ECONOMIC PRINCIPLES AND CONCEPTS AS APPLIED TO MUNICIPAL WATER UTILITIES FINAL REPORT GeoEconomics Associates Incorporated Jeff Harris and Donald Tate in association with Steven Renzetti and Acres Associated Environmental Limited GeoEconomics Associates Incorporated, 2002 GeoEconomics Associates Incorporated, 2002 2 ACKNOWLEDGEMENTS This study was conducted for the Ontario Superbuild Corporation (project number SSB-018197.) GeoEconomics Associates Incorporated (GA) would like to acknowledge the work of Dr. Steven Renzetti, particularly for the use of his published econometrics papers in Chapters 3, 4, and 5, but also for his helpful comments. GA would also like to acknowledge the work of Acres Associated Environmental Limited for their work on the engineering aspects of cost in Chapter 5. GA also acknowledges the work of Andréanne Boisvert, Anton van Heusden, and Lisa van Heusden in finalizing the report. Finally, we have benefited from the comments of members of the Ontario SuperBuild Corporation staff, and we have appreciated the high degree of cooperation, collegiality and insight provided. While acknowledging all of this assistance, we stress that GA is completely responsible for this report, and that any errors, omissions, and interpretations are ours alone. Donald Tate, President, GeoEconomics Associates Incorporated July, 2002 GeoEconomics Associates Incorporated, 2002 3 TABLE OF CONTENTS ACKNOWLEDGEMENTS .............................................................................................................3 TABLE OF CONTENTS................................................................................................................4 LIST OF TABLES ........................................................................................................................6 LIST OF FIGURES ......................................................................................................................8 ABSTRACT.................................................................................................................................9 EXECUTIVE SUMMARY ............................................................................................................ 10 CHAPTER 1 INTRODUCTION................................................................................................... 13 1.1 Background ................................................................................................................. 13 1.2 Purpose of the Report ................................................................................................... 13 1.3 Key Economic Issues ................................................................................................... 14 1.4 Scope of the Report...................................................................................................... 15 1.5 Main Message of the Report.......................................................................................... 16 1.6 Overview of the Report .................................................................................................. 17 1.7 Characteristics of the Municipal Water Industry: An Overview .......................................... 17 CHAPTER 2: KEY ECONOMIC PRINCIPLES AND CONCEPTS ................................................... 23 2.1 Principles .................................................................................................................... 23 2.2 Basic Economic Concepts............................................................................................ 26 CHAPTER 3: MUNICIPAL UTILITIES IN A WATER MANAGEMENT CONTEXT .............................. 36 3.1 Introduction.................................................................................................................. 36 3.2 Economic Theory and Water Management ..................................................................... 36 3.3 Water Quantity Issues in Ontario: An Overview .............................................................. 41 3.4 Water Quality Issues in Ontario: An Overview ................................................................ 45 3.5 Summary .................................................................................................................... 56 CHAPTER 4: THE DEMAND FOR MUNICIPAL WATER SERVICES............................................. 58 4.1 Introduction.................................................................................................................. 58 4.2 Municipal Water Demands in Ontario............................................................................. 59 4.3 Nature and Characteristics of Municipal Water Demand ................................................... 61 4.4 Dependent Variables: Water Supply and Waste Treatment Demands............................... 62 4.5 Independent Variables: Economic Factors ...................................................................... 65 4.6 Independent Variables: Structural Factors ...................................................................... 69 4.7 Other Independent Variables ......................................................................................... 73 4.8 The Demand for Residential Water Services – Theoretical Studies ................................... 74 4.9 Water Demand Management ......................................................................................... 86 4.10 Summary ................................................................................................................. 89 Appendix 4.1: Price and Income Elasticities ............................................................................. 90 CHAPTER 5 : WATER SUPPLY AND ASSESSMENTS OF WATER UTILITY COSTS ................... 95 5.1 Engineering Practice in Water Servicing: An Introduction ................................................. 95 5.2 Cost Estimating Methodology........................................................................................ 98 GeoEconomics Associates Incorporated, 2002 4 5.3 Costing - Part A: Design Standards .............................................................................101 5.4 Costing Part B: Cost Estimate Development .................................................................108 5.5 Econometric Studies of Water Utility Costs...................................................................117 5.6 Summary ...................................................................................................................127 CHAPTER 6: WATER UTILITY PRICING THEORY AND PRACTICES ..........................................128 6.1 Introduction................................................................................................................128 6.2 What Is Full Cost Recovery?........................................................................................128 6.3 Economic Theory Related to Water Utility Pricing ..........................................................134 6.4 Practical Methods and Issues in Water Pricing .............................................................150 6.5 Water Pricing in Ontario: A Brief Overview .....................................................................154 6.6 An Overview of Empirical Studies Related to Future Water System Costs in Ontario ........158 6.7 Summary ...................................................................................................................166 Appendix 6.1: Capital Cost Accounting, Utility and Cash Based Accounts ................................169 Appendix 6.2: The Base-Extra Capacity Method ......................................................................171 Appendix 6.3: Mathematical Appendix to Chapter 6.................................................................173 CHAPTER 7: WATER UTILITY ORGANIZATION AND MANAGEMENT........................................175 7.1 Introduction.................................................................................................................175 7.2 Economic Theory ........................................................................................................176 7.3 Empirical Studies Related to Utility Organization............................................................181 7.4 Innovative Financing Measures .....................................................................................185 7.5 Summary ...................................................................................................................187 CHAPTER 8: PRINCIPAL FINDINGS ........................................................................................190 8.1 Introduction.................................................................................................................190 8.2 Key Principles and Economic Concepts........................................................................190 8.3 Water Utilities in an Water Resource Economics Context...............................................191 8.4 Characteristics of Demand for Water Services................................................................192 8.5 Characteristics of the Supply of Water Services .............................................................193 8.6 Water Utility Pricing Theory and Practice ......................................................................194 8.7 Economic Theory and Empirical Results Related to Water Utility Organization and Management...............................................................................................................196