Sunday, 23 July 2017

Water allocation & pricing in NZ

The Greens water policy proposes a 10c/litre royalty on the "sale and export of water, including bottled water", and cracks open the debate over water allocation & pricing policies by signalling that further measures are under consideration.

This post outlines the main economic issues arising from water-using industries in NZ: bottling, hydro-power, and farming particularly dairy. I'm going to start by assuming that most people would support policies that:

  • don't cause undue depletion of the water resource;
  • don't strand capital investments; and
  • ensure that water polluters pay fair prices. 
After discussing these points, I'll return briefly to the water bottling issue.

Depletion is generally managed by setting minimum flows for rivers and maximum off-takes for groundwater (from aquifers). In a river setting, rights to pump water are typically shut-off when the river level falls to some trigger point. Minimum flow levels are set by Councils in consultation with freshwater scientists, anglers and other interested parties. This works best when the flow is measured downstream from the off-takes: otherwise you need to predict how a low flow at an upstream point will affect the river below the off-takes. Ground water (in aquifers) is much more difficult to measure. The raw data comes from water levels in monitored wells but its not easy to map the aquifers or their connections with rivers and other aquifers.

This issue is not completely sorted out, but the 2014 National Policy Statement obliged Councils to get cracking to ensure that water resources are not over-allocated, and to claw back over-allocations where they exist. My impression is that it has been effective in getting Councils to focus on these issues.

In some cases over-allocations have been notional rather than real: e.g. Marlborough wine growers have collectively been allocated more water than the aquifers can stand, but they're not using their full allocations. The proposed solution is to regulate allocations so that wine growers have enough water in almost all years, which frees up water for allocation to other people at the times of year that wine growers don't need it.

Asset Stranding
The basic point is that if we want revenue from water users then any pricing will need to be at a level that allows them to remain in business. Otherwise we get no revenue. My guess is that a royalty of 10c/litre on the "sale and export of water, including bottled water" would not kill off the bottled water exporting business. If so, people who've sunk capital into wells, pumps, filters, and bottling plants will continue to earn profits that help recoup the capital invested, just at a slower rate. This particular goose would then remain healthy enough for ongoing plucking.

However the same royalty rate would probably stop all hydro-power generation, and agricultural/horticultural irrigation over-night. Any firms owning un-depreciated assets used for this stuff would have to just write them off: those assets would be "stranded", unable to earn because of the water price. End result: dead goose = no revenue & much less productive capacity.

So if you're after revenue, don't set tax/royalty rates so high that they strand assets. More generally, remember these wise words from Jean-Baptiste Colbert 
The art of taxation consists in so plucking the goose as to procure the largest quantity of feathers with the least possible amount of hissing

Polluters Pay
The Greens are targeting the export of bottled water and seeking a contribution to the public purse from these firms. A different motive for tax is to send a price signal to polluters. Ideally, these Pigouvian taxes would be set at a level that recouped just enough cash to compensate for the damage costs that polluters impose on the broader community. Farming is where this issue bites, because the way we farm pollutes our water, imposing a cost on everyone else.

Basic welfare economics suggests we should investigate taxes on bagged nitrogen (urea). If dairy farmers used much less urea, our rivers would be much cleaner and we'd also stand a much better chance of sequestering carbon in our soils rather than emitting it.

Like tobacco, the urea business is highly profitable, so urea suppliers will probably absorb a fairly high percentage of any tax. This means that a relatively small % of any tax will be passed-through into retail prices. And since farmers are addicted, they won't be very price sensitive. So, ironically, even if our aim in imposing a urea tax was to send socially efficient price signals, it would end up raising a fair bit of revenue.

All of the above is very mainstream economics, meaning it is based on the pursuit of (social) efficiency. The water bottling royalty/tax is clearly not aimed at efficiency objectives. I expect it will get some support as a political move, but it's not ideal as a leading measure to address our broader issues around water allocation and quality.


  1. i certainly think the Greens tax is preferrable to inaction. i agree it wont do much towards improving quality and quantity, but if it was to become reality, it may make some overseas companies to think alot harder about taking our water. personally id rather see no water going overseas until we KNOW the quantity our aquifers contain. we'd look pretty stupid in 100-150 years if our water wasnt there in the amounts we assumed today.

  2. thanks Ned. just to be clear, i'm not opposing the Greens plan for a royalty on exporting bottled water.

    but we'd be fools to use the same royalty rate for hydro power or agriculture.