Dynamic water pricing and the risk adjusted user cost (RAUC)

We formalise a dynamic water pricing model as a tool for increasing social surplus in short-term water allocations and long-term water supply planning and investments. We calculate, in monetary terms, the intertemporal risk that current water uses impose on future water availability, termed as the Risk-Adjusted User Cost (RAUC), given multi-period droughts. Our model is calibrated to the water supply system in the Australian Capital Territory. Results show that the RAUC may be a substantial proportion of the cost of supplying water, and incorporating it in the water price can result in long-term welfare gains.