Regulated Monopolies for Profit - A Flawed System.

We are in the midst of a four-year drought in California. No one knows if next winter will produce enough rains and snow to break out of it or not. 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, is imposing quotas for residential customers, restrictions on how they can use water and penalties for not complying.

This post 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 reduce our consumption even more in 2015.

This post is about regulated monopolies in general and San Jose Water Company in particular. Regulated monopolies like PG&E and SJWC serve large customer bases with crucial resources they cannot live without. PG&E supplies electricity and natural gas to 16 million customers – residential, commercial, industrial and agricultural. In California, SJWC supplies water to nearly 230,000 metered connections, serving about a million people. It’s Hobson’s choice for customers who need electricity, natural gas and water in their home or office.

Monopolies like these have their customers by their balls. PG&E and SJWC know it. They probably smile all the way to the bank every month, every quarter, every year, raking in guaranteed revenues.  Consumers supposedly have the Public Utility Commission protecting their interests and regulating rate increases by these monopolies… hence the category regulated monopolies.

I believe regulated monopolies that are for profit is a flawed idea.

AN INEFFICIENT SYSTEM THAT DOESN’T WORK

Let us understand PG&E’s and SJWC’s business. Both businesses involve two key aspects:

1.   Procuring and/or producing the resource: water, electricity or natural gas

2.   Distributing it

PG&E either procures or produces electricity and natural gas; 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. Because of a need for efficiency, the second aspect of the business, distribution, tends to be a monopoly. The good news is that once the lines are laid, the cost of distribution is relatively flat and fixed over long periods of time.

Procuring and/or producing the resource being distributed have an associated market. For instance, wind, solar or fossil fuel may be used to produce electricity and the cost of electricity produced would be different from each source. Any fluctuation in rates should solely be due to the actual cost of resource being acquired.

Is that indeed the case? I am hard pressed to believe it. Let’s analyze the water retailer, SJWC. For the past five years I’ve been a customer of SJWC, and I’ve seen the water rate go up by 31% on the low end and 46% on the high end. In the same period, SJW’s market cap has gone up by 30%. Between 2012 and 2014 alone, SJW’s revenues have gone up 22% and net income has gone up 132%. All of this happened under CPUC’s watch. For 2015 and beyond, SJWC has proposed three rate increases with CPUC that I am aware of – a surcharge of 3.42% in 2015 (Advice Letter 468), a proposal to increase the rates by 12.22% in 2016, 3.11% in 2017, 5.36% in 2018. A true believer in making hay while the sun shines, SJWC is also proposing drought surcharges of 100% and 200% over and above all these rate increases (Advice Letter 473). CPUC ruling on these rate increases and surcharges is yet to happen as of this writing.

Why do I feel the concept of for profit regulated monopolies is flawed? Not only it is an inefficient system, I also believe it does not work. Let me illustrate by analyzing two applications from SJWC to CPUC.

Per Advice Letter 468, “The CPUC authorized SJWC to establish 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; SJWC filed an application with CPUC for authorization to do so. I don’t see any reason for CPUC to refuse this, so this whole process was inefficient if customers were going to be charged a surcharge anyways! Why do we need two organizations to go through this charade?

Let us analyze the General Rate Case increase application 15-01-002. This is the proposal to increase rates in 2016, 2017 and 2018 mentioned earlier. This rate increase is due to the systems and facilities being used by SJWC reaching end of their life. “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.” I will again point out that SJW’s net income has gone up from $22m to $51m or by 132% between 2012 and 2014. As a responsible customer, I do not have issues paying for required rate increases. What I fail to understand is how much of this will become SJW’s profits and how much will go to fix the issues mentioned. For that matter, why can the operating margins not be lowered to fix the issues mentioned without passing the buck to the customer? If SJWC were not for profit, the operating margins would be low and a rate increase request such as this would never be viewed with suspicion.

What incentive does a company like SJWC have to provide good service? Absolutely none! Do read the reviews of SJWC on Yelp to get a feel for the kind of customer service you get from them. I attended a meeting with the SJWC’s officials on May 28^th in San Jose. This was supposed to be a meeting with the public to discuss the drought surcharges. SJWC conducted it simply as a per-functionary meeting just to go through the CPUC process. The three representatives took no notes, there was no recording done and no transcript produced, and no consideration was given to the public opinion. To even suggest 100% and 200% surcharges 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.

Do we really need two sets of organizations, one that is for profit, publicly traded and answerable to Wall Street and another that is a government entity overseeing such a company with the primary interest of fairness and protecting consumers? Can’t we have just one organization that is run in a fully transparent manner setting their rates based on the actual cost of procuring the resource, distributing it and 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 as yet another way of promoting big government and the inefficiencies that come with it.

On the flip side, why can’t we give customers true choice? 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 core resources that cannot be given over to complete privatization.

I am sure there are other ways to skin this cat. It would require strong political will to fix this issue, though.

For now, we are stuck with the flawed system of regulated monopolies that are for profit.

One foot here, another foot there… on a road to nowhere.