Sydney Water engaged Synergies to develop an economic framework for quantifying the risks, costs and benefits of a drought management strategy for Greater Sydney. The framework examines the optimal sequence of new water supply projects as Sydney’s storage levels drop. The optimal strategy is one that avoids the risk of storages falling below critical levels (and triggering the need for very significant water restrictions), while minimising the cost of investing in capital projects that may not be required if the drought breaks.
A key question for drought policy in cities and regional urban centres is how much to invest in additional supply, and when, recognising that new increments in supply provide insurance against the risk that low inflows are more prolonged than previously experienced.
If augmentation projects are triggered too early, the capital is sunk and customers will bear the costs of surplus capacity for many years. On the other hand, if investment decisions are made too late, there is a risk of incurring very severe restrictions – with consequent costs imposed on households, businesses, and the wider community.
Because decisions must be made in an environment of uncertainty about future inflows, the modelling framework developed by Synergies for Sydney Water identifies optimal investment strategies under several different storage depletion scenarios.
For each scenario, we compare the known costs of triggering capital projects (as dam levels fall) to the expected (probability-weighted) benefit of avoiding restrictions.
Using this approach, the economic model identifies the series of capital projects that would be triggered ‘just in time’ to avoid storage levels dropping below 30%, making allowance for the minimum time required for planning, designing and constructing the project.
The analysis is run for several probabilistic scenarios of storage depletion over time, each reflecting different assumptions about future inflows to Sydney’s dams.
The economic benefit of avoiding restrictions is equated to the social cost of restrictions (at varying severity levels) to households and the non-residential sector.
Estimates of the cost of restrictions to households were derived from a previous ‘stated preference’ study that had been undertaken for the NSW Metropolitan Water Directorate. This study quantified how much households were willing to pay, on average, to avoid water restrictions of a particular severity.
The cost of restrictions to commercial water users, and the NSW economy more broadly, was estimated using Synergies’ Input-Output model.
The analysis identified the preferred investment strategy under each of the three depletion scenarios.
Low to medium level restrictions, as set out in the Metropolitan Water Plan 2017, form an important component of the preferred strategy as they are a means by which depletion rates can be slowed down, and this ‘buys time’ (albeit it a modest saving) before very expensive capital augmentation projects need to be triggered. The social cost of these restrictions are relatively low when compared to the benefit of deferring the need for capital investment.
However, at more severe levels of restrictions, the social cost becomes unacceptably high, and investing in new water supply becomes the prudent and efficient strategy, so as to avoid these restrictions having to be introduced. The rate at which new water supply projects are triggered is dependent on the expected future outlook for inflows and storage depletion rates.
The results of this study are being used by Sydney Water to provide assurance on the prudency of investments proposed in Greater Sydney’s drought management strategy.