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| Recent drought conditions across Australia have significantly depleted urban water storages and have resulted in severe water restrictions being implemented in most capital cities. While the recent drought has been abnormally severe, current urban water shortages are indicative of a broader long-term trend of increasing urban water scarcity in Australia. This trend has been driven by a gradual long-term decline in mean inflows into storages, increasing demand because of population growth and minimal additions to supply capacity. Given the increasing scarcity of urban water and the potential for climate change to further reduce water availability and increase variability, there is increased pressure on urban water utilities to implement efficient demand management policies and to make optimal supply augmentation decisions. Currently, urban water demand management predominantly involves the imposition of water restrictions to ration water during times of scarcity. In this paper, scarcity pricing is proposed as an alternative to the use of water restrictions. Scarcity pricing of urban water has received significant research attention in recent times, see for example: The Productivity commission (2008), Grafton and Kompas (2007), Sibley (2006) and Frontier Economics (2008). In July the National Water Commission (2008) released a position statement recommending that scarcity pricing receive further consideration as an alternative approach to urban water demand management. One of the main difficulties in designing urban water policy, particularly in Australia, is the extreme variability of rainfall and dam inflows. This report considers the design of optimal demand management and supply augmentation policies under climate variability, by constructing and applying a stochastic dynamic programming model of an urban water market. This model is used to demonstrate how a scarcity pricing system would operate and to evaluate the basic factors governing the optimal timing of supply augmentation investment. Background information on the demand and supply of urban water in Australia is outlined in chapter 2. Current Australian urban water policy and the potential for reform are outlined in chapter 3. An illustrative model of an urban water market is described in chapter 4 and a discussion of the modelling results is contained in chapter 5. Conclusions are outlined in chapter 6. |
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