Floating Another Way to Pay for New Water in San Diego

By Ry Rivard.

The new desalination plant in Carlsbad and its expensive water are driving up water prices across San Diego County. But does it have to be that way?

Maybe not.

Right now, the two dozen water agencies in San Diego County get water from a variety of sources, including the Colorado River and the delta in Northern California.

Water from each source costs a different amount, but customers don’t see that difference on their bill. That’s because water officials blend together all of the costs so each customer pays roughly the same amount for every drop of water, no matter the source.

Richard Carson, an economist at UC San Diego, thinks it shouldn’t have to work that way. Instead of making everyone pay for desalinated water, water officials could have made only new customers pay for that new source of water. Since the desalinated water is helping cities justify new development by guaranteeing a water supply, why not make the new developments pay for the cost of new water?

Obviously, the idea would not be popular with builders.

But something like this already happens in California: Developers have to pony up to build new infrastructure because their developments add cars to the roads, for example.

Carson and I talked by phone last week about who should bear the cost of new water supplies.

This conversation has been edited for length and clarity.

How do we price water right now?

Right now we engage in what’s called average-cost pricing. The water utility adds up all of its cost, from purchasing water to maintaining its infrastructure and then – [to put it] in a really simplistic way – they divide those costs by the number of gallons being used and that’s what people pay.

It’s somewhat more complicated than that, because there are all sorts of little charges for infrastructure and different classes of customers have different delivery costs.

But, in a simplistic sense, water utilities just generally work by taking the cost and dividing by how much water they sell.

Why might that not be the best way?

What can you imagine here is that you have a city and it’s been a city for a while and, let’s say you annex a new area that currently doesn’t have water being delivered to it. And it costs you a lot of money to start servicing this new area.

Well, you can think you about doing one of two things: You can average-cost price over the entire area of the original city, plus the annexed area. Or, you could charge the people in the original part of the city just what they were paying and you can charge the people in the annexed area a higher rate to cover the fact that their costs are higher.

And this has actually been done lots of places. For instance, the East Bay municipal water district [in Oakland] actually charges households more for hookups where they know they are going to have to experience much higher pumping costs.

So there is always this sort of tension between getting the prices the same for all people, which is the sort of notion of equity; versus the notion of charging water customers what their actual costs are when those costs can be radically different.

It’s not just the annexing where this comes up, or new territory, it’s new supplies too. So the desal costs are driving our increases right now?

Right, and what you can imagine – and this is another common situation – that the original city had a water supply that was roughly sized to that population. And now when it builds new [residential] units it has to go out and find a new water supply, and that water supply typically is going to cost dramatically more than the original water supply.

So, do you think this is what we should have done with desal?

What you can see is because one of the solutions here has the current households paying effectively what they have been paying – that would have made the new development pay a higher cost.

So, it’s a decision that was made probably – you know you don’t know how much thought went into this – but clearly the opposite decision could have been made: Rather than raise all the current residents’ water prices so that the new development can get the same price, you could have kept effectively water rates where they were.

… The decision was made to, in essence, raise the current residents of San Diego’s bills. In essence, one way to look at that is they’re subsidizing the new development.

The same issue plays out over and over again. If you build a new development and you have to put on a new interstate interchange, there’s always the issue of who pays for it – do the current residents pay for it, or does the new development pay for it?

California law here is pretty specific: If you can tie the higher cost – in this case, like the interstate on-ramp – directly to the new development, meeting what’s known as the “nexus test,” then you can charge the new development for that.

So the water here passes an easy nexus test because, in this case, the cities had to go out and contract to get new water supplies in the form of desalination so they could issue these water permits, which certify the city can meet the demand of the new development.

On the nexus fee way of doing it – would that spare those of us who are living here right now and paying water bills right now, the sort of increase we saw from the city?

Let me step back and say if ignored the drought, the answer would be yes. The drought has caused a particular perverse situation that San Diego and some other cities – but not all other cities – have gotten themselves in. And that’s because a lot of the cost of a water system are fixed costs, the pipes and the billing and all that.

So what happens is if you calculate the per-gallon cost, if you calculate rates based on what your costs were in a previous year, they don’t actually change much the next year, but if you’re successful in getting people to conserve, you sell less water.

And since your rates were based on previous water use – which is a common way to do it – you almost always then drive this situation where the water utility loses money and then they are forced to raise your rates to pay their costs of the system. That’s just sort of a mechanical problem that sort of occurs. Some water districts do this better than others because they are forecasting what is going to happen when people cut back.

The problem here is really with California law, which says that on a year-by-year basis that the water utilities aren’t supposed to collect more money than the cost of running the water system, including buying water.

The more successful you are at getting people to cut back – because you set your rates as if you are going to sell more gallons – you then drive these budget deficits and then have to raise your rates again.

It’s an ugly situation that the people in the water business are sort of well aware of.

What you would really like to do is actually have some people who are really big water hogs who are using a lot of water, and you want to charge them a lot of money for that. And that way the people who engage in the behavior that you want them to do – by cutting back – don’t actually see their bills go up.

But we’re in a situation now which causes the people, I think, to be rightly irritated: They actually cut back on their water use and, in addition to cutting back on their water use, they’re now paying higher bills.

San Diego City Councilman David Alvarez has talked about adding another tier, and he’s suggested that will spare the lowest users.

The key thing there is you’re going to have to do something that seems strange to a lot of people. But you really do need some fairly big water users who really have got expensive yards and have reasonably high incomes, be willing to use that extra water. Because they actually have to pay a lot more to keep some of these price increases from happening [for everyone else].

For desal, which is going to guarantee supply for new development, and Pure Water, which is going to do the same thing, would a developer be able to make a credible argument, or a politician be able to make a credible argument that, “This is going to cost two to three times as much as the water we’ve been using. If you put the burden on [just new customers], it’s going to hurt the ability of new families to buy new property, people that are living here to buy a new house, people that are coming in to buy a new house, people who are coming in that want to start a new business – and that’s bad for everybody by discouraging them with water prices”?

They will make that argument. I should say, it doesn’t hold a lot of water.

The easy way to think about that argument is, let’s say that you were building a new subdivision. And you had built houses on one side of the street before a requirement to pay this extra water cost came in. And, then you were building houses on the other side of the street. If it’s a fixed fee to the developer, what you can see is that both sets of houses have to sell for exactly the same amount. What that’s saying is that the real estate developer is basically going to take the hit.

Now, you could – and this is done in some water districts – you could charge the household [water customers] the higher fee [rather than the developer] and this would be the common sort of annexation notion: You could charge households where the building permits were drawn after a particular date a higher fee. And what you would see then is that this would reduce the value of the property in exactly the same way a Mello-Roos fee does now.

And what people would say, you know, “If I buy this house rather than that house and they have a higher water bill, that’s going to reduce the value of the house.”

The way we were talking about it earlier, say One Paseo is approved after the City Council suddenly changes the way it does desal pricing or Pure Water pricing – what would be the better way to do it: for Kilroy to pay it all once, or for everybody living in One Paseo to pay higher rates for the rest of their lives?

People have looked at these Mello-Roos fees and they are not very popular anymore, so, to the extent that new development is responsible for having to move to desal water, I think it’s just better for everybody to say, you know, this is what this extra cost is, and everybody to know that when they engage in new development.

So, another answer, a different way to think about this question of, “Do you discourage people from doing things with these fees?” The answer would be yes, but you also actually have a broader effect when you raise everybody’s water bill.

So, one way to think about this is to see you put on these [developer] fees, it mostly comes out of land value.

The other way you do is you raise everybody’s bills – in that sense, what you do is everybody has less money in their pockets to spend on other things.

From an economist standpoint, that’s not a good thing to have happen, because you need all that money taken over. So, you know, for everybody who complains one way or the other, you would in some sense much rather see the money come out of the land value than you would see it coming out of people’s pockets.

Originally posted at Voice of San Diego.



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