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Establishing Water Rates for California’s Regulated Water Utilities

As with government-owned water providers, rates for regulated water utilities are set and approved by public officials. In California, the California Public Utilities Commission (CPUC) sets the rates and service terms for California’s largest regulated water utilities every three years after an exhaustive review, as required by state law. Rate setting is always a public process, and it includes the opportunity for input by all interested individuals and groups, especially customers.

View a video on the rate-settting process and how to provide input:

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Here’s how the rate-setting process works:

  • Utilities submit a General Rate Case (GRC) application to the CPUC. This application details and fully supports projected sales and customer growth (if any), proposed investments in wells, pumps, treatment plants, pipelines, supplemental supply projects, conservation programs and other costs of operating the utility (including water and power costs, taxes, employee salaries, health care costs and benefits).
  • On behalf of the CPUC and in its role of representing customers, the Public Advocates Office analyzes the GRC applications, checks to make sure they are complete, prepares a report on each utility’s operations and makes a recommendation on the utilities’ rates and terms of service for the next three years.
  • The CPUC’s Administrative Law Judge overseeing the general rate case then hosts public hearings in the local service areas to receive input on the application directly from customers.
  • If the parties to the proceeding, which include other entities besides the utility and Public Advocates Office, cannot reach a settlement in the case, the Judge holds a formal hearing. This is similar to a court proceeding, with presentation of evidence for the formal record, legal briefs, testimony, cross-examination and other elements of formal court proceedings.
  • The Judge issues a Proposed Decision that contains all findings of fact, conclusions of law and ordering provisions. After all parties are provided an opportunity to file written comments on the Proposed Decision, the five-member CPUC issues a Final Decision. Only then can the utility put its new rates into effect.

The entire process–which is entirely open to customers and the public, whether they choose to become parties to or just to follow the case–usually takes 12 to 18 months, but can often stretch to two years.

Factors that affect rates

Among the factors that affect water rates are the age and physical condition of the water system’s infrastructure; the quality of the water and the extent of treatment required to meet regional, state and federal regulations; the level of existing and needed investment in water supply, water treatment and distribution infrastructure; and geographic location.

Other factors include the level of sales, the impact of weather, droughts and conservation efforts on sales, the number of customers, the degree to which economies-of-scale can be applied and the type of financing used to fund needed investments.

All water providers (whether government-owned or regulated) must make system improvements in order to provide a reliable supply of water and to meet increasingly stringent water quality standards. Deferring maintenance and needed reinvestment in the system only leads to higher costs in the future. These system improvements, together with the ongoing costs of utility operations, continue to affect water rates. Most important, though, the regulatory process ensures that water rates accurately reflect the true costs of providing service.

Water conservation and rates

Some customers may ask: Why do my rates go up when I reduce my water use? And why isn’t my bill reduced by a proportional amount? It’s a good question, and the explanation requires an understanding of how water utilities operate, the role of fixed and variable costs, how these costs are reflected in service charges and quantity rates, and how other charges are reflected in the customer’s bill.

Water rates are based on a simple concept–recovering costs needed to operate and maintain the water system. Many of the costs to treat and deliver water to homes and businesses are fixed. These include water mains or pipes, wells and pumps. Variable costs include the costs of water, electricity and chemicals that change, based on actual water use.

Theoretically, fixed costs should be recovered in the billing period’s service charge, and variable costs should be recovered in the commodity (or quantity) rates. However, this is often not the case for two primary reasons: A high percentage of a water utility’s total revenue requirement requires fixed costs. Also, policymakers require a significant portion of fixed costs to be recovered in the quantity charge in order to encourage conservation. But when sales decrease, rates must still be set to cover all fixed costs. The result is that virtually all customers see fixed costs in the “water used” component of their monthly bill. Still, customers who do conserve water will pay less, even with increased rates.

When customers conserve, it helps preserve our precious water resources and is especially important during prolonged droughts. But, regardless of how much water is consumed, a water provider’s fixed costs will remain the same. This means that there can be a monthly bill even when the customer uses no water at all. But it also means that a water provider may not be able to recover fixed costs because of conservation or mandates to conserve water. And this leaves water utilities in the challenging position of having to increase the quantity rates charged to customers in order to recover these fixed costs, or “lost revenues,” as they are sometimes known.

However, this does not necessarily result in a higher water bill—it still depends on a customer’s actual water use.

Do regulated water utilities make a guaranteed profit?

No, not in the traditional sense of being able to “charge whatever the market will bear” and earning a “margin” on sales of the product or commodity (i.e., on the excess of that price over the costs of producing the commodity–in this case, water).

In short, regulated water utilities do not make a profit on the sale of water. However, the California Public Utilities Commission does allow as a cost of service a “fair” or “reasonable” rate of return on equity–the money companies use to invest in the infrastructure needed to reliably produce water, safely treat it to applicable standards and then deliver to homes and businesses. This return is more akin to the interest paid to bondholders, not a “profit” margin on the sale of the water. It amounts to about 9 percent of the capital invested in the water system and is not a guarantee. The companies earn that rate of return only if they manage the business efficiently by controlling costs, planning properly and investing prudently.