MWD's New Water Rate Structure Reviewed: Water Marketing Espoused, But Fair Access Denied

By: Michael George, President and CEO, Western Water Company

At its meeting on October 16, 2001, the Board of the Metropolitan Water District adopted a sweeping reform of its regional water rate structure. That reform is clearly a step forward, but it fails to meet one of its most important objectives: improving reliability through accommodation of a water market.

The new structure is important because it will influence the reliability, quality and cost of water for Southern California for decades to come. It will also have significant effects beyond the Met service area, since it will influence decisions-particularly environmental and economic decisions-throughout California and the West. As the imported water purchasing and delivery agent for the arid coastal region stretching from Ventura County to Mexico, Met's influence on the water system is hard to overestimate.

The actual rates and charges under the new regime won't be adopted until March 2002 and won't go into effect until January 1, 2003. However, the structure itself deserves analysis even before its implementation, both because of its profound effects and because retail water agencies will have to make decisions now in light of the new structure.

My company, Western Water Company, has a private stake in how the new rates work. We represent one of several alternative sources of supply for the Southland. We manage a portfolio of senior water rights, primarily gathered from conservation by agricultural interests, that we would like to sell to meet a portion of Southern California's growing demand for water. However, the rate making soup should be judged on its benefit to the region rather than its impact on private interests.

Unquestionably, the new structure provides many benefits for the region:

• Unbundling: for the first time, Met's customers will know what they are paying for each of the items on the "menu" of Met services; that's the first step to providing the information necessary so that consumers can make intelligent choices.

• Financial Protection: the fixed costs of the region's water delivery infrastructure will be protected through long-term contracts that will insure that Met collects sufficient revenue to amortize its debt and maintain the system; the old, volume-based charges left Met at financial risk for wide fluctuations in water sales from year to year.

• Conservation: the new structure provides subsidies for conservation and recycling programs to get the most out of precious local water resources and provides meaningful financial incentives to restrain use.

• Predictability: the retail water agencies that rely on Met for some or all of their wholesale supplies will have a better understanding of their supply reliability and cost; this is especially important in light of recent legislation that mandates improved water resource forecasts.

• Leapfrog the Wheeling Debate: by ostensibly opening its system to alternative sources of imported water, the new rate structure effectively takes wheeling policy out of Sacramento where it has been stalled in divisive debate for the last three years.

The Missing Ingredient: Fair Access

Notwithstanding these benefits of the new structure, it fails to achieve one of its major stated purposes: to accommodate a water market. Utility rate setting is arcane but important-as our recent energy crisis demonstrated. In addition, the Southland's economy depends on the reliability of its imported water supplies, and the cost of those supplies impacts the region's economic competitiveness. So, while the new rate structure claims to provide consumer choice and the reliability benefits from system access for new water sources, it's critical to examine the details to see if the objective is actually achieved. Unfortunately, close examination reveals that important features of the plan actually create barriers to new imported water supply sources that could benefit the region. It's a critical failure: the new rate structure actually impedes overall reliability, insures higher-then-necessary long-term costs, imposes negative environmental impacts, and withholds the tools local water districts need to manage in the changing water world.

Tier 1: The Protected Market

At its heart, the new structure provides for a two-tiered pricing regime. Tier 1-Met's lowest cost water-is likely to satisfy the demands of most retail water agencies. Through ten-year contracts, member agencies will gain the right to buy Met's most reliable and lowest cost water at attractive prices. These contracts also insure that all of Met's infrastructure costs will be covered by firm water sales. Thus, the Tier 1 regime creates a valuable and mutual benefit: consumers get high reliability and low prices while Met gets a protected market and financial support for its reliable supplies.

Tier 2: The Recipe for Monopoly

Only those agencies who need more than 90-percent of their historic base supply will need to acquire additional water beyond what's available to them under Met's Tier 1 (so long as the occasional drought doesn't reduce the amount of Tier 1 water that Met can supply). For these agencies-those with growing service demands-the question becomes whether to buy the incremental water they need from Met under Tier 2 (when it's available) or to buy from competitive sources. While appearing to open its service territory to accommodate such choice by the 300 retail water agencies within the region, Met has actually established a structure to make sure it retains its current monopoly on imported water supplies.

The two primary mechanisms for restraining importation of alternative water supplies are:

• Discriminatory Pricing for Power: Met will charge alternative supplies a systematically higher power charge than it will charge for its own Tier 2 sales; that is, Met will impose a price barrier in the form of higher energy costs to keep out new, more efficient imported supplies; and

• A Drought Management Plan that Re-allocates Supplies and Reduces Reliability: Under its so-called Water Surplus and Drought Management Plan, Met reserves the right to re-allocate shortages so as to "equalize the pain" of a future drought. While this "to each according to his needs" approach appeals to Met, it destroys the incentive for any retailer to seek improved reliability through diversification of its water supplies.

Reliability: Unavailable at Any Price Under Met's New Structure

Metropolitan disserves its constituents by interfering with water transfers that could improve regional water reliability. The effect is to preserve the region's reliance on Met as the de facto sole supplier of the imported water that is vital to the lives and livelihoods of Southern California. Met admits that it is incapable of guaranteeing the reliability of future supplies, yet the rate structure effectively prevents the retail water agencies of Southern California from securing alternative supplies that might improve overall reliability through source diversification.

Met's new rate structure has other problems: failure to deal with prescriptive rights, perverse incentives to increase peak system use, avoidance of cost accountability, to name a few. But the failure to meet one of its critical stated objectives-to accommodate a water transfer market-is reason enough to send this concoction back to the kitchen. It's got promise, but it's not soup yet.