Quentin Grafton, Ana Manero, Long Chu & Paul Wyrwoll (The Australian National University)
What’s the value of water? Is that value reflected in the price we pay for it? It’s probably not something many of us think about. Like death and taxes, water bills are just one of life’s certainties. Yet, in a time of high inflation, increasing water bills hit everyone, and they particularly hurt low income people who have the least capacity to pay. Quentin Grafton, Ana Manero, Long Chu, and Paul Wyrwoll have just published a global review on the ‘The Price and Value of Water’. They examine key economic concepts in relation to the price and value of water for the supply and demand of household water. Here they discuss how this understanding can help guide actions to achieve affordable water for all.
The return of high inflation in 2022-23 has forced consumers in many economies to pay close attention to the prices of pretty much everything, including their energy and water bills. The marginal value to consumers of most goods and services hasn’t changed but the prices they pay have increased. The divergence between the value of an additional unit of a good or service and the price paid is what economists call ‘Consumer Surplus’. If marginal values are unchanged for necessities like water, but real (adjusted for inflation) prices increase, consumers are worse off.
For those on above median incomes in rich countries, water bills are still affordable and, typically, represent 2% or less of household expenditures. But water supply and sewage charges are not ‘small change’. In Australia, they cost about $600 per year for a single-person household and more than $1,000 for a five-person household. By comparison, on average every Australian spends $580 per year on bottled water.
For low-income households, their annual water supply and sewage costs could be 5% or more of expenditures. Higher costs as a proportion of income also means, typically, they will reduce their water consumption more than high-income households in response to price increases.
In many high-income countries, public assistance is provided to low-income households through rebates or subsidies. Unfortunately, no such assistance is guaranteed for the poor in low-income countries. For those without access to a centralised water network in low-income countries, water costs as a proportion of their income can be much higher than 5%. Both a lack of reliable public water service and a lack of affordability contribute to hundreds of millions of people in low-income countries supplying their own water.
Costs of supply
The problem of water supply also exists in high-income countries. In Australia, some towns such as Wilcannia, in far western New South Wales, ran out of water in the last drought and relied on donations of bottled water. And for some Australian rural communities that continued to have access to water during the drought, residents had to drink water of poor quality. There is a big difference between the water quality and reliability enjoyed by consumers in big cities and the challenges experienced by remote communities, and not only in Australia.
For many city dwellers globally, the price of water includes two components as part of an overall water tariff: a fixed charge that does not vary with consumption, and a volumetric charge per unit of water consumed (in kilolitres), which may increase as more water is consumed. When the volumetric water charge increases with the blocks of the water consumed, this is called an increasing block tariff.
Delivering the lowest possible water price and full recovery of supply costs, requires that the price paid per kilolitre by water supplied to consumers equals the long-run marginal cost of the last unit of water supplied. The marginal cost of supply includes: all explicit private costs, such as the costs of maintaining water storages and the pumping, treatment, and distribution costs of supplying water to consumers; and implicit social costs, such as losses in ecosystems services and the loss of benefits in alternative uses, and loss of benefits from not keeping water in a river rather than extracting and consuming it. The fixed costs of supplying water that do not vary with the amount supplied, such as the capital costs of a dam for water storages, are frequently paid for by a fixed supply charge that is independent of the amount of water consumed by households and/or paid for by government transfers to water utilities.
Subsidies and monopolies
While the theory of water pricing is straightforward, the practice is much more challenging. This is because water is a necessity and, thus, some governments have been reluctant to raise water prices to cover all costs. The alternative to covering all costs from water prices is to subsidise water utilities, but government budget constraints frequently mean that the subsidies are not sufficient. Thus, in many places in the world, water supply services are underprovided, even when consumers are willing to pay for improved water access, because returns from increasing water supplies or improving water services are not enough to cover actual costs at existing prices.
Another challenge is that centralised water supply networks are almost always owned or operated by a single provider for a given location. Thus, if there is no direct competition in terms of who supplies the water, a water utility is monopolist supplier. In the absence of regulation or price control, water consumers would be charged a price that maximises the revenues of the monopolist water utility rather than minimising the costs of water consumers.
To avoid monopoly water prices, many governments have established independent pricing regulators to regulate the price charged to consumers and/or the rate of return on its assets. Typically, water price regulators only allow water utilities to charge for necessary water infrastructure and for the actual variable or operating costs of water supply, but not monopoly profits. In addition, to price regulation for equity reasons, water utilities are frequently required to charge customers a volumetric price for water that is independent of location within a city. When this happens, water prices are cross-subsidised by consumers; those in high-supply-cost locations pay less than they would otherwise, while those in low-supply-costs places pay more.
When water utilities are privately owned or operated as a state-owned enterprise, there must also be regulatory oversight to prevent mismanagement for the benefit of utility shareholders at the expense of water consumers. All water utilities (privatised or publicly owned) should also have supply service obligations (e.g., access, reliability, water quality, etc.) and regulations about how water is extracted and how stormwater and sewage are treated to ensure desired social, economic and environmental outcomes.
Following the privatisation of water utilities in the United Kingdom in 1989, Thames Water – Britain’s largest water service provider –increased its debt-to-equity ratio, apparently for the benefit of shareholders through a process of ‘whole business securitisation’ whereby debts were secured against future revenues. Much of this debt, however, was not spent to improve water services for customers but rather appears to have gone to former owners of the company who received billions in dividends between 2006 and 2017 while its debts skyrocketed. Not only have water consumers failed to benefit from this huge increase in the debt of Thames Water, there are claims that the company itself is in danger of bankruptcy from servicing its debts with higher interest rates.
Figure 1: A summary of the key concepts relating to the economics of the price and value of water (from Grafton et al, 2023)
Four goals of water pricing
To deliver reliable and sustainable water services at the lowest long-term price, we highlight four key goals of water pricing that need to be delivered.
1. Full-cost recovery: which means that the economic costs of the water supplied are paid for through tariffs, taxes, or transfers (Three Ts), and there is an incentive to both invest in necessary additional infrastructure and maintain existing water infrastructure.
2. Efficient pricing: the volumetric water price equals long-run marginal cost (that includes all economic costs, not just financial costs) of supply.
3. Equitable and just outcomes: so that as many people as possible, regardless of income or circumstances, have their basic human right to water met, and low-income households are not disadvantaged either in water access or in the price they pay for water.
4. Water conservation: so that water consumers are incentivised, through water prices and other means, to reduce water use when water is scarce.
See figure 1 for a summary of the key concepts outlined in this economic review.
More information: Quentin.Grafton@anu.edu.au
Grafton RQ, A Manero, L Chu & P Wyrwoll (2023).The price and value of water: An economic review. Cambridge Prisms: Water 1,e3,1–17 https://doi.org/10.1017/wat.2023.2
Professor R. Quentin Grafton is Professor of Economics at the Crawford School of Public Policy, ANU, Convenor of the Water Justice Hub, and Executive Editor of the Global Water Forum.
Ana Manero is a Research Fellow at Crawford School of Public Policy, ANU.
Long Chu is Associate Professor, Crawford School of Public Policy, ANU.
Paul Wyrwoll is a Research Fellow at the Crawford School of Public Policy, ANU, and a Fellow at the ANU Institute of Water Futures.
The views expressed in this article belong to the individual authors and do not represent the views of the Global Water Forum, the UNESCO Chair in Water Economics and Transboundary Water Governance, UNESCO, the Australian National University, Oxford University, or any of the institutions to which the authors are associated. Please see the Global Water Forum terms and conditions here.
Banner image: What’s the value of water? How does this relate to its price and cost of supply? These are important concepts to consider when attempting to make water available to all. (Image by David Salt)