Beyond the Drought: Water Allocation in the UK

Water allocation in the UK needs reform.   Current arrangements rely too much on administrative controls – such as hosepipe bans – and not enough on prices.

There is said to be a drought in much of southern and eastern England.  In reality, there are challenges arising from the combination of:

  • A long period of below-normal rainfall;
  • The water requirements of a dense population and its economic activities;
  • The need to protect freshwater environments;
  • Inadequate water allocation arrangements.

A return to more normal rainfall will probably ease the situation.  But in the longer term, population growth and climate change may lead to much severer challenges.

Water allocation comprises the taking (abstraction) of water from rivers, groundwater, etc., and its distribution to users.  In England and Wales the Environment Agency controls abstraction via a licensing system.  About half of total abstraction is by water companies, which distribute treated water to households and other users.  Electricity generators, other industries and fish farms abstract large quantities of water for their own use.  The Cave Review, the Walker Review and a recent White Paper have recognised the inflexibility and inefficiency of current allocation arrangements.

Addressing Over-Abstraction

Most abstraction rights are under old licences granted in perpetuity (1). The case for treating them as property rights is strong.   But action is needed where over-abstraction results in water scarcity or harms the environment.  Currently there is a lengthy administrative process to decide which abstractors will lose rights (2). Losers are then paid compensation. To minimise compensation costs and ensure that rights are retained by abstractors who value them most, the Cave Review proposes instead the use of reverse auctions.  Abstractors would offer prices to give up rights, and those offering the lowest prices would lose their rights and receive compensation at their offered price (3).

However, retention of rights by abstractors who value them most is only one aspect of efficient water allocation.  The marginal value of water to an abstractor will fall as the volume it abstracts increases.  For efficient allocation, the marginal value to each abstractor (from the same river, etc) should be the same.  The obvious way to achieve this is a volume-related scarcity charge (in other words, a price).  To counter the objection that this would be an unacceptable attenuation of property rights, such a charge could be combined with fixed compensation payments.  The Cave Review presents scarcity charges as a last resort where over-abstraction cannot be addressed in other ways (4).  Instead, they should be promoted as both an economically efficient and a lower cost solution.

Managing Household Demand

Only 37% of households have a water meter (5).  Most households pay on a basis unrelated to use, with no incentive to use water efficiently.  Unable to adjust charges to moderate demand when water is scarce, water companies have little choice but to rely on administrative measures such as the current hosepipe bans.

Extending metering involves installation and other costs.  To minimise these, the Walker Review recommends a more systematic approach to meter installation, rather than – as largely happens at present – reacting to requests from individual households (6).  With universal metering, water companies could charge all households on a volume-related basis, and set higher charges in summer when water is usually scarcer.

The efficiency of allocation could be further enhanced, and hosepipe bans avoided altogether, if charges per volume were quickly adjustable in response to supply circumstances.  This could be achieved with the use of smart meters, transmitting frequent readings, together with appropriate policies by the regulator, OFWAT. The Walker Review acknowledges the potential of smart meters, and sensibly recommends coordination between water, gas and electricity companies to exploit any available synergies (7).  Would it perhaps be advantageous to leap a technological generation, rolling out smart meters as quickly as possible and discontinuing the installation of further non-smart meters?

Conclusion

The two reviews and the White Paper move debate in broadly the right direction.  The case for using prices to make water allocation more flexible and efficient could however be made more strongly.  This is not to advocate laissez-faire.  The state and its agencies have essential roles in protecting the environment, ensuring the quality of drinking water, and protecting consumers where suppliers have a local monopoly.  Also important is their role in establishing the pre-conditions for allocation by prices such as metering and a suitable legal framework.

References

1.  Anglian Water & Frontier Economics 2011  A Right to Water?  p 18    http://www.anglianwater.co.uk/_assets/media/a-right-to-water-full-report.pdf

2.  DEFRA White Paper 2011  Water for Life p 41       http://www.official-documents.gov.uk/document/cm82/8230/8230.pdf

3.  Cave, M  2009  Independent Review of Competition and Innovation in Water Markets  p 33     http://archive.defra.gov.uk/environment/quality/water/industry/cavereview/documents/cavereview-finalreport.pdf

4.  Cave, as above  p 116

5.  DEFRA, as above  p 51

6.  Walker, A  2009  Independent Review of Charging for Household Water and Sewerage Services  p 78     http://www.defra.gov.uk/publications/files/pb13336-walker-water-review-091205.pdf

7.  Walker, as above  p 81

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