Nathan Taylor interview — The economic value of water in storage: what does it cost to maintain water reliability?

An interview with Nathan Taylor, a research fellow at Melbourne University who speaks about quantifying the economic value of water in storage, using risks and society’s tolerance to risk and what water costs to mitigate that risk as a basis of finding a value for water in storage.

Nathan is an economist by profession and has worked for the Reserve Bank of Australia and was also a Chief Economist at the Committee for Economic Development of Australia (CEDA). Nathan feels that his research is important not only for Australia but for other nations too as we grapple with maintaining urban water supplies in an uncertain future.

His background is in finding economic solutions to policy decisions of government. The Millennium drought inspired his research.

Tell us about your background and the research you are doing.

I’m a professional economist and I have worked in various roles, including at the Reserve Bank of Australia and as Chief Economist at the Committee for Economic Development of Australia (known as CEDA). Now I’m a research fellow at the University of Melbourne. Those roles have all involved applying economic principles to policy decisions of government; they have not been about water, as such. However, when state governments all around Australia were facing the potential risk of running out of water, they unanimously decided to build large desalination plants, despite their extreme cost. That made me interested in the economics behind those decisions and I wanted to explore how economic policy can help people make better decisions in the future.

My research is examining the ways in which people quantify the economic value of water and water storage. I’m particularly considering the role of risk and society’s willingness to tolerate risk and what it costs to mitigate that risk. Those factors are fundamental to the value we place on water and water storage.

I think it’s important to understand how people value water, not just for Australia but also for countries around the world as we grapple with maintaining urban water supplies in an uncertain future.

It is an interesting challenge, and I’m very grateful to have some fantastic professional support from very learned individuals. I’m looking forward to publishing and talking with other people who are interested in this issue because I think there are some really interesting outcomes that are applicable to a wide range of people

There is a large amount of data available about water resources in Australia. How does that data relate to the economic thinking you are researching? Does it help you understand risk and the amount of risk people will accept?

For a region to have ‘water security’ the water resources must be able to meet a certain level of demand over time. Hydrologists collect data over as many years as possible to establish a record of water inflows (from rain and streams) to the region’s storages, and to calculate the water used by various populations and industries in that region. That gives them the amount of water that needs to be stored to supply the region’s probable water demand across a range of likely scenarios into the future. It’s called the storage–yield–reliability relationship (SYR). SYR is not easy to quantify because the weather can very quickly change from extreme drought to torrential rain and flooding. In essence, the hydrologists are estimating the risk in the water supply system – the probability that particular storage, such as a reservoir can supply the anticipated water demand throughout the next 1000 years (say), and the risk that it cannot do that. One way the authorities manage that risk is by imposing water restrictions.

The economists’ way of looking at the SYR (or risk) is to quantify the cost of building an alternative water supply: I’m talking here about a recycling system or a desalination plant or other forms of alternative water supply that can be made accessible in extreme situations. The economists ask the question: ‘How do you minimise the infrastructure you need to build to meet a given level of water security?’.

For example, look at how the approach is being used in Melbourne, by Victoria’s Department of Environment, Land, Water & Planning, and Melbourne Water, and the water retailers. From projections, we know that Melbourne’s population is going to double by 2060 or thereabouts. We know that when the city’s reservoirs are full, the volume of extra water resources that will be needed in 2060 can be provided at a cost of X dollars. On the other hand, if the reservoirs are nearly empty, much more water will need to be provided to guarantee the same water security by 2060, and to provide that guarantee may cost twice as much: i.e. 2X dollars. By looking at those relationships, we can actually see what the value of water is, today, in Melbourne.

The reason it will cost twice as much is that if the water storage is very low today — that is, the dams are almost empty now — then you need to take action today: such as putting on really extreme water-use restrictions or building an extra expansion desalination plant. However, if today the dams are full, you won’t do those things until nearer 2060. Some of these expansions you make to the water supply now may never be used.

That is the case in Melbourne at the moment. Water inflows to Melbourne’s storages now are similar to those we have had since Melbourne was founded, and if they continue like that for the next 100 years Melbourne will not need augmentations to the water supply system. The billions of dollars that were spent during the Millennium Drought will have been wasted.

In fact, during that drought Melbourne would have run out of water had consumption continued at the same level it was in the 1980s and the 1990s. People became accustomed to checking an app on their phones showing the current water levels in the reservoirs — it was part of the cost of maintaining our water storages, encouraging everyone to care and to monitor their own water usage — and in fact, there were huge reductions in water demand.

You can’t eliminate hydrological risk. It’s always going to be there, but for the average person walking along the city street, the risk that concerns them is nothing to do with rain filling up the water reserves, and nor should it be. The risk is that they may get wet if they’ve not got an umbrella. They’re also concerned about the size of their water bill, and they do expect water to appear when they turn on a tap.

Can you explain how hydrologists and economists differ in the way they think about water risk? Does your research help them understand each other’s viewpoints?

From my perspective as a professional economist coming into this policy area, two things struck me. First, that economics in the past has tended to simplify hydrological risk. Economists have not represented the risk in a way that decision-makers can appreciate, so decision-makers haven’t understood what we are facing. I think economists haven’t quantified and conceptualised that risk, and their good advice hasn’t been translated into practical policy outcomes for urban water suppliers.

On the other side, I’ve looked at hydrology and seen the amazing insights hydrologists have into the behaviour of reservoirs and water supply systems as a consequence of hydrological variation. But the way they treat demand has also been simplified and it’s been perceived as almost external to the system.

Speaking as an economist I’d say that demand is very responsive to pricing, as Melbourne’s history has proven. So if you give people a choice around the level of risk they’re willing to face and the costs associated with that, then something can be done with it.

And so my advice to anyone looking at this area — that is, the interaction of economics and hydrology — would be to treat with respect the way economists view demand and the way hydrologists quantify risk. Because unless you can actually manage across those two concepts you won’t be able to give any advice resulting from your work.

This is different from rural water supplies in Australia.

I’ve been very fortunate to work with Professor John Langford, who spent a long time operating Melbourne’s water supply system and working across the water supply systems of Australia. He’s incredibly knowledgeable and is a supervisor of my research. John has provided the capacity to translate economic concepts into the hydrological decision-making that is needed. I have begun communicating these concepts to decision-makers and my next challenge will be to expand that to a broader group of people.

Another interesting aspect of economic thinking about urban water supply is the ‘essential for life’ component. Although economists have spent almost 100 years trying to quantify urban demand for water, they’ve not tried to quantify the ‘essential to life’ component: ‘What is it worth to people in the City of Melbourne to have water when there’s none available?’. Partly, this gap has occurred because they assumed water was always going to be available. However, in reality, the trade-off in water demand is from tomorrow’s need for today’s demand. The risk calculation is based on not needing an ‘essential for life’ quantity of water in the future.

Some people have examined the ‘essential for life’ component that an urban centre needs in an industrialised country. Excluding agriculture, the result is around 135 litres per person in a developed country. It may be different in another context. In fact, the World Health Organization standard for people to survive, cooking, drinking and basic hygiene is very small, only 10 to 20 litres a day.

Melbourne is a very dry place compared to many other cities and during the Millennium Drought the water use target dropped to around 155 litres per household per day, so, less than 135 L/person. Of course, when you calculate water needs in a city context you have to include industrial applications and all the other systems that keep a city running, which explains why 135 L/person is so much more than the WHO standard.

Can your work be applied in the context of the Indo-Pacific? Are there any examples from other places around the world?

The concept of looking at what it costs to maintain the reliability of water supply is relevant to anywhere that has water in storages or relies on reserves of water or on variable inflows of water … anywhere that has major variations in the inflows of a river or relies on water in storage from gravity-fed reservoirs. It’s a variation of what’s done quite often by quantifying the reliability of the water supply system.

But the approach we’ve adopted is relatively new, which is why it’s still being researched at the moment. So far as I know, it hasn’t been directly applied to assess the economic value of water in storage anywhere else.

I know of other situations where cities have taken extreme action when faced with running out of ‘essential for life’ water. For example, in 2008 when Barcelona had an extreme drought they hired a supertanker full of water to supplement the city’s water supplies. That would be an extreme case: they didn’t have enough time to build a desalination plant so they did this instead to keep people alive.

It’s interesting because I think the authorities in Barcelona tried to manage the risk of water shortage, but they didn’t quantify the costs of that risk. They tried to get an inter-basin transfer, to buy water from the rural area but were rejected because of the politics of the situation, and they hadn’t quantified the cost if they didn’t manage to buy water from farmers. I think the failure in Barcelona was that they had not quantified the cost of those extreme measures.

What about the rural context, such as in the Indo-Pacific? Is the same risk approach applicable when you need to get water to the agricultural sector to ensure food production when the alternative is to pay to import food?

It does make perfect sense. The principles would be applicable everywhere, except you would need some sort of social program guaranteeing baseline reliability of the water supply in a rural context. Even for places without functioning markets in water, you can ask the question: ‘What is the value of maintaining reliability to an individual or a community and the people within that community?’. Then you can start to allocate the water to those who value it the most.

In Australia, because there is a market, those who value water the most pay the most for it. Here, the risk approach is only viable in relation to a city because the risks of failure are socialised: that is, the government will step in to ensure urban water supplies. In our rural context, the approach isn’t relevant because the risk of failure is privatised: that is, the individual farmers ensure the reliability they want for their water supplies.

We have water trading markets in Australia, and the price of water goes up and down based on its availability. Farmers can purchase as much or as little of these entitlements as they want, according to their desire for reliability — and it is very clear that different agricultural consumers of water value water differently. At the lowest level are the rice growers, who don’t buy reliable water. Instead, they just grow rice when water is very cheap and plentiful. Then there are the dairy farmers who buy water to grow their own crops to feed their cattle, but in times of water shortages, they sell water and buy-in hay from elsewhere to maintain their dairy production. At the other extreme are the orchardists who have trees that need to grow for decades before they start being productive: those farmers value water reliability very highly because if the trees die it takes a very long time to replace them. As a consequence, you see the rice growers initially selling to the dairy farmers who then sell to the horticulturalists what little water is remaining.

Are there any other major research questions arising from your work, that might trigger anyone listening to or reading this to get involved in their own research in this area?

I think the million-dollar question that needs answering is: What are the implications of climate change, and what will be the consequences for risk?

At the moment, that is the big unknown. We can talk about the cost of maintaining reliability, but that’s based on current hydrological expectations. However, the nature of the hydrological distributions in the future is another area entirely.

The other major question is: What is the value to people of maintaining the ‘essential for life’ component of water supplies?

These two questions could also look at the kinds of extreme climatic impacts we are seeing now, and how those occurrences affect the reliability or risks for water supplies.

Economic Approaches to Water Security

  • Nathan talks about economic approaches to water security and says its how to minimize infrastructure you build to meet a given level of water security that helps calculate the cost.
  • Nathan adds that hydrologists use the storage-yield-reliability relationship (SYR) to predict water security for a water supply system.
  • In Australia, historical inflow data is used to make an assessment on future inflow rates to develop synthetic hydrological realizations that can be extended over time.

Water Flow Reliability and Climate Change

  • Talking about weather patterns in Australia, Nathan agrees that predicting water flow reliably is very hard in the country with the changing climate, floods & droughts.
  • He mentions the millennium drought due to which the state of Queensland experienced crippling drought followed by floods was a factor in his choice of a research topic.

SYR & Risk

  • Explaining the relationship risk and reliability, Nathan says unlike the olden days, today the cost of risk can be quantified without considering future demand.
  • For example, recycling and desalination infrastructures can be built since we now have the technology to ensure supply during extreme events. The risk can, therefore, be quantified for an economic context.
  • Nathan gives an example of how this was used in Melbourne working with the Department of Environment, Land, Water & Planning (DELWP), Melbourne Water and retailers to try & quantify water reliability in Melbourne.
  • Long term hydrological expectations were considered, what the demand is going to be on water resource and calculations are made depending on water levels, and population growth to ensure reliability. With this, the value of water was then assessed.
  • Water costs higher when the water levels reduce simply due to the need for extreme measures like restrictions, desalination plants, which can be avoided by quantifying the risk now.
  • These measures are extremely expensive and in most cases, may never be used.

Risk & Nathan’s Research

  • When talking about risk, it’s important to know what security you are trying to give your community and the risk involved in that security.
  • Risk is a difficult concept to explain since it’s a constantly moving target, and Nathan tries to explain how he is using it in his research.
  • Nathan explains hydrological risk in his research and says people only think about the risk to water security only when their water bill is higher and when there are fewer water supplies.
  • He mentions the use of the special app launched for people to self-regulate and understand the resource better but it is not in use these days. When it was in use, it was extremely effective.

Hydrology & Economics

  • Since Nathan’s research is an interesting mix of hydrology and economics, he explains how it is possible to mix the two topics together.
  • He reveals the two things that struck him as an economist coming into policy – economics had good suggestions but has tended to simplify hydrological risk thus not representing the decision policymakers are facing; good advice hasn’t been translated to good policy outcomes for urban water suppliers.
  • On the other hand, the way hydrologists treat demand is also simplified.
  • Nathan feels that demand is extremely responsive to factors like pricing and if people are given the choice and the cost associated with it, then something can be done.
  • His advice is to respect how economists view demand & how hydrologists view/quantify risk. He feels there won’t be any wise results with respecting those two factors.

Nathan’s research to bring attention to decision-makers

  • Nathan is working with Professor John Langford for his research who is helping him convert economic concepts into hydrological decision-making.
  • The next level of his research is to take that to a broader level of decision-makers and he is hoping to take it to a broader group of people.

Application to Indo-Pacific areas

  • The concept of water cost to maintain reliability is relevant to every country.
  • Nathan reveals that his method is unique and to his knowledge has not been applied everywhere yet.
  • He gives the example of Barcelona during the 2008 drought; they hired a supertanker to supplement the city’s water supply when they didn’t have time to build a desalination plant.

Applying the Concept to Rural/Farm Setting

  • Nathan feels that this concept would be hard in a rural/farming setting as risk is not quantified there whereas, in cities, the government will step in to provide supply.
  • In Australia, this concept is not relevant since farming is privatized. It is up to the individual farmers to ensure their own level of reliability they want for their water supplies. Water Trading Markets — the cost of water goes up and down based on its availability so farmers can purchase as little or as much as they want.
  • The principles are applicable for – where do you source water from for the agricultural area. Ex: in Australia, because of water trading, there is a different desire for reliability for different consumers of water. At the lowest level — rice growers — don’t buy reliable water- grow when water is cheap & plentiful. Dairy farmers — buy water to grow a crop to feed cattle but in shortage, they sell their water & buy hay from elsewhere;
  • Horticulturist’s value water reliability the most — trees growing for 20-30 years before producing and replacing them if they die is hard.
  • The concept may not be applicable but is valuable even in places without water markets.
  • Nathan is hoping to publish his research shortly, after which the tools he talks about will be available for everyone
  • Industrial applications are also considered as well & a dollar value will be added.
  • Other research questions are also coming up — what are the implications of climate change; nature of hydrological reliability; understanding essential for life component.

Additional resources

This interview and related content was originally part of the Kini Interview Series. Kini is a retired brand of the AWP and IWCAN.

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