After San Juan Capistrano, Can California Water Agencies Still Price for Conservation?

Yesterday, a California appellate court handed down a decision that set the water world atwitter because of its implications for some important tools needed to cope with our current drought. The decision is disappointing in that it appears to mandate additional hoop-jumping in the already complex rate-setting process, which might make it more difficult for water providers to encourage conservation through pricing structures.

In the case, a local taxpayer association sued the City of San Juan Capistrano for its rate structure, which the taxpayers alleged violated Proposition 218, a state constitutional provision that includes requirements for how local property-related charges are assessed.

The volumetric rate structure in question was designed to encourage conservation among customers by charging high water users more per unit of water than lower-volume users. So, for example, a low-volume user in the lowest tier would pay $2.47 per hundred cubic feet of water, while a very high volume user in the structure's top tier could pay as much as $9.05 per hundred cubic feet for any water use beyond the lower-tier levels. But the plaintiffs claimed that these tiered rates, created to encourage efficient water use, violated the law because San Juan Capistrano had not closely tied the different charges to the actual costs of providing the water at different levels. Additionally, the taxpayer association challenged a fee that the City charged for a recycled water system, which the plaintiffs said violated the law because not everyone who paid the fee received recycled water.

Yesterday, California's Fourth District Court of Appeal issued an opinion on both elements of the plaintiffs' claims. The court found that the recycled water fee was not unconstitutional because the recycled water system was simply a component and a cost of the overall water service. Therefore, the court held, the city was able to charge all customers for the costs of system operations and water supply reliability--even those who didn't directly receive recycled water on their property.

But the second part of the ruling, dealing with the City's tiered rate structure, is less straightforward. The court held that San Juan Capistrano's tiered water rate structure violated Proposition 218 because it charged high-volume customers more for water than it cost the city to provide the service. The court explained its view that proposition 218 requires public water agencies to calculate the actual costs of providing water at various levels of usage, which had not been an explicit part of the City's calculations in determining its rates.

There's good news and bad news in this decision.

First, the best news: The court correctly upheld the need for water suppliers to be able to allocate water system charges to all water users, even those who may not directly receive water from a given source. As California deals with the current drought and prepares for an uncertain water future, the need for both flexibility and innovation is clear (more recycled water means more available potable water!), and the court correctly determined that water agencies have the right to ensure that they're able to maintain their systems and provide water reliably.

Another benefit of this decision is that for now it creates at least a bit more certainty among water suppliers regarding how they may need to structure and justify their water rates, while still encouraging conservation. We now know that at least the way San Juan Capistrano originally conducted its rate study in this case did not sufficiently assure the taxpayers or the court that prices weren't being set arbitrarily.

Importantly, the court also upheld the constitutionality of tiered rate structures in general and acknowledged the prudence of charging higher rates where high water use leads to higher costs of service. As the court put it, "we see nothing in...the California Constitution that is incompatible with water agencies passing on the true, marginal cost of water to those consumers whose extra use of water forces water agencies to incur higher costs to supply that extra water. Precedent and common sense both support such an approach." This means that in cases where water agencies have needed to expand treatment plants or purchase additional water from more expensive sources to accommodate high-volume users, they are free to pass along these additional costs to those customers who demand the most.

But unfortunately, the opinion still leaves some questions unanswered. We're left wondering how precise a "cost of service" calculation a given agency must make before it's able to set its rates. Given fluctuations in a utility's own costs and the many different sources from which the utility may get its water, such calculations may be difficult to make, and the court does not lay out a clear standard for the level of precision required or how to account for variations in the cost of service.

And even if the decision were perfectly clear about the standard here, for now things still aren't settled and water agencies can't rest assured that this is the final word on the matter. There will likely be one or more appeals to higher courts, so this issue may not be fully settled for quite some time. Not ideal as many water providers are evaluating their current rate structures in hopes of redesigning them to promote conservation.

The court's interpretation of this particular Prop. 218 provision also highlights the urgent need for legislative reform around this issue. In these difficult times, water agencies need to be able to use every tool to encourage conservation, and studies have shown that pricing is one of the most effective.

In a statement yesterday, Governor Jerry Brown expressed similar concerns: "The practical effect of the court's decision is to put a straitjacket on local government at a time when maximum flexibility is needed. My policy is and will continue to be: employ every method possible to ensure water is conserved across California."

All Californians, including and especially our water providers, have a moral (and constitutional) imperative to conserve water. Water agencies need the flexibility to set prices in a way that reflects water's true value as a precious resource and that encourages us all to take conservation seriously.