The Marginal Cost of Los Angeles’ Water Supply

The Situation

In January 2020, the City of Los Angeles Department of Water and Power (DWP) provided to the City of Los Angeles Office of Public Accountability/Ratepayer Advocate (OPA) a draft of its fiscal year 2018–2019 water cost of service study (COSS). The assessment of customer class revenue allocation contained in the draft was expected to be used to develop water rates that would be brought before the DWP Commissioners and Los Angeles City Council in 2021. The COSS contained elements of marginal cost ratemaking, as required by the findings, reported in 1992, of Mayor Tom Bradley’s “Blue Ribbon Committee on Water Rates.”

NERA's Role

OPA asked NERA to perform a comprehensive review of the DWP COSS to determine
whether the COSS conformed to marginal cost methodologies standard in regulated
industries, and to assess how customer class revenue allocation would change if
the COSS were better aligned with such methodologies. NERA concluded that the
COSS did not align with standard marginal cost methodologies and amended the
COSS accordingly. Most significantly:

  • Whereas DWP considered all budgeted costs marginal, NERA designated costs as marginal
    only if they were related to expected changes in water consumption;
  • Whereas DWP did not assess first-year “economic carrying charges” to annualize planned
    capital investments, as is typical in marginal cost ratemaking, NERA developed
    first-year economic carrying charges for each functional category (source
    development, transmission, treatment, distribution, pumping, local storage, and
    customer costs); and
  • Whereas DWP allocated all costs to customer classes based on customer classes’ historical
    annual water consumption, NERA allocated costs to customers based on customer
    classes’ forward-looking contributions to each functional category’s
    expected cost driver.

NERA recommended that DWP implement 13 specific adjustments to the COSS to better
align it with standard marginal cost methodologies. NERA constructed its own
version of the COSS model and implemented those 13 adjustments. The adjustments
resulted in a reallocation of costs to customer classes. The NERA adjustments
led to an increase in costs for single-family households of 0.75%, relative to
the unadjusted DWP COSS, and a decrease in costs for multi-family households of

The Result

NERA presented its findings to DWP on behalf of the OPA. At the time of writing, it is not certain when DWP will propose water rates before the DWP Commissioners and Los Angeles City Council, nor whether DWP intends to implement the suggestions offered by NERA.