Inefficient and inherently flawed, regulated profit-oriented monopolies fail the people they serve.

We are in the middle of a four-year drought in California, and no one knows if next winter will produce enough rain and snow to break out of it. Water usage and conservation have become heavily debated topics, with opinions ranging far and wide. The governor of California has mandated a 25% reduction in water usage statewide.

In this backdrop, our local water supplier, San Jose Water Company (SJWC), is imposing quotas for residential customers and restrictions on how they can use water—and there will be penalties for not complying.

This article is not about the drought and water conservation; I am fully appreciative of the seriousness of the drought. My family has reduced our water consumption by 38% in 2014, compared to 2013, and we will make every effort to further reduce our consumption in 2015.

This post is about regulated monopolies and SJWC, in particular. Regulated monopolies such as Pacific Gas & Electric Company (PG&E) and SJWC serve large customer bases with essential resources. PG&E supplies electricity and natural gas to 16 million customers in residential, commercial, industrial and agricultural sectors. In California, SJWC supplies water to nearly 230,000 metered connections, which serves around a million people. It’s a Hobson’s choice for customers who need electricity, natural gas and water in their home or office.

Monopolies such as SJWC and PG&E have their customers at their mercy. PG&E and SJWC know this as they rake in higher guaranteed revenues. Consumers supposedly have the California Public Utility Commission (CPUC) protecting their interests and regulating rate increases from these monopolies—hence the category “regulated monopolies.” But the idea of regulated profit-oriented monopolies is a flawed one.

Ineffcient System That Doesn’t Work

Let us understand PG&E and SJWC. Both businesses involves two key aspects: procuring and/or producing the resource be it water, electricity or natural gas; and distribution.

PG&E either procures or produces electricity and natural gas, while SJWC is a water retailer that procures water from Santa Clara Valley Water District. It would not make sense for multiple companies to run power, water and gas lines to homes and businesses. In order to attain efficiency, the distribution tends to be a monopoly. The good news is that once the infrastructure is laid, the cost of distribution is relatively flat and fixed over a long period of time.

Procuring and producing the resource for distribution has an associated market. For instance, the cost of electricity generation from wind, solar or fossil fuel is different. Any fluctuation in rates should solely be dependent on the actual cost of resource acquired.

However, this is not the case. My water rate has gone up by 31-48% over the past five years. In the same period, SJWC’s market capitalization has gone up by 30%. Between 2012-14, SJWC’s revenues rose by 22% and net income increased by 132%, as seen in SJWC’s 2014 annual report. All of this happened under CPUC’s watch.

For 2015 and beyond, SJWC has proposed four rate increases with the CPUC that I am aware of: a surcharge of 3.4% in 2015 (Advice Letter 468); a proposal to increase the rates by 12.2% in 2016; a 3.1% increase in 2017; and a 5.3% rate hike in 2018. SJWC is also proposing drought surcharges of 100-200% over the above mentioned rate increases as stated in Advice Letter 473.

This system of regulated profit-oriented monopolies is flawed as it is inefficient, and it does not work. This can be illustrated by the following two applications from SJWC to CPUC.

As per Advice Letter 468:

“The CPUC authorized SJWC to establish [Mandatory Conservation Revenue Adjustment Memorandum Account] MCRAMA to track the revenue impact of mandatory conservation upon SJWC’s quantity revenue resulting from mandatory conservation instituted by the State of California and Santa Clara Valley Water District. As directed by the CPUC’s Water Division, the increase will be recovered via a surcharge on the existing quantity rate for a period of 12-months from the date of the CPUC approval.”

In this example, CPUC asked SJWC to institute a surcharge, and SJWC filed an application with CPUC for authorization. There is no reason for CPUC to refuse this, which makes the whole process inefficient. Since the imposition of this surcharge is guaranteed, it is inefficient for the companies to formally go through this charade.

An analysis of the General Rate Case increase application 15-01-002 reveals that the rate increase is used to replace the aging SJWC’s systems and facilities. “SJWC is proposing this rate increase due to escalating operating expenses related to water quality and safety requirements, as well as significant system infrastructure replacement requirements as the water system ages over the next several years.”

As mentioned before, SJWC’s net income has gone up by 132% from $22 million to $51 million between 2012-14.

As a responsible customer, I do not have issues paying for required rate increases. What I fail to understand is how much of this increased revenue will feed into SJWC’s profits and how much will go to fix the infrastructure issues previously mentioned.

For that matter, why are the operating margins not lowered to fix the issues mentioned without passing the buck to the customer? If SJWC was a nonprofit organization, the operating margins could be lower and a rate increase request such as this would never be viewed with suspicion.

I attended a meeting with SJWC’s officials on May 28 in San Jose concerning the drought surcharges. It was a perfunctory meeting as SJWC merely went through the CPUC process. Neither did the representatives record the conversation, nor were there any notes. As a result, no transcript was produced. To even suggest a 100-200% surcharge simply indicates to me that SJWC’s interest is not water conservation, but revenue generation.

Possible Solutions

Any problem can be fixed if we put our minds to it. Let me explore a couple of ways by which we can improve this specific situation.

Is there a need for two sets of organizations, one that is profit-driven, publicly traded and answerable to Wall Street, while the other is a government entity—overseeing the profit-oriented company—with the primary interest of fairness and protecting consumers? Can we not have one organization that runs in a transparent manner and sets its rates based on the actual cost of procuring and distributing the resource, as well as taking into account its operating costs? It is likely that such an outfit may turn out to be a government entity. A segment of the population will shoot down this idea by stating that this is another way of promoting big government and the inefficiencies that come with it.

What about giving customers the freedom to choose their utility provider? After all, with fixed distribution costs, one can argue that customers should have the choice to play in the free market of producing and procuring the resource. The other segment of the population will shoot down this proposal, arguing that water, natural gas and electricity are essential resources that cannot be given over to complete privatization. I am sure there are many other alternatives, but it would require strong political will to fix this issue.

The current situation can be summed up by the adage: “One foot here, another foot there … on a road to nowhere.” For now, we are stuck with the flawed system of profit-oriented regulated monopolies.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

Photo Credit: Eddie J. Rodriquez / Shutterstock.com

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