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Working document by the Commission services
Water pricing policies in theory and practice
Accompanying document to the Communication by the Commission COM()
Pricing policies for enhancing the sustainability of water resources
TABLE OF CONTENTS
1.Introduction...... 3
2.Basic concepts and theory...... 4
2.1.Water, services and uses...... 4
2.2.Costs, prices, charges and taxes...... 4
2.3.Water pricing and economic efficiency...... 5
2.4.Pricing structure...... 7
3.A review of water pricing policies in the European Union...... 9
3.1.Key characteristics of the water availability, water use and management...9
3.2.Water pricing structures...... 10
3.2.1.Household water pricing...... 10
3.2.2.Agricultural water pricing...... 10
3.2.3.Industrial water pricing...... 11
3.3.Price level and cost recovery...... 11
3.4.Dynamics and trends of water pricing policies...... 13
4.Water pricing policies in accession and developing countries...... 15
4.1.Water pricing in the context of enlargement...... 15
4.2.Water pricing policies in developing countries...... 16
4.3.International financial and development institutions...... 17
5.Investigating the impact of water pricing policies: economics, environment and society 19
5.1.Sector demand and elasticity...... 19
5.2.Environmental impact...... 20
5.3.Consistency between infrastructure development and pricing...... 21
5.4.Water bills and affordability issues...... 22
5.5.Competitiveness of economic sectors...... 23
Annexes …………………………………………………………………………..…. 25
1.Introduction
As part of its overall strategy for promoting the use of economic instruments to implement environmental policies, and in line with the proposed Water Framework Directive, the Commission has prepared the Communication entitled Pricing policies for enhancing the sustainability of water resources. Its purpose is to present the issues surrounding, and options for, the development of water pricing policies that enhance the sustainability of water resources.
The present document summarises the theoretical and empirical analyses that support the key messages presented in the Communication. It reviews theoretical concepts and issues (Section 2), existing water pricing policies in the EU Member States (Section 3) and existing water pricing policies in other countries of direct relevance to EU policies (Section 4). The document also assesses the impact of existing pricing policies (Section 5) with regards to economic, environmental and social objectives.
2.Basic concepts and theory
2.1.Water, services and uses
Water as a good has many different quantitative, qualitative and ecological characteristics. Water supply and demand have strong spatial and temporal variability that explain in large part of the difficulties in managing this resource. And water can have the characteristics of a private, common or public good, according to the water services considered and the institutions in place.
It is common practice to divide users into use categories. These include the traditional economic sector uses, e.g. agriculture, industry, energy (hydro-electricity or cooling), domestic and navigation. It also includes environmental uses, e.g. a natural waste-treatment role through dilution, habitats for wildlife and fish and recreation. Each use is characterised by specific water supply requirements and impacts on water bodies. Some uses lead to limited modifications of water bodies (e.g. cooling), while others significantly consume or pollute the water they receive (e.g. agriculture and industry)[1], or alternatively modify the environment (infrastructure building).
There are a number of technological services that deal with both water quantity and quality issues. These include abstraction, storage or any significant physical modification of water bodies, distribution and treatment of raw water, collection and treatment of wastewater, and emission of water back to natural water bodies. The relative importance of these services varies greatly from one use to the other.
2.2.Costs, prices, charges and taxes
Developing water pricing policies requires a proper definition of the costs of the provision and consumption of water and water services. Three main cost types are defined:
(1)Financial costs include the costs of providing technological services and the costs of administering these services. They include operation and maintenance costs, capital maintenance costs, capital costs (principal and interest payment, and return on equity where appropriate).
(2)Environmental costs: these costs represent the costs of damage that water uses impose on the environment and ecosystems and those that use the environment (e.g. recreation, see Box 1)[2].
(3)Resource costs represent the costs of foregone opportunities, which other uses suffer (in the present and in the future) due to the depletion of the resource beyond its natural rate of recharge or recovery.
If a consumer or producer undertaking an activity does not take account of (i.e. internalise) the environmental costs linked to this activity, then external effects or externalities remain that may affect the viability of water resources.
The term water price is used in this document in its very general sense. It is defined as the overall monetary amount paid by users for all the water services they receive, including the environment[3]. It includes water quantity and water quality aspects. It usually comprises different charges and taxes[4] related to water supply and sewerage and wastewater treatment services, and to environmental costs linked to water abstraction and emission of pollutants to natural water bodies. The term also covers the charge for the marginal unit of water and/or the marginal unit of pollution.
The term Full Cost Recovery (FCR) will be used when water prices recover the totality of financial, environmental and resource costs. And the term Full Financial Costs Recovery (FFCR) will be used when only financial costs are recovered.
2.3.Water pricing and economic efficiency[5]
The socially efficient level of provision of a given resource, e.g. water, is reached at the point of intersection of the supply and demand curves for this resource, provided that the water price reflects all the costs of its provision (financial, environmental and resource costs). The demand curve describes how demand for water changes with price. The slope of the demand curve at any point represents the willingness of users to pay for an additional unit of water, which in turn reflect the benefit the user would derive from using the additional unit. The supply curve relates the total quantity of water supplied to the costs of its provision. The slope of the supply curve at any given point expresses the extra costs that would be incurred to increase the quantity supplied by one unit (long-term marginal cost).
Box 2 represents a simple water demand curve D for a given use and two water supply curves: S that includes only the financial costs of supplying water, and S* that accounts for the financial, environmental and resource costs. Three options for pricing are considered:
(1)A price PO, that covers only part of the financial costs, is fixed. At PO, the demand curve predicts that the quantity of water QO will be used.
(2)A price Pe, that covers the full financial costs (FFCR), is fixed. At Pe, the demand curve predicts that the quantity of water Qewill be used.
(3)A price Pe*, that covers the financial, environmental and resource costs (FCR), is fixed. At Pe*, the demand curve predicts that the quantity of water Qe* will be used.
Box 2 demonstrates that the quantity used is higher when the price fixed is lower[6]. When the marginal price does not account for the full financial, environmental and resource costs, then the resource is overused at levels higher than the social optimum Qe*[7]. The benefits derived from the additional consumption are then less than the total costs of supply. And this is likely to threaten the sustainability of water systems.[8]
The order of magnitude of this overuse depends on:
(1)How responsive demand for water is to changes in price. A useful parameter that captures this is the price elasticity of demand. For any point of the demand curve, the price elasticity of demand is defined as the percentage change in quantity demanded when the price changes divided by the percentage change in price[9].
(2)The extent to which PO and Pe fall below Pe*.
It is important noting that it is possible to recover on average only the financial costs, whilst charging the full costs (i.e. financial, environmental and resource costs) at the margin for achieving economic efficiency.
2.4.Pricing structure
As specified above, water prices usually includes different charges and taxes related to different water services and to the use of the environment (e.g. abstraction and emission charges). As an illustration of possible pricing structures, the main elements that form the price structure of water supply services include[10]:
(1)A connection charge, usually a "one-off up-front" charge for connecting a customer to the water supply system.
(2)A fixed (recurring) charge, either equal for each consumer or based on specific consumers' characteristics. This charge usually covers fixed administration costs such as meter maintenance and reading, billing and collection costs, and also water use if volumetric charging is not practised.
(3)If the volumes used can be measured (e.g. with a meter), the following elements may be added: a volumetric rate, which gives rise to the volumetric charge when multiplied by the volume of water used; a series of block charges, defined by lower and higher volumes of water use (different volumetric rates, whether increasing or decreasing, are usually defined for each block).
The price system may be even more complex to deal with periods of very high water scarcity and peak demand.
Clearly, the combinations of these elements within different price structures are not all equally good in terms of their economic environmental and economic efficiency properties. Achieving economic efficiency and enhancing the sustainability of water resources implies prices that include an incentive or volumetric-based element that would recover all short-run and long-run costs that vary with average or peak demand.
To play its incentive function for both water quantity and pollution, a price P would then be equal to F + a.Q + b.Y with:
F: an element related to fixed costs, general taxes, etc;
a: the charge per unit of water extracted from the environment and used;
b: the charge per unit of pollution produced and emitted to the environment;
Q: the total quantity of water used;
Y: the total pollution emitted.
A reduction in the quantity of water used (Q) and/or the pollution produced (Y) would then lead to a reduction in the overall price, thus provides an incentive for users to enhance water use efficiency and reduce pollution[11].
Also, aiming at economic efficiency implies that the connection charge should not be used to recover general system development costs. In some cases, however, the transparency of water services charges alone, as compared to water charges being hidden in rents, taxes or other service charges, may play an incentive role and lead to lower water demand.
3.A review of water pricing policies in the European Union
3.1.Key characteristics of the water availability, water use and management
Current water supply in the European Union is estimated at 21% of total renewable water resources, which can be regarded as sustainable[12], with most countries relying on surface water resources[13]. However, the large differences in climatic, geographical, hydro-geological conditions and in economic development lead to considerable heterogeneity of water availability and stress between and within countries. Some regions are already under water stress conditions from both a quantitative and qualitative point of view.
Water resources and water quality are affected mainly by agriculture, industry and domestic water use, but with large variations among Member States. Irrigation water use, for example, is highest in the Southern Member States where it accounts for 80% of the total water demand versus less than 30% on average in the EU[14]. Competition between irrigation and other uses is particularly strong in Greece, Southern Italy, and Spain.
Nearly every household has access to the public water supply in the EU. But this is not the case for access to the sewage network and wastewater treatment facilities. In Southern Member States, for example, only around 50% of the population are currently connected to sewage systems. A small share of water used for industrial purposes is drawn from the public water supply network, as industries rely mainly on direct abstraction (in particular for non-consumptive uses) that accounts for 80% of total water abstraction of the sector. Industries that are connected to the public water supply system are mainly Small and Medium Enterprises, shops and public organisations.
Member States have developed a variety of institutional frameworks for managing public water services. These include: direct public management (Austria, Denmark, Finland, Ireland, Luxembourg, Sweden), direct inter-municipal or regional structures (Belgium), delegated public management (Greece), delegated management with mixed or private involvement (France, Germany, Italy, the Netherlands, Portugal, Spain) and private management (UK). The control of prices is usually a non-systematic ex-post control undertaken by national, regional, or local authorities. In the UK, an independent economic regulator, the Office of Water Services (OFWAT) has been established to set prices and promote more efficient performance by the private water companies who provide the public water supply.[15]
3.2.Water pricing structures[16]
3.2.1.Household water pricing[17]
Public water supply pricing structures in the European Union cover a range from increasing block-tariffs (Italy, Spain, Portugal, Greece) to a flat rate system (most of the UK). In Ireland, there is no domestic water price and domestic water services are directly financed through the general taxation budget.
The most common configuration for pricing combines a fixed element and a variable component based on volumetric consumption[18]. The fixed element can be equal for all households within a given utility or given water company (Belgium, Germany, Denmark, Greece, England and Wales) or based upon the property value/size (the Netherlands), or the meter size (France, Finland, Spain, Sweden). An abstraction charge is levied on public water supply in Belgium, France, Germany, Italy, the Netherlands, Spain and England and Wales. In England and Wales, there is presently either a mixture of volumetric charging or a property value related charge. And users in vulnerable groups who are metered can opt to pay only the average measured charge[19].
Wastewater and sewerage charges are frequently included in the household water bill and generally calculated based on the proxy of water supplied. In the case of those households which are not metered, an annual volume is assumed (Belgium), or charges are based on property size or value (Portugal, England and Wales). In Ireland, domestic sewage charges have been consolidated in the general tax system. In addition, the cost of rainwater disposal can be included in the overall water bill (e.g. Germany, and England and Wales) or in the separate wastewater bill (e.g. Denmark). Where rainwater and storm water collection and treatment is a municipal responsibility, the costs are covered from the general public revenues. Several countries also impose fixed pollution charges that are directly integrated into the water and wastewater bills.
3.2.2.Agricultural water pricing
Agricultural water pricing structures widely differ between and within countries. They have usually been set out according to the ability-to-pay of the users, and to keep costs to a minimum to fulfil social and rural development objectives. Pricing usually takes three forms: an abstraction levy, a charge per hectare irrigated or charges per hectare irrigated and per crop. Where metering is introduced (which remains the exception), the standard volumetric and fixed pricing structure applies.
Some countries have introduced pollution charges on water use to account for water quality problems. Financial earnings are returned to farmers as compensation for restrictions on fertiliser use in vulnerable zones (Germany), or as tax rebates (the Netherlands).
3.2.3.Industrial water pricing
For the public water supply, the industrial pricing structure is similar to that of the households. Increasing-block tariffs exist in Italy, Portugal and Spain. Industrial firms pay according to a fixed element, i.e. the property value/size (Sweden) or the meter size (Finland, the Netherlands, Portugal), and to the volume consumed. In addition, a connection charge is levied in Denmark, Finland, France, Greece, Ireland, the Netherlands and England and Wales. Firms can negotiate special contracts directly with water suppliers, on a bilateral basis to buy bulk water or lower quality water at reduced unit rates (Finland, France, Germany, England and Wales). In some cases, special discounts are applied to the entire industrial sectors (e.g. agri-food industry).
Both volumetric and fixed components are used for piped sewage and wastewater services, when the industry is connected to the public water network. Unlike the household sector, water consumption does not always represent the adequate basis for charging. The pricing structure often includes separate pollution loads or content, i.e. industrial users with highly polluted water pay a charge per unit of pollution produced (Belgium, Finland, the Netherlands, France and England and Wales) or a special pollution fee based on the extra costs the polluted water causes for the wastewater treatment plant (Denmark).
Industrial abstraction charges are set in Belgium, France, Germany, Italy, the Netherlands, Spain, and England and Wales. Charges can vary according to the type of water abstracted[20], the type of use and the season. Regional variations reflecting water scarcity have been introduced in most countries that apply abstraction charges. A few countries have introduced discharge charges (the Netherlands, Finland, France, Germany, Ireland, Belgium and Spain), but discharge control occurs mostly through reliance on permit procedures.
3.3.Price level and cost recovery
Currently, water pricing policies are designed to fulfil objectives of cost recovery and revenue raising (England and Wales, Austria, Germany, France, Denmark) or social equity/affordability (Spain, Italy, Greece, Belgium). Revenues arising from charges and taxes are channelled into water supply and wastewater infrastructure programmes, to cover administration costs, or are directed to the general taxation budget of the country.