Panel Paper: Pricing Structure and Urban Water Demand in California

Saturday, April 13, 2019
Continuing Education Building - Room 2040 (University of California, Irvine)

*Names in bold indicate Presenter

Mehdi Nemati and Isaiah C Wright, University of California Riverside, School of Public Policy

Public utilities in arid regions struggle to balance supply and demand of water resources both in the short- and long-term. Most of California's water suppliers in 2015, for example, were mandated to achieve a 25 percent reduction. In addition to these short-term policies, water suppliers are required to comply with longer-term policies. An example is California’s 2018 “Make Water Conservation a California Way of Life” standards, which mandated water agencies to reduce water usage. The primary reason for conservation is financial; conservation reduces water consumption in a cost-effective and less politically sensitive manner than developing new supplies or reallocating from the agricultural to the urban sector (Kenney 2014, Kenney et al. 2011). To this end, water agencies continue to put significant effort into increasing water use efficiency, particularly in the residential water use sector, with impressive results. In California, per capita water use has decreased from 244 gpcd in 1995 to 178 gpcd in 2010 (Hanak 2016).

Utilities use a variety of tools to meet these conservation goals including price adjustments, outdoor water use restrictions, and rebate programs (Olmstead 2010). In particular, and the focus of this research, changing pricing structure is one potential demand side management approach that can be used to encourage water conservation. Although there is limited evidence of this approach’s effectiveness, initial research suggests significant potential (Olmstead, Hanemann, and Stavins 2007, Hewitt and Hanemann 1995).

Excluding smaller water utilities, there are more than 400 urban water suppliers in California that serve more than 3,000 customers each. Each of these utilities, based on the characteristics of the service area and supply sources, have different price levels and pricing structures (e.g., uniform, tiered, and budget pricing structures). These prices and their structures evolve based on utility financing requirements and conservation goals. Quantifying residential customers’ response to different pricing structures has direct implications for the water agencies, many of which are considering this strategy as a mechanism to encourage conservation. Also, considering that the popularity and prominence of alternative pricing structures have grown substantially over time, there is a critical need to understand how different structures impact water demand (i.e., the price elasticity of water demand) and how this impact changed during the drought periods.

The primary goal of this paper is to provide a deeper understanding of the effect of pricing structure on water demand to gain new policy insights. Our empirical strategy relies on panel data models with fixed effects. Price levels are obtained through a survey by the author from 200 water utilities in California. Water consumption is measured as the average monthly household consumption for each utility. Data on household characteristics is obtained from the publicly available U.S. Census and DataQuick. These household attributes are average of the lot size, household size, and income, and are averaged to the utility service area. We also included data on average maximum temperature, summertime temperature maximum, and precipitation as environmental drivers of residential water demand using PRISM Climate Group data.