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Optimal water tariffs and supply augmentation for cost-of-service regulated water utilities

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  • Grafton, R. Quentin
  • Chu, Long
  • Kompas, Tom

Abstract

We describe how a common method for regulating water utilities, cost-of-service regulation, can both in theory and practice result in the premature and economically inefficient water supply augmentation. Using a dynamic model calibrated to demand and supply conditions in Sydney, Australia we show how to optimally determine the time to supply augment using a ‘golden rule’ that minimises the average volumetric price paid by consumers. Our results show that, the greater the water scarcity and the longer the operational life of the additional supply, the sooner is the optimal time to augment. Based on our findings, we recommend that price regulators of water utilities adopt an historical cost less depreciation basis for a regulated asset base and a fully flexible and dynamically efficient volumetric pricing that accounts for the marginal opportunity cost of water supplies.

Suggested Citation

  • Grafton, R. Quentin & Chu, Long & Kompas, Tom, 2015. "Optimal water tariffs and supply augmentation for cost-of-service regulated water utilities," Utilities Policy, Elsevier, vol. 34(C), pages 54-62.
  • Handle: RePEc:eee:juipol:v:34:y:2015:i:c:p:54-62
    DOI: 10.1016/j.jup.2015.02.003
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    References listed on IDEAS

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    1. Commission, Productivity, 2011. "Australian’s Urban Water Sector," Inquiry Reports, Productivity Commission, Government of Australia, volume 2, number 55.
    2. Hugh Sibly & Richard Tooth, 2008. "Bringing competition to urban water supply ," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 52(3), pages 217-233, September.
    3. R. Quentin Grafton & Tom Kompas, 2007. "Pricing Sydney water ," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 51(3), pages 227-241, September.
    4. R. Quentin Grafton & Michael B. Ward, 2008. "Prices versus Rationing: Marshallian Surplus and Mandatory Water Restrictions," The Economic Record, The Economic Society of Australia, vol. 84(s1), pages 57-65, September.
    5. Michael H. Riordan, 1984. "On Delegating Price Authority to a Regulated Firm," RAND Journal of Economics, The RAND Corporation, vol. 15(1), pages 108-115, Spring.
    6. Guasch, J. Luis & Laffont, Jean-Jacques & Straub, Stéphane, 2008. "Renegotiation of concession contracts in Latin America: Evidence from the water and transport sectors," International Journal of Industrial Organization, Elsevier, vol. 26(2), pages 421-442, March.
    7. R. Quentin Grafton & Tom Kompas & Hang To & Michael Ward, 2009. "Residential Water Consumption: A Cross Country Analysis," Environmental Economics Research Hub Research Reports 0923, Environmental Economics Research Hub, Crawford School of Public Policy, The Australian National University, revised Aug 2009.
    8. García-Valiñas, María de los Ángeles & González-Gómez, Francisco & Picazo-Tadeo, Andrés J., 2013. "Is the price of water for residential use related to provider ownership? Empirical evidence from Spain," Utilities Policy, Elsevier, vol. 24(C), pages 59-69.
    9. Whittington, Dale & Hanemann, W. Michael & Sadoff, Claudia & Jeuland, Marc, 2009. "The Challenge of Improving Water and Sanitation Services in Less Developed Countries," Foundations and Trends(R) in Microeconomics, now publishers, vol. 4(6–7), pages 469-609, September.
    10. R. Quentin Grafton & Tom Kompas & Hang To & Michael Ward, 2009. "Residential Water Consumption: A Cross Country Analysis," Environmental Economics Research Hub Research Reports 0923, Environmental Economics Research Hub, Crawford School of Public Policy, The Australian National University, revised Aug 2009.
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    Cited by:

    1. repec:spr:waterr:v:31:y:2017:i:10:d:10.1007_s11269-017-1606-9 is not listed on IDEAS
    2. Cooper, Bethany & Crase, Lin, 2016. "Governing water service provision: Lessons from Australia," Utilities Policy, Elsevier, vol. 43(PA), pages 42-47.
    3. Molinos-Senante, María & Donoso, Guillermo, 2016. "Water scarcity and affordability in urban water pricing: A case study of Chile," Utilities Policy, Elsevier, vol. 43(PA), pages 107-116.

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