Access Cost and Distribution Costs – AC and DC – for water


Return to water home

By Brian and Lynne Chatterton.


Castel di Fiori,

05010 Montegabbione (TR)

ITALIA.


INTRODUCTION.

The cost or charge for water can be conveniently divided into two parts. There is the obvious “distribution cost or charge” (DC) which is the payment made by the user to the distribution authority or the cost of pumping and infrastructure for a self contained user. There is the less obvious, often invisible, “access cost or charge” (AC) that applies to some water users such as farmers.

ACCESS COSTS.

In Australia water rights in the Murray – Darling Basin have been separated from land and are traded in water markets. The price of the water right is clearly identified and the access cost of the water can be expressed as either a single capital payment to purchase the water right or the equivalent opportunity cost for those with existing water rights. (Chatterton and Chatterton 2001)

In most of the world water rights are not separately identified and there are often strong beliefs within these societies that “Water is not an economic resource” - WINER (Allan 2000) In spite of these beliefs and the policies based on them access costs can occur. To determine access costs one needs to ask the following questions:-

* Is access to water freely available? Yes/No

Yes. In this case there is no access cost to water.

Included in the “yes” group is the situation where a charge is made to connect the water supply to the user. This charge represents the cost or part of the cost of making the connection. The vital point is that there is no limit to the number of users so anyone paying the charge can obtain a connection. Some examples are domestic users who pay a charge to connect and then pay normal distribution charges. Within agriculture, growers in South Australia before the closure of the Murray for further irrigation in the mid-1960’s paid a fee for an irrigation licence. There was no limit on the number of licences nor the amount of water that could be pumped. These are examples of free access in spite of some payment being made.


No. Access costs may apply.

The “no” answer will be applicable to agriculture in many regions of the world. In the WANA area the water deficit has been rising steadily over the last 30 years and no longer meets the need of agriculture in all but a few countries. In most places domestic, commercial and all but the heaviest industrial water users still have free access even when supplies to agriculture are limited. In the case of a “no” answer a further question needs to be asked.


* Is the value of the irrigated farm greater than the value of the land without irrigation and the value of the capital improvements? Yes/No

Yes. There is an access cost for water.

It is hidden in the price of the land but the premium represents the value of the water available for irrigation.

No. Access to water may be limited but there may not be a premium on the price of the land.

This will occur in the early stages of closure of the water resource. In most cases closure takes time and there is considerable political debate before access is restricted. During this period there is ample opportunity for new entrants to gain access to the water ahead of any closure deadline. After the resource is closed, there are more people inside trying to get out at a profit than there are willing buyers on the outside trying to get in. (Chatterton and Chatterton 1996) Once this transitional period has passed access to water is only possible through the purchase of an existing right by paying a premium on the land where the water is available.

LEVEL OF AC

* Buyers and sellers.

As with a commodity the price of water (AC) will be determined by the action of buyers and sellers. This is a simple truism but in the case of water we find there are three phases.

Firstly there is the open resource which has existed in most of the world until the 20th century. When the resource was open there was no need for potential irrigation farmers to purchase existing water rights at a high AC as they could establish new farms on new land. Most did not choose to do this as it was more convenient to purchase existing farms from retired farmers but the fact that the option existed limited the potential for a premium land price to cover the access cost of the water.

The second phase is the transition during which the resource is closed but many additional potential users have entered in anticipation of the closure. There are more sellers than buyers. In addition, while the resource may be closed in one area there may be alternative water resources that are still open. This occurred in Australia where the South Australian part of the Murray was closed well before other sections in NSW and Victoria. As South Australian farmers have a tradition of mobility it is likely that this dampened the formation of an AC in South Australia.

The third phase is the established closure of the water resource and reasonable alternatives as well as a balance between buyers and sellers. At this third phase one can expect the AC of water to reflect the fundamentals over a long term but like all prices determined in markets there can be fluctuations based on expectation realistic or otherwise. (Chatterton & Chatterton 2001) Most of the water resources in the arid regions of the world are entering this third phase whether governments and political elites wish to acknowledge the fact or not.

* Fundamentals.

The underlying fundamental that should determine the AC of water over the long term is the gap between costs and returns. The cost is DC of the water and the returns are based on a combination of efficiency and the price of the commodity being produced. In Australia at the moment the AC of water is being driven by the high marginal profitability of Chardonnay grapes used for wine making.

The inverse relationship between DC and AC means that in purely theoretical terms low DC will not be of long term assistance to farmers as it will increase the marginal profit for water and thence the AC will rise and farmers will pay in another form. Although this may be a sound economic argument it will not assist in the political debate over higher DC as the reality perceived by farmers is different. Most farmers already own water rights or have inherited them therefore the AC is an opportunity cost not something they have paid cash for. Farmers rarely bring opportunity costs into their budgets. Even if the farmer has actually paid cash for access to water there is a deep streak of optimism among farmers that allows them to believe they can always sell the access for an even higher price than they paid for it.

While farmers may not willingly pay high DC at least the debate will bring into the open the fundamental public/private nature of the division. In most developing countries DC are paid to public authorities while AC is paid to the generation of farmers who had access to the water resource at the time of closure.

There is one possible scenario of high DC that may be acceptable to farmers. If the high DC are invested in improving the water quality and preventing illegal access it is conceivable that the marginal return for water may also increase and AC rise as well. This would benefit current water right holders but add to costs for new entrant. As there are more current holders than new entrants and they are more keenly aware of the value of water rights this would be a formula that could receive political support.

WINER - WIER debate.

The use of the DC and AC division shows that there is a degree of inevitability about AC that is not going to disappear by refusing to admit that water rights exist or that they have an economic value. In fact many of the ideals of equity that are expounded by the WINER group will be undermined by the development of hidden AC within land values. When AC are finally admitted and openly debated it may be difficult to change them (or their distribution) as the values may be so high and the political interests so strong that reform is impossible.

The WINER belief has many parallels with the development of land values during the British colonisation of Australia. In NSW the WIER line was taken. As there was so much more aboriginal land than could possibly be settled or worked by British migrants it was in effect an open resource and had no value. (Burroughs 1967) The idea that land had no value was profoundly disturbing to the Victorian political class, as land ownership was a fundamental pillar of their class ideology and belief system. They established another colony in South Australia where land was given an artificially high value - that is a “Land is not an economic resource” or “LNER” policy was adopted. (Gibbs 1969)

REDUCING AC and other policies to restore benefits to the community.

* AC can be reduced over time by higher DC as this will reduce the margin between costs and returns for water. There are strong arguments for higher DC but they are reinforced once it becomes obvious and is openly stated that the community subsidies for lower DC are being capitalised into high AC’s which are then sold to the next generation of farmers.

* AC can be taxed directly. At present this seems a distant dream because DC in most cases are below the actual cost of distribution of irrigation water. The political cost of increasing DC is considered too great for most governments and the addition of even more charges is at present unrealistic. As well, capital taxes in general are in retreat in the current world ideology of market capitalism. Until the 1970’s all Australia states had some form of capital taxation on agricultural land but those taxes have disappeared and new concessions have been made to capitalists. These concessions in favour of capital accumulation have been carried out by parties of the left as frequently as of the right.

One form of capital tax that might just be politically acceptable in the current climate is to convert water rights embedded in land into separate tradable rights as in Australia but with the difference that farmers pay for the conversion. The political opposition to such a move could be tempered by making it voluntary. That is farmers could continue unchanged with land/water but if they wanted to trade their water rights separately they would have to convert them first and pay the capital levy. This was done with the conversion of leasehold property to freehold in South Australia.

* A more realistic policy may be a trade off. Instead of attempting to claw back to the community some of the value of the community water resource that has been expropriated by private farmers, the community may wish to make a trade off between acceptance of the farmers’ water rights by the State and responsible water management by the farmer. Such a system would accept and grant separate water rights for a fixed period conditional on water management practices being followed. If the management is good the water rights, or more accurately water leases, are renewed again and again if not they are allowed to expire. This system would be particularly well suited to over exploited ground water resources as it would apply steady but increasing pressure on users and allow a separation between responsible users and water miners.

DISTRIBUTION COST

The DC of water is a political decision - both the level of cost recovery and the method of charging. Even where water distribution is privatised water regulators working within rules laid down by governments are the greatest force in determining the charging system,

DC consists firstly of the cost and maintenance of the infrastructure. Now that water resources in most countries, particularly in the WANA region, are fully developed the infrastructure cost, dams canals, pipes etc. is high. The second element of cost is the running cost of the system, pumping, administration etc. The running costs often increase in discontinuous jumps to higher levels as additional water becomes more remote. For example, Adelaide a city in a semi arid region of Australia is able to get reasonably cheap water from seasonal streams stored in dams in the nearby hills. When this water is exhausted the city relies on more expensive water pumped across the hills from the Murray River using cheap night tariffs for the electric power. Finally if demand is even greater water has to be pumped day and night using more expensive power. Demand is high in summer when costs are high.

METHODS OF CHARGING FOR DC.

1 Accounting charges.

This is the method favoured in the past by most public authorities supplying domestic, industrial and irrigation water. The charge reflected the high cost of the infrastructure. Charges or rates were levied on properties that reflected their value and this provided the base revenue to the authority whether they delivered any water or not. For irrigation the method is translated into a charge per ha. irrigated.

In Adelaide until the 1990’s the rating system based on land values was combined with water meters to provide an ingenious system of transfers. All properties connected to the water distribution system were valued and charged a “rate” that was a percentage of that value. Water was also priced per 1000 litres. The rate on the property was divided by the price per 1000 litres of water to give the owner a “free” quota of water. Any additional usage above the quota was charged as “excess water” per 1000 litres in addition to the rate.

The practical effect was that small domestic users paid only the rate. Large domestic users with tennis lawns and swimming pools had a larger “free quota” but still paid excess water. Commercial properties and high priced apartments without gardens paid the rate and used only a small part of their “free quota” and could be considered as cross subsidising other users. Industrial users paid for most of their water as “excess” on a per 1000 litre basis.

2 Efficiency charges

With the world swing toward privatisation or at least commercialisation of public authorities accounting charges were considered as inappropriate as they gave the authority a fixed income and did not encourage competition and efficiency. The trend has been to charge for water at a price per litre that bundles up the infrastructure costs and running charges into an average charge. Like so much connected with privatisation this reflects a particular ideology that states that the market for fizzy drinks or chocolate bars should be the model for all enterprises and that hospitals, water authorities or public transport have to be bashed and bent until they fit this pattern.

The difficulty with water is that unlike fizzy drinks or chocolate bars there may not be any economies of scale. In fact the reverse often applies. Delivering more and more water through the same system sounds an excellent means of improving efficiency but soon runs into the limitations of the water resource.

Whether this system is appropriate will depend on individual cases. To take the Adelaide example as a case study, low volumes of water will be expensive because of the high infrastructure component. Increasing volumes will spread this overhead cost and running costs are still reasonable. Very high volumes will mean greatly increased pumping charges. Whether the average unit charge that is now in place is a better method of achieving efficiency has yet to be proved.

With irrigation in South Australia the change from a system of charging per ha and delivering water to farmers by a fixed rota to a pressurised delivery system where water is available on demand and is priced per unit has provided the basis for greatly improved efficiency.

There does seem to be considerable scope for further fine-tuning of charges based on efficiency. In the past the “hydraulic mission” led by engineers attempted to meet water “needs” but with the exception of basic drinking and hygiene requirements water needs are dependent on price.

In Australia there are already water rights with different levels of reliability. Some guarantee water in 98 year out of 100 while others only in 70 years. Some water managers also issue annual water leases for seasons when there is an exceptionally high river flow. These alternative water rights allow the storage of water to be put into an economic context. Investment in additional storage can be quickly compared with the alternative of using the water when it is available. If in a hypothetical case the market priced 70/100 year water at half the price of 98/100 year water it would be possible to identify the value of a new storage that allow a certain amount of water to be changed from 70/100 to 98/100.

Supplies of water in good seasons produce crops which can be stored as “virtual water” in grain silos rather than the actual water in dams.

In semi arid regions with a Mediterranean pattern of wet winters and dry summers there may be scope for a seasonal variation in water charges which would encourage farmers to grow crops that are better able to withstand summer droughts. Water on demand at the same fixed price all year allows farmers, for example, to budget the cost of water for tomatoes which require continual irrigation throughout summer on the same basis as olive trees which actually thrive under some summer drought.

3. Equity charges.

The ideology of the present world economic order claims that equity and economic growth do not mix in spite of the fact that the economic tigers of the last half-century, Japan and Germany have more equitable societies than most developed countries.

In the Philippines land reform has been supported by a system of water charges based on the volume of water used. Water permit holders up to 30 litre/second pay 0.50 pesos per litre/second, those with 30 to 50 pay 0.75 pesos and above 50 litre/second the rate is 1 pesos for each litre/second (Cruz 1989) Progressive charging systems do seem to be rare and the Adelaide cross subsidy for small domestic consumers has been swept away.

There is no reason given the political will why progressive charges for water could not be used more widely but there are considerable doubts whether they are effective. Cheap water for connections with low supply potential will favour low income people in apartments but also wealthy apartment owners will pay little for their water. Unemployed people trying to reduce their living costs by growing fruit and vegetables in their gardens or on allotments will pay dearly for their water. A better way to reduce inequalities for domestic consumers may be to subsidise connection costs as part of a package of affordable building land and housing.

4. Environment charges.

One of the difficulties with a charging system that bundles together infrastructure costs and running cost into an average charge per unit is that it encourages authorities (particularly privatised ones) to sell more water. Provided the infrastructure can handle more water, greater supply will increase revenue and should increase profits. In cases such as Adelaide the supply costs for the additional water may rise steeply and offset the advantages of more efficient use of the infrastructure but it would be unwise to rely on this factor being sufficient to discourage consumption either in Adelaide or in other areas where additional supplies may be more readily available.

A system of charges that encourages sensible use of water is urgently needed. One model that might be useful is the system introduced in USA by some electricity regulators which allows supply companies to increase the unit cost of electricity provided the average consumer does not pay more in total. The Supply Company must work with the consumer to use electricity more efficiently and is then able to share some of the cost savings by charging more per unit on fewer units. The system does seem to have some potential for water, in fact it may be more effective for water than electricity as the complicating fact there is the switching of energy demand between electricity and other sources. If high priced electricity forces consumers to switch to gas there may be little environmental benefit but similar alternatives do not exist for water.

Another method of introducing an environmental aspect to water charges might be to look at net water use - that is water supplied minus water returned to the system - together with the quality of the water returned.

WATER METERING

All the systems of charging for water except the accounting charges based on property value or irrigation area will require water metering. There has been considerable popular resistance to water metering but it does provide much greater flexibility in devising a water charging system and in itself does not produce inequalities. It is the water charging system that is introduced for the metered water that needs examination and debate.

CONCLUSIONS

Distribution costs/charges (DC) are visible and the subject of economic and political debate. As countries (particularly those in the WANA region) move into the phase of water deficit their water resources become fully exploited and are closed to new entrants. Once the resource is closed access costs (AC) will begin to grow as access rights are purchased from previous owners.

While many countries wish to ignore the growing value of water rights and pretend that they are land values this will not prevent the growth of access costs (AC) for water. In political terms a determination to ignore the economic costs of water access and maintain that water is not an economic resource (WINER) will collapse in time when AC have grown to such a level that the pretence is so hollow that it is beyond society’s credibility. At this late stage the value of AC will have been transferred to private ownership and the social and political values that it is currently hoped are being preserved (by ignoring the economic value of water) will be difficult to recover. A frank admission of AC before it has become fully capitalised would provide the opportunity for more equitable ownership and better management of the water resource.

REFERENCES

Allan J. A. 2000 The water question in the Middle East: Hydropolitics and the global economy, London, I.B. Tauris Academic Publications. London and New York.

Burroughs, Peter. Britain and Australia 1831-1855 A study in Imperial relations and Crown Lands administration, Clarendon Press, Oxford.

Chatterton. B & Chatterton. L 1996 Closing a water resource: some policy considerations. Howsam P. and Carter R. C. 1996 Water policy: allocation and management in practice, London: E & FN Spoin pp 355- 361

Chatterton B. & Chatterton L. 2001 The Australian water market experiment, Water International. Vol 26 No1 pp 62-68

Gibbs, R. M. 1967 A history of South Australia, Balara Books, Adelaide.