How Do Price Surcharges Impact Water Utility Financial Incentives to Pursue Alternative Supplies during Drought?

Municipal water utilities commonly manage drought by encouraging conservation. Efforts to temporarily reduce water consumption can cost significantly less than investments in infrastructure to increase supply. However, reduced water sales during an extended drought can hinder a utility’s ability to recover its (mostly fixed) costs, potentially leading to lower credit ratings and higher bond financing rates. Drought surcharges have emerged as an increasingly common solution to this problem. Compared to typical restriction-based policies (i.e., residential irrigation mandates), pricing incentives increase the economic efficiency of conservation while also mitigating some or all lost utility revenue. However, drought surcharges can also provide utilities with financial disincentives for pursuing cost-effective alternatives to conservation, like water transfers or wholesale (treated water) purchase agreements, when they are available. Wholesale water purchases between neighboring water systems are playing a more prominent role within urban water management plans, particularly in growing metropolitan regions of the southeastern United States. By reducing the need for conservation during drought, wholesale purchases can help utilities avoid welfare losses associated with consumption reductions. Using simulations of changing consumption patterns obtained from the detailed billing data of a mid-sized water utility, we found that the use of surcharges can cause conservation to appear more financially attractive to utilities than wholesale purchase agreements, even when the consumer welfare losses from conservation are larger than purchase costs. Results illustrate how the pursuit of efficiency with respect to one policy option (i.e., conservation) can alter the incentives to integrate that policy with a wider range of potentially beneficial alternatives.