This is Part 2 of a series. Part 1 was on how drought-water pricing violates Proposition 218’s ban on tax increases without a vote of the people.

What is good water pricing during a drought? Let’s look at some situations.

1. Voluntary conservation

A good place to start is the continuing series on the drought by Caitrin Chappelle and Ellen Hanak of the Public Policy Institute of California. It their Sept. 3 installment, they tout the city of Roseville as an example of good drought pricing:

“The city of Roseville is one community using the drought pricing tool, which was adopted — and vetted with customers — before the drought hit. In June, Roseville implemented a temporary 15 percent drought surcharge while also mandating a 20 percent reduction in water use.”

But here’s how Roseville itself justified increasing water rates:

“With almost three months of declining revenue and increased costs, the water utilities financial reserves are no longer able to cover this deficit. Costs are increasing for many reasons — water is scarcer and more expensive. The drought has also required us to expand our water conservation programs, invest in operation of our back-up groundwater wells, and build new wells as water from Folsom Lake has become much less reliable due to an unprecedented drought.”

In other words, customers were curtailing water use voluntarily at the onset of the drought and water utility revenues dropped below fixed costs. Customers (“the market”) had already reacted by cutting water use.

But public utilities are not allowed to run an operating deficit.  Thus, Roseville appropriately raised water rates to cover their fixed costs, and for drilling new wells, without needing to get voter approval under Prop. 218. So Roseville’s water rate increase did not use a “drought pricing tool” to spur conservation, because conservation already was happening.

2. Agricultural pricing

Many agricultural water districts have been hit hard. Shouldn’t they impose a “conservation rate”?

Actually, water sales by auctions already adjust for the scarcity of water due to drought. So there is no need to impose water conservation rates on farmers.

During wet years, water auction prices commonly range in the hundreds of dollars per acre-foot. But during droughts, that typically increases at least tenfold to the range of thousands of dollars per acre-foot.

Once again, the market itself has imposed “conservation water rates.”

3. Senior water-rights farmers

Some farmers have “senior water rights” and are entitled to deliveries of cheap system water through the State Water Project. Are they overusing water because it is so cheap at the expense of everyone else?  No.

Like electricity, farming water commonly is not bid on each day or month on the spot market. Instead, contracts are for years, even decades, because of the large capital investment needed upfront for land, seeds and farming equipment. Such water contracts are a market mechanism to ensure continued supply at affordable prices.

Hanak mentions in her “California Water Markets by the Number – Update 2012” that water markets have evolved from one year contracts to longer-term contracts and trades.  The number of short-term contracts increases during droughts (see Figure 3, Page 19 here).

So those with locked-in lower water rates by contract in a drought aren’t getting away with anything. If the government violated these contracts to take the water, or force the farmers to pay higher rates, it would be a “taking,” which the U.S. Supreme Court has ruled must be compensated. That would mean taxpayers would pick up the tab. The court affirmed its previous rulings last year in Koontz vs. St. Johns River Water Management District.

Moreover, the water contract market is highly developed.

4. Selling wholesale water to farmers

The UC Davis Center for Watershed Sciences proposes selling government wholesale water allocated to fish and wildlife refuges back to farmers at duress drought water prices. But that’s fraught with double-payment problems because farmers have already paid for the water once to maintain California’s Central Valley Project.

Such sales would not reflect fair market pricing and are probably illegal under the eminent domain “project influence rule.” That rule says you can’t take water from farmers for a public project to protect fish, create an artificial scarcity, then charge farmers the higher scarcity price in a drought.

5. Supply-side solutions

The above solutions are “demand-side solutions” to drought: they reduce the use of water.

But what about “supply-side solutions,” that increase the supply of water? As reported earlier on CalWatchdog.com, such solutions are being pursued by the city of San Antonio, Tex., and by Cadiz, Inc. in California.

The big benefit of supply-side solutions is that they don’t take water from one use and give it to another. Rather, they develop water for new uses, reducing legal and regulatory entanglements.

Conclusion

Drought-water pricing advocates largely are experts in academia and think tanks. Yet the reality in the pipes, so to speak, is what goes on in the water contract market and with established law.

Our system of government requires the rule of law and the consent of the governed, which is missing in calls to increase water rates to curtail usage of water.

Wayne Lusvardi worked for 20 years for one of California’s largest water agencies as Chief Real Estate Appraiser in the valuation, leasing and management of land with water rights, including the Palo Verde Irrigation District land fallowing program.

Calls now are going out to raise water prices even higher to spur conservation. Instead of fining people for watering their lawns, numerous economists are recommending just tacking a punitive surcharge onto water rates until use drops.

But there’s a problem with this drought fix: It would violate Proposition 218, which voters passed in 1996. It requires voter approval for any tax increase. And higher rates for using more water effectively are a tax on usage.

CalWatchDog.com brought up the matter with Jon Coupal, president the Howard Jarvis Taxpayers Association, a major backer of Prop. 218 and defender in court of voter consent for taxes, especially punitive or luxury taxes.

“Some of these tiered rates are probably illegal,” Coupal said. “To be fully compliant with Prop 218, a [water] district would probably have to characterize the higher tiered rate as a penalty or fine.” 

So voters would have to approve any higher water rates for “drought pricing,” “tiered drought water rates” or “water conservation rates.”

The matter also has been litigated in a case settled by the California Supreme Court in 2006, Bighorn-Desert Water Agency vs. Verjil.  That case concerned whether the public initiative process under Prop. 218 could repeal water-rate increases. The court established that water-rate increases or decreases are “property-related fees” subject to Prop. 218.

So do all water rates have to be approved by voters? No. Prop. 218 only stipulated any rate increase “shall not exceed the funds required to provide the service.” That allowed rate increases for higher operating costs or inflation. But it did not allow rate increases for anything above such costs, such as for water conservation, unless a majority of voters gave their approval.

Water Experts 

“Drought prices” are being advocated by some water economists from both sides of the political spectrum:

• Kathryn Shelton and Richard B. McKenizie of American’s Future Foundation;
• Benjamin Powell, director of the Free Market Institute at Texas Tech University;
• Former U.C. Davis water economist David P. Zetland, writing on the libertarian website Reason.com;
• Ellen Hanak and Caitrin Chappelle of the Public Policy Institute of California;
• Jay Lund of U.C. Davis;
• Stephanie Pincetl of the UCLA California Center for Sustainable Communities;
• Peter Gleick of the Pacific Water Institute in Oakland.

These advocates call it a “market solution.” Yet 95 percent of system water in California is a monopoly controlled by the government, with only 5 percent sold on the spot market.  When purchasing a car, a computer or a hamburger, if one is dissatisfied with a high price or low quality, one simply switches to a competitor. But with water, one cannot do that except by moving into a new water district — something hardly practical for most people or businesses.

So even a “market solution” really is political, meaning it falls under the rubrics of state law, including Prop. 218.

Tiered usage

Many water districts already use a tiered structure for water usage, where those who use more pay more, to encourage conservation even in times and places where there is no drought. Such tiers can be structured around the water source or service (potable, recycled, construction, fire), and do not trigger Prop. 218.

But if the tiers are based on usage, then the tiers trigger Prop. 218 approval by voters.

Finally, long-term studies show tiered usage does not discourage use. See the study from July by the Centre for Energy Policy and Economics Department of Management, Technology, and Economics in Zurich, “Urban Water Demand and Water Rate Structures Over Decades.” It found:

“Using primary pricing data from 125 Texas communities spanning more than two decades (1981 – 2003)…. The adoption of water pricing structures alleged to promote water conservation (e.g. increasing block rates) does not lead to expected results as in our sample (13447 observations) consumption increased by 5-6 % … after the change occurred.”

In Part 2, we will further explore the notion of drought-pricing water. 

Wayne Lusvardi worked for one of California’s largest water agencies for 20 years in valuing land with water rights, agricultural land leases, and land fallowing contracts for water conservation.