Natural Resource Economics

Vijaya R. Sharma, Ph.D.

University of Colorado at Boulder

WATER RESOURCES

I. WO SOURCES OF WATER
There are two types of water resources: surface water available from streams, rivers, and
lakes, and ground water available from aquifers beneath the earth. Aquifers are natural
reservoirs of water that the earth collects from percolation of surface water.
Surface water is a renewable resource, but ground water is an exhaustible resource
because the rate of use of ground water generally far exceeds the natural replenishment
rate. It is conceivable that an aquifer of ground water may dry up if water is pumped out
continuously in excess of replenishment rate. In the U.S. a total of 16,000 trillion gallons
of ground water are estimated to be available but only about 400 trillions are available on
renewable basis. The rest is a finite depletable resource. Many aquifers receive recharge
and many do not receive any significant amount, at least compared to the amount that is
regularly pumped out of them. Therefore, ground water is a replenishable but depletable
resource.
II. GROUND WATER SAFE YIELD USE PRINCIPLE
Some ground water specialists argue for a safe yield use of ground water: pump only that
much water out of aquifer, which is recharged by the nature. This would insure that the
water table in the aquifer is always maintained at the same level. Is such a use rate
economically efficient? Very likely not!
The only difference between an exhaustible resource and ground water is that the rate of
recharge is almost zero for exhaustible resource. If the safe yield principle were strictly
observed in case of exhaustible resources, the rate of use of exhaustible resources should
be zero. We already know that such a use rate is not efficient. In fact, in the optimal rate
of extraction of exhaustible resources, maintaining the stock of resource is not an
objective. The objective is to find the rate that maximizes the total net benefit. In contrast
to this approach, the safe yield principle does not examine the benefits and costs
associated with the use of ground water. If at the rate of extraction greater than the
replenishment rate benefits outweigh costs, it would be efficient to extract more water
from aquifer. The safe yield use principle focuses on the negative external effects of
drying out of aquifers. The key is to appropriately measure the external costs and include
them in the marginal extraction cost of water for determining the efficient rate of
extraction.
III. GROUND WATER: EQUALIZATION OF PRESENT VALUE OF MARGINAL
NET BENEFITS OVER TIME
Like any exhaustible resource the rule for efficient extraction of water from aquifers is
find the extraction rates that equalizes the present value of marginal net benefits across
all periods.
Besides the issue of negative externality that may be ignored or not adequately
captured in the cost of extraction, another prominent reason of market failure generally
associated with the use of ground water is the open access or common property
ownership nature of aquifers. There is generally no private property rights over ground
water resource and the governments enforcement of regulations on use of ground water

is generally lax. In effect, ground water becomes an open access resource. Any potential
user can tap into the same aquifer, and no user has an incentive to conserve water for
future uses. In a privately owned aquifer, if one existed, the owner would have considered
the marginal user cost of water the sacrifice the owner would have to undertake in
future when he/she extracts one more gallon of water this period and would have tried to
attain a balance between the current marginal net benefit and the marginal user cost. But,
in an open access aquifer, water conserved by a user for future could be extracted by
another user, denying the benefit of conservation to one who conserved; therefore, there
is not incentive to conserve. Till the price or marginal benefit of water exceeds the
average cost of extracting water, users keep extracting. Since too much water is pumped
out, the resource is depleted earlier.
IV. SURFACE WATER: TERMINOLOGIES AND FEATURES
Every year nature makes us available certain flow of water. However, the amount of flow
of water in any year and the amount in a season within a year are governed by the
hydrological cycle and the fluctuations in the hydrological conditions. So, variability of
supply seasonal and annual variability is a major characteristics of surface water.
Let us define a few terminologies. Runoff of a river represents the quantity or flow rate of
water that actually reaches the river. It is a hydrological determination of the maximum
amount of water available in the river for capture and control. River basin refers to the
geographical areas that are hydrologically connected to a major river system. For
example, the Colorado River basin has an area of approximately 30,000 square miles,
located in southwestern Wyoming, western Colorado, eastern Utah, northwestern New
Mexico, Arizona, South California, and a corner of Nevada. Any planning or
management of water resources, therefore, should ideally consider the whole basin,
because the supply and use of water are interdependent in the entire basin.
Many times water development authorities divert water from one basin to another. For
example, water is captured in reservoirs on the Feather River in Northern California and
sent via canals to the arid Central Valley and beyond to Los Angeles. The Big Thompson
Project in northeastern Colorado collects water in the west, pumps it to an elevation, and
allows to flow through tunnels to produce electric power at different points and also
distributes water for irrigation through feeder canals.
V. ALLOCATION OF ANNUAL FLOW WHEN CHOICES ARE DISCRETE
In certain cases the decision problem has only a few discrete numbers of alternatives to
choose from. For example, choice may consist of whether a dam should be built or not to
utilize the annual runoff of a river, or whether a large or small dam should be built. The
economic tool that is used to make the correct choice is called the benefit-cost analysis of
the alternatives. In an earlier chapter, we have already discussed this tool.
VI. ALLOCATION OF ANNUAL FLOW WHEN CHOICES ARE CONTINUOUS
In certain cases, there are numerous alternatives available and the problem is to find the
optimal choice from the whole continuous ranges of choices. For example, there are

100,000 gallons of water available each year, what would be the optimal allocation of this
volume of water among many competing users of water.
Although human actions can contribute to the variability of flow of water, for example
through denudation of forests, we will assume away such possibilities in our model. We
will assume that a fixed amount of annual flow of water is certainly available and once
we find the efficient allocation of this amount, we will then discuss the method of finding
efficient reallocation if the amount of flow varies. Since both annual and seasonal
variability are assumed random, the allocation decision is essentially a static decision (not
a dynamic decision).
Let in a river basin the annual runoff be Q. This volume of water has to be distributed
among, say, two users of water. The efficient allocation would be the one that maximizes
the total net benefits from this volume of water. Although the nature of decision problem
is static, this problem looks similar to the dynamic decision problem of allocating a fixed
reserve of an exhaustible resource between two time periods. The only difference is that
the users are two time periods in the allocation of exhaustible resource and the users are
two individuals or institutions in the allocation of water resource. So, having known the
rule of efficient allocation of a fixed quantity of exhaustible resource between two time
periods, we should be able to infer the rule of efficient allocation of a fixed quantity of
water between two individual users, which we have done below.
Allocation between two time periods: PV(MNBt+1) = MNB0
Allocation between two users:
MNBA = MNBB
The rule is to equalize the present value of MNBs over two time periods when allocating
between two time periods, and the rule would be to equalize the MNBs over two users
when allocating between two users in the same time period. This rule is known as the
equimarginal principle. To explain it further, if at the current allocation the MNBA
exceeds the MNBB, then reallocate more to A and less to B. Similarly, if the MNBA is
lower than the MNBB, reallocate less to A and more to B. The efficient allocation is
achieved when the MNB of all users become equal. The equimarginal principle can be
proven mathematically, but below we explain the rule with the help of some numbers.
Imagine a siphon with its two tubes as two users User A and User B (see Figure 1).
Suppose only 10 gallons of water are available for allocation to the two users and the
objective is to allocate such that the sum of the net benefits to the two users becomes
maximum. Each user has its demand curve for water, which reflects the marginal benefit
(MB) to the user at a given amount of water allocated to the user. Similarly, there is a
marginal cost (MC) associated with delivery of water to a user. The difference between
the two, i.e., (MB MC), would be the marginal net benefit (MNB) of water that a user
derives from having and using water. In the Siphon diagram, each tube shows the
amount of MNB at each level of allocation of water to the corresponding user.

Figure 1: Allocation of 10 Gallons of Water

(Users A and B)
USER A
USER B
MNB
GALLONS
GALLONS
MNB
$15
8
2
$55
$20
7
3
$50
$25
6
4
$45
$30
5
5
$40
$35
4
6
$35
$40
3
7
$30
$45
2
Water Allocation Valve
8
$25
$50
1
9
$20

Let us assume that currently User A has been allocated 6 gallons and User B 4 gallons. At
that allocation, the MNB of the 6th gallon of water to User A is $25, whereas the MNB of
the 4th gallon to User B is $45 (see Figure 1). It means that at that allocation, User B
derives a higher marginal net benefit than User A from the last gallon of water. Efficiency
requires that more water be then reallocated from A to B: say, 5 gallons to A and 5 gallons
to B. Even at this new allocation, MNBA is less than MNBB ($30 to $40). Further more
water should be withdrawn from A and given to B until MNBA = MNBB, which happens
at the allocation of 4 gallons to A and 6 gallons to B, when both MNBA and MNBB
become equal to $35.
What is the value of water at the margin at this efficient allocation? A gallon of water
generates marginal net benefit worth $35 to both users; therefore, this is the marginal
value or the scarcity rent of water. If at this allocation a gallon of water is withdrawn
from A to B or vice versa, the reallocation imposes a sacrifice worth $35 of MNB to the
user who loses this gallon of water; this sacrifice imposed by the reallocation is also
called the marginal user cost (MUC) of reallocation of water.
VII. SUPPLY VARIATION AND REALLOCATION
According to the above example, the efficient allocation of 10 gallons of water between
to users is 4 gallons to A and 6 gallons to B. But, suppose we have a year of drought and
only 8 gallons are available. From whose share 2 gallons should be cut down? Should we
ask User B to use only as much as User A? For the answer, go back to the siphon
diagram: Figure 1. At the proposed reallocation of 4 gallons to A and 4 gallons to B,
MNBA would be $35 and MNBB would be $45. That means, more water should be given
to B than A; keep doing until the MNBs become equal ($40), which happens at 3 gallons
to A and 5 gallons to B.
What has happened to the scarcity rent and the marginal user cost of water, due to the
shortage of water? They have increased from $35 to $40 a gallon, because water has
become scarcer.

Efficiency demands that whenever there is a shortage, water has to be reallocated from
lower value uses to higher value uses, until the MNBs are again equalized. If there were a
perfectly competitive water rights market for allocation of water, the market would have
achieved this by itself. Lower value users would have been willing to sell their water
rights to higher value users, and there would have been a price at which the trade would
have taken place. But, there exists a very imperfect market for water rights and there are a
number of regulations that complicate the trading of water rights. Therefore, water
distribution authorities decide and command redistribution mostly through administrative
and regulatory means. We will talk about water rights market later.
VII. WATER RESOURCES IN COLORADO
a. Everything west of 1000 W longitude in USA (the middle of the country) is essentially
dry, and everything to the East is wet.
b. Water allocation is governed by the Riparian Doctrine in the East (the person who
owns land adjacent to a water source has the right over water from that source) and by
the Prior Appropriation Doctrine in the West (the person who first used a certain
volume of water from a source has the first claim on that volume of water from that
source).
c. Colorado is the only state in USA where all rivers within its borders flow out and
none flow in from its neighbors.
d. There are four major river basins in Colorado
i. The Colorado River
ii. The Arkansas River
iii. The Rio Grande River
iv. The Platte River
e. Precipitation and Usage of Water
i. Winter snowfall provides 80 percent of Colorados water.
ii. The heaviest population growth in Colorado is occurring along the Front
Range of the Eastern Slope, but the most precipitation falls on the Western
Slope of Colorado. This demand-supply pattern requires water to be
reallocated within the state of Colorado from the west to the east through
projects called trans-basin or trans-mountain diversions.
f. Trans-basin Diversion
i. In a trans-basin diversion project, water is moved from one river basin into
another; most of them from the Upper Colorado River basin on the Western
Slope to the South Platte basin on the Eastern Slope.
ii. The largest trans-mountain diversion in Colorado is the Colorado-Big
Thompson Project (CBT).
g. Colorado Big Thompson Project (CBT)
i. The construction of CBT Project started in 1938 and completed in 1957
ii. The project diverts about 260,000 acre-feet of water annually from the
Colorado River headwaters on the western slope to the Big Thompson River, a
tributary of Platte River on the eastern slope.
iii. Provides water resources to 30 towns and cities through a network of 12
reservoirs, 35 miles of tunnels, 95 miles of canals, and about 700 miles of
power transmission lines.

iv. Water is collected in Willow Creek, Shadow Mountain Reservoir, Grand Lake
and Lake Granby from the upper Colorado River on the western side of the
continental divide.
v. Water is then pumped up hill into Shadow Mountain Reservoir, from where it
is gravity fed to Grand Lake.
vi. From Grand Lake the water is transferred under the continental divide through
a 13.1 mile long tunnel called the Alva B. Adams Tunnel to the eastern slope.
vii. Once the water is on the eastern slope it is gravity fed through five power
plants falling approximately one half mile.
viii. After these power plants the water is stored on the Front Range in Carter
Lake, Horsetooth Reservoir and Boulder Reservoir until needed.
ix. The CBT delivers 213,000 acre feet of water to northeastern Colorado used
for industrial, agricultural, and municipal uses.
VIII. WATER SCARCITY IN COLORADO
Agriculture is the primary user of water on the west, but commercial and municipal uses
are the needs of the east. Therefore, the shift of water from agriculture to urban use is an
important transition that Colorado will have to make to keep up with the growing demand
for water of an increasing population. Another way the Front Range is currently
supporting intense population growth is by using its ground water reserves, especially in
Douglas and Arapahoe Counties. Even though Groundwater reserves in the Denver Basin
aquifers are vast, using this water is a temporary solution, because ground water is a
nonrenewable resource.
During the recent three years of drought from 2000 to 2002, Colorado faced water crisis
because of three converging problems:
i.
rapidly increasing population
ii.
building of no new water storage projects for decades
iii.
a deep prolonged drought.
Currently 400,000 acre-feet of surface water a year in Colorado go unused; there is no
storage capacity to hold this volume of water. Big Straw Storage Project is a plan to
pump water back from the Colorado River at the Utah border and reuse it. There was a
proposal to float $2 billion bond to construct the project, later to be repaid from the
revenues of the projects. The proposal was put to referendum during the 2003 elections,
which did not pass, due to tensions between the Western and Eastern Slope of Colorado,
regarding this project. Many from Western Colorado thought the project would have an
adverse impact on the farming industry of the West, as they may have to pay $500 an
acre-foot or more for the water they were accustomed to paying just $20.
Colorado has not added any water storage capacity in over 35 years (see Figure 1). Many
consider that storage is the best way to protect against drought, since 80 percent of
Colorados water comes from snowmelt. But, storage always tends to be a controversial
proposition. Ecologists and environmentalists argue against building large dams for
adverse ecological impacts, loss of lot of water stored in reservoirs due to evaporation,

and the silt build up that reduces the storage capacity of reservoirs over time. Instead,
they suggest building smaller storage projects that have less of an ecological impact.

Another alternative proposal is to opt for a conjunctive use system. Aquifer

(groundwater) becomes a water source during dry periods but would act as a storage
reservoir during wet periods. This type of scheme is used in California, but is new for
Colorado.
IX.
YAMPA RIVER PIPELINE PROJECT
The Colorado Water Conservation Board estimates that the gross water use in Colorado is
expected to increase by about 50% (400,000 to 600,000 acre-feet per year or AFY) from
Year 2000 to 2030. The Northern Colorado Water Conservancy District (NCWCD) has
recently investigated a project to deliver water from the Yampa to the Front Range.
The Yampa River plan could provide about 400,000 AFY. The river originates in the
northwestern part of the State, just west of Craig. Excess water of the river during the
spring runoff would be diverted into a reservoir that would be built in Maybell to store
500,000 AF. The water would be pumped from the reservoir over the Continental Divide
and passed through hydroelectric generators through underground tunnels, as water
would make its way to the Front Range. There are three proposed routes being
considered. The estimated cost of construction is about $4 billion and the annual
operational costs $125 per AF of water. Although withdrawing the excess runoff (400,000
AFY) during the spring months would not violate the Colorado River Compact, but it
may limit the opportunities the lower basin states have to address their own drought
problems in the future. A dam would have to be built in Maybell; therefore, rafters may
no longer find the turbulent water once they enjoyed. The fish species in the river and the
terrestrial species that live in the land that will be inundated with dam also may suffer the

consequences of the dam. But, a new form of recreational activities may emerge. The
trans-basin movements of pipeline, heavy equipment, and construction activities may
wreck the environment.
X.
COLORADO DIVISION OF WATER RESOURCES (CDWR)
In 1881, the Office of State Engineer was created in Colorado. It was renamed the
Colorado Division of Water Resources, under the Colorado Department of Natural
Resources (CDNR) in 1965. It has 7 Divisional Engineer Offices under it, and there are
Water Commissioners under each Divisional Engineer Office. Its functions are:
i.
Measure runoff of streams
ii.
Approve major dam projects
iii.
Enforce water rights throughout the state
iv.
Evaluate and issue water well permits
v.
Maintain databases on Colorado water information
vi.
Represent Colorado in river compacts
XI.
GROUND WATER COMMISSION (GWC)
In 1957, Ground Water Commission (GWC) was created. It has a 12 member board
nine Governor-appointees, executive director of the Department of Natural Resources,
the director of the Colorado Water Conservation Board, and the State Engineer. Its
functions are:
a.
Issue permits to construct and operate groundwater wells
b.
Ensure fair distribution of water among rights holders
It has established 8 designated groundwater basins and 13 groundwater management
districts. A designated groundwater basin is defined as groundwater that is not adjacent to
continuously flowing natural streams or would not be available or required for the
fulfillment of decreed surface rights. The GWC has delegated almost all functions to the
State Engineer (except designating groundwater basins).
The Denver Groundwater Basin comprises of four different aquifers overlying each other
the Upper and Lower Arapahoe, Laramie-Fox Hills, and Denver. Most of the water
districts pump water from the Lower Arapahoe and/or the Larimer-Fox Hills because
these two aquifers have the most abundant water supply and also the best water quality.
Because of heavy pumping demands, new wells now tap the Denver aquifer as well.
The amount of water an individual district can pump out from an aquifer is regulated by
the states office of Division of Water Resources. Before a well is drilled, the water
district is obligated to submit a water well permit application to the state agency. Using a
rather confusing engineering algorithm based largely on land ownership the Colorado
Division of Water Resources issues a well permit to the district that sets limits on the
maximum pumping rate and annual pumping volume that can be extracted from the
aquifer. The districts are required to place meters on their wells to record the pumping
rates and then submit the records to the state on a monthly basis for verification.
There are three types of ownership for non-tributary ground water rights (does not apply
to tributary ground water, which is allocated in conjunction with surface water rights):

i.

Individual ownership This is rare because of the high cost of drilling

wells. But in some non-incorporated areas, individual (wealthy) owners have
wells drilled into an aquifer for their private household and outdoor lawn
watering purposes.
ii.
Water Co-ops A small minority of well pumping is developed by
homeowners banding together to form a small cooperative water district.
These districts usually do not usually exceed 200 homes. The homeowners
assess themselves fees to pay for the well drilling usually one or two wells
per co-op and the O&M for annual pumping costs. The accumulative land
area owned by the co-ops homeowners is used to determine the amount of
water that can be pumped.
iii.
Water Districts - This is by far the most common. Usually, before a
land developer can get a building permit for a subdivision, the county forces
them to enter into a water contract with an established water district for its
water supply. The water district, by a contract with the developer, gains the
rights to the ground water underlying the land to be developed. Then, a well
field is established by the water district (paid for by tap fees or an up-front
charge to the developer who in turns, adds the cost to the price of the house) to
deliver water to the new subdivision.
XII. COLORADO WATER CONSERVATION BOARD (CWCB)
The CWCE was created in 1937 with the missions of using water wisely and protecting
water for future generations. It has seven major program areas:
iv.
Water supply protection
v.
Water supply planning and finance
vi.
Management
vii.
Flood protection
viii.
Stream and lake protection
ix.
Water conservation and drought planning
x.
Intrastate water management and development
The CWCE has a 15 member board: 10 voting members and 5 non-voting. The 10 Voting
members are appointed by the Governor and confirmed by the Senate: one from each of
the eight water basins (South Platte, North Platte, Arkansas, Rio Grande, Gunnison /
Uncompahgre, Colorado Mainstem, Yampa/White, and the San Juan/Dolores/San
Miguel), one from the City and County of Denver, and the Executive Director of the
Department of Natural Resources. The 5 non-voting members are the Director of CWCB,
State Engineer, Attorney General, Director of Division of Wildlife, and the Commissioner
of Agriculture.
XIII. WATER RIGHTS TRADING
The ownership rights over water belong to states. Only in the beginning of the 20th
century was established the principle of state ownership on water, and the claimants or
users had only a right to use, or usufructary rights. Since then the state governments
started controlling rates charged by the private irrigation companies. Also began the
involvement of the federal government in large scale diversion of water across states.

Every water right that an individual wants to trade has to be approved by the state water
board. Even in the presence of willing buyers and sellers, trades of permanent water
rights may not be approved by regulators/the board if the trade is likely to result in
significant externalities physical impacts on parties not involved in the transaction
and in third party financial impacts to the exporting region.
In most western states, water property rights are governed by prior appropriation,
whereby the first in time to claim the water in a waterway for beneficial use has first
priority to the water. A water right that has not been exercised for a period of time may
have to be relinquished, sometime known as the use it or lose it principle. As a result,
western rights holders have historically been reluctant to lease water out, for fear of
losing their right to the water in the longer term. Also, this principle discourages users
from conserving water. In addition, permanent transfers of water rights under prior
appropriation have usually been costly and time-consuming.
In the periods of shortages of water, there is often another restriction placed on use of
water; the users in the bureaucratically determined higher value category get the priority
in allocation, called the preferential use principle. Within the same value category (for
example, irrigation), the prior appropriation determines the priority. There are two
potential efficiency-related problems with this principle. First, the value hierarchy is
bureaucratically determined based upon some gross notion of beneficial uses of water
(for example, irrigation is a more beneficial use of water than in-stream recreational use).
The efficiency requires that such a value ranking be done in terms of the marginal net
benefits (MNBs), which may not be the same as the above-mentioned bureaucratic value
hierarchy. Second, the users in the lower preference ladder will have almost no incentive
to make investment in water development as they may be denied water at times of
shortages, in favor of the users in higher preference ladder.
Water rights can be sold (permanent sale), leased (short term transfer), or loaned. In many
parts of the West, the water supply is uncertain; there is tremendous temporal and spatial
variation in rainfall. Supply and demand peaks generally do not coincide within the water
year. When snow pack melts in the spring, it is stored in surface reservoirs until late
summer when farmers' irrigation demand peaks. These fundamental characteristics of
precipitation make water market development all the more desirable, but they hinder the
creation of markets in the first place. In California, option agreement is becoming
popular, which allows a purchaser to pay an option cost at the beginning of the fall,
before winter precipitation occurs, for the right to purchase a specific amount of water in
the spring.
Water leases dominate the water rights market. A majority of the trades tend to be from
agricultural sellers to urban buyers. In Colorado and New Mexico, municipal agencies are
purchasing permanent rights and leasing them back to the irrigators from whom they
purchased in the first place until needed to meet anticipated future demand. Water
purchases for municipal and industrial use trade at higher prices than water for
agricultural or environmental use.

XIV. COLORADO RIVER COMPACT (1922)

The Colorado Water Compact was outlined in 1922 to share water of Colorado River
among the states in Colorado River basin. There are four states in the Upper Basin
Colorado, New Mexico, Utah, and Wyoming and three states in the Lower Basin
Arizona, California, and Nevada. Of the total runoff 15 million acre-feet (1 acre-feet =
326,000 gallons), the Upper Basin states get 7.5 million acre-feet and lower basin states
7.5 million acre-feet.
The intra-basin allocation mutually agreed by the upper basin states in 1948 is:
a.
Colorado: 51.75%
b.
Utah: 23%
c.
Wyoming: 14%
d.
New Mexico: 11.25%
Similarly, the allocation among the Lower Basin states decided by the Supreme Court is:
a. California: 4.4 maf
b. Arizona: 2.8 maf
c. Nevada: 300,000 acre-feet
The 1944 U.S. Treaty with Mexico promised to make 1.5 maf available to Mexico. The
issue of Native Indian Water Rights is still unresolved. The 1908 Supreme Court decision
requires the United States to recognize Indian water rights whether or not a tribe had used
the water. Twenty five tribes have claims to the Colorado River. There are two major
problems associated with this issue. What quantity of water each tribe should be allocated
and should the tribes be allowed to lease their water to others?
Californias use exceeds its allocation (4.4 maf) by about 800,000 acre-feet. The surplus
water not used by the Upper Basin states is flowing downstream and is used by
California. In 1996 the U.S. Secretary of the Interior forced California to devise a plan to
limit the use to the level of allocation within the next 14 years. California has developed a
plan the Quantification Settlement Agreement to shift water from low-value use in
agriculture to higher-value uses in industrial sector.
There has hardly been any attempt by states for inter-state trading of water rights. The
exception is a water-swap arrangement (Inter-State Water Banking) between Arizona and
Nevada. Under this arrangement, the State of Nevada can store up to 1.25 maf of surplus
water in the aquifers of Arizona as a credit. Arizona pays the costs associated with
delivery, storage, and recovery of water. When Nevada needs and uses some of their
credits they draw water from Lake Mead. Once water is drawn from Lake Mead the water
in the aquifers becomes Arizonas water.
XV. DRINKING WATER PRICES IN DOUGLAS AND DENVER COUNTIES
Water price in Douglas County is mainly based on the annualized costs of paying back
debt for water treatment and transmission. This is mostly comprised of water districts
charging prices in order to payback loans for the construction of raw and wastewater

treatment plants and pipelines within the various service areas. Tap fees usually fund new
water purchases or the issuance of bonds established by the individual districts.
Pricing has been different for Douglas County when compared to Denver Water Board.
Denver Waters prices needed to be raised to offset the revenue loss resulting from higher
conservation practices and lowering water demands; Denver sold less water as a result of
the 2002 drought. Since then, Denver has experienced a drastic reduction in homeowner
water usage due to conservation promoted by the Board. To offset the loss in revenue
and the fact that the water was under priced to begin with rates were increased in 2004.
The situation is slightly different in Douglas County. Here, the pricing is set to reflect the
repayment costs of water districts that were incurred when new treatment plants and other
infrastructure facilities were built. Loss of revenue due to the drought was not a factor.
Oddly, during the drought of 2002, water usage in Douglas County did not decrease
significantly. This is due to the fact that a water supply that is mostly dependent on nontributary ground water is immune from surface water droughts. Therefore,
conservation was not a big issue in Douglas County during the drought, and water
districts revenues were not impacted to any great degree. Prices in Douglas County have
increased mostly because of the escalating repayment costs, not loss in revenue.
Economic theory tells us that for efficient allocation the price of water should reflect the
total marginal cost, which is the sum of the marginal cost of supplying water and the
marginal user cost or scarcity rent of water: P = MEC + MUC. But, municipal
governments generally control water supplies and their traditional pricing system is based
on the requirements approach the notion that water is an essential commodity and
therefore fairness or equity should be a guide its allocation. The price has to be affordable
to the poor also. In addition, governments may feel that certain uses of water are more
important and should be subsidized. That has been the general notion with irrigation.
Therefore, there may be a system of differential pricing by use of water. This is a case of
preferential use principle discussed earlier. The differential pricing system is often abused
by users by diverting water from its subsidized uses to other uses.
While determining price of drinking water, public utilities tend to account for the historic
average costs of supplying water, instead of marginal cost of supplying water. Historic
average costs are often lower than the marginal cost, because the newest source of water
mostly tends to be more expensive than the previous exploited sources of water. In many
countries, the price does not account for scarcity rent. In U.S., scarcity rent is only partly
and indirectly collected from the users of water, in the form of tap fees capitalized into
the value of house at the time of purchase of a new house. Since tap fee is a one-time fee,
it does not affect the marginal cost of water and hence does not provide incentive to
conserve water. Thus, for reasons of choosing average cost, instead of marginal cost, and
choosing to charge rent of water as tap fee and not as unit price of water, water tends to
be mostly underpriced, which promotes over use of water.
There are efforts to modify a uniform unit pricing system to a system of increasing block
rate pricing to promote conservation but yet keep the minimum level of use of water
affordable to poor. In a block rate pricing system, water is supplied at a low unit price up

to a certain limit, and when the consumption exceeds this limit, the unit price goes up.
This system can also be adapted to deal with peaks in water demand. If auxiliary water
supply is needed during dry summer month, a higher block price could be charged, which
could help cover the additional costs of supplying auxiliary water.
It is difficult to price recreational or in-stream use of water due to the open access nature
of the use. Recreational use of water is a public good and is likely to be under supplied by
the market. Even when entrance fees are charged, the charges usually do not reflect the
marginal willingness to pay. This is one reason that despite its value the recreational use
of water receives a lower preference in the scheme of allocation of water.