Water Policy and Economics

Ron Griffin

www.waterecon.com/uade.pdf

University of AdelaideNovember 9, 2016

The Language of Noneconomic Water Policy

• need

• conservation

• governance

• transparency

• stakeholders

• sustainability

Water economic’s primary goals

• Expanding social welfare

‣ Efficiency is usually either maximizing aggregate NBs or NPV

‣ considering all resources

‣over all agents and uses

‣over time too, when applicable

‣water quantity & quality are issues

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Water economic’s primary tools

• Project & policy analysis

• Policy innovation

Pricing/signalling

• For raw/natural water: marketing

• Marketing commences with the conversion of common property to private property by the State

• For processed/finished water: pricing

• Pricing refers to rates set by utilities, often at the beginning of each fiscal year

Neither smarter W pricing

nor expanded W marketing (quantified, enforced, private property rights)

are complete solutions for our water scarcity problems,

but they are severely underutilized.

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1. It’s confusing: the output resembles the input

2. Physical supply varies over time and space

3. Water “need” is irrelevant

4. Mobile molecules survive use

• thus sequential use and reuse

• so water is difficult to track or fence

5. Water is not a public good (economically defined)

• although some water uses are

Problem elements (to water economists)

100 200 300 400

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Water Service (S=0)Water & Wastewater Service (S=1)

$/kgal

Figure 4.1 Texas Community Water Demand Functions

D1Jan

D1Aug

D0AugD0Jan

Gallons perPerson per Day

6. More water is not necessary for economic growth

7. Economics’ optimal allocation questions arise within sectors, between sectors, and over time.

8. Water is delivered by capital-intensive natural monopolies

• fixed costs dominate

• LRMC>>SRMC

• infrastructural expansion is lumpy

9. Prices commonly omit scarcity values!

Problem elements (continued)

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#10: Important instream uses

• fish, fowl, etc. habitat (use and nonuse values)

• bay, estuary, wetlands inflows

• recreation

• wastewater processing & dilution

• hydropower

• navigation/transportation

• flooding

Some public good uses

Institutional design?

• Climate change; risk & uncertainty

• snowpack; glacial recession

• noisier, more forceful weather

Problem forces

• Population & economic growth ↑ final demand

• Depletion & pollution ↓ raw supply• Stochastic weather; risk & risk preferences

Weather vs Climate

• Climate is the bounds and probabilities within which weather varies.

• So weather changes even if climate does not.

• Climate change infers weather changes.

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1. ... Very heavy precipitation events have increased nationally and are projected to increase in all regions. The length of dry spells is projected to increase in most areas, especially the southern and northwestern portions of the US.

2. Short-term droughts are expected to intensify in most US regions. Longer-term droughts are expected to intensify in large areas of the Southwest, southern Great Plains, and Southeast.

3. Flooding may intensify in many US regions, even in areas where total precipitation is projected to decline.

Quoting a US Climate Change document:

6. Increasing air and water temperatures, more intense precipitation and runoff, and intensifying droughts can decrease water quality in many ways … .

7. Climate change affects water demand and the ways water is used within and across regions and economic sectors. The Southwest, Great Plains, and Southeast are particularly vulnerable … .

10. … US water resources managers and planners will encounter new risks, vulnerabilities, and opportunities that may not be properly managed within existing practices.

So:

Not merely warmer but riskier.

So more robust policy instruments would be great to have.

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• Projects

• costly, usually C>B, environmentally damaging

• Preachments • weak signals

• Policemen – regulations • but people are different, so are businesses

• Prices

Tool types

• Volumetric price

• Flat monthly fee

• New connection fee

3 Primary Pricing Instruments

} the 2 parts

Max B(w f )−C(w f )s.t. w f ≤ kw − d where 0 < k ≤1, d ≥ 0

w ≤W

Optimal water signaling(one community)

yields FOCs that combine to say: ′B = ′C + λk

Informed, rational clients (i) consume at ′Bi = p, so

p*= ′C + λk

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Implications(one community)

• MC-pricing is efficient; • AC-pricing is not

• a uniform rate is efficient; • block or customized rates are not

• "full costs" involve both accounting costs and nonaccounting opportunity costs (λ)

Potentially relevant λ

• marginal value of water

‣ for renewable water, such as surface water

• marginal user cost

‣ for depletable water, such as ground water

• marginal capacity cost

‣ when supply constaints are infrastructural

• marginal rationing costs (minor)

Now

OptimalCapacity

year

MCC

year

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Setting volumetric prices

• Oddly, the bills from our water service providers tend to include only the value-added stuff, not the natural resource itself!

What should economists do?

• This model directs us to study costs more thoroughly

‣ accounting costs‣ opportunity costs

• Decision makers think the rate programs they design are progressive. How about some welfare analysis to examine this?

Tripping points of this theory

• Obtaining another goal: revenue = costs• fixed fees can balance utility budgets

• Assumption: consumers match their MB to p• This is actually more difficult for consumers

under tinkered rates (blocks, etc.)

• Volumetric rates don't signal location decisions• Again, there is another rate instrument to

address this

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Optimal regional water signaling(two communities with reallocation)

Max NB1(w1f )− ewre − E s.t. NB2 (w2

f ) ≥Uw1

f ≤ k1w1 − d1 ; w2f ≤ k2w2 − d2

w1 ≤W1 + rwre − dre; w2 ≤W2 −wre; r ≤1

Optimal pricing results are:

p1* = ′C1 +

λ1k1

and p2* = ′C2 +

λ2αk2

where λ2 = rλ1 − e

Optimal regional signaling findings(two communities)

• prices should be different in different places• some opportunity costs are extrajurisdictional

• such as instream flow effects, return flows, depletion of ground water

• so even econ-smart, self-interested communities won't set socially efficient water rates

• complicates "what economists should do"

So Economics finds that:

• Increasing block rates are

• economically inefficient

• often inequitable

• hard for clients to understand & respond to

• Economic inquiry is disappointed with IBRs

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W Markets: Evidence of Natural W Value

Palo Verde ID$150-350/af

Truckee-Carson$1200/af

Yakima$2000/af

lower Rio Grande$2K/af

Edwards Aquifer$6K/af

NW$22K/af

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natural waternatural waternatural water delivered water

Lease Valueper AF

Permanent Valueper AF

Permanent Value

per MLper 1000 liters

US$1500 AU$1600 AU$0.08

US$194 US$5000 AU$5330 AU$0.24

US$20000 AU$21320 AU$0.97

*Columns 1 & 4 are computed using 15% conveyance losses, 50 year planning horizon, and 3% discount rate (of time preference).

Water Wastewater

meter fee per qtr $71.60 ≥$76.75

0 - 30 kL $2.27/kL 0

30 - 130 kL $3.24/kL 0

> 130 kL $3.51/kL 0

SA Residential Water Rates 2016-17

Bill = Meter Fee +

Demand

Increasing block rate structureInncreasing block rat

0 w1 w2 w3water

p1p2

p3

$/water

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Million Gallons(per year)

Change in Net Benefits by Initial Water Use(IBR → UR)

MOC=$0

ScarcityLevel

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35

-$200

-$150

-$100

-$50

$0

$50

$100

Million Gallons(per year)

Change in Net Benefits by Initial Water Use(IBR → UR)

MOC=$0.5

MOC=$0

ScarcityLevel

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35

-$200

-$150

-$100

-$50

$0

$50

$100

Million Gallons(per year)

Change in Net Benefits by Initial Water Use(IBR → UR)

0 0.05 0.1 0.15 0.2 0.25 0.3 0.35

-$200

-$150

-$100

-$50

$0

$50

$100

MOC=$1

MOC=$0.5

MOC=$0

ScarcityLevel

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Change in Net Benefits by Incomefor MOC=$1.00

Income ($1000)

0 20 40 60 80 100 120 140 160

-$200

-$150

-$100

-$50

$0

$50

$100

Some references:

Boulding, Kenneth E. "The Implications of Improved Water Allocation Policy." In Western Water Resources: Coming Problems and the Policy Alternatives, pp. 299-311. Boulder: Westview Press, 1980.

Griffin, Ronald C. "Water Rate Policy: Prescription and Practice." In Handbook on the Economics of Natural Resources, pp. 421-41, edited by Robert Halvorsen and David F. Layton. Northampton, MA: Edward Elgar Publishing, 2015. (obtainable at waterecon.com)

Hanemann, W. Michael. "The Economic Conception of Water." In Water Crisis: Myth or Reality?, pp. 61-91, edited by Peter P. Rogers, M. Ramon Llamas, and Luis Martinez-Cortina. New York: Taylor & Francis, 2006.

Hayek, Friedrich A. "The Use of Knowledge in Society." American Economic Review 35 (September 1945): 519-30.

Contact me if you want assistance obtaining any of these.

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