Water pricing under climate uncertainty – an economy-wide model considering precipitation stochastics

So far uncertainty of input parameters has not often been systematically analyzed in computable general equilibrium (CGE) modeling. Especially this is true when it comes to climate uncertainty. Instead, CGE models are mostly applied in a deterministic setup making their findings highly dependent on point estimates of key exogenous variables. In this study, we employ a Monte Carlo approach to simulate uncertainty of annual rainfall-induced freshwater recharge in Israel. A novelty of our approach is that we systematically determine the sufficient sample size. The CGE model includes a detailed depiction of water supply and demand it also considers alternative water sources, such as desalination and reclamation of wastewater. We apply our approach to determine the minimum water price that should be charged in order to avoid overexploitation of natural freshwater resources with 90% confidence under different desalination-capacity regimes. Our findings suggest that the current pricing scheme guarantees only in about 45% of the years that water demand remains below the annual renewable freshwater recharge rate. In order to avoid overdrafting of in 90% of the years, the water price would need to be doubled. Yet, the overall effect on the economy of such a price increase would be relatively small, resulting in a drop of GDP by 0.02%, as water constitutes only a small expenditure share in the production of most commodities and services and there are alternative water sources which serve as substitutes. On the household level, welfare effects are overall negative and result in a more unequal distribution. In case the desalination capacity is doubled, potable water prices would only need to be increased by only 21% in order to avoid overdrafting of freshwater resources in 90% of the years. The effect on GDP would not be much different, but effects on household-welfare would be much more balanced and less negative.