Oil and Water: A Guest Post

INSERT DESCRIPTIONDavid Zetland

David Zetland, the S.V. Ciriacy-Wantrup Postdoctoral Fellow in Natural Resource Economics and Political Economy at U.C. Berkeley, blogged here earlier this week about the economics of water. This is his second of two posts on the subject.


Oil and Water
By David Zetland
A Guest Post

Over the past few months, newspapers, blogs, and television screens have been filled with stories of two precious liquids — oil and water. Although the stories seem similar (demand outstripping supply), they report fundamentally different means and success in coping with “shortage.”

Ironically, we are coping better with scarce oil — nearly 60 percent of which we buy from abroad — than scarce water, which falls from the sky.

Why such a contrast? Because oil is bought, sold, and marketed as a commodity. Water, in contrast, is treated as a “human right” that should not be allocated by price. Because scarcer oil costs more, quantity demanded falls to equal supply. Because scarcer water does not cost more, demand exceeds supply and rationing, misallocation, and hardship result.

Put differently, we would not have water shortages if water prices rose and fell with supply and demand. But prices do not change that way.

Most water users in the U.S. pay a price for water that reflects the cost of delivery. The price of water is actually zero.

Although the fixed costs of dams, pipes, etc. and the variable costs of pumping (20 percent of California’s energy is used for “moving water”) are large in aggregate, those costs are spread across many units of water. In southern California, for example, urban water customers pay about $3 for 750 gallons of tap water, most of which is imported from hundreds of miles away.

When demand exceeds supply, water managers do not raise prices; instead, they ask customers to use less. When “voluntary” conservation fails (often), managers send water cops out to ticket those who water their lawns on the wrong day, impose mandatory rationing of 20 percent, stop issuing building permits, etc. Although such methods do have some impact, their blunt nature affects people in odd, often unfair, ways.

Mandatory rationing, for example, is based on household use in prior years, which fails to reward those water misers who used less in the past and fails to recognize that the number of people in a household can change. It is also rather ineffective: Anyone who goes over quota pays an extra $1 per 750 gallons. That’s not much.

Students of bureaucracy and monopoly will note that water managers have little incentive to manage water efficiently. They can “declare” a 20 percent reduction in demand (nice round number) without worrying about the most efficient way to achieve it. They keep their jobs no matter the cost (e.g., business closures) or ineffectiveness of rationing.

Why haven’t water managers turned to higher prices?

First, because they are used to prices that reflect costs; second, because higher prices are politically difficult to impose; third, because their “public service” mandate tends to require that prices be set as low as possible and result in zero profits; and fourth, because many in the water business think that people will not respond to higher prices.

If water managers wanted to implement conservation prices that were, say, 200 percent higher than current prices, they would need political support (most urban water is supplied by public utilities; investor-owned utilities are regulated). Politicians would be able to support higher prices if the poor were protected (e.g., by giving everyone some water for free and charging more for additional water), if “excess” revenue was rebated (per capita rebates would be progressive), and if higher prices ended shortages and rationing.

Can higher prices reduce the quantity of water demanded? Yes — just as higher prices reduced the demand for oil.

When oil (gas) was “cheap,” we didn’t pay attention to how much we used. Instead, we paid attention to how fast our cars went, how long we’d be willing to drive from an affordable home to work, where to shop for cheaper stuff, etc. When prices rose (most notably when crossing the $4-per-gallon barrier), we changed our behaviors: S.U.V. sales plummeted, total driving fell, and people moved closer to work.

If water prices were raised to levels worthy of attention, we’d see the same reactions: people would reduce water consumption in the short run (not watering the sidewalk) and long-run (installing high-efficiency appliances, ripping out lawns, moving from drier places, etc.).

Let me repeat one caveat and add another: Higher prices need not harm the poor. If everyone got x gallons of water at a low price, only those who used more would pay higher prices. Second, these price-reform suggestions are relevant to urban water management, not water users everywhere. As many readers will know, agriculture consumes 70 to 80 percent of the water in the United States, and I have addressed agricultural/urban/environmental consumption elsewhere.

Bottom Line: We don’t have a gas shortage because gas is expensive; we will have a water shortage until water is expensive. Want more water? Pay for it.


David Zetland

@16/17: Higher prices CAN BE politically viable if they reduced water shortages (i.e., increased reliability) without harming the poor (i.e., some water free but pay a lot for more)

@18: Your logic is faulty. Remember that their are "life" and "non-life" (e.g., drinking vs swimming pool) uses of water.

@19: Free restaurant water is NOT the problem (in urban areas, it's landscaping). Charging something for water that costs $3/750 gallons makes no sense for restaurants.

@20: Water problems in poor countries are even more acute. See this post on India: http://aguanomics.com/2008/09/municipal-water-in-india.html

@21: You are repeating my idea. Excellent!

@22: You are right. We are worried about running out of "useful" water and conservation (via prices) is cheaper than more technology.

@23: excellent point!

@26: if you read the post carefully, you see that I propose SOME free water ("need to live quantity") and then advocate higher prices on the rest ("need for lawn"), where people CAN use less...

@27: If it's not priced now, waste will be even greater. See India link in my comment to #20.

@28: You also missed my pricing suggestion (that I've repeated four times -- arg!): some water for free to all, but those who want to use MORE water pay MORE.

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David Zetland

@Eric: Read CMSmaxi [Thanks also Nick!]

@Matthew: I'm not talking about ag water, but urban water. Keep reading until you get to "As many readers will know, agriculture consumes 70 to 80 percent of the water in the United States, and I have addressed agricultural/urban/environmental consumption elsewhere. "

@Jim: You're right. That's why I favor per capita allocations -- not allocations based on historical use.

@Sacto Mike: We'll see. Please send any documentation on the SB increase to me. I'm interested.

@Everyone else (to 11 so far): I agree!

Will

Electricity is a similar problem. The price is rising rapidly because of scarce generation, but it has not reached the point where most people consider conservation measures. Time of use pricing will eventually hit most places, but I predict it will have little impact on usage. Most people consider cheap electricity, whether it's supplied by an investor-owned utility or public utility, some kind of a right. Staggered pricing could work there, too. The first 1000 kwh is one price, the next 1000 is higher, and so on. Investing billions in more generation to meet the demand at peak times is an expensive proposition.

Nuclear Mom

Excellent piece, agree completely with the logic.

One caveat: You can't charge by use if you haven't measured use. There are areas where water usage is not metered (sometimes by law, which will need to be changed). These areas are shown to have far greater than average water usage. (Reminiscent of the consumption shift when calories are brought forcibly to our attention on menus.)

Nick

Eric (#1) says, "The economic argument on water breaks down for me because while I can live without oil/gasoline for days or even weeks at a time, it would be really hard for me to do the same with water. "

That is why Zetland says, "Let me repeat one caveat and add another: Higher prices need not harm the poor. If everyone got x gallons of water at a low price, only those who used more would pay higher prices."

Ben

I agree mostly, and I think supplying cheap water for a set amount of gallons solves the fact that to a certain point there is a highly inelastic curve for water, but people will curb usage for frivelous water usage that has a more elastic demand curve.

Sacto Mike

200 percent rate increases might not be enough. If memory serves, this was tried in Santa Barbara during the 1990s. The result was that laundromats went out of business while mansions did not notice.

A more fruitful line of questioning might be, "Why are people living in large numbers so far away from the sources of water?" Visits to Needles and Redding, followed by visits to Sausalito and La Jolla might shed some light.

jim

Our municipality just instituted demand-based water pricing, in which usage above a previously-established, household calculated "winter average" is billed at a progressively higher rate -- usage over 25% of the winter average is billed at $8.55 per 1000 gal, while usage below the winter average is billed at $3.42 per 1000 gal.

This is a massive improvement on low unit pricing and will likely be very effective at constraining water use in a drought-stricken area. However, the method for calculation penalizes residents with efficient winter use (i.e. water-saving devices in the house, front-loading washing machines, etc.) who also wish to water their lawns. They pay a higher marginal cost per gallon of irrigation water than those who run water like crazy all winter.

Matthew

The economic arguement breaks down because any change of the consunption pattern of the users of 20 percent of the water will not be as effective as changes to the users of 80 percent. And the industial/agricultural uses have all the political clout.

Imad Qureshi

I think first couple of thousand gallons can be supplied free of charge and then a dollar for every 20 to 50 gallons. I also think that poor countries that have real scarcity of water should charge their citizens under a similar mechanism.

Logan

why are so many (or at least a few) people here making the argument that "we can't survive without water, so the economic argument to raise its price breaks down."

what? not charging more for a good as demand for it increases doesn't fit with a free market model. you pay for food right? and you need that to live. and to say that you can go without gas... where do you live? you don't consume plastic, polyester, gasoline, and any product made from crude oil? are people ignorant (not in the derogatory sense) of basic economics or are there really that many socialists in the US?

Imad Qureshi

Nice piece. In fact everything is plane common sense but only if common sense was so common.

CMSmaxi

The issue with pricing water is that most individuals believe water should be a free resource, seeing as it is necessary for the most basic activities such as bathing. Society would view rising the prices on water as simply a way for companies to earn greater profits. They would not realize that the increase in price had the vital purpose of keeping the demand of water intact with the actual supply. If governments were to fund advertisements that educated people on the declining water supply, communities would be more willing to spend a bit more cash. Moreover, in order to encourage large firms and businesses to utilize lower amounts of water, the government could provide subsidies to those who used more efficient water installations. Like the author suggested, there should be an amount of water that is provided at a relatively low price and when people pass this amount, there should be a kind of tax on each additional 5 gallons or so. This would discourage people from using excess amounts.

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Eric

The economic argument on water breaks down for me because while I can live without oil/gasoline for days or even weeks at a time, it would be really hard for me to do the same with water.

A E Pfeiffer

As Eric at # 1pointed out, we can't survive without water. We can survive (albeit less comfortably) without oil.

Raising the price of water will just mean that the rich can continue to waste water, while only the poor do their best to conserve dwindling reources. Focussing on price distracts us from the real issue - we all need water. By turning it into a question of price, we lose sight of the collective responsibility to ensure that our family / community / nation / fellow human beings have adequate access to water. Instead, anyone who's prepared to pay the going price can basically use water as they like.

DJH

A lot of the places in the world with little or no potable water available, don't really have market economies, they operate at a subsistence level. How is making water a market commodity going to help them? In what way would they pay for it?

This is a good idea in theory, but not practicable in many of the places that need it the most.

DJH

Zetland's response (#30) to my comment (#27) was not a response at all, just a reiteration of his position, which unfortunately remains ignorant of what I already noted in #27, that people living at a susbsistence lvel will be unable to purchase water as a commodity.

I can only surmise that his effort to commoditize water is really just like all other efforts to commoditize things that are not already commoditized ... and that is to make people pay for things they are not currently paying for now, so that it costs them additional money to get nothing more than they already have now.

This in turn only benefits governments (which use taxation to create these additional costs) and corporations and speculators (who are able to profit from the commoditazation). IOW it's a money-making scheme, not an solution to a problem (as is claimed).

I'm still waiting for the rational reason anyone would WANT his/her cost of living to go up, while his/her standard of living remains the same.

... yeah, I didn't think there was one. 'Nuff said.

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NicWaves

The Bottom line is Energy. Like sep-12@12:59pm said, there is plenty of water on Earth, but it is very costly to make it potable and accessible to the ones needing it. If energy is cheap, like for most Americans, then they use more water, hence they have larger "water-print".
You need energy to make it potable, to create the machines to make it potable, to fabricate the equipment and pipes to transport it. You also need energy to manage waste water and transform it into potable or "safe" water.

In summary, as long as there is a problem with energy price in the world, the question if water should be priced or not is less important.

FREE ENERGY! Fusion?...when? ... Solar: Free.

Simple things solve complex problems.

Sally Dominguez

Thing is that if, as David proposes, the first x gallons are free then the process of bathing would by necessity become more reasonable bringing showers down to 4 minutes, sharing a shower :) and even using the showered water on the garden. You need to limit the freebies to help most people realize just how much water they are consuming. Only then might they stop washing the car and watering the garden with drinking water....crazy!

David Zetland

@31: Your comments make no sense. Should we not charge more when people eat more? The reason we have to charge for FRESH water is because it IS scarce (at least in many places). As to "educating" people to use less, you have more faith in education than I, who prefer to use price as a signal of scarcity.

@32: I'm NOT in favor of directing excess revenues to "conservation strategies" because these projects often have negative net present value. Better to evaluate them on a strict profit and loss basis. (Also better to rebate per capita, since that's progressive.)

@33: Higher prices induce water wasters to use less water, patch pipes, etc. Again, I'd not link price to "correct actions" (green roofs, etc.) because those actions should be taken if NPV>0 WITHOUT subsidies.

@34: Good point, but note that water in the lawn cannot be used as potable any more.

@35: Good point, but many urban systems have a FIXED amount of water to allocate. Linking urban and ag watr is a good idea, which I address elsewhere.

@36: People living at subsistence often get ZERO water when it's nominally free and must buy it (for far more) or walk to it (for time cost).

See this post: http://aguanomics.com/2008/09/does-free-water-help-poor.html

"I'm still waiting for the rational reason anyone would WANT his/her cost of living to go up, while his/her standard of living remains the same."

Nobody WANTS that, but sometimes that's what happens (more expensive oil due to political risk) or something we want (more expensive oil to reduce carbon emissions OR more expensive water to increase reliability). I am proposing higher prices to get the latter (reliability).

@37: Solar is not free. Like water (free!), it requires infrastructure to convert into use, i.e., panels for solar (now at record prices) and pipes for water...

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