A vicious cycle

We learned this past week that WV American Water used to have a gas chromatograph (the equipment used by Cincinnati and other water utilities to monitor for contaminants upstream of their intake) and other chemical testing equipment at their Kanawha Valley plant, but got rid of it in 2004. This is part of a broader focus on cost-cutting by the company – which is reflected in their high and growing unaccounted for water (leakage) rate, and their attempt to cut 10% of their staff back in 2011.

It is tempting to lump these activities under the general corporate management trend over the past 30-40 years of aggressively cutting costs and eliminating redundancies, but there is a more specific dynamic at work here. WV American Water is facing a declining market. Its overall sales have been on a declining trajectory since the late 1990s, and industrial sales have declined 60% since 1991. Because so much of a water utility’s rates go to cover the cost of infrastructure that has already been built, then when sales decline the utility has to raise rates on the remaining customers to be able to cover those costs.

The Public Service Commission has tried to hold WV American Water’s rate increases in check, but this means that the company has not been able to earn much of a profit on its WV operations. WV American Water’s return on equity (the return that shareholders get for investments in WV) has hovered in the range of 4%-5.5% for the past 5 years (see p. 116 here). Utility returns on equity are more typically in the 9-10% range. Because WV American is owned by a holding company, American Water Works, that owns water utilities across the country, the WV subsidiary is essentially in competition with the other subsidiaries for investment by the parent holding company. As stated by former WV American Water president Wayne Morgan in a 2010 rate case, “Why would American Water – or any company for that matter – invest in West Virginia when it can earn much more in Pennsylvania or New Jersey?”

The Public Service Commission’s attempts to keep a lid on WV American Water’s rate increases have almost certainly played a role in the company’s decisions to cut corners on operations & maintenance. This regulatory history also probably makes the utility vary wary of making any new infrastructure investments on its own (a second intake, for example) for fear that the PSC will not let them raise rates enough to cover it.

The underlying reality of gradual economic decline doesn’t appear to be going away any time soon. That means its time for some new thinking here – this vicious cycle of rising rates and under-investment in infrastructure hasn’t worked for us in the recent past, and it’s not going to work in the future.

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