Saving the Natural Monopoly on Water

From the Texas Tribune: Witchita Falls, TX, along with other Texas cities, imposed an outdoor watering ban in order to conserve water during recent drought conditions. The result? Not enough revenue to cover the costs of operating and maintaining the city’s water infrastructure.

Even though the 100,000 residents of this northwest Texas city have substantially cut their water use, their dry lawns may no longer continue to save them money on their water bills. Instead, they will be asked to pay more; the city lost $4.5 million in water sales last year because of the conservation efforts.

Water utilities are what’s known as a natural monopoly in economics jargon.  This means that it’s more economically efficient to have a single provider of the good (here, water) than to have many providers of the good, which is normally more economically efficient. On the other hand, most people know that monopolies tend to charge high prices which lead to high profits and low consumer surplus (i.e. monopolies tend to be bad for consumers). Because of this problem, water utilities are regulated so that they cannot charge prices that are “too high” and thereby restricting their profits to be relatively small. Why is this? Because water is considered a necessity, so most policy-makers agree that everyone should have access to a reasonable amount of safe water.

When a drought occurs, a common policy is to implement a restriction on outdoor water usage because, of all uses of water by typical households, it’s considered the least necessary (relative to bathing, cooking, cleaning, etc.). In the case of Witchita Falls, the restriction resulted in insufficient revenue to support the water utility so it is now considering raising water rates.

Fort Worth’s goal, like that of many other cities in Texas, is to change its rate structure to avoid such ups and downs. Today, about 17 percent of the utility’s revenue comes from fixed monthly charges that all water customers pay regardless of how much they use; by 2018, Gugliuzza said, 25 percent of its revenue will come from such charges. Dockery said Wichita Falls is considering a similar transition.

Still, the changes will be hard to swallow politically. Consumers have underpaid for water for decades, said Sharlene Leurig, a program director at Ceres, a nonprofit sustainability advocacy group with which many Texas cities have consulted on water rate structures.

One pricing policy that is often suggested by economists but which isn’t always adopted is known as a two-tier pricing strategy. Under this strategy, all water consumers are guaranteed a certain amount of water for free or at a very low cost so that they can meet their basic human needs such as cooking and bathing.  Water consumed beyond that level is charged at a much higher rate (closer to or even above the true marginal cost of providing the water).  The idea is that this water is more likely to be used for less necessary purposes such as watering the lawn or washing the car. The water utility earns a profit on water consumed at the higher rate in order to make up for losses earned on providing water for basic human needs.