Opinions

Pricing Water

Pricing Water

“Ultimately, quality standards can only be raised when tariffs are adjusted more comprehensively.”

Debra Tan, WSJ 

We have been saying that tariff hikes are inevitable given the urgency of the water crisis in China.  New drinking-water standards are expected to be in place by 2015 and there is pressure to up investment to treat water to meet this.

Ultimately, quality standards can only be raised when tariffs are adjusted more comprehensively.

 

The progressive tariff scheme proposed is supposedly designed to punish water intensive users and to slow down the rate of water usage in the face of rising urbanisation. The proposed three tiers are as follows:

  • Tier 1: Base rate (80% of households)
  • Tier 2: 1.5x the base rate (15% of households)
  • Tier 3: 3x the base rate (5% of households)

“prices remain the same for 80% of residents, it is doubtful whether the tiered pricing will have any significant impact on people’s profligate water use”

China Daily

There is much skepticism however, about the tiered pricing inflexion points. According to China Daily, since “prices remain the same for 80% of residents, it is doubtful whether the tiered pricing will have any significant impact on people’s profligate water use”.

Guangzhou residents were the first in China to face these tiered hikes tied to water usage last year. It is interesting to note here that Guangzhou residents faced a 50% hike in the base rate from RMB1.32/m3 to RMB1.98m3 in 2012 before the three tiered tariffs were implemented. The NDRC has so far been silent on whether there will be a base rate hikes across Chinese cities.

So it remains to be seen whether these rates will be effective in controlling water usage but regardless, the tiered hikes are seen as a step forward in over-hauling water pricing in China.

Following a similar pricing path to California?

Last month, we had the pleasure of meeting with Professor Michael Hanemann who was intimately involved with setting water tariff policy in (especially) California and is currently part of the working group for the IPCC (Intergovernmental Panel on Climate Change) 5th Assessment report out later this year. The meeting largely focused on developments in water policy in the US and what struck all of us present at the meeting (including Robert Gibson and Charles Yonts) were how similar developments in China are to the US. Yes, China has yet to reach 100% primary sewage treatment but then again, the US didn’t get there until the 1960’s with the exception of Boston which only reached 100% primarily sewage treatment in the 1990’s!

“in real life you can only increase water tariffs if you can convince people you need to spend the money”

Professor Michael Hanemann

In Professor Hanemann’s view, the US public is “disproportionately sensitive to water rate hikes” and there was public backlash when tiered tariffs were introduced in Los Angeles in the 90’s. He believes that “in real life you can only increase water tariffs if you can convince people you need to spend the money” rather than to harp on about water scarcity. Well, China obviously has to re-haul its wastewater & drinking water treatment systems & pipes and people are concerned about the cleanliness of their water, so rate hikes in cities will probably not face much resistance. Indeed, there was no backlash in Guangzhou which could indicate that pricing reform in China will go smoothly.

Price points & switchpoints between tiers

The key is to set the right pricing mechanism to influence water usage behavior. Price points set for each block/ tier matters and as does the “switchpoint” when users move into a different tier.

the lower block is generally based on estimated average cost of supply… the upper block should reflect the cost to “replace” water ie. priced at the real scarcity value

Hanemann spoke to the basic residential pricing system with a lower and upper pricing block. In California, the lower block is generally based on estimated average cost of supply whilst the upper block should reflect the cost to “replace” water ie. priced at the real scarcity value. In China, the NDRC has indicated that pricing should be 2.5%-3% of household income to reflect the limited water resources of the country. Currently, water prices are only 0.8% of household income. A rough calculation means that the current proposed 3x increase in prices for Tier 3 would translate to water prices reflecting 2.4% of household income, in other words, the real scarcity value of water. So perhaps China is not that off point on pricing in scarcity.

But what about the “switchpoint” when users move into a higher tier?

the switchpoint between the lower and upper blocks is set about 25% above median consumption in the US

According to Hanemann, the switchpoint between the lower and upper blocks is set about 25% above median consumption in the US. In China, a back of the envelope calculation on Guangzhou’s tariffs, assuming that Tier 1 with 80% of the users denote ‘median consumption’, Tier 3 which starts at 34m3 (the upper block) is 26% above the 27m3 for Tier 1 (lower block). Again, it appears that switchpoints China are set in the right ballpark.

Given that water usage quotas under the “Most Stringent Water Management System”, differ from province-to-province, we expect switchpoints and price points to also differ from province-to-province.

The real question is does the current base rate in Tier 1 reflect the price of average cost of supply of water? Or is water still priced too cheaply to cover the average cost of supply? It remains to be seen whether base rate hikes will be put into place to support water infrastructure build-out but the base rate price is definitely not correctly set in HK’s case….

Out of Sync: HK & China Tariffs

HK & Guangzhou Water Tariff Comparison Table

According to Dr Frederick Lee, HK’s average water supply price to the user is HK$4.58/m3 whilst HK buys water from Guangdong at a higher rate. The implied water tariff paid by HK government to Guangdong Investment Limited for 2013 is HK$4.75/m3 (RMB 3.71/m3). Hong Kong cleans this water again bringing the average water supply cost up. In 2011-2012, the all in cost of water was HK$7.60/m3. In other words taxpayers are subsidizing heavy water users to a tune of HK$41.7billion for 2011-2012 (read his full analysis here). This means that only HK’s top tier is paying the average supply cost let alone the replacement cost.

More interestingly, it is obvious that the implied tariff paid by HK to Guangdong Investment of RMB3.71/m3 is less than that paid by Tier 3 residential users in Guangzhou. Given that HK takes up to 1 billion m3 per annum from Guangdong, is there upward pressure to adjust tariffs? Moreover Tier 3 in Guangzhou is not only 2x the base rate versus the 3x proposed by the NDRC last week. An apt time to debate water pricing as the Dongjiang Water Supply Agreement is up for renewal this year. (Check out Civic Exchange’s Su Liu views on HK’s water strategy).

It’s industry, stupid!

Yes, current base rates do not reflect the average supply cost of water across cities in China and unless they are raised, probably will not influence 80% of water users. But let’s keep things in perspective. The public only uses 13% of water use in China. Industry uses 25%. So if China is serious about reining in water usage, industrial water hikes are looming and inevitable.

Going forward, NDRC has signaled that industry will bear the brunt of the hikes with rising industrial water and wastewater discharge tariffs. The MEP should also be stepping up monitoring and enforcement with higher penalties for pollution violations.  All of these should push water intensive and polluting industries towards more efficient water use and better treatment of wastewater discharge.  This should not only help China meet the ‘three red lines’ (national water quotas) but also address rising public concern over water pollution and food safety. Unfortunately for industry, it will mean rising costs.

The use of pricing along with pollution fines, quotas and enforcement are just tools to get water management right. For China where water scarce provinces drive 45% of her GDP, managing water is key. It is time to move way of a “silo-ed” view of water. Adjustment of water prices are just the start

 


Further Reading:

  • Bridging Gaps to Water Innovation Water scarcity and pollution will drive innovation in partnerships and technology. But for water tech, the potential for commercialisation remains the biggest challenge to innovators. Here, Will Sarni discusses the barriers and opportunities associated with innovation in the water sector.
  • Water Fees & Quotas: Set for Economic Growth? Debra Tan reviews the new joint standard on water pricing and new provincial quotas on water use, water efficiency and water quality released in January 2013
  • Big Spender: Buying Up Water A savvy investment or villain in the making? Debra Tan looks at the HK tycoons’ water shopping spree, buying up water rights, water philanthropy and venture capital in water innovations
Debra Tan

About Debra Tan

Debra heads the China Water Risk team and spearheaded the development and build out of the China Water Risk brand and website in 2011. Since then, she has written extensively about the water-energy-food nexus as well as reports analyzing the impact of water risks on certain sectors for financial institutions and corporates. She has also given numerous keynotes, moderated and participated in panel discussions and conferences around water issues to investors and corporates. Debra started her career in finance, spending over a decade as a chartered accountant and investment banker specializing in mergers & acquisitions and strategic advisory. She has lived and worked in Beijing, HK, KL, London, New York and Singapore. Debra left banking to explore her creative side pursuing her interest in photography resulting in her first solo exhibition within a year. She also ran and organized hands-on philanthropic and luxury holidays for a small but global private members travel network and applied her auditing, financing and photography skills in the field for various charitable organizations and foundations.

Read more from