Ordering Information:
ORDER NUMBER: 90690
DATE AVAILABLE: Winter 1996

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Prepared by Daniel B. Bishop and Jack A. Weber
Montgomery Watson Americas, Inc.

BACKGROUND
Over the past two decades, water utilities have been challenged by increasing regulations, environmental concerns, and water shortages. In many cases, the impact on water utilities has been either reduced availability of current water supply or the prospect of reduced availability in the future. New regulations have made some sources no longer available for use. Environmental claims on water supplies have even challenged long-established water rights. Climatological conditions have made water shortages a common occurrence in many parts of the world, including in the United States. With the specter of declining water supplies, water utilities have had to explore new methods of meeting the needs of their customers. Utilities have had to look not only at supply-side solutions but also at demand-side management to bring the desire for water into line with available supplies.

A water utility that loses 15 percent of its water sales through conservation efforts will have similar financial impacts as a utility that loses 15 percent of its water sales as a result of economic factors. The costs of production will decrease by some amount and revenues will decrease, almost always in a larger amount. The short run impact is likely to be a net reduction in the financial strength of the utility as revenues decrease faster than costs decrease. The ability to modify costs is limited in the short run by the fact that much of the operating costs of the utility are fixed in nature. The questions become: "How much impact will there be on costs when demand is reduced? Will the utility save 20 percent, 50 percent, 80 percent of its costs when it produces less? And, what will happen to revenues as customers cut back on water purchases?" These are the types of questions that this study was intended to answer.

In addition to determining how much can be saved in the short run, the study also addresses the potential savings in the long run. These are savings that result from reduced need for new facilities, or from being able to provide for water needs through smaller facilities. In addition, long-term beneficial impacts on the environment may result from lower water demands and smaller construction requirements.

OVERVIEW
The subject of this study is the impact on water utilities when the demand for water is reduced. To develop meaningful data for the water industry, the study was organized in a case-study format with eight water utilities and one wastewater utility.

In the data collection process, the participating utilities provided detailed information about their operational and capital costs. From each utility, three to five years of monthly data were collected for operating costs that the utilities believed were significantly related to the volume of water produced and distributed. Included in these costs were the costs of chemicals, electricity, total treatment, and total operations and maintenance (O&M). Along with the operating cost data, the utilities provided corresponding data on volumes of water produced each month, and such water quality characteristics as turbidity and temperature of the water. From the data provided by the utility, statistical methodologies were applied to determine the impact on the utilities' short-run costs from the change in the volume of water produced.

RESULTS
Short-run cost reductions occurred for the participating utilities as a result of demand reductions. However, in the short run, the cost reductions fell far below the reductions in the revenues the utilities receive from its customers. Since rates must cover all the costs of the utility, they will always be much higher than the marginal costs of producing water. In Chapter 5, marginal production costs were determined. These short-run marginal cost reductions varied from as little as $0.06 per thousand gallons to a high of $0.81 for a water agency that purchased treated water from a neighboring city.

In Chapter 6, the losses in revenues are determined for several different levels of demand reductions. The revenue losses more than offset the short-run cost savings for all but one participant. Depending on the level of demand reduction, the participants could face potential rate increases ranging from 1.3 percent to nearly 14 percent. Chapter 6 also examined the issue of induced demand reductions, that is, the additional reductions in demand that come about as a result of the increased rates. For price elasticity responses ranging from 0.20 to 0.40, additional consumption reductions in the range from 1.5 percent to 16 percent were determined. This range was determined by the level of initial demand reduction and the type of rate structure in place at the water agency.

While the short run financial impacts are negative for the water utilities, the real impacts from demand reductions can be seen in the long run adjustments to capital facilities spending. As demand reductions occur, existing facilities can be utilized for a longer period of time before additions need to be made to capacity. Planned expansion spending can be deferred or avoided altogether, providing savings both in capital expenditures and in the costs to operate the new facilities. Chapter 7 describes the long-run impacts from capital spending reductions that are induced by demand reductions. Several of the participating utilities have already experienced significant savings as a result of reduced demand levels. The study determined cost savings (on a present value basis) of hundreds of millions of dollars for one utility alone.

While the scope of the study was to examine the impacts on water utilities, Chapter 8 looks beyond water utilities to some of the external impacts that might occur when water demand is reduced. The impact on the environment that come about due to reduced diversions from rivers and streams, the impacts on the quality of life for water users, the effects on wastewater utilities, and the potential for negative results are all addressed in Chapter 8. Analysis of savings from reduced wastewater flows indicated that even a five-percent reduction in flows could lead to significant capital deferrals saving million of dollars. Though they are very difficult to quantify, the external impacts on the environment can also be quite significant from both the short- and long-term perspectives.