The regulation of public utilities of the future in Latin America and Caribbean: water resource regulation in Brazil

Abstract

While 12% of the world’s freshwater is located in Brazil, it is unevenly distributed across the country. As a result, water scarcity is a real and present challenge in many areas across Brazil. Scarcity, in turn, creates conflicts among water multiple users. These conflicts are expected to increase due to climate change and the consequent increase in water shortage. Existing mechanisms for water resource management does not seem sufficient for addressing water scarcity as they do not provide for the reallocation of water. The objective of this paper is, therefore, to examine the desirability and feasibility of creating water markets as a mechanism to promote the efficient reallocation of water. We conduct a first-principles analysis to show that water markets may dominate other instruments, including water pricing (i.e., a price above and beyond the cost of storing and transporting water to reflect water scarcity). There are two key reasons for favoring water markets over water pricing. First, calculating the correct water pricing is not a trivial exercise. In contrast, a well-designed water market will lead to price discovery and efficient outcomes. The second reason is of a political economy nature. By assigning tradable water rights, users can benefit financially from selling water to a higher value user, whereas a water price is essentially a tax that may not send the correct signal to users. To assess the feasibility of water markets, we conduct a readiness assessment to identify the main barriers to the creation of water markets in Brazil. Policy recommendations are then provided to overcome the barriers identified in our analysis. For illustration purposes, we simulate the gains from a water market in the São Marcos River Basin. In this river basin agriculture and hydroelectricity generation activities compete for the existing water resources. In a scenario of water scarcity, we suppose that the regulator restricts the use of water that generates an excess demand of 30%. If a proportional rationing system is applied, the total loss of welfare would be 30%. However, if a market for water exists and works competitively, we estimate that the total loss of welfare would only be 2.5%.