Economics Expert Proposes Tiered Pricing Drought Solution

Tiered water pricing may be an answer to California's drought challenges, according to a Stanford economics professor.

Frank Wolak's recent work focuses on methods for introducing competition into infrastructure industries. He is trying to develop a new blueprint for pricing. In particular, he studies tiered pricing, which would mean charging a higher rate as consumers use more gallons of water. His model charts customer-level water demand in a way that could help utilities design tiered water rate structures to meet conservation and revenue goals, Stanford News reported.

Tiered pricing structures, sometimes known as increased block price schedules, can push customers to save water.

"The lowest price block or tier typically corresponds to an amount of water sufficient to meet basic indoor needs like drinking and bathing. Each subsequent tier charges a higher per-unit price for additional consumption, and is designed to discourage households from using water for non-essential things like watering lawns and filling swimming pools," Wolak explained, per the report.

Wolak said his work aims to help utilities meet the demands of Proposition 218, a local government financing measure that makes new requirements for water standby charges in California.

"My work provides water utilities with a tool that they can use to predict a customer's demand, and hence their water bill, for any given price structure. It can be used to design a price schedule such that the customer’s expected monthly water bill is equal to what it costs the utility to provide that customer with water. This would help the utility make the case that its prices meet the requirements of Proposition 218," he explained.

Wolak emphasizes data and analytics as key to the future of utilities. "There’s plenty of low-hanging fruit, such as online surveys, that can provide utilities with data that they can feed into my model to better estimate water consumption for any given price schedule. A utility’s rates can then be better correlated with the cost of service to withstand court challenges like the recent one," he said.

One of Wolak's studies examined the concept of dynamic pricing, exploring how residential customers respond to hourly pricing. The study suggested that "responding to single hourly pricing warning by reducing demand in that hour and surrounding hours of the days is likely to deliver economic benefits because wholesale prices in those hours are also likely to be high."

New rules announced by California Governor Jerry Brown in April order localities to cut water use. Utilities must cut usage between 8 percent and 36 percent by February 2016. Overall, "the governor is looking to cut urban water use by 25 percent by the end of next February. There are 411 urban water districts in California and the 25 percent reduction will be drawn from all of them combined," KPCC reported.

Brown's new policies present challenges to water utilities. Analysts say utilities "could struggle to raise revenue in the arid conditions," The Bond Buyer reported.

Usage cuts are just one among many ongoing difficulties for water utilities. Regulatory compliance and infrastructure also present major challenges. At utilities, "you have a cesspool of financial worries," The Kansas City Star reported, citing a research paper by the consulting firm Black & Veatch.

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