Water economic regulation can be defined as the rules and institutions which set, monitor, enforce and change the allowed tariffs and service standards for water providers.
Why is economic regulation needed?
Economic regulation is a solution to the 3 main problems of the water and wastewater sector:
- It can be considered a natural monopoly
- Has consistent asymmetry of information
- Often it lacks professional expertise
Let’s start with the first problem of natural monopoly in the water sector.
Economic regulation is a solution to the problem of natural monopoly in the water sector. Water is unequally distributed, with regions rich in groundwater resources, rivers and lakes, and others drier and without access to steady flows of water. The costs and technical difficulties related to the transport of water from a rich region to a dry one make the water sector a natural monopoly,
Water utilities, either public, private or mixed, work in a natural monopoly environment. They don’t have competition from other utilities for the same market. Furthermore, water is an essential good, and customers are willing to pay prices that are way higher than the real cost of the service for the water utilities. The possible negative effect of these two factors is addressed through water regulation.
The second mentioned problem is the asymmetry of information.
Service providers own information that the government, public agencies and consumers don’t have access to. This can lead to market abuse and mistrust among stakeholders.
The third problem is the lack of professional expertise.
The water sector needs to balance a range of economic, social and environmental interests. Universality, continuity, quality of service, equality of access, affordability, transparency and cost-efficiency are all goals to be pursued for a healthy and efficient water sector. Nonetheless, achieving such a wide variety of goals needs a consistent amount of resources and expertise, and a strategic unified view to deal with multiple goals, sometimes in contrast between them. The trade-offs across various interests and the need for a proficient team of experts are one of the reasons why we need water regulation and water regulators.
The goals of water regulation
The goal of water regulation is to mimic competition and guarantee water consumers. One of the main focuses of water regulators is to guarantee that providers do not overcharge water consumers. At the same time, water regulators try to guarantee that water prices (see also tariffs) are not too low.
Tariffs below cost represent a problem for water utilities. A water utility without enough funds to provide the service must rely on government subsidies or cut expenses for maintenance, service, and investments. An underfunded utility can represent a problem for consumers, public finances, and the environment.
A water provider obliged to cut expenses for the lack of funds will cut maintenance or investments, bringing lower water quality and worst services for the consumers. Furthermore, a water utility not able to maintain and build the needed infrastructures bring most of the time a waste of water and energy. Leakages and inefficient and ageing water infrastructure damage the environment, wasting its resources and polluting it and the local population.
In the other case, a utility sustained by public funds represents a heavy toll on public finances. Despite the heavy impact on public finances, subsidies are seldom enough to address all the needs of a utility. And even if they are, they undermine the focus of a utility on their consumers, not promoting equity.
Water regulators have, therefore, a double-sided goal to guarantee both the supply and the demand in the water sector of a country or region. Observing more in detail the goals of a water regulator, attain 4 main areas.
- Consumers
- Environment
- Society
- Safety
A regulator guarantees consumers from low quality or too expensive services, guarantees the society improving water service coverage, guarantees the environment from waste or pollution, and the safe drinking water and management of wastewater for the population.
How water regulation works
Water regulators mimic the presence of competition, pushing water providers to offer consumers the services they want at the highest quality achievable while charging a reasonable tariff on the services.
Reasonable tariffs, in this sense, are tariffs which are enough to cover the efficient cost of providing the service, including allowing a reasonable return on capital employed. Regulators use the law to instruct water providers to do certain things and enforce the above-mentioned goals through penalties and other forms of compulsion.
Typical regulatory functions are:
- Tariff structure setting and control
- Specifying asset conditions and specifying efficiency or performance targets
- Drinking water standards control
- Setting effluent discharge standards
- Consumer complaints monitoring
- Service coverage targets setting.
Conclusion
This article is part of the Water Basics Series, where we dive into the fascinating world of water regulation and the EU Water Acquis. We aim to provide you with a comprehensive understanding of the fundamental aspects governing this critical sector.
From economic regulation and tariff structures to water governance and environmental considerations, we explore the essential concepts that shape the water industry. Delve into topics such as the Water-Energy Nexus, water scarcity, and the intricacies of ensuring water quality.
In addition, we shed light on the relevant EU directives and regulations that play a crucial role in water management. Learn about the EU Water Acquis that shape the water landscape across Europe.
Every Week we’ll add a new article on a different topic. Follow us on LinkedIn and Twitter not to lose any, and consider registering to WAREG’s monthly newsletter to be constantly updated about the water sector in Europe.