Dynamic Water Pricing

Abstract

Water insecurity poses threats to both human welfare and ecological systems. Global water abstractions (extractions) have increased threefold over the period 1960–2010, and an increasing trend in abstractions is expected to continue. Rising water use is placing significant pressure on water resources, leading to depletion of surface and underground water systems, and exposing up to 4 billion people to high levels of seasonal or persistent water insecurity. Climate change is deepening the risks of water scarcity by increasing rainfall variability. By the 2050s, the water–climate change challenge could cause an additional 620 million people to live with chronic water shortage and increase by 75% the proportion of cropland exposed to drought. While there is no single solution to water scarcity or water justice, increasing the benefits of water use through better planning and incentives can help.

Pricing is an effective tool to regulate water consumption for irrigation, for residential uses, and especially in response to droughts. For a water allocation to be efficient, the water price paid by users should be equal to the marginal economic cost of water supply. Accounting for all costs of supply is important even though, in practice, water prices are typically set to meet a range of social and political objectives.

Dynamic water pricing provides a tool for increasing allocative efficiency in short-term water allocation and the long-term planning of water resources. A dynamic relationship exists between water consumption at a point in time and water scarcity in the future. Thus, dynamic water pricing schemes may take into account the benefit of consuming water at that time and also the water availability that could be used should a drought occur in the future. Dynamic water pricing can be applied with the risk-adjusted user cost (RAUC), which measures the risk impact of current water consumption on the welfare of future water users.