Home > Economics - General, Environment > Water paper for CEDA

Water paper for CEDA

February 12th, 2007

Just before Xmas, I wrote a paper for CEDA about water policy, with themes I and others have been writing on for some time, including the need to repurchase irrigation water rights for urban use and environmental flows, and some sceptical comments about the idea of a Federal takeover of water (then being pushed by Peter Costello, IIRC).

CEDA released the paper today (I did a briefing last week) and it’s had a fair bit of coverage (at least by comparison with most stuff I put out), including a nice mention from Andrew Leigh. I’ve posted the PDF over the fold. Comments appreciated.

Ceda0702

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  1. February 12th, 2007 at 20:17 | #1

    John thanks for the link and for the report. We have been thinking about the problem for the last few years and we have been working on an approach to urban water that I mentioned in a previous post. A description of the system can be found at http://www.waterrewards.org

    You will find that the system is a way of implementing many of the ideas you suggest. Namely a politically acceptable way of increasing prices and an acceptable way of funding new infrastructure. It has the potential of making an Australia Wide market in infrastructure for water savings.

    Our first attempt at a solution was a trading one where we would simply give every meter an allocation and provide an automatic balance periodically where people who consumed less than the sustainable amount were given money raised from people who used more than the sustainable amount. The idea was to increase the price for people who consumed more but to distribute the money to those who consumed less. This would enable prices for excess consumption to be raised to whatever amount was required to reduce consumption and it would meet with the approval of the Pricing Authority and not require approval each times prices needed to be raised. Because water supply is a monopoly in urban Australia the price is regulated by Pricing Commissions of various sorts and it is a long process to get prices increased to meet looming water shortages in times of drought and then you would like to reduce them again in the wet times and so you need the ability to flexibly adjust the prices. This idea was passed by Pricing Bodies and while we could not get a written guarantee that it would free up prices there were positive feedback to say that the Authority would look favourably at such a scheme. There was also another practical advantage to this scheme as it does not require any change to existing metering or collection of water charges as the system exists independent of the existing collection of money.

    When we passed this by different groups it soon became apparent that you had to base the allocations on a head count for equity reasons. You could do other schemes but the simplest one and the one that had the least number of objections was a head count per meter. However, this poses many logistics problems as in effect the system will be a census based around water meters. It is impractical to police such a scheme if it was compulsory so we invented the idea of making it a voluntary scheme that people would join as members and as a privilege of being a member then you had to report accurately the number of people served by your water meter on penalty of being excluded from the system if you disobeyed the rules. We believe that self reporting and self censorship and with the publication of the number of people attached to each meter to other members in the neighbourhood would make it likely that people would comply

    The next step in the evolution of the system was how to encourage people to spend their savings on ways of saving water so we hit upon the idea of making it necessary for money earned from saving water to be spent on ways to save water. At about the same time as this idea came up I was exposed to the marketing success of “rewards” compared to giving discounts. Putting the two ideas together we came up with the idea of giving money to people who saved water as “Water Rewards”. People will respond much better to earning Rewards than they will to getting a discount. If people wish they can advertise their Rewards and you can imagine the opportunities for groups to compete for the most Rewards.

    We also then realised that a large part of the money collected for water in urban areas is money collected for future infrastructure. Water Rewards can then be supplemented by giving the extra money for the future infrastructure as Water Rewards. For those people who cannot be bothered with spending the money on water savings things or who have run out of things they can personally do they can sell their Water Rewards to the highest bidder. Typically this will be the Water Authority who in effect will get money at discount in comparison to having to borrow from the bank.

    Once you have the idea of tradeable Water Rewards then there are other possibilities. One that we think holds a lot of promise is the ability of community groups to pool their Rewards for a community project. We are currently working with a local school who has an unwatered oval and who want to put in a scheme to catch water from the built up areas and from local roads and store for use on their oval.

    Another thing that can happen with Water Rewards is that they can be used on any approved project or infrastructure – which doesn’t have to be in the same jurisdiction. Thus in Canberra it would seem we could spend our Water Rewards on pipes in Murrumbidgee or on dams for Queensland if we had no good schemes ourselves. Money will thus tend to go where it will get the best return.

    The mechanics of looking after compliance of spending Water Rewards means that we can abolish all “rebate” schemes on water tanks etc. because people can use Water Rewards and it is possible to automatically track what the money is spent on so removing the need for people to apply for a rebate on water saving devices but for it difficult for people to rort the system.

    While at first sight it appears complicated in practice it will be simple because people will earn Rewards automatically, they can dispose of them automatically for cash, or they can spend them at their leisure. They know what their water bills are going to be and our latest slogan is they “Save not Trade”.

    The system – we think – works equally well for rural water but in many ways is simpler because the allocations are set and are traded with a separate system. If an irrigator uses less than their allocation then they can sell them or get some money to spend on approved projects. This will encourage irrigators themselves to press for an increase in the cost of water as the money from water sales does not go into consolidated revenue but will be returned to them in funds to save water.

  2. jquiggin
    February 13th, 2007 at 06:11 | #2

    Thanks for this. It sounds like a very promising idea.

  3. gordon
    February 13th, 2007 at 09:35 | #3

    Prof. Quiggin’s idea of a free basic allocation of water for individuals and KCox’s idea of tradeable Water Rewards both remind me of Flemings idea of individual carbon allocations coupled with a market for carbon savings. The Tyndall Centre did a paper (.pdf) on the idea.

  4. Kevin Cox
    February 13th, 2007 at 10:34 | #4

    gordon thanks for the reference. I knew the idea had to have been proposed before but was unable to find any references and that concerned me.

    Water Rewards is the same as Flemings idea and we have been suggesting a variation on it as an idea for carbon credits – but I have called them “Cleans” because Carbon Credits are associated with Carbon Trading. Carbon credits are new form of currency which can only be used on certain activities. From the point of view of “the system” it doesn’t matter how you create or distribute the currency as long as you give it to enough people for them to spend and when they spend it they get a benefit. However, once you accept the idea that it is the spending of the money on appropriate things that is the important issue you do not have to worry about trying to get a “true price” for carbon through trading or emissions control but simply put a surcharge on all purchases that involve the emission of carbon. You put enough of a surcharge to give enough money to invest in carbon reduction measures. My back of the envelop calculations say that we can eliminate carbon emissions from energy generation within ten years with a surcharge of 30%. Note it is not a tax but is a savings. We have given a slogan to the approach of Save not Trade.

    Carbon Trading has many similarities to Urban Water Trading and I will put up another post on why Urban Water Trading is unlikely to work and I expect similar arguments will apply to Carbon Trading but I have not thought about it for very long.

  5. Kevin Cox
    February 13th, 2007 at 10:37 | #5

    Comments on Tim Fisher article in AFR 13 feb on Urban Water Pricing

    The concept of creating tradeable water allocations has much theoretical merit but it would be difficult for urban household users to accept and operate. It is unlikely to lead to investment in water infrastructure because it does not solve the underlying problem of a single natural monopoly urban water supplier. It will solve the problem of urban water restrictions by rationing on price and it may be appropriate for large commercial users and irrigators who have genuine alternatives but not for most urban water users.

    Urban users do not want to become urban water traders. They do not want to go to the effort of trying to work out their consumption of water and they do not want to have to pay large amounts of extra money for water they have already consumed. They want certainty over the availability of water and the price of the water and they do not want water restrictions. Urban water users do not use water for profit making activities. There is no price/benefit equation and the price required to cause someone to reduce the number of times they will flush the toilet is many times the current cost of one or two cents.

    Already in cities like Canberra consumers pay on average $1.65 per kilolitre for water which is above the cost of supply obtained through increasing the storage capacity of existing dams – or in coastal cities the cost of desalination.

    The price of water is already high enough to pay the marginal cost of increasing water supply. As this is the case we have to ask the question on why we have water restrictions? Increasing the price of water through trading schemes may replace water restrictions by edict with water restrictions by price but it will not solve the problem of increasing the supply. If increased supply was only dependant on price then it would have happened already. If this is true then Water Trading is unlikely to increase supply and is likely to make the situation worse. The most likely scenario is for the monopoly water suppliers to decrease supply below the sustainability level so as to increase scarcity and so increase the cost. The monopoly supplier will then release some water to meet the demand at the higher rate. This is what has happened with existing urban water supplies where the monopoly supplier has taken large profits, not increased supply and has restricted consumption when there is a drought by water restrictions. Allowing the monopoly supply to increase prices as the rationing mechanism is guaranteeing that prices will increase and that supply will continue to be limited. The monopoly supplier will not only not increase supply but continue to restrict other organisations increasing supply water through such ideas as storm water harvesting.

    The temptation to increase the financial yield by limiting the supply of water in times of plenty as well as times of scarcity will be very difficult for governments of all persuasion to resist.

  6. Kevin Cox
    February 13th, 2007 at 13:13 | #6

    I have had a closer look at Flemings idea on Tradeable Allocations and while there are some similar elements to Water Rewards there are some fundamental differences. Tradeable Allocations are a “rationing” device where the allocations are a commodity. The nice thing about them is that unlike Carbon Taxes and Carbon Credits they are distributed thoughout the community so making for more efficient “expenditure” of the commodity. However it is still basically a Carbon Trading scheme but it still has the problem of setting of allocations or creation of the commodity being subject to manipulation. It is more difficult to manipulate than giving the commodities to the government, it will still result in wild price variations if the allocations are set wrong and there is no guarantee that the monies obtained from selling the allocations will be spent on reducing carbon emissions so the system relies on price.

    In contrast a system based around the invention of a new currency as opposed to a new commodity is less subject to manipulation, will give stable prices, and will guarantee that money will be spent on the problem being addressed as well as giving price signals. Something like Water Rewards are positive, are easier to adjust in terms of getting the result wanted, I think easier to explain (because people are familiar with frequent flyers) and are easier to administer. The main area of manipulation is in defining where the currency can be spent. However, rorting of the system in the sense of diversion of the money to things other than reduction of greenhouse gases is easy to detect, can be easily punished (you don’t give people any of the currency) and rorting will have little effect on the desired result.

    I think the fundamental difference between Water Rewards and Schemes based around trading is that Water Rewards creates a new currency for a special purpose while Trading schemes create a commodity for trading in the old currency. Because Rewards are a currency they are easier to control and harder to manipulate – and there is a limit to the damage that can be inflicted because there is a cap on the value of the Rewards whereas with Trading there is no cap on the value of the commodity and we can get the Californian Electricity Enron experience.

    This may be an incorrect understanding and I would very much like to hear from an economist.

  7. IlCattivo
    February 13th, 2007 at 17:37 | #7

    Kevin sez:
    “In contrast a system based around the invention of a new currency as opposed to a new commodity is less subject to manipulation,”

    Sounds great: Fiat Water. With Fiat Water, you wander out to the garden and you tell the plants how much water you’ve got in the bank, and you put the kids in the empty bath and tell them how wonderful it’ll be when all that lovely interest builds up and you can afford to withdraw a bit.

    Lets just hope there isn’t a run on the water bank!

  8. February 13th, 2007 at 19:35 | #8

    IlCattivo Water Rewards can be thought of as water in the bank as it is money that can only be spent on ways to increase the supply of usable water be it through recycling, or water saving technologies or desalination or new dams or… We also hope that there will be a run on the bank because that means the money is being spent on water sustainability. One thing that we forgot to mention is that Water Rewards do not earn interest because we want to encourage people to spend the Rewards and so increase supply.

    Thanks for pointing it out as it is another way of explaining the concept. Water Rewards are the equivalent of future water but you do not get the water until you spend the Rewards. Unfortunately it is a bit too subtle so I don’t think we will use it in our promotions.

  9. pablo
    February 13th, 2007 at 19:54 | #9

    John, can I get you to ‘deep throat’ on a country NSW decision that I, as a ratepayer on level 4 restrictions over water use regard as quite incomprehensible. Downstream of our town sewerage water treatment station (tertiary treatment – approx 1350 Ml perannum) three landowners have benefitted for a number of years with free water. This unwritten arrangement suits Council as their tertiary treatment ponds lie on a floodplain and in the event of a flood, Councils sewerage overflow could reach the distant river. I feel this old world approach is no longer tenable as the water volume is about one quarter of annual town use and that at the very least these landowners should be paying at least 10 cents per 1000 lt as I beleive your study found.

  10. Terry Dwyer, ANU
    February 21st, 2007 at 20:54 | #10

    The top price for water in Canberra-Queanbeyan is $2.29 per kl and is quickly reached.

    The cost of new water from the proposed Tennent Dam if cost were all recovered from future volumetric charges was estimated at around $1.20 per kl.

    If instead the dam were sensibly financed by land rates marginal cost could be as low as 10 cents per kl.

    But since when have we seen pricing tribunals look at short run marginal cost or consider the optimality of meeting fixed costs through rates on land serviced by infrastructure? Have they ever heard of Hotelling and Vickrey?

    Hence my letter below to the Financial Review today.

    “Henry Ergas (“Muddying the water no helpâ€?, Letters, February 16) is quite wrong when he says urban water prices are too low. As an example, in the ACT, the long-planned Tennent Dam would cost less than $250 million and add two and half years’ reserves. This cost could be easily paid off by 100,000 households within a couple of decades through an average $200 land rate increase per block serviced. Once the fixed cost is covered and the dam fills, the scarcity rent for stored water would drop to zero and the marginal cost of supplying the stored water would drop to an operating cost of around 10 cents per kl. By contrast the ACT Government is charging up to $2.29 per kl, more than 35 to 900 times what some inland irrigators pay.

    If Mr Ergas wants proof of monopoly abuses by Governments in water supply, the $90 million being extracted annually by the ACT Government from water assets it never paid for is a pretty good starting point. Urban water pricing represents a perversion of economics – the making of profits out of manufactured scarcity instead of supplying the market. It has nothing to do with rationality, economic or otherwise and urban water restrictions have more to do with a perverted Brownshirt eco-fundamentalism which sees a quasi-religious virtue in the vexations and oppressions which are daily visited upon millions of householders.”

  11. pseudonym (econowit)
    February 22nd, 2007 at 05:50 | #11

    If anybody “wants proof of monopoly abuses by Governments”

    In NSW, you need look no further than ‘IPART’ to find prime evidence of a price regulator that is rubber stamping systematic price gouging by statutory monopolies; just to feed the Iemma Governments addiction to revenues.

    The Iemma Government have syphoned off $4 billion out of Sydney Water over the last ten years. More than twice the money needed to pay for a new dam in the upper Shoalhaven at ‘Welcome Reef’.

    http://www.theaustralian.news.com.au/story/0,20867,21195842-601,00.html

  12. John Gunthorpe
    March 23rd, 2007 at 12:05 | #12

    John Irrigators have recieved a lot of bad press in recent years but as i’m sure you are aware they are some of Australia’s most efficient users of water, not only this but are at the forefront of cotton research and development as well as adding around 1.7 billion dollars to the economy. It is my belief that if we attempt to remove water rights from cotton growers in Australia that this research with discontinue leaving the expanding irrigation schemes of south America, China and Southern Russia without such technology. Surely with the continued population growth clothing the masses must be seen as a priority. I am aware that the point may be raised that this technological advancement will conyinue overseas however i am very doubtful as the reason for such efficient use of wter in Australia was due to the limited supply of water and with these other schemes not suffering from the same problem i am affraid that this development will end.

  13. jquiggin
    March 23rd, 2007 at 18:05 | #13

    I’ve been very critical of the practice of demonising particular crops, such as cotton, or proposing that particular industries be deprived of water rights. That said, we must ensure that water is allocated to its most socially valuable purpose. If cotton farmers choose to sell their entitlements, I don’t think we should stop them.

  14. Peter Wood
    April 21st, 2007 at 18:22 | #14

    A very minor typo: twice on page 5 and in the reference on page 21 “WAter Corporation (2005)” has the ‘A’ which shouldn’t be capitalised

  15. April 18th, 2008 at 01:53 | #15

    Australia does need to reduce the total allocation of water rights for irrigation and I accept reluctantly that some compensation will be made but irrigators ought to contribute as well through an efficiency levy. After all if the right wing Thatcher government could introduce such a levy it should not be beyond the current centre government in Australia

    We should not panic and reduce the irrigation to reflect the recent drought but introduce a larger buffer of annual water rights. If the risk of using these rights is too great to interest rice and cotton growers then we need a drought insurance scheme. For details see my web site where I outline the insurance needed for dryland farming. The scheme could easily be modified for irriagtion.

    Urban users can certainly buy their water from irrigators but the failure to introduce a progressive pricing policy in Australian cities (there was a crude system in Adelaide 20 years ago) means that huge amounts of water are wasted. In parts of Adelaide wasting water is the new status symbol. After the 4X4 gas guzzler you have large areas of green lawn – at least you will when the current restrictions are lifted.

    Brian Chatterton, Former Minister of Agriculture SA.

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