Water Privatization Ii: Pricing Promotes Efficiency And Conservation

This post is the follow-up to yesterday’s post on water infrastructure ownership and management, building on Arnold Kling’s original comment. See also Robert Prather’s post from yesterday, in which he helpfully provides links to his posts on the same subject.

Water is a resource that has multiple uses human consumption (residential, commercial, and industrial), recreation, sustenance of wildlife, generation of electricity, and so on. As water becomes increasingly scarce relative to our demands for its use, the staggering inefficiency and bureaucratic politicization of its allocation will become more and more costly. Market-based pricing of water use would enable consumers to prioritize their water use and would also promote conservation when it is most needed. It would also encourage increased supply when that supply is most needed, as well as inducing innovators to pursue technological change that would enhance our ability to meet our water needs. In the absence of market-based pricing, as is the case currently, little such activity finds actual commercial application, and does little to benefit society.

In many commercial and residential buildings, water consumers do not see a direct price per gallon of water they use. Charges for water use are frequently bundled into rent, and do not vary when the consumption of water varies. The connection between the use of water and the price the customer pays is either extremely weak or nonexistent in such cases. So we tend to leave the water running while we brush our teeth, use more water than we need to for washing dishes, and have little or no incentive to replace washing machines and dishwashers that use a lot of water with newer technologies that reduce water use.

Even in cases where consumers do pay monthly bills for water, and they do face a per-gallon price, that price usually does not vary when water is more or less scarce. Thus the standard invocation during drought periods to avoid watering your lawn or washing your car, and difficult-to-enforce restrictions on water use on alternate days, and so on.

Why go through such ineffectual and cumbersome machinations when a simpler approach can deliver more bang for the buck? Allowing market pricing of water would serve a variety of objectives. Even municipal water utilities could use dynamic pricing to signal relative scarcity and to induce conservation, so dynamic pricing is a policy that can be applied regardless of company ownership.

Pricing is the most parsimonious way to communicate information on the relative value of and scarcity of something across a large number of unconnected people. The benefits of competitive water markets start with efficient resource allocation through the use of prices to transmit information about prices, costs, and scarcity. Our choices in the face of prices reflect the real value that we place on things, by revealing our decisions in the face of tradeoffs. Price discovery through markets, and the ability to use prices to compare the value of water to other commodities, leads to dynamic efficiency. Thus consumers and producers can see the true tradeoffs among the wide range of potentially conflicting uses of water.

Most importantly, price signals provide simple, straightforward incentives to conserve when that conservation is most needed. Increased water prices would be more effective at reducing the demand for watering the lawn or washing the car than plaintive platitudes about the value of conservation. These market prices therefore provide users with a natural inducement to decrease water use when water is scarce, and therefore to conserve, when water prices rise. Currently, price signals do not exist to enable the movement of water from lower-valued uses to higher-valued uses. These value change over time, and prices allow for flexibility in water allocation that bureaucracies and nationalized industry do not possess.

Indeed, water pricing can be even less complicated than electricity or natural gas pricing, which in its simplest form would require inexpensive interval meters. I think that water does not have the diurnal consumption pattern that electricity has, and that to the extent it does, the peak/off-peak consumption ratio is not as large as you can get in electricity. Thus dynamic pricing over the course of the day may not be the most profitable way to price water, but perhaps day-to-day price changes would be sufficiently dynamic to induce conservation and signal scarcity. Even something as simple as an email saying that starting tomorrow morning at 6 AM, the price of water will increase from X/gallon to Y/gallon until you are informed otherwise would be a simple way to change consumer decisions (although we are not sure by how much, because the lack of actual price changes means that it is hard to estimate the price elasticity of demand for water). In any case, if suppliers thought more creatively about the value proposition they bring to water consumers, they would find pricing terms that would appeal to customers.

An overlooked feature of market-based pricing of water is that it would induce suppliers to make more water available when prices rise, just when the supply is most valuable. The most potent force behind that supply increase is likely to be technological change that can make more water available, such as desalinization. In the current ownership and pricing environment, little incentive exists to explore such technologies except in the most arid and populated areas of the world. Dynamic pricing of water would stir the creativity of entrepreneurs who would see an opportunity to profit from new technologies to treat wastewater and saltwater to make them potable, or at least usable in industrial and agricultural applications. Such a supply would simultaneously reduce strain on the supply of potable water.

This observation raises a related point: water can also be a differentiated product. Not all uses require the quality of water that human consumption requires, and even common infrastructure can transport water that becomes a differentiated product through filtration at the customer interface. As the economies of scale in filtration technology decrease (which has happened over the past decade, with your Brita or PUR as one manifestation), the business model in which suppliers can sell water as a differentiated product becomes even more viable and profitable.

Many barriers exist to such a forward-looking and dynamic approach; customers, both urban and agricultural, have gotten used to a century of subsidized and cheap water, and are not likely to support changes that would improve the efficiency of water allocation and use across the wide range of uses to which we can put water. The benefits of dynamic pricing of water are large but diffuse, and are likely to be sufficiently in the future that any increases in the current water expense of most customers would weigh more heavily in their decisions than would the future benefits of the sustainability of the water supply.

Market-based water pricing enables better allocation of water rights, and optimized use of water, among power generation, consumption, and in-stream flow for recreational and commercial fishing and boating. Continuing to base water policy on open access will lead to overuse, inefficient allocation among those excessive uses, and continuing threats of water scarcity that will endanger both human and aquatic life.

8 thoughts on “Water Privatization Ii: Pricing Promotes Efficiency And Conservation

  1. Lynne,

    I read that agriculture accounts for something like 85% of fresh water consumption in the country and had also wondered if it would be possible to use treated sewage for irrigation. If chemicals were removed you would, in effect, have water with fertilizer built in.

    I also had another thought on this: could water markets possibly act as a tool for flood prevention or minimization? You clearly have a surplus of water and if it can be predicted and a framework created, drawdowns of rivers could be done in advance of flooding.

    Just a thought and another possible benefit of a water market.

  2. I forgot to mention: that 85% is heavily subsidized, according to what I read, and farmers pay as little as $50 / acre foot of water.

    When California had a water shortage in the 1990’s, Pete Wilson arranged to buy the farmers’ water — which they were getting at the $50 / acre foot price — for something like $125 / acre foot to alleviate the shortage of municipal water.

  3. kismet,

    A quibble: it isn’t necessary for people to have advance information for their behavior to change. When I lived in the Chicago area I became sensitive to natural gas prices a couple of years ago after receiving a bill for $140 one month. The thermostat went down five degrees as soon as I received it.

    In the current environment there’s little, if any, incentive to conserve.

  4. Robert –
    Actually, I outlined that existing option – 2) providing after-the-fact pricing and hope to change behavior over the long term

    Sort of a negative feedback loop – ouch, that hurts, better not do that again ;-). But a little late in the game to have avoided the costly behavior in the first place – and to have averted the crisis if the problem was supply shortage. Only good for next time, and the long term.

    Most people understand on/off peak calling rates, and easily adapt to seasonal or on/off peak electric/gas/water rates, which are already available in many places. In these cases, prices are fixed in advance, and signal the most efficient behavior, but are not strictly dynamic.

    I absolutely agree with the general concept and long term objective of dynamic pricing. I just think we have to structure the pricing granularity to different customer classes. Hourly electricity/gas/water pricing is highly appropriate for large industrial customers.

    But I have a hard time with the idea that a residential customer could get screwed retrospectively because he was watching TV at the same hour that a nuke went offline.

  5. Water supply shortages tend not to be short term events. They may persist for months or even years, as is the case on the West Coast, and was the case in the Mid-Atlantic region until this Spring/Summer. Therefore, there is no need (and little justification) for any response that is shorter than a meter reading period. Even if meters are read quarterly. the water authority could announce that the rates were being raised as of a certain date, and long period consumption could be prorated for the current billing period. I understand that this penalizes even those who conserve during some portion of the first long billing period, but the cost of perfection is quite high while the cost of water is generally quite low. Any inequity could be largely reversed by reducing the rates at the same point in a later billing period, after the water supply problem was resolved.

    Water meters, like gas meters are not electrified, in general, so peak period measurement is not possible with most current meters; and, as pointed out earlier, is really not necessary anyway.

    Many communities provide the option of separate meters for lawn watering, which are typically billed at a lower rate because no sewer charge is included in the rate. In these cases, a separate and even higher rate could be assigned to consumption through these meters during droughts or other periods of limited water supply. These users would still get a benefit when water was plentiful, but would be further penalized when water was in short supply.

    Some communities, such as the older sections of Phoenix, still provide flood irrigation from their canal systems. This is a horribly wasteful practice and probably should be discontinued, especially during periods of limited water availability.

    As the population of the US increases, these problems will become much more severe and will require more creative solutions. Probably one of the first end uses to be curtailed will be electric power plant cooling water, which will be hard pressed to compete with human consumption and agriculture for limited water supplies. I would vote for banning grass and rose bushes in the desert next; if you want to live in the desert, live in the desert and leave “up North” up North.

    If population trends in the US continue, we will be sharing our current fresh water resources among a population of ~500 million souls by ~2050. Many once-through cooling and once-through washing applications are unlikely to survive through that period.

    Waste water cleanup and reuse is very common practice today. I don’t remember the source, but I have read that the drinking water in New Orleans, LA has been through ~11 toilets on its way to the tap. Not a pleasant thought, particularly if you happen to live in NOLA, but a modern day reality apparently.

  6. Robert,

    The potential to distill and/or desalinate water with the energy in the waste streams of electric power plants, particularly nukes, is huge. It isn’t done now because there has been limited need and the price of water is generally low.

    The plant efficiency of most steam-cycle power generators is ~33% (nukes somewhat lower), with the balance of the energy rejected through the exhaust stack or to cooling water or a cooling tower. Many power plants already use sea water or brackish water for cooling. Plant efficiency, particularly in new plants, could easily be doubled by recovering thermal energy for water purification. I believe this will become a major new source of potable water as a growing population increases demand for both human consumption and agriculture.

    NOLA merely has the distinction of sitting at the mouth, rather than the source, of a long river. The further downriver you are. the more times the water has been removed from the river, used, treated and returned to the river. NOLA also has compensations, including crawfish, gumbo and great jazz. Also, the water used to brew the beer in NOLA is further treated after it enters the plant, so there are viable alternatives to NOLA’s city water readily available. Drink up.

  7. A couple things about water competition –

    There is actually a fair amount of variety in water types (or levels of purity/cleanliness) – distilled water, drinking water, tap water, fresh water, salt water, gray water, runoff sewage, waste sewage, etc. In many places of the world, tap water is essentially undrinkable, thus we have the fairly mature market for bottled water. Competition could exist on both price and product differentiation, though the later would require a separate parallel infrastructure.

    If too many people disintermediate the utility, via cherry picking by competitors, doesn’t that drive up the per-gallon costs of universal / provider-of-last-resort service by the utility?

    Will private providers accept the risk that they could be priced out of the market during wet years? (I use as an example the lack of peaking power plants in California – peak demand is too infrequent to justify the investment.)

  8. Ed,

    Thanks for the response. I used to work in the nuclear industry — most of my time in that industry was with ComEd — and you are correct about the efficiency. The rule of thumb is that it takes 3300 thermal megawatts to generate 1100 megawatts of electricity from the turbine. The LaSalle, Braidwood and Byron plants are 1100 megawatt plants — each with dual units — which is why I chose that number.

    I’m trying to picture how the primary cooling system might be used for water purification and it escapes me. There is some steam created before the water is re-introduced to the lake / river but from looking at it, it would seem inadequate for those purposes. Can you expand on this at all or maybe provide a link to some research that’s been done on this? I have a water-market fetish, so to speak, and would love to learn more.

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