January 22, 2013

The free (and un-free) markets in water

Filed under: Economics — Tags: , — Nicholas @ 09:58

Water is often described as a “natural monopoly”, because most of us only encounter a water bill from a municipally owned water utility company. But there are other markets for water where the price varies exactly the same way as it does for other commodities:

Earlier this year the Aurora Sentinel reported that the city will sell $9.5 million worth of water to an energy company. Why? Because the company is offering four times the price offered by other customary buyers. Potential profits in oil and gas make the water highly valued by drillers. Of course, this valuation is subject to change along with the prices of oil, crops, and all of the other resources required to produce them. If oil prices decline relative to crop prices, drillers will bid less for the water and farmers more, and water will flow to its most highly valued use. In other words, when markets are allowed to work, it’s a beautiful thing.

Public utility customers aren’t used to, and don’t really understand, how a free market works when it comes to water. Because a local water utility is seen by most economists as a natural monopoly, retail costs are fixed at low levels despite potential fluctuations in supply and demand. These low costs are accomplished not only through price fixing, but also through rationing (i.e., the public utility regulates when and how much water can be used, rather than consumers responding to true prices).

Water rationing usually affects what the utility considers a low-value use of the good, such as lawn watering. You are permitted to water your lawn only during certain hours, on certain days, and for a certain amount of time. Even if you have a prize-winning English garden in the middle of a desert and would gladly pay more for water, you aren’t given that opportunity. The guy next door with the dandelion lawn, whose sprinkler spends more time spraying the sidewalk than the grass, has no incentive to be more careful with his water, except when he’s forced to follow the directive of the local authority and water his sidewalk on Tuesdays and Thursdays between the hours of 6 and 8 p.m.

Because there is no price incentive for the average public utility water customer to respond to, there are very few creative conservationists. Instead, public utilities resort to ridiculous advertising campaigns aimed at persuading their customers to use less of their products. You’ve probably received the flyers or seen TV ads sponsored by your water and electric utilities offering tips on how to use less. A more direct way to economize on water and energy use might be to let prices fluctuate for public utility customers like they do for customers in the wholesale market.

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