Modeling sectorally differentiated water prices and policies: an application to the Israeli water economy

At the moment Israel is facing the worst water supply crisis since the beginning of record keeping more than 80 years ago. The Israeli National Water Authority (NWA) declared recently that drought conditions are continuing for eight consecutive years now (Jerusalem Post, 2012). This, together with an increasing demand for potable water due to economic growth and immigration has led to a situation of overexploitation of the renewable water resources within the country. Already by 2010 the cumulative deficit amounted to about 1.5 - 2 million m³, which is close to Israel’s annual total water consumption (NIC, 2010). Also the quality of potable water resources is deteriorating. With groundwater tables falling due to over-extraction, especially the coastal aquifer is prone to seawater intrusion resulting in an increasing salinity level of potable water (Zaide, 2009). In response to this crisis, the development of alternative water sources including desalination of seawater and wastewater recycling as well as usage of brackish groundwater for irrigation purposes was fostered (Zaide, 2009). In addition, the NWA was established in 2007 to centrally govern water resources within Israel and the existing complex water pricing regime, with prices being differentiated according to user-group (municipal including households and services, industrial and agricultural) as well as between different water qualities (saline, reclaimed, fresh). This pricing scheme particularly favors the agricultural sector which is charged relatively low water prices, whereas the price charged from municipal users covers the costs of supply. On the other hand, the main supplier of water in Israel (67% of total water supply) is a state owned company which receives financial support from the government in order to reduce water-provision costs (Zhou, 2006). To increase efficiency in the Israeli water economy, a report by the National Investigation Committee on the subject of the management of the water economy in Israel (NIC) published in 2010 suggested several principals for the management of national water resources. Among these are that water needs to be regarded as a raw resource and its extraction needs to be limited to an amount below the average annual recharge. To achieve this, a water pricing scheme reflecting total water supply costs, including extraction, transportation and also environmental costs was recommended. In addition, a block rate pricing scheme with increasing prices for higher consumption levels was suggested to ensure affordable for basic consumption (NIC, 2010). This study takes up the proposal by the NIC and applies a computable general equilibrium (CGE) model, in which the water sector is explicitly modeled. With this approach, an efficient pricing scheme regarding the different water qualities and users within the Israeli economy is simulated. We employ a single country CGE-model to reflect the relations between the Israeli water sector and the rest of the economy. The model is based on the standard STAGE model (McDonald, 2009) and is adjusted to fit an Israeli SAM, which depicts the Israeli economy in the year 2004 and includes data on 45 commodities and activities, 38 factor accounts, 10 household types and 18 tax categories. The water sector is explicitly modelled to include the freshwater resource as a factor of production and three different water commodities (potable water, recycled wastewater and brackish water) which are produced by three activities with different cost structures. All three activities employ fixed proportions of capital, labour and intermediaries. The three water commodities are included as intermediate inputs in the production functions of the other sectors or are consumed as final products by households. Furthermore, as the SAM only provides value data, satellite accounts for water quantities consumed by different user groups based on data provided by the Israeli Central Statistical Office are included (CBS, 2009). To be able to model water prices endogenously, new variables for the prices of the different water commodities are introduced. We introduce quotas to reflect the block rate pricing scheme and the subsidized prices for basic domestic consumption as well as the agricultural and industrial sectors. The reference scenario, depicting the applied water prices in 2004 is compared to a simulation in which quotas for subsidized water prices are reduced. In a second scenario additionally the above quota water price is lifted to the cost of desalination, representing the marginal price for water in Israel (Zhou, 2006). An increase in the price of potable water is expected to have a negative effect on the economy as a whole, especially the agricultural sector is expected to be hit hardest as it is the biggest potable water consumer in Israel and enjoys the most favorable prices in the reference scenario. However, within the agricultural sector the shock can partially be mitigated by an increased usage of marginal water (reclaimed wastewater and brackish water) which can be supplied at a lower price, but cannot be used in all agricultural sectors for hygienic reasons and due to low salinity tolerance of many crops. Industrial and municipal users are expected to be affected to a lower extend, as the share of water in the cost structure of most industrial and service sectors as well as in household consumption is rather small. However, due to the block rate pricing scheme rich households are expected to be stronger affected than poor households, as rich households tend to consume more water above the basic consumption quota and therefore on average face higher prices. References CBS (2009): Statistical Abstract of Israel 2008, No. 59. The Israeli Central Bureau of Statistics (CBS), Jerusalem, Israel. Jerusalem Post (2012): Water Authority: Israel in 8th straight drought year. The Jerusalem Post. 01.02.2012. Available at: http://www.jpost.com/Headlines/Article.aspx?id=251892&R= R101. Accessed: 01.12.2012 McDonald, S. (2009): STAGE Version 1: July 2007. Course documentation. NIC (2010): Committee’s Report Abstract. National Investigation Committee on the subject of the management of the water economy in Israel. Haifa, Israel. Zaide, M. (2009): Drought and Arid Land Water Management. United Nations Commission on Sustainable Development (CSD)-16/17 National Report Israel. Zhou, G. (2006): Water Resources Management in an Arid Environment - The Case of Israel. Background Paper No. 3. The World Bank, Environment and Social Development Department, East Asia and Pacific Region, Washington D.C.