Demand Management through Water Pricing and Discounts

Actew’s proposal for a new water restriction regime includes the idea of using a variable price as a control mechanism. As water levels fall the intention is to reduce consumption by increasing the price to discourage consumption.  This approach could theoretically replace water restrictions.

A problem with this approach, and with other price mechanisms such as water trading, is that variable pricing is difficult to adjust and tends to be inequitable. It can cause unnecessary hardship that in turn requires some form of compensation. This in turn reduces the effectiveness of the price increase.

If variable pricing does stem the use of water, it can reduce the competitiveness of the community because of losses due to lack of water. There is no guarantee that the water supply will be increased, as the return on investment for water supply is low compared to other investments. The pitfalls associated with using price alone are described by SavenijeandvanderZaag.

To overcome these difficulties it is recommended that Actew introduce a discount system for people who consume less water.  Actew’s current pricing mechanism – under which the greater the volume of water consumed, the higher the cost per litre – is already a discount for low consumption households.

This recommendation is that instead of water restrictions, we introduce more discounts for low consumers as well as price increases for high consumers as water levels drop. This approach automatically adjusts income received because the water “saved” by the low consumers is sold to the high consumers for a higher price, so keeping total income the same even though water consumption drops.  Such an approach will be seen by the community as fair and will not be seen as a form of tax grab by the ACT government.

The approach can be made even more effective by requiring the discounts to be invested in ways to increase the supply of water.  Actew could offer different investments, such as bonds to build the Cotter Dam or to refinance the loans Actew have taken out for the dam.  Discounts could be used more directly to purchase water tanks or recycling systems or could go towards community-wide investments such as ponding with water use for outdoor areas. Discounts could be sold if people did not wish to purchase investments.

This approach of giving discounts when a person does some other restricted transaction is widely used in private markets. Examples are the Coles and Woolworths petrol discount and other coupon systems.

The system can be further leveraged by Actew soliciting interest free loans from banks and the interest free loans used to increase the size of the discounts.  The loans are repaid from the payment from the bonds or from water savings or from sales of the increased water obtained from direct investments and so are “no risk” to the people receiving the loans.

Actew increasing the value of discounts with interest free loans

In Australia banks have to go to the international and local capital markets to raise loan funds for their reserves to satisfy the need for loans.  When a bank makes a loan it creates credit and extra cash deposits but it needs a certain level of reserves. There are limits on how many loans a bank can create and this is determined by the reserve ratio of deposits to loans.  That is, in total a fraction more must be held in deposits than there are loans outstanding. Therefore, if a bank increases the money supply with a loan it must have a fraction of the amount of money it loans available as reserves.

These reserves could be obtained via interest free loans that make it much cheaper and therefore more attractive for the banks when compared to raising reserve amounts on the open interest bearing loan market or from raising equity.

If the government, or Actew, has large cash deposits that are being held for long term purposes such as pensions and superannuation,  those deposits can still earn interest but may also  be used as security for the interest free loans.  One or more banks are likely to take up the offer as they will obtain large cash deposits that they can use to leverage the creation of their regular loans. The banks give interest free loans equivalent to the cash deposits that are held in reserve. The loan funds are safe because they are secured against cash deposits and the loan funds will – over time – be repaid from the returns on the investments created with the funds.

Actew wins because it obtains financing without having to pay interest on the funds.  The citizens win because they get a stake in the water infrastructure that will continue to earn income long after the loans are repaid.  The government wins because it does not have to impose water restrictions or increase the price of water as the loan funds can be used as discounts for the low consumers.  The citizens will see that the system is fair and equitable, and that they will be ensured of an adequate water supply no matter what happens with the climate.

Summary of Water Discounts

Along with increasing the price of water as dam levels drop Actew can introduce a scheme of Water Discounts for citizens who consume less water.  Water Discounts must be invested in ways to increase the supply of water or to make better use of existing water.

Making sure all investments go through a market place of approved investments will ensure compliance. Those who abuse the system are banned from future allocations of Water Discounts.

The funds to pay for Water Discounts comes from the higher prices paid by high water usage consumers and from issuing interest free loans.

The system can be set up within the existing pricing regulations and approval sought later from the Price Regulator for varying the price if it proves necessary.  Approval from the Price Regulator to allow future variable pricing is likely because the increase in collections is returned to consumers as discounts.

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