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Funding water conservation efforts need attention to costs, savings and beneficiaries.

Water utilities throughout the United States are looking more closely at water conservation and other measures to supplement their more traditional supply-side water resources in meeting future water demand increases. Some now see conservation and demand-side management (DSM) efforts, such as customer audits, landscaping ordinances, ultra-low-flow toilet rebates and wastewater re-use, as the only new water resources they will need to meet their increasing needs during the next five to ten years.

Exploring these options is laudable, but several potential problems may be encountered from a financial perspective. Even if DSM resources are the least-cost resource for a utility in the long term, these programs can have significant initial costs while the benefits of these water savings are spread over many future years.

Traditionally, conservation program costs have 'been funded from current rates; however, as these costs become significant, problems may arise.

For example, a utility's shortterm revenues will be lower as water savings-result in lower customer bills unless rates are adjusted upward. Rates may be unstable over time, increasing initially to meet program costs and then declining as water savings are realized. Revenues may become variable and difficult to predict, particularly during periods of drought or extreme weather conditions, as less predictable DSM resources are relied upon. Current ratepayers may end up subsidizing future ratepayers, resulting in inequltable water rates over time. If rates are set high enough to fund DSM programs and future rates decline, water users will get the wrong price signals concerning long-term conservation goals.

For these reasons, a number of water utilities are using innovative funding and financIng techniques to meet their conservation and DSM program costs. The challenge is to match the future resource savings of each program, measured as lower overall resource costs, with the recipients of, the benefits of these savings.

The Integrated Resource Plan

An integrated resource plan (IRP) is along-term planning tool for the utility that places supply-side resource alternatives on an equal footing with DSM resources, The utility can then evaluate future supply alternatives together with DSM programs. A complete IRP will include estimates of environmental and other resource remediation costs and savings for the various resource altemafives.

The IRP provides estimates both of the long-term water savings expectations for each DSM program and of the required development and operating costs of these programs. To be selected as a viable resource alternative, a DSM program needs to be the lowest cost, or one of the least-cost, resource options available to the utility in the long term.

One useful side benefit of the IRP is the development of levelized unit-cost estimates for each possible resource that can be used for other utility purposes. For example, the summarized results of the IRP will presumably show that adopted DSM measures are cost-effective resources for the utility, which provides an effective tool to help sell the resource to 1901icy makers and potential financing markets. Also, the unit-cost estimate of selected DSM programs can be compared with the utility's current resource costs and overall rate levels to help evaluate more aggressive water conservation rates.

Because the unit-cost of new DSM or supply-side resources usually will be higher than the portion of the rates that reflect the utility's investment in existing resources, an evaluation of financing alternatives is needed. The IRP provides the utility with both a road map and a compass for examining these funding options.

Water utilities are using both traditional and innovative funding techniques to help spread the costs of DSM and other resource alternatives over the expected useful fife of these resources.

Funding Through Current Rates

This is the status quo funding method for most water utility systems, and is appropriate for any DSM and conservation programs. For example, many utilities have implemented conservation education and public Information campaigns. Such programs are on-going annual programs and future water savings are difficult to quantify.

Funding these programs from rates accurately reflects the cost/benefit relationship. However, using current rates to fund larger, more expensive DSM programs with quantifiable future savings is more debatable and likely to be less desirable.

Conservation Rate Stabilization

These funds can be useful if program implementation is several years away or moderate in magnitude. Rates are set higher than current requirements to generate revenues for a reserve fund used to spread the costs of DSM resources over a longer period. In effect, the creation of a rate stabilization fund recognizes that current ratepayers are underpaying the hypothetical cost of water sufficient to develop and ensure adequate future resources. The rate stabilization fund can be used both to fund DSM and various conservation program implementation costs, and to provide a financial cushion for the uncertain and variable effects of the DSM programs.

Utility financing of DSM Resources

Utility financing may be an option depending on the financial strength of the utility, as we]] as its size and overall marketability, and the requirements of the program. General obligation or utility system debt obligations can spread the costs of the program to coincide with the estimated fife of the resource.

Third-Party Financing of DSM Measures

Third-party financing is one of the more innovative alternatives. A private third party agrees to develop, finance and "produce" a specific level of resource savings within a set period using a DSM resource. As part of the IRP process, the utility establishes an avoided cost rate for its own development of new resources. This rate is used by private firms as a price ceiling for developing competitive price proposals to provide DSM resources to the utility. The utility evaluates the alternative proposals from technical, financial, reliability and other perspectives, and then negotiates secured contracts to pay the third party for the savings from installing or operating the DSM measures.

Measurement and verification of the resource savings are specified in the contracts, as well as the terms and calculation of payments.

Joint Financing Programs

Joint financing initiatives are potentially the most encompassing option open to most water utilities, and may provide the greatest future promise for water utilities of all sizes. A group of utilities (frequently organized at the state level) jointly form an agency or authority to raise funds to finance conservation and other utility development activities.

The numerous benefits of this innovative option include access to tax-exempt debt financing at more favorable interest rates, lower issuance costs and more flexible debt-issuance seheduling to benefit from favorable interest rate levels. The diversity associated with pooled DSM resource acquisition can also reduce the utility's risk and thereby overall system financing costs.


The unique circumstances of each water utility will determine which funding alternatives are the most practical and useful. Some combination of these options will likely be the best alternative for meeting both the funding requirements and the overall policy goals of an individual water utility.

Richard Cuthbert is an economist with R.W. Beck's Consulting Services in Seattle, and can be reached at (206) 727-4434. Pam Lemoine, also with the firm's Seattle Consulting Services, is an engineer and rates specialist. She can be reached at (206) 7274436. This article reprinted with permission from the fall issue of "Update," a quarterly publication of R.W. Beck
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Author:Cuthbert, Richard; Lemoine, Pam
Publication:Nation's Cities Weekly
Date:Jan 3, 1994
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