A Model of Water Pricingfor Melbourne, Sydney and Perth

Report No WSAA 2

August 1989




In 1987, theWater Authority of Western Australia commissioned the Institute to set out thetheoretical principles which should guide urban water pricing decisions. Theresulting paper by Professor Ng was published in the Australian EconomicReview, 3rd Quarter 1987.


In 1988, thewater authorities of Melbourne, Sydney and Perth asked the Institute to applythese theoretical principles in a quantitative framework. The result is thepricing model reported in this paper.


The preliminaryresults contained in this report have been derived using the best datacurrently available to test the realism of the model constraints andassumptions. Some physical aspects of the water supply and sewerage systems arenot adequately modelled at this stage, and as a result, the model will befurther developed and data refined to provide a more realistic forecastingcapability which can be applied in practice. Notwithstanding, some tentativeconclusions have been made based on the initial results. These should not inany way be construed to represent the views of the sponsoring authorities.


The model usesdata on demands for water authority services and the technologies for producingthem. From these data it projects for 50 years the output levels in the waterauthority and the authority’s investments in water harvesting facilities(mainly dams), waste water treatment plants and main sewers. With the demandand supply sides in place, the model generates optimal prices for waterauthority services.


Preliminaryapplications of the model have been made for Melbourne, Sydney and Perth. Wefind that volumetric charges for water and waste water disposal in these threecities have usually been too low. Too much reliance has been placed onnon-volumetric charges (water rates) for water authority financing. This mayhave led to over-investment in water authority capital and over-production ofwater authority services. If the cost to a household of consuming an extrakilolitre of water is only 15 cents, then the household is likely to expand itsconsumption of water until the last kilolitre produces a benefit which thehousehold values at 15 cents. However, if the resources used up in producing thislast kilolitre have an opportunity cost of 90 cents, then the community wouldbe better off with one less kilolitre of water and 90 cents worth ofalternative production.


Although ourmodel indicates that volumetric charges should rise and non-volumetric chargesshould fall, we find that these changes should be introduced quite slowly. Allthree cities currently have sufficient infrastructure to satisfy the demandsfor water which arise at very low volumetric prices, especially Melbourne wherea major increase in water supplying capacity (the Thomson dam) has recentlybecome available. If volumetric charges were substantially raised in the shortrun, then demand would be suppressed leaving the existing capital of the waterauthorities wastefully under-used.


Over the next 10to 20 years as the populations of the three cities grow, the appropriate policywill be to choke off some of the resulting increases in demand for waterservices by increases in volumetric prices. At the same time, non-volumetriccharges should be lowered. In this way, the existing capital of the waterauthorities will continue to be adequately used while future over-investmentswill be avoided.


The modeldeveloped in this project focuses primarily on the promotion of economic efficiency.Such an objective is a key consideration in formulating water pricing policiesbut there are others, including the financial viability of the water authority,equity between different consumer groups and generations, environmentalconsiderations and political feasibility. Professor Ng has indicated that thepursuit of economic efficiency is also conducive to the achievement of some ofthese other objectives. Nevertheless, a water pricing model based on economicprinciples should not be regarded as taking into account all of the factorsrelevant to water pricing.


The reportcontains separate sections on Melbourne, Sydney and Perth in non-technicallanguage. A full technical specification of the model is in the appendix. Theconcluding remarks list some of the shortcomings of the model and suggestdirections for future research.



Copiesof the Report are available from WSAA, price $A40. Orders may be placed throughthe Bookshop at www.wsaa.asn.au or byemail to info@wsaa.asn.au.