Volumetric water pricing, social surplus and supply augmentation

Abstract

We evaluate the welfare losses of undertaking water supply augmentation in Sydney, Australia with a fixed, regulated water price given weather variability. Stochastic dynamic programming is used to determine dynamically efficient water prices and to estimate the losses in social surplus from premature water supply augmentation. Results show that premature water supply augmentation under the base case reduces the net present value of the welfare of households by more than $A 3 billion, or some $A 1900 NPV per household. With a broad range of parameters controlled in our sensitivity analysis, the actual construction time of the water plant is associated with a net loss, unless the lifetime of the plant is exceptionally long in combination with a low discount rate. While the findings are specific to Sydney, our modeling is of general interest because it could be employed to avoid costly and premature supply augmentation elsewhere.