The Role of Demand Side Measures and Flexible Incentive-based Instruments for Addressing Drought

Kurt A. Schwabe, Ph.D.

Associate Professor of Environmental Economics

Associate Director, Water Science and Policy Center

University of California-Riverside

Objectives/Outline

• Describe some economic concepts that (hopefully) help better frame some of the issues surrounding drought and water scarcity

• Highlight recent findings from studies of water conservation

• Comparison of costs and water savings across strategies

• Illustrate the valuable insights made possible by combing knowledge and data partnerships between researchers and water utilities

• (if time) Identify two supply augmentation strategies for addressing drought and water scarcity

• Water banking / conjunctive use

• Water Markets and Transfers

Concept 1: Scarcity

Definition of Scarcity: The degree to which demand exceeds supply at a given price

“Australian cities are currently facing severe, and in most cases chronic, shortages of water, relative to the demand at prevailing prices.” Professor John Quiggin (2006), Uni Queensland.

Two issues that fall out of this definition…

1. One way to reduce scarcity is to raise price, or…

2. For a given price, scarcity can be reduced by either reducing demand, increasing supply, or some combination of each

Example: MWD residential gpcd decreasing by 16% since 1990 (208 gpcd to 175 gpcd)

Concept 2: Portfolios, through diversification, may increase reliabilities and lower costs

Numerous options to address water scarcity/drought on both the demand and supply side

• Each strategy has a cost and an “effectiveness”

• Often interdependencies among strategies

• Diversified portfolio increase reliability and may lower costs of drought (i.e., don’t put all your eggs in one basket)

• Strategies that allow water to be moved spatially (via conveyance) and temporally (via storage) allow water to be used more efficiently (allocated to highest valued use)

• Water conservation often the cost-effective strategy

• Water markets are extremely diversified

Analyzing Cost-effective Options to Decrease Water Scarcity Using a Portfolio Approach (Rosenberg and Lund, 2009)

Analyzed short and long-run strategies to increase water supply reliability for Amman, Jordan

Identified a portfolio of actions along with their costs and scarcity implications

Results suggested…

• Postpone activities that include large infrastructure investment and exorbitant operating costs (e.g., Seawater Desal)

• Invest in water conservation activities such as leakage repairs, customer education, water conserving appliances and rebates, at the household level

• Consider low-cost brackish water desal in longer term

Concept 3: Cooperation, including those implicit in water banking and flexible markets, can significantly

lower costs as win-win strategies

Actions in one district / region may have (unintended) positive or negative impacts on activities in another district / region

Þ Externalities

When externalities are present, there are gains from cooperation or markets that allow trade

Can we benefit from cooperation and/or markets?Central Valley Irrigation and Colorado River Flow

Central Valley, California…

• 1/6 of US irrigated land

• $21 billion in agricultural value

• Generates water vapor that ends up increasing streamflow in the Colorado River by 28% (56% in four corners region)

• 325,000 ac-ft annually (supports apprx. 3 million people)

• Increases precipitation by 15%

• Previous models overlooked anthropogenic loop

Question: Could a market ever develop?...Certainly there are potential gains to trade and/or cooperation….

An understanding of the natural, physical, and economic linkages across jurisdictional boundaries is important and offers opportunities

________________________

Lo and Famiglietti. 2013. Geophysical Research Letters.

(National Taiwan University and UC-Irvine)

Water Conservation: Residential Water Use• Private Benefits from water conservation...

• Delayed infrastructure spending to lower municipal taxes for residents

• Enhanced resilience to deal with potential variability in future supplies

• Energy savings potential

• Public benefits from water conservation…

• More water available to contribute to health and quality of aquatic habitats and ecosystems

• Savings from deferred capital expenditures associated with system expansion.

How does California stack up in terms of urban water use per capita (Hanak et al. 2011; 20x2020 Water Plan; Rancho California Board Meeting 2011)

• California: 201• Australia: 80 to 130• Israel: 84• Spain: 76

• Rancho California: 386 (2003-2007)• Central Coast: 154• Tulare: 285• South Lahontan: 237

Water Conservation: Residential Water UseTwo Types of approaches to water conservation (not mutually exclusive)

1. Price-based approaches (e.g., volumetric pricing and retrofit rebates)

• Indirectly try to alter behavior through changes in relative prices

• Pricing based on volume of use…

• Albuquerque, NM, instituted summer surcharges in 1995

• Toronto’s volumetric pricing which increases by 9% annually from 2003 to 2013

• Rebates: changing relative prices of appliances (e.g., subsidizing)

• Toilet rebates, subsidizing low flow shower heads, rain barrels, xeriscaping

• Some research finds that subsidies don’t influence water conservation, just the information campaign increases when people are going to do it.

• Renwick and Archibald (1988) find that water-efficient irrigation techniques reduce water use by 11%..motivated by environment attitudes rather than potential cost savings (as does Millock and Nauges 2010).

• Water use must be metered

Water Conservation: Residential Water Use2. Non-price-based approaches (e.g., summer water use restrictions, education, etc.)

• Directly try to alter behavior

• Many different types

• Voluntary

• Mandatory restrictions / rationing use and activities

• Education (e.g., educate school-aged children to change preferences; more information on water bill or send flyers to inform customers of use and issues; education for adults for landscape)

• Moral suasion

• Israel provides a daily report to education society of level of its major reservoir, Kinneret

• During 1987-1992 drought in California, 65-80% of urban water utilities implemented outdoor watering restrictions (Dixon et al. 1996).

• In 2008, 75% of Australians live in communities with some form of mandatory water use restrictions

Water Conservation: Residential Water UseHow have rebate/technology-based measures stacked up against price-based?

• Timmons (2003). Compared mandatory low-flow appliance regulation vs. a modest water price increase using data from 13 groundwater dependent California cities

• In almost all cases, prices were more cost-effective than technology standards

• Mansur and Olmstead (2007). Study of 11 urban areas in US and Canada comparing outdoor water use restrictions to drought pricing for residential households in short run

• For same aggregate demand implied by a 2-day-per week outdoor watering restriction, a market clearing price would result in gains of about $81/hh per summer, about ¼ of a household’s total annual water bill in the study

• Brennan et al. (2007). Studied sprinkler restrictions in Perth, Australia

• Restrictions on use of sprinklers leads to more overwatering from hand-held hoses resulting in little water savings but additional costs to consumers

• Grafton and Ward (2008). Similar to Brennan but for Sydney, find mandatory water restrictions to result in costly and inefficient responses relative to prices

• Grafton and Kompas (2007). Find that tying water prices to reservoir levels is most efficient (cost-effective) means of addressing short-run water scarcity.

• Suggest equity issues can be addressed through rebates to low-income households, water budgets (and low 1st tier pricing), and negative fixed fee charges.

Water Conservation: Residential Water UseGrafton and Kompas (2007). Evaluating supply and demand-side options confronting Sydney, Australia in early 2000s.

• Government uses a 2-tiered price structure based on long-run marginal cost of supply.

• To address shortages in 2000s and decreasing reservoir levels, along with projected population increases, govt. initiated a number of strategies

• 2003: water use restrictions…weren’t very effect (demand > supply)

• 2005: more severe water use restrictions (days and hours of week; hand-held approaches)

• Included subsidies to purchases water saving technologies and rainwater tanks

• Undertook major capital works

• Access other surface and groundwater supplies; initiated recycling projects to make potable water

• IPR projects at $3 billion/year capital and $175 million/year O&M

• Increase capacity of dams at $300-400 million

• Desal considered at $1.3 billion capital and $38 million/year O&M or greater

• Results suggest if continue to price at LRMC, will need to increase supply capacity and demand prices significantly to deal with periods of drought.

• Find that short-run pricing adjustments – sort of like peak-load pricing in the elecricity sector – tied to reservoir levels – are most cost-effective and responsive policy

Water Conservation: Residential Water UseWater savings from rebates programs often estimated to be smaller than initially supposed (Olmstead and Stavins 2007)

• Mostly due to incorrect assumptions regarding behavior (rebound effect).

Examples:

• Low-flow showerheads result in longer showers (Mayer et al. 1998)

• Low-flow toilets result in more flushing (Mayer et al. 1998)

• Front load clothes washers result in more cycles (5.6% increase) (Davis 2008)

• Studies of households fit w/ low flow fixtures get mixed results

• Low-flow toilets save 6.1 to 10.6 gpcd in some studies vs. no savings in others

• Low-flow showerheads save from 0 to 9% across studies

• Price (2013) finds no rebound effect and low-flow to reduce demand by 12%

• Mandatory water use restrictions…mixed results

• Studies in Santa Barbara and Pasadena find mandatory water use restrictions to save aggregate water, but restrictions in Corpus Christi did not.

• Detail matters – program, household type, pricing, etc.

Water Conservation: Cost-effectiveness Considerations

Would customers that participate in rebate programs have participated without rebates?

1. Bennear and Taylor (2013). North Carolina’s Rebate Program for low-flush toilets

• 30% of indoor water use consumed by toilets

• Offered rebates to households to purchase low-flush toilets

• Considered “additionality” – did program increase # of hh’s using low-flush toilets and was it cost-effective?

• if not, then customers received a windfall gain and agency lost money

• If so, then have to estimate cost-effectiveness

• NCSU economists worked with utility agencies to collect household level data on water use

• Included a survey requesting information on motivations for replacing toilets

• Had info on households that did and did not replace toilets

• Find that water savings from toilet program are approximately 7% annually (3,612 gallons)

• Only 37% of this attributed to rebate program

• 2/3rds of water savings were obtained independent of program

• Program cost $11 to $15/1000 gallons, yet other programs cost $7/1000 gallons

• Therefore not cost-effective

• If target people that wouldn’t have purchased w/o rebate, cost-effectiveness is $4/1000 gallons

Water Conservation: Cost-effectiveness Considerations

2. Price et al. (2014). Estimated water demands that are conditional on rebate information for a number of alternative rebate programs

• Account for rebound effects that tend to reduce effectiveness of program often observed in initial stages of program

• Worked w/ utilities to collect costs of different rebate programs and predicted water savings

• Find that most cost-effective water savings for water utility are for low-flow showerheads at $0.39/1000 gallons saved.

• $0.97 for first low-flow toilets; $8.33 for 2nd low-flow toilet

• $4.51 / 1000 gallons for xeriscaping.

3. Ferraro and Price (2013). Worked w/ agencies to collect info on how information provisions and pro-social messaging influence conservation behavior

• Results suggest that if strong social norm treatment (all households receiving info on neighbor’s water use) would have resulted in cost of $0.58 / 1000 gallons saved

• If focus on households that are above median water consumption level, would achieve 88% of the water savings at 65% of the costs

• Supports Waukesha Water Utility’s (Wisconsin) decision to create on-line tool that allows customers to track and monitor their daily water use as well as to compare to their neighbors (Behm 2013).

Water Conservation: Residential Water UseDo moral suasion and social norms matter? (Ferraro and Price 2013)

Cobb County Water System, Georgia: Researchers partnered with agency in 2007 shortly after a change from a fixed price per gallon to a tiered system…

• Randomized experimental design through mail messages to residential customers

• Three water conservation treatments along with a control

• No info

• Info tip on providing technical advice on how to reduce water use

• “weak” social norm treatment that provided tip sheet and a personally signed letter appealing to residents to conserve

• “strong” social norm that provided them with personalized information on own water consumption and comparison to neighbors

Results:

• Tip sheet alone alters behavior slight 7.8% to 8.4%;

• Weak and strong social norms altered prices from 10 to 12%, respectively

• Responses by high uses to strong norm was double that of low users

• Agencies that want to promote conservation may want to consider price and non-pecuniary measures.

Water Conservation: Summary• Rebate conservation programs are attractive…but fall short of initial estimates

• Cost-effectiveness of programs depend on “rebound” effects and “additionality” of program

• Some studies suggest rebound effects are small – more research required

• Some rebate programs simply result in a wind-fall for households that would have participated regardless and hence call into question cost-effectiveness of program

• If considering long-run programs, should consider partnering with researchers to evaluate individual programs --- could save money and water

• Volumetric price-based conservation program supported by research on elasticities

• Elasticities differ across seasons, socio-economic factors, and in relation to different types of non-price alternatives available (complementary effects)

• Suggests benefits from targeted program and consideration of complemetarities across program

• Poor water pricing leads to excessive scarcity and costly policies in short run (e.g., drought) and likely unsustainable land-use patterns in long run

• If water prices rose as reservoir levels fell, consumers would respond by using less water, reducing or eliminating uses according to their preferences

• Illustrates some benefits of water agencies partnering with researchers to better understand household behavior for water conservation and the cost-effectiveness of those programs (particularly to account for “rebound” and “additionality” concerns)

Water Conservation: Summary

• Question: Why so much emphasis on rebate/non-volumetric-based programs when water pricing can work and are more cost-effective?

• Answer:

• Tucsan, AZ, 1970s.

• First to adopt marginal cost water pricing after 2-year drought

• One year after adoption – entire city council voted out of office (Hall, 2000)

• Fiscal illusion…more expensive than pricing but this not well-known (poor information)

• Yet advantages of water pricing for conservation and drought are clear from the literature…

• Increases revenues (since operating on inelastic portion of demand)..rebate programs and mandated water restrictions often lead to necessary price increases due to revenue losses

• Less costly than rebate or non-prices measures…evidence is clear!

• Gives households the choice of how to respond to prices (as opposed to more costly mandates and measures provided by district)

• Likely a combination is both politically feasible and cost-effective

• Have to account for household behavior when using rebate/technology standards

• Best /cheap to include a good public information campaign, moral suasion, and info on social norms

Water Conservation: Summary

• Regardless of conservation approach, research shows that people’s heightened sensitivity to circumstances of relatively greater water scarcity mean they often respond more readily and with more vigor

• Lavee et al. (2013) ~ drought surcharge more effective at encouraging water conservation than smooth water price increases

• Kenney et al. (2008) ~ introducing block-rate pricing during drought had greater impact on high water-consuming groups than lower ones.

• Consumers more responsive to price changes during drought (higher elasticities) (Dalhuisen et al. 2013)

• Seems to support the saying, “Never waste a good crises.”

• Reducing scarcity cost-effectively means considering both demand and supply-side measures

• Demand side measures, in many instances, are more cost-effective

• Working together, whether it’s through cooperation and/or markets, generally leads to lower cost solutions as economic theory and empirical evidence suggests

Conjunctive Use / Groundwater Banking

• Aquifers increasingly considered as main storage option• Allows for low-valued water to be used for high-valued purposes at some

later date• > 65 water agencies engage in some form of conjunctive management• Offer between 4 to 30 times more storage capacity than existing surface

reservoirs (Hanak et al. 2011)

• Emergency Drought Bank of early 1990s played significant role in establishing the value of water and reducing the economic costs of major shortages• Reduced drought damages by $104 million (Easter et al. 1998) • Most benefits accrued to urban areas and some high-valued agriculture• DWR served to mediate purchase/sale. Allocated 660,000 ac-ft in 1991;

297,000 went to urban• Dry year program allocated 138,806 ac-ft in 2001

• Australia has mature water banking/carryover system• Increases agricultural productivity in MDB by nearly 12% (Hughes 2009)

Conjunctive Use / Groundwater Banking

• Several advantages relative to surface storage

• Often considered less environmentally damaging than dam or reservoir construction

• Less evaporative losses relative to dam or reservoir storage

• Conjunctive mgmt. offers 4 to 30 times capacity of surface systems (Hanak et al. 2011)

• In general, lower capital costs than dams or reservoirs

• Some concerns regarding banking/conjunctive use

• Evaporation occurs during transport to groundwater system, and groundwater deposits may not be 100% recoverable (or not recoverable at particular times)

• May require extensive distribution networks, infiltration areas, and injection wells.

• O&M costs may be expensive with banking due to recovery costs (i.e., pumping water for withdrawal during dry years)

• Local impacts from withdrawals – e.g., possible subsidence and water quality degradation

• Exchanges require mature institutional infrastructure, including agreements, monitoring, and accounting methods to guarantee a secure right to the banked water

• Other landowners can pump from basin unless adjudicated/need better regulation

Alternative Storage Options:Aquifers via artificial recharge from surface water

(Scanlon et al. 2012)

Cumulative water storage in the Arvin Edison groundwater bank relative to precipitation. Note: drought events

Water Markets to Manage Drought/Water Scarcity

• Reductions in system wide scarcity and operating costs of supplying water can be achieved with more water transfers from

• low-value to high-value agriculture

• agriculture to urban uses (Draper et al. 2003; Pulido et al. 2004)

• Encourages efficiencies in urban and agricultural settings

• Allows opportunity to allocate over time, space, and to higher valued users

• Addresses need for more adaptable and responsive method of allocating water in the state

• Substantial opportunities and gains for allowing short-term leases and spot markets where water can be traded

Water Markets: Examples of Potential Gains• Australia: very well developed temporary and permanent water markets

• 2007 to 2010 1/3rd of all water in Murray-Darling Basin was traded• Decreased economic impacts of drought by 50%

• San Joaquin Valley, California (Howitt et al. 2011, 2013)• 500,000 ac-ft traded in San Joaquin Valley alone in 2009 significantly offsetting

localized effects of drought

• Southern California (Medellin-Azuara et al. 2013)• Allowing more flexible operations including transfers from low-value to high-value

agriculture and urban uses is estimated to reduce the operating costs of supply water by $1.93 billion at 2020 level of development

• Lower Rio Grande Valley: Increasing intrastate and interstate water markets can reduce future impacts of drought by 1/5th to 1/3rd (Ward et al. 2006)

• Upper Klamath Basin: 2001 curtailment of irrigation water cost irrigators between $27 to $46 million (Boehlert and Jaeger 2010)• Allowing more conjunctive use reduces damages by 37%• Allowing more flexible trading alone reduces damages by 57%

Developing Markets for Temporary Leases and Options

• Expand markets to include more temporary markets (spot leases) and options

• Most markets involve permanent and multi-year leases

• Not as cost-effective in addressing short-term scarcity

• Temporary transfers and options can reduce expected water supply costs substantially while still maintaining high reliability

• Suggests role for spot market leases and options

• Immediate transfer of water with lease price subject to considerable variability based on supply and demand conditions

• Option – initial payment that guarantees the purchaser the right to lease water at a later date at an agreed upon exercise price

• Certainty with spot price is a good hedge against spot market price volatility while providing the additional advantage of postponing transfer decisions until better information is available

• Leases and options improve market flexibility relative to permanent transfers alone

• MWD tried options w/ PVID in early 1990s…rejected by farmers

• Helps agencies meet the dual objectives of maintaining water supply reliability and lowering supply costs

“Let me explain something to you…this business requires a certain amount of finesse”

Jake Gittes Chinatown (1974)

Role for Government?

• Improve information regarding transfers and transfer impacts

• Establish a process for managing third party impacts

• Reducing the transactions costs of arranging and implementing water transfers

• Increasing the probability that efforts between parties to arrange a water transfer will be successful, and reducing the risks to parties from involvement with transfers

• Improved monitoring and metering of surface and groundwater extractions with property rights consistently defined in volumetric terms

• Provides more accurate price signals as to scarcity value of water

• Promotes more efficient use

• Improvements to allow more flexible interbasin water transfers

• Streamlining approval process for trades through mechanism such as zone-based trading ratios or preapproved trades that identify and account for third party effects (Hanak et al. 2011)