Introduction to water demand management

economicsYann Laurans

Hashemite Kingdom of Jordan – Ministry of Water and Irrigation

Agence Française de

Développement –

French Agency

for Development

Marseille Center

for Mediterranean IntegrationEnvironment and

Development of the

Mediterranean

Towards a common language

““CostCost””, , ““priceprice””, and , and ““valuevalue””

of of ““waterwater””??2

Are we really talking about Are we really talking about ““waterwater””??

� Water / H2O is supplied by nature

� When abundant, it is free

� When scarce, no one “buys” the water itself.

� Its processing: protection, pumping, treatment, storage, distribution, sanitation…

� The fact that each used cubic meter is not available for other uses

� ���� In fact, economics of water services

3/

The price of water serviceThe price of water service

� Price = exchange ratio.

�Market

� Buyer’s perspective

� Ex: the price of the water service for a household, a garage, a hospital…

� Based on the water bill from the water company

� Price = what water services buyers pay to get the service

4/

The cost of water serviceThe cost of water service

� Cost ���� Production function

� = cost of resources needed to produce a service

� Investments (pumps, dams, network…) “Capital expenditures”

� Functioning (staff, energy, …) “Operating expenditures”

� From the (service) producer’s perspective

� Cost = what it costs to produce a service (for yourself or for others)

5/

The value of waterThe value of water

� Value of water (service) for someone:

� How important is the service?

� To produce

= production value ���� value added per m3value added per m3

� To consume ���� drink, wash,…= consumer value ���� willingness to paywillingness to pay

� To provide life of ecosystems

= environmental value���� ecosystem servicesecosystem services or

avoided costsavoided costs

6/

How do prices cover costs

Assessing the recovery of costsAssessing the recovery of costs7/

The full cost of water servicesThe full cost of water services

8/ Type of costWhat does it mean? How do you measure it?

Capital

charges

The consumption of infrastructures, equipment…

The cost of loans

Capital consumption: depreciation of existing infrastructures (underestimates) or replacement. Financial costs: sum of interests

Operating and maintenance

Expenses needed to run the system: energy, staff, etc.

Based on charges, bills, staff dataSometimes needs delicate allocation

Foregone benefits from reduced other activities (limited by shortage of water)

Economic

externalities

Damages to economic activities that suffer from water shortage

or from pollution

Foregone benefits from activities that would have used a better environment and/or suffer from environmental damages.

Environmental

externalities

Damages to the environment, Loss of ecosystem services

Indicators of value of lost biodiversity. Contingent valuation,…Cost of replacing vanished ecosyst.

Benefits from other activities that would have used the water differently

(and can’t, when water is scarce)

Opportunity costs

The full cost of water servicesThe full cost of water services

9/ Type of cost How is it called?

Capital

charges

Operating and maintenance

Economic

externalities

Environmental

externalities

Opportunity costs

Water service Supply costSupply cost

Economic cost Economic cost of water service

Full costFull cost

An example of urban and industrial waterAn example of urban and industrial water

full cost estimationfull cost estimation(Subernarekha Basin, India. Source: Global Water Partnership)

10/ Valuation Methodology

Cap. ex

$ 0.066 / m3 Op. ex

Benefits foregone for irrigated agriculture: net value of crop output ($0.027), + from water returning to environment ($0.008), + from employment and food security ($0.053)

Economic

externalities

Environ-

mental

externalities

Impacts of water withdrawal on downstream users (others than irrigation)

$ 0.097 / m3Opportunity

costs

Mostly cost of pumping from the river, and supply from a large reservoirs with economies of scale. + cost of distribution and treatment for households

$ 0.017 / m3

$ 0.29 / m3 Approximated with cost of treating polluted water to original quality

Supply costSupply cost$0.066

Economic costEconomic cost$0.18

Full costFull cost$0.47

Using economic analysis Using economic analysis

to inform policyto inform policy--makingmaking11

Using economics to inform policyUsing economics to inform policy--making. making.

CostCost--effectiveness analysiseffectiveness analysis12/

Principle of Cost Effectiveness Analysis (CEA)Principle of Cost Effectiveness Analysis (CEA)

Possible options

Option 1

Transfer Option 2

Non-revenue water

reduction

Option 3

Dam

Total

annual

cost (depre-

ciation +

Opex)

Effective-ness:

annual volumes or %

of objective

Cost-effectiveness ratio

(JOD/m3 /yr)

Cost-effectiveness ratio

(JOD/m3 / yr)

Cost-effectiveness ratio

(JOD/m3 /yr)

Effective-ness:

annual volumes or %

of objective

Effective-ness:

annual volumes or %

of objective

Ranking of projects according to cost-effectiveness ratio

Total

annual

cost (depre-

ciation +

Opex)

Total

annual

cost (depre-

ciation +

Opex)

Ranking measures according to costRanking measures according to cost--effectiveness and effectiveness and

impact for households in Californiaimpact for households in California

Ultra Low Flow

Toilets

663,000 AF=

target supply in

the median term

CostCost--efficiency analysis efficiency analysis

for an Algerian Willayafor an Algerian Willaya

Cumulated cost per Hm3 / year

20

18 MDA Desalination plant Cap Djinet

16

14

12

10 Transfer from El Eulma

8

6 Leakage reduction willaya Boumerdes

4 Souk Tleta dam

2

20 40 80 100 120 Impact (Hm3/year)

Objective: 90

Hm3

ConclusionConclusion

� Economics is for raising new questions based on

comparisons

� Costs to prices and values : do prices cover costs? what

residual costs then? For whom?

� Use of water versus another foregone use: which is the

most profitable to society?

� Option / project A with Option / project B: which is the

most cost-effective? Which brings the best profitability over time?

16/

Thank you

yann.laurans@ecowhat.fr

17/

Continued -

In complement to Moroccan case

Using economic analysis Using economic analysis

to inform policyto inform policy--makingmaking18

Price elasticity of water demandPrice elasticity of water demand

� = how does demand react to price

� Ratio of variation rates. Observed demand variation divided by price variation

� If - 10 % of demand due to + 10 % of price, price elasticity ratio = - 0.1 / 0.1 = - 1

� If - 1 % of demand due to + 10 % of price ����, price elasticity ratio = - 0.1

� If demand is reduced by 20% due to a 10% price raise, price elasticity is - 2

19/

CostCost--Benefit analysisBenefit analysis

� For a given project

� Sum of costs over considered period

� Annual depreciation of capital

� Operating expenditures

� Financial costs

� Opportunity costs

� Environmental costs

� Sum of benefits (= values) over considered period

� Economic benefits: outputs & economic impacts to the economy

� Environmental benefits: value of enhanced / preserved environmental services

20/

How account for different chronological How account for different chronological

profiles?profiles?

Costs

+

-

time

Benefits

Costs

+

-

time

Benefits

Project A

Project B

Solution: discountingSolution: discounting

Costs

+

-

time

Benefits

Costs

+

-

time

Benefits

Project

A

Project

B

Reducing future values

Proportionally to how far we are from their occurrence (“year from now”, “y”)

Based on current interest rates (“i ")

Sum of discounted values = “Net Present Value”(see excel formula)

Valuing ecosystem servicesValuing ecosystem services

Eco. Functions Use - Service

Replace

Replacement cost Sustain and loose

Cost of damages

Mitigate (protect from

consequences)

Protection cost

2 balances of costs and prices2 balances of costs and prices

24

Capital

charges

Operating and maintenance

Economic

externalities

Environmental

externalities

Opportunity costs

Water billStrict balance

Water

charges,

taxes, …

Large balance

Assessing the recovery of costs Assessing the recovery of costs

by corresponding pricesby corresponding prices25/ Costs

Capital

charges

Operating and maintenance

Economic

externalities

Environmental

externalities

Opportunity costs

Price paid (example)

Environmental taxes

Water bill

Other water

charges

Subsidies

External costs

Opportunity costs

Residual costs Borne by…

Environment and its users

The other activities

The tax-payers

The user of water service

The user of water service

The user of water service

Paid by…