or ranking of arguments was required. In
decreasing order of mentions (indicated in parentheses), commission staff indicated
agreement with the following arguments in favor of single-tariff pricing:
a Mitigates rate shock to utility customers (17)
n Lowers administrative costs to the utilities (16)
a Provides incentives for utility regionalization and consolidation (15)
a Physical interconnection is not considered a prerequisite (13)
a Addresses small-system viability issues (13)
a Improves service affordability for customers (12)
a Provides ratemaking treatment similar to that for other utilities (10)
n Facilitates compliance with drinking water standards (9)
n Overall benefits outweigh overall costs (9)
a Promotes universal service for utility customers (8)
a Lowers administrative cost to the commission (8)
a Promotes ratepayer equity on a regional basis (6)
n Encourages investment in the water supply infrastructure (5)
a Promotes regional economic development (3)
a Encourages further private involvement in the water sector (2)
n Other: Can be consistent with cost-of-service principles (1) and found to be in
the public interest (1)
Staff members also noted that single-tariff pricing could be consistent with cost-of-service
principles (New York), that separating small-system costs may not always be cost-
effective (Virginia), and that the genesis for the issue was regulatory simplification
(California). Mitigating rate shock also was equated with "rate stability" (Indiana).
Vermont regulators found that single-tariff pricing addressed small system viability issues
and generally was in the public interest, approving the method over the objections of staff
60 Excluded were 6 commissions without jurisdiction for water utilities, 16 commissions without jurisdiction
for multi-system water utilities ("not applicable"), and 8 commissions that regulate multi-system utilities but
where single-tariff pricing has not been an issue (including the Idaho commission, where single-tariff pricing
was approved for one utility but not an issue of significance).
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members concerned about subsidization issues. Typically, more than one argument affects
commission deliberations regarding rate consolidation.
Arguments Against Single-Tariff Pricing
Commission staff members also evaluated the key arguments against rate consolidation.
Various reasons for commission disapproval of single-tariff pricing were provided. Table
El provides the primary reason for the disapproval. Cost-of-service issues were
frequently mentioned, although some staff also indicated that single-tariff pricing could be
consistent with cost-of-service principles. As reported in Table E4, commission staff
members also were asked to identify the arguments that influenced their commissions'
deliberations or policies regarding rate consolidation.
These data reflect only staff member views, not necessarily the views or policies of the
commissions. As mentioned earlier, twenty-one (21) commission staff members
responded to this portion of the survey based on their experience with the issue of single-
tariff pricing for multi-system utilities. Staff could cite more than one argument and no
weighting or ranking of arguments was required. In decreasing order of mentions
(indicated in parentheses), commission staff indicated agreement with the following
arguments against single-tariff pricing:
a
a
a
a
D
a
a
a
a
a
a
a
a
a
a
Conflicts with cost-of-service principles (14)
Provides subsidies to high-cost customers (12)
Not acceptable to all affected customers (10)
Considered inappropriate without physical interconnection (8)
Distorts price signals to customers (7)
Fails to account for variations in customer contributions (6)
Justification has not been adequate in a specific case (or cases) (6)
Discourages efficient water use and conservation (4)
Encourages growth and development in high-cost areas (4)
Undermines economic efficiency (3)
Provides unnecessary incentives to utilities (2)
Not acceptable to other agencies or governments (2)
Insufficient statutory or regulatory basis or precedents (2)
Overall costs outweigh overall benefits (2)
Encourages overinvestment in infrastructure (1)
Regarding unacceptability to other agencies or governments, the California staff member
noted that opposition to single-tariff pricing had come from other utilities.
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9. Commission Policies on Rate Consolidation
As already noted, twenty-two (22) state commissions have allowed regulated water
utilities to implement single-tariff pricing. Single-tariff pricing is generally accepted in
eight (8) states, as summarized in Table 12 and Figure 10 (and detailed in Table El).
Texas commission staff members noted that single-tariff pricing was accepted "and
preferred." In fact, the Texas commission provides a simplified procedure for merging the
rates of acquired systems with the rates of the acquiring utility. While the regulated water
utility usually requests consolidated rates, at least one commission (New York) has
imposed its use. Pennsylvania staff noted that the use of single-tariff pricing has evolved
from its application on the basis of physical interconnection to its application on the basis
of common ownership.
Based on the updated survey findings, staff members at seventeen (17) commissions
characterized the policies of their commissions as "case-by-case," indicating that the use
of single-tariff pricing must be justified for every specific application (even when the
policy is "generally accepted"). In many states, only some of the multi-system utilities
under commission jurisdiction are implementing single-tariff pricing. In fourteen (14) of
the case-by-case commissions, single-tariff pricing has been approved (including the five
recent cases decided in favor of single-tariff pricing). In California, regulators have
approved partial rate consolidation. In the two (2) other case-by-case commissions,
single-tariff pricing has not been approved or considered in the context of a regulatory
proceeding.
Commission Decisions
The experience of West Virginia-American Water Company stands as one of the least
controversial and most enduring examples of single-tariff pricing. Implementation of
single-tariff pricing has played a role in the company's expansion. A case study of the
West Virginia experience appeared in a 1984 issue of the American Water Works
Association Journal.61
In its order, the West Virginia Public Service Commission considered the consistency of
single-tariff pricing with the commission's general regulatory obligations and operating
principles, finding that:
1. The company's single tariff pricing proposal resulted in a j ust, reasonable,
sufficient and nondiscrimmatory rate for all the customers of the company.
2. Each customer will pay the same rate for a like and contemporaneous
service made under the same or substantially similar circumstances and
conditions.
61Limbach(1984).
59
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Table 12
Summary of State Public Utility Commission Policies on
Single-Tariff Pricing for Water Utilities
Commission Policy
Generally Accepted (8)
Case-By-Case (17)
Never Considered (5)
Not Applicable — No
Multi-System Water
Utilities (15)
No Jurisdiction for Water
Utilities (6)
State Commissions
Connecticut
Missouri
North Carolina
Oregon
Single-Tariff Pricing Has Been
Arizona
Delaware (a)
Florida
Idaho (not an issue)
Illinois
Indiana (b) (f)
Massachusetts (c) (f)
Pennsylvania
South Carolina
Texas
Washington
Approved (14)
New Hampshire (d) (f)
New York
New Jersey (e) (f)
Ohio
Vermont
Virginia
West Virginia
Single-Tariff Pricing Has Not Been Approved (3)
California (g)
Maryland (not an issue)
Mississippi (not an issue)
Iowa
Kentucky
Louisiana
Alabama
Alaska
Arkansas
Colorado
Hawaii
Kansas
Montana
Nebraska
Georgia
Michigan
Minnesota
Maine
Wisconsin
Nevada
New Mexico
Oklahoma
Rhode Island
Tennessee
Utah
Wyoming
North Dakota
South Dakota
Washington, D.C.
Source: Author's construct based on survey of state public utility commission staff members, January-
February 1996 and subsequent contacts with the commissions (including a follow-up survey in early 1999).
(a) Reclassified from "not applicable" following an acquisition with approval of consolidated rates.
(b) Since the original survey, a case was decided in favor of single-tariff pricing (previously rejected).
(c) A pending case at the time of the original survey was decided in favor (partial consolidation previously).
(d) Since the original survey, a case was decided in favor of single-tariff pricing.
(e) A pending case at the time of the original survey was decided in favor.
(f) Characterization of commission policy as "case-by-case" was unchanged following the recent decisions.
(g) Partial consolidation with possible phase-in of single-tariff pricing. A case was pending in 1999.
60
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Generally accepted
Case-by-case policy - approved
Case-by-case policy — not approved
Not considered, not applicable, or no jurisdiction
Figure 10. Summary of Commission Policies on Rate
Consolidation.
4.
The approval of the company's proposal was in compliance with the
commission's duty to regulate utilities of this state in order to provide the
availability of adequate, economical, and reliable utility services to
encourage the well planned development of the utility resources in a
manner consistent with the state needs and hi a way consistent with the
productive use of the state's energy resources.
Single tariff pricing strikes a reasonable balance in the interest of current
and future water consumers, the general interest of the state's economy, and
the interest of West Virginia Water Company.62
62 Order of the West Virginia Public Service Commission as cited in Limbach (1984), 55.
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In a 1986 order, the Pennsylvania Public Utility Commission approved single-tariff
pricing for Western Pennsylvania Water Company (1986) and provided several pragmatic
reasons for approving this pricing strategy.63 First, a larger rate and revenue base
ameliorates the impact of major capital additions needed from time to time in every
service area. Second, a larger revenue base promotes flexibility in timing and financing
major capital additions. Third, the impact of instability resulting from changes in sales
volumes is mitigated when the effect of such volumetric factors is spread over a larger
economic base. Finally, the reduction of the number of accounting units and the number
of individual rate filings result in administrative efficiency with a potential to reduce costs
to ratepayers.
Ten years later, in a general proceeding on acquisition policy, the Pennsylvania
Commission stated its belief "that every system and every ratepayer in the
Commonwealth will eventually be in need of specific service improvements and at that
point, the true benefits of single tariff pricing will be realized by all citizens in the
Commonwealth."64 The Commission now views single-tariff pricing as a central
component of acquisition incentives provided to jurisdictional utilities.
Although single-tariff pricing has been approved without much consternation in some
jurisdictions, in others the level of controversy has been much more pronounced.
Consumer advocates, local governments, large-volume users, and commission staff
members (even within agencies) have at times been deeply divided on this issue.
The regulatory commissions have struggled in particular with whether or not physical
interconnection among water systems should be a prerequisite for single-tariff pricing.65
As noted by the Massachusetts Department of Public Utilities, physical interconnection is
not necessarily required: "[Sjeveral factors (viz., the contiguity of the communities served
in that zone; the commonality of personnel for meter-reading, operations, maintenance,
and construction duties; and administrative convenience) are decisive in favor of treating
the [two communities] as a single zone .. ,"66
Similarly, the Florida Public Service Commission once concluded that state law supports
the view that multi-system utilities can be considered a single system because the utility's
facilities and land axe functionally related (in administrative, operational, and managerial
terms); even without physical interconnection.67 An analogy provided in the case was that
63 Pennsylvania Public Utility Commission, Order in Docket R-850096, Western Pennsylvania Water
Company (1986), 148.
64 Pennsylvania Public Utility Commission, Order in Docket M-00950686, Policy Statement Re: Incentives
for the Acquisition and Merger of Small, Nonviable Water and Waste Water Systems (1996).
Physical interconnection in the other industries may be the reason why pricing across larger regions tends
to prevail.
66 Massachusetts Department of Public Utilities, Order in Docket No. 90-146, Massachusetts-American
Water Company (1990), 3-4. See also MA DPU 95-118 (1996).
67 Florida Public Service Commission, Order No. PSC-96-1320-FOF-WS, Docket No. 950495-WS,
Southern States Utilities (1996).
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USEPA-NARUC
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the multi-system utility operations were like a "wagon wheel," where the separate service
territories are the spokes and utility management is the rim holding them together.
Following an appeal of the Florida order, however, the District Court held that rate
consolidation need not be conditioned on a finding by the commission that the systems
involved are functionally related. "Because we decide that the determination of functional
relatedness is not controlling on the issue of whether uniform rates can be set," noted the
Court, "we express no opinion on whether the utility systems involved in this rate case
were 'functionally related.'"68
In a 1993 case, the Illinois-American Water Company articulated the variety of ways in
which the systems of a multi-system utility are operationally related:
All operation and maintenance and construction activities are performed on a
uniform basis throughout the five districts... All five districts utilize similar
facilities, such as pumping stations and purification plants, transmission and
distribution mains, storage reservoirs, service lines and meters... All five
districts utilize the same engineering and construction standards, maintenance
programs, operating procedures, inspection programs, budgeting and
accounting procedures, types of materials and supplies and management
structure... All five districts utilize the services of the American Water Works
Service Company (the "Service Company"), which provides, pursuant to a
contract with the Company, support to Illinois-American personnel in the areas
of accounting, engineering operations, rate design, regulatory practices,
finance, water quality, information systems, personnel information and
training, purchasing, insurance, safety and community relations.69
The company also argued that the evolving corporate structure of the multi-system utility
is germane to these issues, as described in Illinois Commerce Commission's order:
According to Illinois-American, another important factor supporting the
adoption of single tariff pricing are the many steps the Company has taken in
recent years to centralize and consolidate its operations... Illinois-American,
as it presently exists, is the result of two mergers. Pursuant to the mergers,
which were approved by the Commission... water systems once operated as
five separate companies were merged to form a single integrated unit, rather
than as five independent, stand-alone systems.70
Staff members of the Illinois Commerce Commission found that "Commission practices
in Illinois... support the uniform rate concept."71 In this particular proceeding, the
commission approved partial rate consolidation and ordered Illinois-American to submit a
proposal for company-wide single-tariff pricing.
68 District Court of Appeal, First District, State of Florida, Decision in Case No. 96-447 (June 10, 1998), 1.
69 Illinois Commerce Commission, Order Docket No. 92-0116, Illinois-American Water Company (1993).
70 Ibid., 85.
Ibid., 87.
63
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In a parallel proceeding, Indiana-American Water Company argued before the Indiana
Utility Regulatory Commission that single-tariff pricing is justified in part on the grounds
that the company's districts are managed by a single corporate structure and financed
through a common capital structure.72 The Indiana Office of Consumer Counselor
opposed this reasoning and the Indiana Commission rejected that particular bid for single-
tariff pricing, but the company prevailed in a 1997 proceeding (discussed below).
Another rationale in the regulatory context is that rate consolidation can help reduce the
frequency and complexity of rate filings by regulated firms. According to John Guastella,
regulatory acceptance of single-tariff pricing as a matter of policy reduces costs associated
with preparing separate cost-o£service studies to allocate common costs among the
separate systems, and thus significantly reduces the cost of utility rate filings.73 A related
point is that rates under a single tariff are easier to communicate to customers (lowering
administrative costs) and easier for customers to understand.
In some deliberations, the focus is shifted from differences in the cost of service to
comparability in the value of service that utility customers receive regardless of their
spatial location. Indiana-American Water Company has argued that, "The single tariff
pricing concept is supported by the fact that any one of the Company's customers,
regardless of where that customer is located, expects, is entitled to and receives essentially
the same service as the customers in any other district."74
In a recent regulatory proceeding involving the New Jersey-American Water Company,
the administrative law judge echoed this argument:
Inasmuch as all customers of New Jersey-American, be they New Jersey
Commonwealth or Monmouth customers, receive comparable service on a
comparable basis, it seems only appropriate that all customers be charged
similarly... By distributing the burden of system improvement to all
customers, the relative impact is decreased. All Company customers in the
three operating groups are benefiting by the relative economics [sic] of scale
and system integration and administration the unified company produces.
Likewise, all customers should equally shoulder the costs involved.75
The New Jersey Board of Public Utilities agreed with the administrative law judge in
adopting a statewide (single-tariff) price for the New Jersey-American Water
Company in this particular proceeding.
Richard E. Hargraves, Direct testimony in Cause No. 39595 before the Indiana Utility Regulatory
Commission, Indiana-American Water Co., Inc. (1993).
73 Guastella (1994).
74 Hargraves (1993).
75 New Jersey Board of Public Utilities, OAL Docket No. PUC 520795, Agency Docket No. WR-95040165,
New Jersey-American Water Company (1996), 14-15.
64
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USEPA-NARUC
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Several of the commissions have implemented variations of single-tariff pricing or partial
forms of rate consolidation. The Missouri Public Service Commission, for example, once
reasoned that rate shock is the result of rate changes not rate levels. Thus the commission
ordered the company in question to maintain existing rate differentials while equalizing
future rate increases. By maintaining current rate differentials and equalizing rate
increases, rate shock is minimized, subsidization is limited, and the company is afforded
greater flexibility in timing plant additions.76 The commission later found, for another
company, that the movement toward rate consolidation was in the public interest.77 But in
a subsequent rate case, and to the understandable chagrin of the utility, the commission
reiterated "that it is not committed to a specific position regarding cost recovery for capital
plant additions by means of [single-tariff pricing] ."78
In a phased approach, implementation of single-tariff pricing may occur over several
commission decisions involving the same multi-system utility. According to a former
regulator, a phase-in plan may be especially justified when differences in rates are
"extreme."79 A phased approach "facilitates the goal of single tariff pricing, but does not
negate the requirement for future commission approval of its full implementation."80
Interestingly, zonal rates for groups of systems can be used in conjunction with a phased
approach to rate consolidation. The Florida commission recently advanced a "capband"
approach establishing rates for groups of systems with similar cost characteristics,
reasoning that:
First, the capband structure represents a greater move toward the long term
goal of a uniform rate. It eliminates the need for separate rate structures for
each individual service area under the cap. The number of rates would
decrease from 56 to eight for the water facilities under the cap, and from 23 to
six for the wastewater facilities. Second, as noted above, the capband structure
reduces subsidies in terms of deviation from stand-alone rates. This is true
both in terms of number of service areas and number of customers. Uniform
rates within the band mitigate the subsidy within the band... [The capband
rate structure] embraces all of the advantages of the modified stand-alone rate
structure and adds the additional advantages of simplifying the rate structure by
moving the utility closer to a uniform rate.81
76 Missouri Public Service Commission, Order in Case No. 90-236, Missouri Cities Water Co. (1990).
77 Missouri Public Service Commission, Order in Case Nos. WR-95-205 and SR-95-206, Missouri-American
Water Company (1995).
78 Missouri Public Service Commission, Order in Case Nos. WR-97-237 and SR-97-238, Missouri-American
Water Company (1997).
79 Wendell F. Holland, "Acquisition Incentives Encouraging Regionalization in the Water Industry a speech
made at the Great Lakes Conferences of the National Association of Regulatory Utility Commissioners in
Greenbrier, West Virginia (July 11, 1995). ft
80 Pennsylvania Public Utility Commission, Western Pennsylvania Water Company, 72 PUR 4 (1986), 154.
81 Florida Public Service Commission, Order No. PSC-96-0549-PHO-WS, Docket No. 950495-WS,
Southern States Utilities (1996), 78-79.
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The Florida decision was appealed on a variety of grounds. As noted earlier, the Court of
Appeal held that the commission need not determine that utility facilities are "functionally
related" prior to approving consolidated rates. In the same decision, the Court also found
that "no statute prohibits resort by the Public Service Commission (PSC)—in an
appropriate case—to so-called "capbands" to fix rates that are just, reasonable,
compensatory, and not unfairly discriminatory."82 Specifically:
Nothing inherent in the capband methodology runs afoul of the statute. The order
under review sets rates [footnote omitted] so that no ratepayer's rates exceed by
more than seven per cent what they would have been if each system's rates had
been set on a stand alone, cost of service basis. This modest deviation from a pure
cost of service basis for individual rates pales by comparison to the magnitude of
inevitable intra-system subsidization. Nor is a pure cost of service basis as to each
individual ratepayer mandated by a statute which directs that "the commission
shall consider the value and quality of service and the cost of providing service."
§ 367.081(2), Fla. Stat. (1997). See Occidental Chem. Co. v. Mayo, 351 So. 2d
336,340 (Fla. 1977) ("Given the multiplicity of methods suggested by the experts
to allocate expenses between various users, we cannot say that the Commission
departed from the essential requirements of law in relying on a range of criteria for
this purpose."). A shift in the direction of "affordability" takes the value of service
into account. Although using stepped rates or "capbands" requires offsetting
increases and does not spread offsets perfectly evenly among households paying
less than maximum rates, such use need not lead to unfairly discriminatory rates.83
The Indiana Utility Regulatory Commission articulated the pragmatic rationale for single-
tariff pricing in the recent Indiana-American case.84 The press release accompanying the
commission's order asserts that the company's movement toward single-tariff pricing is
"in the best interest of all of the customers" and that all areas will benefit in the long term
by increased rate stability and mitigation of construction cost impacts. The order found
that single-tariff pricing was consistent with pricing for other utility and nonutility services
and that it would help the company meet demands associated with environmental
compliance, infrastructure replacement, and service adequacy for customers.85 The
commission also addressed the issue of price discrimination:
There will always be customers who over a given period of time will be required to
pay higher rates than would result if they were included in some smaller or
different customer group. But this does not mean undue discrimination exists so
long as they are paying an equivalent price for an equivalent product. Moreover,
we must not forget that all of the customers today are the beneficiaries of water
82 District Court of Appeal, First District, State of Florida, Decision in Case No. 96-447 (June 10, 1998), 1.
83 Ibid., 13.
84 Indiana Utility Regulatory Commission, Order in Cause No. 40703, Indiana-American Water Company
(1997).
55 Ibid., 77.
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facilities built in the past, and the cost of developing these facilities was borne in
large part by earlier generations of customers.
As a general rule, individual water utilities must make the case for single-tariff pricing
before regulators, who consider the merits on a case-by-base basis. The Indiana-American
decision also is instructive on this point because the case was made by the utility several
times—and the arguments rejected—before regulators were persuaded that single-tariff
pricing was in the public interest. As with many initiatives by utilities, regulatory
approval often requires more than one attempt, as well as modifications to the proposed
method to address the legitimate concerns of regulators and consumer advocates.
A few commissions have explicitly recognized single-tariff pricing as a policy tool. As
already noted, Pennsylvania regulators have placed single-tariff in the broader context of
regulatory policies to promote regionalization and specifically the acquisition of smaller,
nonviable systems.87 The general provisions of the commission's policy, appearing in
Table 13, provides for the application of single-tariff pricing to the rates of acquired water
systems "to the extent that is reasonable."88
Similarly, New York Public Service Commission staff members expect acquiring utilities
to include a plan for "rate equalization" (with phase-in provisions as appropriate) as part
of petitions for acquisition incentive mechanisms.89
Connecticut regulators have interpreted state statutes to authorize rate equalization in
connection with mandated takeovers.90 The commission also recognizes the potential use
of annual price caps (to avoid rate shock) and surcharges ("so that customers of the
acquiring company are not always obligated to assume full responsibility for the cost of
ordered improvements to the acquired company").91
Implementation Strategies
Utility regulators can consider several implementation strategies if they find that rate
consolidation is in the public interest. Implementing the single tariff can be accomplished
in conjunction with acquisition proceedings. Utilities can phase-in single-tariff pricing for
all or part of their service territory. A partial form of single-tariff pricing is to adopt a
86 Indiana Utility Regulatory Commission, Order in Cause No. 40703, Indiana-American Water Company
(1997), 81.
87 Holland (1995), 10.
88 Pennsylvania Public Utility Commission, Order in Docket M-00950686, Policy Statement Re: Incentives
for the Acquisition and Merger of Small, Nonviable Water and Waste Water Systems (1996).
89 New York Public Service Commission, Order in Case 93-W-0962, Investigation of Incentives for the
Acquisition and Merger of Small Water Utilities (1993), Appendix E.
90 Connecticut General Statutes, 16-262o. According to Connecticut Statutes (16-262r), rate equalization
also can be used in connection with satellite management of a smaller by a larger system.
91 Connecticut Department of Public Utility Control, Order in Docket No. 96-03-31, DPUC Review of Water
Companies Acquisitions and Transfer Processes (January 8,1997), 27.
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common fixed or customer charge for all utility customers, and alter variable charges
based on variations in the cost of service. Utilities can use surcharges or other
mechanisms to differentiate prices based on extraordinary costs and send customers a very
specific price signal. A partial approach to single-tariff pricing is to develop tariffs based
on groupings of systems or "zones" with roughly similar cost or service characteristics.
Another partial approach, mentioned earlier, is to use a phased method of implementation
by which rates are made more uniform over several rate adjustments.
Innovative pricing options and implementation strategies for water utilities can emerge in
the context of regulatory proceedings, dispute resolution processes, and a continuing
dialog among utilities, consumers, consumer advocates, and other interested stakeholders.
Related Strategies
Commissions may want to consider implementing specific regulatory strategies in
conjunction with single-tariff pricing. First, regulators could use auditing or other
evaluation techniques to establish that utilities are meeting efficiency and other
performance goals. Second, the commission could coordinate with other regulatory
agencies to promote compliance with water quality standards. Third, regulators could
evaluate the long-term strategic plans of water utilities for serving customers throughout
their service territories. Fourth, features of the consolidated rate could be assessed in
terms of their effectiveness in promoting efficient water use and discouraging waste.
Fifth, the commissions could implement a monitoring and evaluation system to assess the
effects of consolidated rates on all systems and customer groups. Sixth, alternative
dispute resolution could be encouraged to provide parties with a forum for participation
and an opportunity to reach a settlement agreement on single-tariff pricing issues. Finally,
regulators could assess utility efforts to communicate with customers about the value of
water and build understanding of the rate structure.
Commission Authority
Commission authority to approve consolidated rates has been met with legal challenges in
some jurisdictions. Obviously, single-tariff pricing policy must be consistent with a
state's legislative framework and legally sustainable. Regulatory and legal doctrine
generally seem to permit this pricing method. Legislative, judicial, or other constraints on
rate consolidation would be undesirable from a public policy standpoint and undermine
the ability of the regulatory commissions to craft effective policies for the water industry.
In a recent case, the New Hampshire Public Utilities Commission acknowledged the
absence of a clear regulatory standard for, or prohibition of, the use of single-tariff pricing.
The commission essentially asserted its policymaking authority to approve rate
consolidation based on a public-interest standard:
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While New Hampshire law is replete with references to the appropriate standard
for establishing a utility's rate base and rate of return, there appears to be no
specific guidance on the point of rate consolidation or single tariff pricing. Thus,
in the absence of any legal impediment to utilizing single tariff pricing, our
decision essentially becomes one of policy that is bound only by our statutory
constraints that rates be just and reasonable and that we act in the public interest.
See RSAs 374:2 and 378:28.
Opponents of rate consolidation in this case argue that we should adhere to our
traditional ratemaking policy of cost causation. We find their position
unpersuasive in this case for two reasons. First, traditional cost of service
regulation already includes some measure of rate averaging in that customers are
not charged the true costs of serving them on an individual basis. Second, and
perhaps more important, stand alone rates in this case produce results for some
customers that are well beyond the zone of "just and reasonable." One needs only
to look at the stand alone rates that would result from the settlement Agreement to
see just how extreme the results are when significant investments are required in a
very small system. Most of the community systems are simply too small to absorb
the magnitude of investments mandated by environmental enactments. However,
without these investments, it is clear that the small community systems would have
been unable to provide safe and adequate water service to their customers.
92
Single-tariff pricing evolved as a legitimate policy tool and is used by a clear majority of
the states that regulate multi-system water utilities. Rate consolidation is a tool that can be
used on a case-by-case basis, where regulators carefully weigh the evidence before them,
and as a general policy tool to encourage acquisitions and regionalization. The precarious
condition of very small water systems merits the consideration of alternative regulatory
approaches, including consolidated rates.
Rate consolidation will continue to focus attention on some fundamental regulatory issues:
Does it result in a measurable "subsidy"? Does the subsidy constitute a form of price
discrimination? Are the resultant rates just and reasonable? Do the long-term benefits of
implementing single-tariff pricing, including subsidization, outweigh the costs?
Regulators must be satisfied with the answers to these questions before approving a rate
consolidation strategy. Generally, however, the commissions are arriving at conclusions
that support the use of single-tariff pricing.
The commissions have demonstrated their policymaking authority to approve consolidated
rates, as well as their capacity to consider and weigh the complex ratemaking and policy
tradeoffs involved. Only the commissions can specify the circumstances appropriate for
single-tariff pricing in their jurisdictions. Water utilities should continue to advance
innovative pricing strategies. The commissions should continue to exercise due diligence
in approving water rate structures that serve the public interest.
92 New Hampshire Public Utilities Commission, Order in Docket DR 97-058, Pennichuck Water Works, Inc.
(1998).
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Table 13
Pennsylvania Public Utility Commission
Policy Statement on Acquisition Incentives
Title 52, Part I, Chapter 69
Incentives for Acquisition and Merger of Small Nonviable Water Utilities-
Statement of Policy
§69.711. ACQUISITION INCENTIVES
(a) General
To accomplish the goal of increasing the number of mergers and acquisitions to foster
regionalization, the Commission will consider the acquisition incentives at subsection (b).
However, the following parameters must first be met in order for Commission consideration of a
utility's proposed acquisition incentive. It should be demonstrated that:
(1) The acquisition services the general public interest;
(2) The acquiring utility meets the criteria of viability which will not be impaired by the
acquisition; that it maintains the managerial, technical, financial capabilities to safely and
adequately operate the acquired system, in compliance with the Public Utility Code, the
Sate Drinking Water Act, and other requisite regulatory requirements on a short and long
term basis;
(3) The acquired system has less than 3300 customer connections; the acquired system is not
viable; it is in violation of statutory or regulatory standards concerning the safety,
adequacy, efficiency or reasonableness of service and facilities; and that it has failed to
comply within a reasonable period of time, with any order of the Department of
Environmental Protection or the Public Utility Commission;
(4) The acquired system's ratepayers should be provided with improved service in the future,
with the necessary plant improvements being completed within a reasonable period of
time;
(5) The purchase price of the acquisition is fair and reasonable and the acquisition has been
conducted through arm's length negotiations; and
(6) The concept of single tariff pricing should be applied to the rates of the acquired system,
to the extent that is reasonable. Under certain circumstances of extreme differences in
rates, and/or affordability concerns, consideration should be given to a phase-in of the
rate difference over a reasonable period of time.
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Table 13 (continued)
(b) Acquisition Incentives
In its efforts to foster acquisitions of suitable water and sewer systems by viable utilities when
such acquisitions are in the public interest, the Commission seeks to assist these acquisitions by
permitting the use of a number of regulatory incentives. Accordingly, the Commission will
consider the following acquisition incentives:
(1) Rate of Return Premiums - Additional rate of return basis points may be awarded for
certain acquisitions and for certain associated improvement costs, based on sufficient
supporting data submitted by the utility within its rate case filing;
(2) Acquisition Adjustment - In cases where the acquisition costs are greater than the
depreciated original cost, that reasonable excess may be included in the rate base of the
acquiring utility and amortized as an expense over a 10-year period;
(3) Deferral of Acquisition Improvement Costs - In cases where the plan improvements are of
too great a magnitude to be absorbed by ratepayers at one time, rate recovery of the
improvement costs may be recovered in phases. There may be a one time treatment (in
the initial rate case) of the improvement costs but a phasing-in of the acquisition,
improvements and associated carrying-costs may be allowed over a finite period; or.
(4) Plant Improvement Surcharge - Collection of a different rate from each customer of the
acquired system upon completion of the acquisition could be implemented to temporarily
offset extraordinary improvement costs. In cases where the improvement benefits only
those customers who are newly acquired, the added costs may be allocated on a greater
than average level (but less than 100%) to the new customers for a reasonable period of
time, as determined by the Commission.
(c) Procedural Implementation
The appropriate implementation procedure for the acquisition incentives listed would be to file
the request during the next filed rate case. In the case of the first incentive, for example, the rate
of return premium, appropriate supporting data should be filed within the rate of return.section in
order for Commission evaluation of its applicability. The rate of return premium as an acquisition
incentive may be the most straightforward and its use is encouraged.
Other appropriate incentives may be considered by this Commission, provided they meet the
parameters listed at subsection (a). Acquisition incentive requests will be considered on a case by
case basis. In acquisition incentive filings, the burden of proof rests with the acquiring utility.
Source: Pennsylvania Public Utilities Commission, Incentives for Acquisition and Merger of Small
Nonviable Water Utilities: Statement of Policy (February 28, 1996).
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APPENDIX A
GLOSSARY OF TERMS
Block rate. A billing rate applied to
water usage that varies according to
blocks of water usage (measured in
gallons or cubic feet). See uniform rate,
decreasing-block rate, and increasing
block rate.
Common-management costs. Costs
that are incurred on the basis of the joint
operation of multiple systems. Costs
under common management, given
management economies of scale and
scope, should be less for the utility than
the sum of stand-alone costs for all of
the operated systems.
Decreasing-block rate. A variable rate
that decreases with additional blocks of
water usage. See uniform rate and
increasing-block rate.
Equity. A condition under which costs
have been fairly allocated among
customer groups consistent with cost-of-
service and efficiency criteria. See
horizontal equity, vertical equity, and
subsidy.
Efficiency. A condition under which
prices charged, and quantities produced
and used, are optimal (that is, not too low
or too high).
Fixed charge. The portion of a
customer's water bill that does not vary
with water usage. Fixed charges often
are used to recover administrative and
other recurring costs that are not
determined by water usage. The fixed
charge may include a minimal water
allowance, above which a variable rate
is applied.
Horizontal equity. A condition under
which customers that impose similar
costs on the utility system pay similar
prices for comparable utility services.
See vertical equity.
Intergenerational equity. A condition
under which one generation of customers
does not pay for costs imposed on the
utility system by another group of
customers. See horizontal equity and
vertical equity.
Increasing-block rate. A variable rate
that increases with additional blocks of
water usage. See uniform rate and
decreasing-block rate.
Investor-owned (or privately owned)
utility. A utility owned and operated by
a private firm on a for-profit basis. See
publicly owned utility.
Just and reasonable. A concept used to
evaluate utility rates related to the
concept of undue discrimination.
Multisystem utilities. Public or private
utilities that operate two or more water
systems serving distinct service
territories; systems may or may not be
physically interconnected.
Municipal-unit dpctrine. The treatment
of a municipality as a distinct service
territory and unit for cost allocation and
ratemaking purposes (that is, "city-
based" rates).
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Phase-in (rates). Implementation of a
significant change in rate levels or rate
design in phases, rather than at once, in
order to reduce rate shock to customers
and revenue instability to the utility.
Reflects the principle of gradualism.
Physically interconnected systems.
Water systems joined by a system of
pipes and pumps for transporting water
(usually treated water) from one system
to another.
Primacy agency. A state agency
responsible for regulating community
and noncommunity water systems to
ensure compliance with federal drinking-
water standards established under the
Safe Drinking Water Act.
Privately owned (or investor-owned)
utility. A utility owned and operated by
a private firm on a for-profit basis. See
publicly owned utility.
Public Utility Commission (PUC). A
state agency responsible for regulating
the rates and profits of public utility
monopolies.
Publicly owned utility. A utility owned
and operated by a governmental agency,
such as a municipality, on a nonprofit
basis. See privately owned utility.
Safe Drinking Water Act (SDWA).
The federal statute that establishes
drinking-water standards for community
and noncommunity water systems.
Substantial amendments to the SDWA
were enacted hi 1986 and 1996.
Service territory. The geographic area
served by a public utility; a utility's
service territory may or may not
correspond to geopolitical boundaries.
Single-tariff pricing. Single-tariff
pricing is the use of a unified rate
structure for multiple water (or other)
utility systems that are owned and
operated by a single utility, but that may
or may not be physically interconnected.
Under single-tariff pricing, all customers
of the utility pay the same rate for
service, even though the individual
systems providing service may vary in
terms of operating characteristics and
stand-alone costs.
Stand-alone pricing. Pricing based on
the costs that a commonly owned or
managed water system would incur if it
replicated the same services and
functions on a basis completely
independent of the parent utility and
other systems.
Subsidy. A transfer of welfare from one
group of customers to another that is not
based on differences in the cost of
serving the different customer groups.
Tariff. The official rate schedule
document specifying all of a utility's
rates and charge; the tariff must be
approved by appropriate state or local
governing bodies.
Undue discrimination. Price
differentiation that is not based on
variations in the cost of service.
Uniform rate. A variable rate that does
not change with the total amount of
water usage.
Variable rate. The billing rate applied
on a per gallon or per cubic foot basis to
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the amount of water used by customers
during the billing period. The variable
rate multiplied by water usage
determines the portion of a customer's
water bill that varies with water usage.
Vertical equity. A condition under
which customers that impose different
costs on the utility system pay different
prices for utility services based on the
relevant cost differences. A related
concept is undue discrimination.
Water system. An infrastructure system
for withdrawing, transporting, treating,
storing, and distributing water to a
defined service territory.
Water utility. A public or private entity
that owns and operates one or more
water systems and typically charges
customers for the cost of providing water
service. In multi-system utilities, two or
more water systems are owned and
operated by the utility and they may or
may not be physically interconnected.
Zonal Pricing. Differentiation in rates
according to substantial differences in the
cost of serving different areas. Zones
generally are defined in spatial terms and
represent geographic clusters of
customers with similar cost
characteristics.
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APPENDIX B
SELECT COMMISSION ORDERS ON
SINGLE-TARIFF PRICING
California
California Public Utilities Commission. Decision No. 89-06-007. Hillview Water Company, Inc. June 7,
1989.
Connecticut
Connecticut Department of Public Utility Control. Docket No. 86-12-08. Connecticut-American Water
Company. June 2, 1987
. Docket No. 89-03-22. Connecticut-American Water Company. September 21, 1987.
Florida
Florida Public Service Commission. In re Rate Setting Procedure and Alternatives for Water and Sewer
Utilities. 1989.
. Docket No. 920100-WS. Southern States Utilities, Inc. November 2, 1993.
. Docket No. 930880-WS. Southern States Utilities, Inc. September 13, 1994.
. Docket No. 930892-WU. Venture Associates Utilities Corp. December 30, 1994.
. Docket No. 931122-WU. Lakeside Golf, Inc. February 9, 1995
Hawaii
Hawaii Public Utilities Commission. Docket No. 6434. GASCO, Inc. April 3, 1992.
Illinois
Illinois Commerce Commission. Docket No. 92-0116. Illinois-American Water Company. February 9, 1993.
. Docket No. 94-0481. Citizens Utilities Company of Illinois. September 13, 1995.
. Docket No. 95-0076. Illinois-American Water Company. December 20, 1995.
Indiana
Indiana Utility Regulatory Commission. Cause No. 36483. Northern Indiana Fuel & Light Company, Inc.
October 1, 1981.
. Cause No. 36427. Terre Haute Water Works Corp. November 13, 1981.
. Cause No. 38880. Indiana-American Water Company. September 26, 1990.
. Cause No. 39595. Indiana-American Water Company. February 2, 1994.
. Cause No. 40703, Indiana-American Water Company. December 11, 1997.
Iowa
Iowa Utilities Board. Docket No. RPU-94-2I. ES Utilities, Inc. June 30, 1995.
Maine
Maine Public Utilities Commission. Docket Nos. 91-193 and 93-027. Michael McGovern v. Portland
Water District. February 28, 1994.
Maryland
Maryland Public Service Commission. Case No. 8643. Chesapeake Utilities Corp. August 17, 1994.
Massachusetts
Massachusetts Department of Public Utilities. D.P.U. 95-118. Massachusetts-American Water Company.
May 31,1996.
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Missouri
Missouri Public Service Commission. Case No. 90-236. Missouri Cities Water Company. October 12, 1990.
_. Case Nos. WR-95-205 and SR-95-206. Missouri-American Water Company. November 21,
1995.
1995.
1997.
_. Case Nos. WR-95-205 and SR-95-206. Missouri-American Water Company. November 21,
_. Case Nos. WR-97-237 and SR-97-238. Missouri-American Water Company. November 6,
New Hampshire
New Hampshire Public Utilities Commission. Docket DR 97-058. Pennichuck Water Works, Inc, Request
for Permanent Rates. March 25, 1998.
New Jersey
New Jersey Board of Public Utilities. Docket No. WR95040165. New Jersey-American Water Company.
March 3, 1996.
New York
New York Public Service Commission. Case No. 93-W-0962. Order Instituting Proceeding and Soliciting
Comments, Investigation of Incentives for Acquisition and Merger of Small Water Utilities. November
10, 1993.
Ohio
Ohio Public Utilities Commission. Case Nos. 88-716-GA-AIR et. all, 88-1011 -GA-CMR. Columbia Gas
of Ohio, Inc. October 17, 1989.
Pennsylvania
Pennsylvania Public Utility Commission. Order in Docket R-850096, Western Pennsylvania Water
Company (January 29, 1986).
. Order in Docket No. M-00950686. Policy Statement Re: Incentives For The Acquisition
And Merger Of Small, Nonviable Water And Waste Water Systems. February 23, 1996.
Rhode Island
Rhode Island Public Utilities Commission. Docket No. 2216. Narragansett Bay Water Quality Management
District. March,24, 1995.
Texas
Texas Public Utility Commission. Docket No. 4240. Texas-New Mexico Power Company. June 2, 1982.
West Virginia
West Virginia Public Service Commission. Case No. 81-126-W-42A. West Virginia Water Company. May
26, 1982.
. Case No. 89-498-W-42T. West Virginia-American Water Company. May 4, 1990.
. Case No. 89-498-W-42T. West Virginia-American Water Company. May 24, 1990.
. Case No. 93-0279-W-42T. West Virginia-American Water Company. January 23, 1994.
Source: Adapted and updated from Daniel W. McGill, "Memorandum on Single-Tariff Pricing"
(correspondence dated December 31, 1996).
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APPENDIX C
DETAILED EXAMPLE OF
SINGLE-TARIFF PRICING
Table Cl
Cost-of-Capital Determination
Source of Capital
Short-term bank debt
Issuance
Cost ($)
End-of-year
Capitalization
($)
4,800,000
Capita lizatio
n (percent)
7.47
Cost
Rate ($)
14.00
Weighted
Cost ($)
1,046
Long-term debt bonds
First-mortgage bonds
53/8% series due 3/1/82
93/4% series due 5/1/95
10% series due 10/1/96
93/8% series due 8/1/96
Total long-term debt
2,040
40,544
229,017
83,423
2,500,000
3,000,000
16,800,000
7,840,000
30,140,000
3.90
4.67
26.17
12.21
46.95
5.427
9.884
10.116
9.474
9.54
0.211
0.462
2.647
1.157
4.477
Preferred stock
1 0 percent
9 1/2 percent
7 1/2 percent
Total preferred stock
31,781
19,067
21,926
2,940,000
1,368,000
1,920,000
6,228,000
4.58
2.13
2.99
9.70
10.092
9.602
7.692
9.24
0.462
0.204
0.230
8.896
Common equity
Common stock
Capital surplus
Earned surplus
Total common equity
Total capitalization
986,073
7,172,538
14,875,670
23,034,281
64,202,281
35.88
100.00
15.00
5.381
11.800
Source: Adapted from Edward M. Limbach, "Single Tariff Pricing," Journal American Water Works
Association 75 no. 9 (September 1984).
Table C2
Allocation of Expenses by District and Under Single-Tariff Pricing
Expense Per 1 Million
Gallons of Pumped Water
Fuel and power
Chemicals
Total operation cost
Total maintenance cost
District A
49
15
374
103
District B
91
31
2,136
499
District C
115
76
2,443
111
District D
102
17
789
94
Single-
Tariff
Pricing
57
20
513
116
Source: Adapted from Edward M. Limbach, "Single Tariff Pricing," Journal American Water Works
Association 75 no. 9 (September 1984).
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Table C3
District Revenue Requirements and Effect on Average Residential Water Bill
Cost and Service Characteristics
Ratebase ($)
Rate of return (percent) *
Utility operating income ($)
Operation & maintenance expense ($)
Depreciation & amortization ($)
Taxes other than federal income tax ($)
Provision for federal income tax ($)
Total revenue requirement ($)
Percentage of revenue assigned to
residential customers
Number of residential customers
Average residential water bill ($)**
Impact of $50,000 investment on
average residential bill
District A
52,231,951
11.80
6,163,370
5,835,260
806,306
1,789,540
1,057,772
15,652,248
53.03
51,651
12.01
0.12
(1%)
District B
211,630
11.80
24,972
173,506
5,931
16,527
2,919
223,855
70.86
534
27.70
15.16
(55%)
District C
351,510
11.80
41,466
139,624
9,750
18,728
2,944
212,512
66.4
558
24.21
$13.59
(56%)
District D
2,320,677
11.80
273,840
806,709
32,509
131,035
45,127
1,289,220
64.67
5,180
13.30
$1.43
(11%)
Source: Adapted from Edward M. Limbach, "Single Tariff Pricing," Journal American Water Works
Association 75 no. 9 (September 1984).
» From Table C1. » * Based on 4,500 gallons per month.
Table C4
Comparison of Tariffs for Selected Districts Before and After Implementation of
Single-Tariff Pricing
Usage Charge
District A ($)
District B ($)
Single-Tariff Pricing
($)
Minimum charge
17-mm (5/8-inch) meter or smaller
20-mm (3/4-inch) meter
25-mm (1-inch) meter
40-mm (1 l/2-inch) meter
50-mm (2-inch) meter
80-mm (3-inch) meter
100-mm (4-inch) meter
1 50-mm (6-inch) meter
200-mm (8-inch) meter
6.62
9.78
16.30
32.59
52.15
97.78
162.96
325.92
521.47
13.11
19.67
32.78
65.56
104.91
196.70
327.85
655.69
1,049.11
7.35
11.06
18.40
36.80
58.90
110.40
184.00
368.00
568.80
Variable charge (per 1,000 gallons)
First 2000 gallons/month
Next 28,000 gallons/month
Next 970,000 gallons/month
Next 9 million gallons/month
All more than 10 million gallons/month
2.597
1.562
1.107
0.858
„
4.526
3.147
3.147
3.147
__
2.74
1.56
1.14
0.902
Source: Adapted from Edward M. Limbach, "Single Tariff Pricing," Journal American Water Works
Association 75 no. 9 (September 1984).
79
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USEPA-NARUC
Consolidated Water Rates
APPENDIX D
COMMISSION SURVEY ON
SINGLE-TARIFF PRICING
Date:
To:
January 10, 1996
C
J
From: Dr. Janice A. Beecher, Director of Regulatory Studies
Center for Urban Policy and the Environment, SPEA, Indiana University
(317) 261-3047 Office, (317) 261-3050 Fax
Re: Quick Survey on Single-Tariff Pricing
Happy New Year! Can you help me by taking a moment to fill out this quick survey and faxing it
back as soon as possible? Completing the survey should require only a short amount of time and I
will make the results available to everyone.
Single-tariff pricing is used to implement a single rate structure for multiple water (or other)
utility systems that are owned and operated by a single utility. With single-tariff pricing, all
customers of the utility pay the same rate for service, even though the individual systems
providing service may vary in terms of the number of customers served, operating characteristics,
and stand-alone costs. Water utilities with multiple systems are not necessarily found in every
state.
Please answer the following:
1.
Do any of the water utilities regulated by your
commission have multiple water systems (0)?
Yes d
NO a
2.
3.
If No, the remaining questions are not applicable to your state. Please return the first
page of the questionnaire so that your state will be represented in the survey.
If you answered Yes to Question 1, please name the multi-system water utilities, the
number of systems they operate, and the approximate number of connections for the
smallest and largest system operated by the utility. Use an additional sheet if necessary.
Utility Name
Total Number
of Systems
Approximate Number
of Connections for the:
Smallest Largest
System System
3.
Has your commission approved single-tariff pricing Yes O
for any of the utilities named in Question 1 (0)? No D
Go to Question 4
Go to Question 5
80
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USEPA-NARUC
Consolidated Water Rates
4. If your answer to Question 3 was Yes, please name the utilities and when the tariff was
first approved. Use an additional sheet if necessary.
Utility Name
When was the
tariff
first approved?
If your answer to Question 3 was No, please check all of the following that apply (0):
O Single-tariff pricing has not been an issue.
n Single-tariff pricing has been considered but not specifically approved.
n A proposal for single-tariff pricing has been rejected.
CJ Other:
Has single-tariff pricing been explicitly prohibited
in your state by statute (0)?
When was the statute passed?
Yes
NO n
Please describe the
nature of the prohibition:
7. Has your commission put any monitoring and/or
evaluation systems in place for single-tariff pricing
in cases where it has been implemented (0)?
Yes
No O
If Yes, please describe:
8. If your commission approved single-tariff pricing, what was the primary reason for the
approval?
9. If your commission rejected single-tariff pricing, what was the primary reason for the
rejection?
10. Please characterize your commission's policy position on single-tariff pricing (0)?
V
n Generally accepted
d Generally not accepted
Cl Decided on a case-by-case basis
n Never considered
81
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USEPA-NARUC
Consolidated Water Rates
11. If single-tariff pricing has been an issue in your state, whether or not it has been
implemented, please review the following arguments in favor and against single-tariff
pricing and check all that have influenced your commission's deliberations or policies on
the issue. Check (0) all that apply:
Arguments in Favor of Single-Tariff Pricing
/
D Provides incentives for utility regionalization and consolidation
O Mitigates rate shock to utility customers
n Promotes universal service for utility customers
CJ Promotes ratepayer equity on a regional basis
O Improves service affordability for customers
CJ Addresses small-system viability issues
D Facilitates compliance with drinking water standards
D Provides ratemaking treatment that is similar to that for other utilities
n Lowers administrative costs to the utilities
D Lowers administrative costs to the commission
O Promotes regional economic development
n Encourages further private involvement in the water sector
O Encourages investment in the water-supply infrastructure
D Physical interconnection is not considered a prerequisite
n Overall benefits outweigh overall costs
D Other:
Arguments Against Single-Tariff Pricing
y
n Conflicts with cost-of-service principles
CD Undermines economic efficiency
n Provides subsidies to high-cost customers
O Distorts price signals to customers
D Discourages efficient water-use and conservation
D Encourages growth and development in high^cost areas
CJ Encourages overinvestment in infrastructure
tl Fails to account for variations in customer contributions
n Provides unnecessary incentives to utilities
D Considered inappropriate without physical interconnection
D Not acceptable to all affected customers
d Not acceptable to other agencies or governments
CJ Justification has not been adequate in a specific case (or cases)
D Insufficient statutory or regulatory basis or precedents
CJ Overall costs outweigh overall benefits
n Other:
Please provide any additional comments on another sheet. Thank you again for your
assistance. I look forward to working with you in 1996.
82
-------
USEPA-NARUC
Consolidated Water Rates
APPENDIX E
DETAILED FINDINGS FROM COMMISSION SURVEY
ON SINGLE-TARIFF PRICING
83
-------
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