Department of Agricultural and Resource Economics

Water suppliers have been adopting new rate structures to promote conservation. The shift away from rates based on historical average cost toward rates based on marginal cost has been motivated by the desire to send consumers the "right" price signal about the need to conserve drinking water. The shift toward conservation rate structures, though perhaps providing better incentives to use scarce water resources wisely, has predictable effects-it changes who pays what and it increases the variability of future revenue streams to the water agency. Though the definition of the "correct" rate structure can rightfully vary in different communities-depending on the marginal cost of new supplies or avoided demand and on the community's understanding of equity-the managerial strategies necessary to cope with the uncertainty brought about by conservation rate structures are universal. Revenue instability creates direct costs for water suppliers in the form of increased costs for borrowing, to say nothing of the indirect but very real costs of more complicated planning to provide for a reliable supply of water in the future. This study empirically examines the experience of water agencies that have adopted conservation rate structures and proposes ways for using quantitative tools to: 1) measure and cope with the added uncertainty; and 2) make explicit the magnitude of tradeoffs between revenue stability, equity, and the provision of incentives for efficient use of water resources.