By Bob Egelko

A state appeals court dealt a potentially serious blow Monday to local governments' attempts to encourage water conservation in drought-parched California, ruling that they cannot charge higher rates to big users simply because those customers guzzle more water.

Instead, the court said, cities and water agencies can charge only as much as it costs them to provide service to customers.

Tiered rates can be legal when additional water costs more to supply -- for example, if an agency must build a new recycling plant or turn to high-priced sources -- said the Fourth District Court of Appeal in Santa Ana. But the court said Proposition 218, a tax-cutting constitutional amendment that state voters approved in 1996, requires that water rates and other government fees be pegged to the costs of providing the service, and not to other factors such as government's desire to encourage conservation.

Governor criticizes ruling

"Above-cost-of-service pricing for tiers of water service is not allowed by Proposition 218," Justice William Bedsworth said in the 3-0 ruling, the first by a state appellate court on the issue. Unless overturned by the state Supreme Court or contradicted by another appellate court, the ruling will become binding on trial judges statewide.

Gov. Jerry Brown, who ordered a 25 percent cut in statewide urban water usage this month, said the ruling will "put a straitjacket on local government at a time when maximum flexibility is needed."

The ruling came in a lawsuit that a business-sponsored group filed against tiered water rates in the Orange County community of San Juan Capistrano. A lawyer for the group said the rate structure was exactly the sort of "hidden taxation" that voters sought to ban when they passed Prop. 218.

"You can't charge somebody for a service unless it's cost-based," said Benjamin Benumof, attorney for the Capistrano Taxpayers Association. "There are other ways to achieve conservation. This doesn't mean you can't have a very solid conservation program and pass on those costs to the users."

But Kelly Salt, a lawyer for statewide associations of water agencies and city and county governments, said the ruling will make it harder for governments to get users to conserve water.

Between 60 and 70 percent of urban water districts in the state use their rates to discourage excessive water use and encourage conservation, said Deborah Sivas, who filed arguments for the Natural Resources Defense Council and the Planning and Conservation League in support of tiered rates.

Bay Area agencies optimistic

Water managers at big Bay Area agencies, however, were cautiously optimistic that their rate structures will survive the court ruling. The San Francisco Public Utilities Commission, for example, changed its pricing just last year to insulate it from any Prop. 218 challenge. The two tiers for city residents reflect the cost of delivering that water, said agency spokesman Tyrone Jue.

"When you use more water, you are putting more strain on the system," he said. "You require more treatment chemicals. You require more pipeline. We've calculated out what that difference is."

The East Bay Municipal Utility District, which recently sent notices to its customers in Alameda and Contra Costa counties that rates will rise, said its new prices, too, will reflect the cost of doing business.

San Juan Capistrano enacted water rates in 2011 in four tiers, with the top charges for uses that the city classified as excessive. After a Superior Court judge ruled that the rate structure violated Prop. 218, the city appealed and invoked a 1928 state constitutional amendment that committed California to conserving water and preventing "the waste or unreasonable use or unreasonable method of use of water."

But the appeals court said Prop. 218 requires water agencies to link rates to costs while promoting conservation.

"In times of drought -- which looks increasingly like the foreseeable future -- providing water can become very pricey indeed," Bedsworth said. "There is nothing at all ... in Proposition 218 that prevents water agencies from passing on the incrementally higher costs of expensive water to incrementally higher users. That would seem like a good idea."

Calculating 'true cost'

But, he said, the 1996 ballot measure requires the agencies to "figure out the true cost of water, not simply draw lines based on water budgets."

Sivas, representing the conservation groups, said the ruling "left the door open" to tiered water rates.

"You have to show that the higher users caused the district's higher costs," she said. "The question is, can they make that showing? It's hard to tell."

Chronicle staff writers Kurtis Alexander and Carolyn Lochhead contributed to this report.

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