Case Study 7: Determining Water Rates
Pages 8

Case Study 7: Determining Water Rates Determining a water rate, which is the price a consumer pays for water delivered by a water utility to his or her residence or company, is well documented for a range of methods (NRRI, 1990). A water utility may be publicly owned or privately owned. Ownership makes a difference, since the water rate for privately owned utility includes a return on equity (ROE), a payment expressed as a percent that is made to shareholders who provided capital for the utility. Water utilities typically do not sell water in competitive markets, so they are treated as monopolies. As a result, their water rates are set by a unit of government, a municipality, or other local government in the case of most publicly owned utilities, or by a state utility commission in the United States in the case of privately owned utilities. A water rate may be treated as a value of water in the uses to which the rate applies. The utility presents its expenditures, which are in turn recognized as needing a revenue stream to be paid by consumers based on rates applied to projected amounts of water purchased. For the purposes of this discussion, a simple approach will be described, followed by a case example. Water rates are determined based on the expenses of the water utility, which generally include the following expenditures in Exhibit CS7.1:

The simple cost-of-service approach that relies on a specifi ed rate of return (ROE) on the utility’s capital investment follows from this basic equation (NRRI, 1990, p. 40):

= + + +RR O&M (RB)D T r

where RR = annual revenue requirement O&M = annual operation and maintenance expenses D = annual depreciation expense (representing the change in the value of the utility’s property

from last year to the current year, usually set by law or the regulatory agency) T = annual taxes (sales and income) r = rate of return RB = rate base (adjusted for accumulated depreciation)

(Rate base is the value of a water utility’s property used in computing an authorized return under the applicable laws and/or regulatory policies of the agency setting rates for the utility. [NRRI, 1990, p. 193])

The revenue requirement, RR, is used then in setting water rates, usually by customer category (such as residential, commercial, agricultural irrigation) and/or by time of year (such as winter and summer). A range of rate-setting techniques are available and were summarized previously.