Jason Mumm, global director of financial, commercial and risk management services
The New York Times recently featured a story, of all things, about the water rates in Santa Fe, New Mexico. Why, you might ask, would the prestigious newspaper write about something like that? The answer is that the paper, like so many actual residents in drought-stricken areas, was looking for answers to the “secret” of sustaining large populations of thirsty people with an ever dwindling supply of water. Santa Fe poses a fascinating case study in pricing urban water deliveries in a way that, if not the kernel of the “secret,” at least helps ration scarce supplies responsibly. The article, titled “Water Pricing in Two Thirsty Cities: In One, Guzzlers Pay More, and Use Less,” appeared in the May 6 issue of the New York Times.
Our team has worked with the City of Santa Fe since 1999. The New York Times story has been a long time coming and the drought in California finally gave rise to the opportunity to tell it. That Santa Fe has used its pricing strategy as a tool – one among many – to encourage water conservation is certainly true and conservation has always been a critical consideration there. For many years, the City (and, sometimes, its consultant) were ridiculed for the “ridiculous” water rates the City adopted in 2001. Those rates today cause residents to pay $6.06 per 1,000 gallons for the first 7 – 10 thousand gallons of usage, depending on the time of year (it’s 10,000 gallons in the summer). After that, for those so inclined to use more, the rate increases to $21.72! Environmentalists love what they see as pricing that matches the “true value” of water. The critics, meanwhile, look at those numbers, which have no equal anywhere in the U.S., and assume they are arbitrarily set only to punish water use in the 400-year old desert community. Both are wrong.
Here are some things about Santa Fe’s water rates that are even more compelling than the fact that they’ve also succeeded in reducing water demand by over 40 percent.
Myth No. 1: The rates have no basis in the actual costs of providing services.
Yes, they do. The best municipal utilities follow industry guidelines for establishing rates and charges for water utility service. Those so-called cost-of-service guidelines mean that the rates charged are built from the costs incurred. In California especially, the courts require a clear connection between real costs and every tier in the pricing schedule. Santa Fe’s rates have always followed cost-of-service guidelines to the letter. The reason the rates are so high is simple: there are a lot of expenses, just like most any other utility in the world, but in Santa Fe there is very low water use. The 2nd Tier is especially high because the rate structure recovers the cost of providing peak capacity mostly in that tier. Santa Fe’s rates are entirely supported by an exemplary cost-of-service approach.
Myth No. 2: Santa Fe must suffer from extreme revenue instability.
Not so. Santa Fe recovers a large portion of its revenue from its volumetric charges, which would normally lead to some variability based on weather cycles, but unlike so many other utilities with tiered rates, the City depends very little on water sales in the 2nd tier of pricing (and there is no 3rd tier). Water usage in Santa Fe is so low that a very large part of all usage is for indoor needs. Indoor needs have also been reduced in Santa Fe thanks to low-flow fixture rebate programs and other targeted conservation efforts, but indoor usage is ultimately a stable level of demand, and that fuels revenue stability.
Myth No. 3: Those rates must mean Santa Fe has financial problems.
Wrong again. In 1999, when the City first started examining the issue of water rates and water conservation hand-in-hand, the water department was in serious financial trouble and was teetering on a credit downgrade that would have placed the department’s municipal bonds into non-investment grade status (i.e. junk bonds). Since then, the water department has become a model of financial strength achieving credit ratings of AA and above. The water department has not had to raise its rates for two years; there is enough cash in reserves right now to fund the next five years of anticipated pipe replacements and other repairs without issuing another cent of debt.
Myth No. 4: Santa Fe’s situation is unique and could never be repeated elsewhere.
Utilities who implemented tiered pricing were often told that they could use the rates from high tiers to make the cost of lower water usage more affordable – i.e. that they could subsidize one kind of water use by penalizing another. Over time, that kind of thinking unravels in spectacular fashion. When the high-tier users quit using water – just as intended – the revenues disappear while the mostly fixed costs remain. The reason why Santa Fe’s tiered rates have worked so well isn’t because of their uniqueness as a community; it’s because the City’s leaders were willing to do things the right way. By ensuring a strong relationship between costs and rates, and by eschewing the idea of subsidization for the more important goal of conservation, the City put in place a nearly perfect rate structure to accomplish its goal of conservation while also promoting financial stability and long-term sustainability.