February 12, 2010

The Conference Board of Canada has joined the growing ranks of those endorsing full-cost pricing of water and wastewater services.

In Improving Infrastructure Management: Municipal Investments in Water and Wastewater Infrastructure, the Conference Board’s Len Coad points out that much of Canada’s water and sewage infrastructure is old and due for replacement – work that will cost many tens of billions of dollars. In order to tackle their infrastructure deficits, municipalities will need stable sources of revenue.

Government grants are not the answer. As Coad explains, grants “can be criticized for subsidizing inefficient planning and investment practices, or for creating ‘white elephant’ assets…. [I]n isolation, grants could be seen as enabling or extending the planning approaches and pricing mechanisms that contributed to the infrastructure deficit.”

Instead of waiting for grants, municipalities should rely on water revenues: “Consumers must pay for every unit of water they consume, and the price paid must reflect the supply cost.” Coad calls this recommendation simple and self-evident, but acknowledges that it has not been widely implemented in Canada.

Here is how Coad explains full-cost pricing: “In a full cost recovery model, water rates include all costs of providing water and wastewater services. These costs may consist of the direct investment cost, interest costs, operating costs, source protection, and ecosystem restoration. If systems that use full cost recovery rates implement appropriate planning processes and rate structures, funds are available to meet investment requirements and keep the water and wastewater system up-to-date and efficient. The available funds can also provide necessary upgrades and expansions, often with very little impact on short-term rates.”

Proper prices, Coad argues, would vary from season to season, reflecting “the fact that water demand peaks in the summer, requiring greater infrastructure capacity.” Proper prices would also vary with the distance between the water user and the water source. “[Z]oned or distance-based water rates could help to address some of the cross-subsidization issues related to replacing inner-city mains or urban sprawl.”

In addition to putting water and wastewater utilities on a sound financial footing and enabling them to provide quality service over the long term, full-cost pricing will encourage consumers to conserve scarce water resources. Coad writes, “Consumers must be aware of their consumption, and the price must provide a clear incentive to limit consumption, for the price of water to allocate the resource to its highest value uses.”

The Conference Board’s endorsement of full-cost pricing echoes that of several other prominent Canadian think tanks. In February 2009, the C.D. Howe Institute published Wave of the Future: The Case for Smarter Water Policy. In that commentary, economist Steven Renzetti noted that municipal water prices are far too low. In 2007, revenues earned represented just 70 percent of recorded expenditures – and a still smaller percent of the full costs of providing water and wastewater services. As a result of this chronic under-funding, aging infrastructure needs expensive repairs, water quality suffers, and consumers waste water.

Renzetti proposed several reforms, including universal metering and full-cost accounting. He argued for prices that reflect marginal costs: “for water, as for other commodities, efficient pricing should differ according to the quantity consumed, the location of consumption, and the time [and season] of consumption.”

Another Ontario economist, Harry Kitchen, produced a report on water financing for the Residential and Civil Construction Alliance of Ontario in 2007. In Financing Water and Sewer Systems in the GTA: What Should be Done?, Kitchen advocated a system in which “those who benefit from a service pay for it.” He continued, “Financing on this basis has a number of advantages. Whenever a direct link exists between the users of a service and its funding, a more efficient use of resources ensues. Accountability, transparency, and fairness also follow.”

Kitchen made a number of specific recommendations, including:
• Install meters for water and sewers everywhere with the cost of installation borne by the property owner.
• Implement volumetric water prices designed to improve the efficient use of local resources and encourage conservation.
• Water prices should vary by time of day or season of the year.
• Water prices should include the opportunity cost of water use.
• Annual asset replacement costs must be included in annual operating costs.

Support for full-cost pricing has also come from government commissions, industry associations, environmental organizations, and consumers themselves. (See my blogs of August 4, September 1, and September 18, 2009.) What more will it take to convince municipalities to price water sustainably?