LOS ANGELES — A California appeals court ruling is a credit negative and an impediment to the ability of California water suppliers to meet conservation mandates without financial repercussions, according to an April 30 Moody's Investors Service report.

California's Fourth District Court of Appeal on April 20 upheld a lower court ruling that the City of San Juan Capistrano's tiered water rates are unconstitutional.

Under Proposition 218 of 1996, the state constitution requires that municipalities charge no more for residential services like water supply than the actual cost of providing the service. San Juan Capistrano's rates were not based on the actual cost of providing water at each rate tier, thereby making them illegal, according to the ruling.

"This ruling is credit negative for California's urban water suppliers because it creates significant complications for implementing this type of rate structure, which was the primary way suppliers had planned to use to most recent, state-mandated 25% water conservation goals," wrote analyst Lori Trevino. "Under most current rate structures, the mandated conservation will depress water enterprises' revenues."

The court's ruling, according to Moody's, will make implementing conservation pricing more difficult and time consuming.

"Very few utilities have price schedules that meet this test and it is unclear how many have a cost structure that would support cost-based price increases between tiers sufficient to encourage mandated conservation levels," Trevino wrote in the report.

Large, more sophisticated water enterprises are expected to fare better, as they have done the necessary cost of service study to justify cost-based pricing tiers, she wrote.

Water suppliers with tiered pricing create water budgets for each customer and then charge escalating usage rates above the budgeted usage, she said. Customer water budgets can be reduced, and the higher price of usage in higher tiers both encourages customer conservation and offsets revenue declines that would normally result from reduced consumption, according to Moody's.

"Whether an individual water enterprise has a cost structure that will support tiered pricing based on high levels of water use will depend entirely on its local conditions," Moody's wrote.

Governor Jerry Brown has indicated he plans to introduce legislation that would enable water suppliers to more easily adopt conservation pricing that complies with Prop 218, according to Moody's.

Of the 411 water suppliers subject to state conservation mandates, 379 have metered water service and about 25 use tiered pricing, according to the report.

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