Managing the Demand for Water John Braden University

Managing the Demand for Water John Braden University of Illinois, USA Visiting, Katholieke Universiteit Leuven Lecture 2 Leuven, Belgium March 2004

Outline 1. Economic ideal 2. Prices & elasticities 3. Realistic demand management – Ownership

Helpful Resources • Baumann, D. et al. 1998. Urban Water Demand Management and Planning. Mc. Graw. Hill. • Lallana, C. et al. 2001. Sustainable Water Use in Europe, Part 2: Demand Management. EEA, Environmental Issue Report no. 19.

Economic Ideal: Maximize Value • Water should go to the highest value uses • Equalize value at the margin value • Minimize supply costs maximize total

Maximizing Value of Water Pw Drinking Industry Agriculture Total Demand Pw Wd Wi Wa W Water

Value by “Use” (U. S. 1980)* Sector Value Indicators(1980) Price Elas. Residential $0. 25/m 3 - 0. 45/m 3 (tariffs) Indoor: 0. 1 to 0. 7 Outdoor: 0. 7 to 1. 4 Agriculture $0. 01/m 3 - $58/m 3 (deriv. ) n/a Industry $0. 02/m 3 - $0. 38/m 3 (o. c. ) M&I: 0. 2 to 0. 7 Waste assim. < $0. 01/m 3 (o. c. ) n/a Recreation & < $0. 02/m 3 (cont. val. ) Aesthetics n/a Navigation $0. 0 - $0. 22/m 3 (SR) (o. c. ) n/a Power <$0. 02/m 3 (SR) (o. c. ) n/a *Gibbons, D. 1986. The Economic Value of Water; Hanemann, M. 1998, in D. Baumann et al. , Urban Water Demand Management and Planning.

Value by “Use” (Europe 2001)* Use Sector Residential Value Indicators Price Elasticity € 50/200 m 3 - € 350/200 m 3 (tariffs) Agriculture Industry Waste assim. Recreation & Aesthetics Navigation Power • Lallana, C. et al. Sustainable Water Use in Europe, Part 2: Demand Management. European Environment Agency, Copenhagen, 2001

Price Elasticity of Demand • η = | (%Δ Q) / (%Δ P) | – If η > 1, increasing price reduces revenues – If η < 1, increasing price increases revenues • Sectoral elasticities – Domestic: 0. 2 – 1. 4 (higher in summer/arid) – Industry: 0. 2 – 0. 8 – Agriculture: 0. 8 – 1. 4 (higher w/ low-value crops)

Elasticity and Management • Low-value agriculture most responsive to price • Households & industry do respond to price • Increasing price usually increases revenue, as well as inducing conservation

Ideal vs. Real Water Management a) Geography and jurisdiction b) Marginal vs. fixed costs c) Infrastructure combines uses d) Acceptability and practicality e) Planning

a) Geography and Jurisdiction BORDER LAKE RIVER AQUIFER

Geography and Jurisdiction • Jurisdiction limits value considerations • Cost of moving water limits market scope • Externalities – Interconnected resources – Downstream consequences

Challenges to Geographic Isolation • Local vs. regional perspectives – Unitization of supply – Regional integration of use – Conveyance charges • Free trade imperatives – International uses of shared resources – Exporting embodied water

Resolving Geographic Issues • Supply – – Conjunctive management (unitization) Pricing at opportunity cost of supply Regulation of conveyance Quality regulation • Demand – Nondiscrimination – Pricing to include full costs of externalities and delivery

b) Cost of Water Supply Cw (€) Infrastructure Costs Operating Costs (MCw) Water

“Natural Monopoly” € MVw Operating costs not covered By marginal cost pricing. MCw Water

“Natural Monopoly” • High fixed costs, low operating costs • Scale and network economies • Marginal cost pricing fails to cover fixed costs

Solutions to Natural Monopoly • Sole provider (public utility) – Public ownership w/ taxpayer oversight – Private ownership w/ regulatory oversight • Two-part pricing – Connection fees – Use tariffs • Use fees – variable pricing – Cumulative quantities - resource – Peaks - infrastructure

c) Infrastructure • Current practices – – – Uniform quality standards Centralized treatment Integration of supply & conveyance Uneven metering Leakage

Smart Infrastructure • Smart technologies – – Real-time sensors Metering Quality tagging Recycling • Sophisticated pricing (e. g. , waste charges) – Peak shaving – Quality/reliability differentiation • Innovation from markets • System inventories and replacement

d ) Acceptability & Practicality • Public education – System viability – Building codes • Transparent tariff structure – – “Lifeline” rates for basic use Peak-use pricing Future needs, not previous costs Minimize cross-subsidies • Performance reporting

e) Planning • Demand forecasting – Short-term vs. long-term – Mutivariate: Population, Real income, Family structure/housing mix, Geographic differences, Economic structure – Technological shifts: Reuse, quality segmentation – Building codes – Real prices (Demand vs. extrapolation)

Planning • Infrastructure & growth – – Conserve all resources, not just water Flexibility Complementary R&R (sewer, telecom, electricity) Utilities leading growth • Supply forecasting – Alternative resources – More efficient technologies

Planning - Tariffs • Integrating demand supply • Revenues to meet full costs (future) – Adequate – Stable • Allocate costs – Fair – Minimize cross-subsidies • Provide incentives – Static & dynamic – Encourage conservation • Transparent & easily administered

Conclusions-Managing Demand • Demand as well as supply must be managed • Forward-looking, w/ mutivariate forecasting • Demand, supply, & conservation respond to price • Equity and transparency in application