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Water Economics 1 – Price Shapes Demand

Barry Nelson

Posted May 4, 2010

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Environmentalists have long decried subsidies for water used in the agricultural sector.  In the water-short West, agriculture uses 80 percent or more of the developed water supply.  Subsidizing agricultural water use exacerbates shortages for other farmers, increases environmental conflicts and reduces the water available for urban areas.  But the impact of water prices isn’t limited to the farm.  It plays a role in our cities as well.  Circle of Blue just released this interesting survey of water rates in 30 cities across the nation.  The importance of price is quite clear.

A few numbers jump out in this summary of findings.  For example, Fresno has the lowest average monthly water bill and the highest per capita water use in the entire survey.  Continuing the trend, Salt Lake City has the second lowest average bill and the second highest water use.  On the other end of the spectrum, Seattle and Santa Fe have the highest water rates and, not surprisingly, are among the cities with the lowest use of water.

Anyone who has taken Economics 1 can tell you that price influences demand.  This lesson, however, is often lost in the water policy debate.  As my colleague Ed Osann wrote recently, water in California is not getting cheaper.  It’s also not getting more plentiful.

It’s not hard to do the math here.  We’ve hit “peak water” in every major California river system.  Climate change is likely to reduce our existing supplies.  Water rates are already increasing in California.  Those prices are certain to face larger increases in the future.  There are a couple of obvious lessons here.

Cities like Fresno, which is among the thirstiest cities in the West, should do more to save water and help their agricultural neighbors.  Fortunately, state law already requires Fresno and Sacramento, their thirsty neighbor to the North, to install water meters and bill volumetrically.  This requirement will send a price signal to customers for the first time – undoubtedly leading to water savings.  These cities should plan to install meters as soon as possible.

For Southern Californians, the lesson is a little different.  In the coming few years, Southern Californians will be faced with decisions about how to invest billions, and possibly tens of billions, in water system improvements ranging from helping to pay for a Delta Plan  to investments in additional supplies.  On the latter front, water agencies face a vast array of choices, including desalination, water recycling, agricultural transfers, capturing urban stormwater, urban conservation and groundwater management.  Given the dramatic impact that these investments will have on water rates, economics will likely play a major role in this discussion.

I predict that we are entering a period in the California water debate where the economics of water will play an increasingly prominent role.  More and more, California water agencies will be asking themselves what their options are, what these options cost, and what benefits they would deliver.   Most of the time, the right environmental answer also represents the sound business decision.  Realistic water pricing is a good first step. 

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PhilipMay 5 2010 09:51 AM

Although some water is subsidized (primarily in the form of interest forgiveness) it is a fairly small percentage of delivered water, nor is the money large.
You are correct about pricing, however. Most of the water used by *all* users, not just agriculture, is not priced according to supply and demand, but by many different dictats with ancient histories and dubious logic. It would not be impossible for the State Water Board to address this, I think.
The 80 percent figure is outdated, if it were ever true. As with many of these so-called statistics ("how much water does it take to make a gallon of wine?"; "How high is the sky?") it is meaningless and misleading because it is measuring an abstract condition, with no standard boundary.

PeterMay 5 2010 11:46 AM

As a "Senior" water analyst it is surprising that you continue to communicate the myth that Ag uses 80% of the developed water supply. Ag uses 41% of California's water supply, Urban 11%, the Environment uses 48% after co-opting such through judicial and legislative actions that are contributing to the overall economic crisis California faces today. But then again, that may very well be the goal.

Barry NelsonMay 5 2010 01:44 PM

Peter –
There is, as you point out, some confusion regarding total water use in California. DWR’s new State Water Plan update has a detailed year-by-year summary on page 4-21. Of all of the precipitation that lands on California, including water that evaporates or is consumed by vegetation before it ever enters a stream, 40-50 percent is captured, diverted and used. This is our “developed” supply. That percentage is higher in the highly developed Central Valley and South Coast regions.

The assertion that the environment “uses” 48 percent of the developed water supply is inaccurate for several reasons. First, DWR’s methodology for calculating this number included environmental water “uses” that have little to do with our developed water supply. For example, it included the water flows in the Wild and Scenic Smith River, near the Oregon border. California’s elaborate water system doesn’t tap into the Smith River, nor is it ever likely to. Water in the Smith River is not developed and protections for it don’t result in losses to water users. In addition, DWR counted water that flows down the Wild and Scenic Tuolumne River as “dedicated” to the environment – even though that water is captured downstream in Don Pedro Reservoir and is available for water users. In both of these cases, water that DWR counted as “used” by the environment has no impact on water users or our developed supply.

You are certainly right that managed wetlands in the Central Valley use water in much the same way that agriculture uses water. However, as the table on 4-21 of the State Water Plan indicates, that water use is quite small in comparison with state-wide use.

DWR’s new document includes detail regarding how water use varies from year to year. However, in ballpark terms, it is still fair so say that agriculture uses 80 percent of our developed supply.


Chris BrooksMay 5 2010 04:16 PM

I was also very impressed with the work done and data presented by Circle of Blue and tried to show the connection between prices and water use graphically on my own blog ( While the analysis is not perfect, I think it does provide pretty clear evidence of the connection. Also of interest was their inclusion of the type of rate structure used in each of the cities shown and the unfortunate fact that conservation often leads to rate increases because of the way costs of service are allocated to ratepayers under these systems.

David ZetlandMay 5 2010 04:38 PM

Good post except:
1) the "price of water" is the price of service. It does not include the scarcity -- or resource -- value of water. That's why the average bill in Vegas is $21 when the average bill in SF is $60+

2) The easiest way to eliminate "subsidies" (an idea that is hard to quantify) is through markets, where value, not cost, determine allocation. This is true for ag. In cities, prices can be structured so that nobody faces big bills for "basic" water.

3) All of this, and more, are discussed on my blog, aguanomics :)

4) Cheers!

Barry NelsonMay 5 2010 07:24 PM

David -

You're absolutely right that the scarcity of water will increase its value in the market. And I share your belief that an appropriately regulated market can help increase the efficiency of water use and meet water needs in a supply-constrained world.

I'm a regular reader of your blog. Thanks!


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