The Theory of Water and Utility Pricing - Global Drinking Water Management and Conservation - page 104

successful water pricing schemes use some form of two-part tariff structure, which
resulted from the 1994 Council of Australian Governments Water Reform Agree-
ment (Australia National Water Commission 2011 ). As noted by Rogers et al.
( 2002 ),

One of the main advantages of the two-part tariff system is the stabilized revenue base it
affords the supplier. The fixed charge protects the supplier from demand fluctuations and
reduces financial risks. The volumetric charge can vary according to the consumption level,
[which] therefore encourages conservation.

In Australia, local governments and water businesses have set the volumetric
tariff based on the long run marginal costs to provide signals for conservation and
for ef

cost
attributable to an extra permanent unit of consumption in bringing forward the
future capital program

cient water use. Long run marginal costs can be de ned as the “

(Australia National Water Commission 2011 ).
Drought has always been a serious concern in Australia. According to the data
from Australia National Water Commission ( 2011 ), the local governments and
water businesses invested billions of dollars in supply augmentation such as
desalination plants through

”

“ ”

water sources. For example,
the total cost of desalination plants in Melbourne was $3.50 billion; in Sydney it
was $1.83 billion; Perth, $1.34 billion; the Gold Coast, $1.20 billion; and Adelaide,
$1.83 billion. The total investment of all these desalination plants amounts to $9.7
billion. Moreover, in addition to increasing volumetric charges to balance supply
and demand in periods of drought, water authorities and governments in Australia
have chosen to impose mandatory water restrictions to reduce consumption through
an increasing-block tariff (Australia National Water Commission 2011 ). Thus if a
household uses water above a given consumption threshold, it will pay a higher
volumetric price for its water. It seems to encourage water conservation, but there is
a disadvantage associated with an increasing-block tariff. For example, a poor
household with a larger family may have higher water usage than a high-income
household with a small family, and yet the large family, poor household would end
up paying higher prices for water than the high-income household. Therefore, such
pricing is inequitable.
As noted by the Australia National Water Commission in a recent review of
water pricing reform (2011):

high cost, high reliability

Consumption-based or volumetric pricing led to demand reductions and more economically
efficient water use. Through the recent drought, however, problems with the current
approach to setting the volumetric tariff based on the long run marginal cost [LRMC] of
augmenting supply were brought into sharp focus. LRMC prices ostensibly signalled the
future costs of capacity augmentation to meet growth over the longer term but did not
respond to increasing scarcity of water and did not re ect the high degree of variability in
in ows. The problem with fixed pricing is it ignores the effect of weather on supplies. If
there is a drought and reduced in ows into catchments and dams, then less water will be
available. With fixed pricing, the amount charged to consumers is unchanged and the price
is set too low to balance demand and supply in dry years.
The current urban water tariffs are therefore not responsive to changes in the
value of water and thus lead to inef

cient use (or nonuse) of water because the