Systems Analysis Approach to the Design of Efficient Water Pricing Policies under the EU Water Framework Directive

Abstract

Economic theory suggests that water pricing can contribute to efficient management of water scarcity. The European Union (EU) Water Framework Directive (WFD) is a major legislative effort to introduce the use of economic instruments to encourage efficient water use and achieve environmental management objectives. However, the design and implementation of economic instruments for water management, including water pricing, has emerged as a challenging aspect of WFD implementation. This study demonstrates the use of a systems analysis approach to designing and comparing two economic approaches to efficient management of groundwater and surface water given EU WFD ecological flow requirements. Under the first approach, all wholesale water users in a river basin face the same volumetric price for water. This water price does not vary in space or in time, and surface water and groundwater are priced at the same rate. Under the second approach, surface water is priced using a volumetric price, while groundwater use is controlled through adjustments to the price of energy, which is assumed to control the cost of groundwater pumping. For both pricing policies, optimization is used to identify optimal prices, with the objective of maximizing welfare while reducing human water use in order to meet constraints associated with EU WFD ecological and groundwater sustainability objectives. The systems analysis approach demonstrates the successful integration of economic, hydrologic, and environmental components into an integrated framework for the design and testing of water pricing policies. In comparison to the first pricing policy, the second pricing policy, in which the energy price is used as a surrogate for a groundwater price, shifts a portion of costs imposed by higher water prices from low-value crops to high-value crops and from small urban/domestic locations to larger locations. Because growers of low-value crops will suffer the most from water price increases, the use of energy costs to control groundwater use offers the advantage of reducing this burden.