The Water Framework Oirective and Portuguese Water L.aw require that water prices provide an appropriate incentive for efficient resource use as well as recover costs, including environmental and scarcity costs. Nonetheless, recent evaluations 

(EC07) show that economic instruments still play a limited role in water management, while significant problems persist in ecological water status. The European Commission has thus identified the promotion of economic instruments, and pricing in particular, as a priority action. 

ln this project we will develop a thorough and innovative analysis of prices in the water sector, including behavioural responses and considering the relevant features of costs, in order to identify policies that allow a balance between welfare maximization, including environmental constraints, and other traditional criteria for utility pricing, such as cost recovery, equity and simplicity. The project will build on previous contributions of the research team in the areas of nonlinear pricing, water demand and cost estimation, while applying new theoretical methods and developing additional empirical dimensions, as described below. 

There is a significant amount of literature on pricing structures in regulated utilities, yet none of it explains the popularity of increasing block tariffs (!BT} in the water sector, since the nature of the supply infrastructure points to constant or decreasing tariffs (EI0l, EI09). ln previous work (RoMo08) we have already shown that increasing marginal prices may nonetheless come about as a combined result of water scarcity and customer heterogeneity if utilities are required to maintain a balanced budget. Additional insights will come from this project, where we will develop theoretical work on the behavioural responses of consumers to price structure, using asymmetrical value functions with loss aversion (TvKa91). ln particular, we will look for framing effects, as initial blocks may provide consumers with reference points against which subsequent block prices are seen as losses (!BT) or discounts (OBT). These results should be applicable to all types of utilities, and although we will focus on the water sector we will keep such extensions in mind. 

Furthermore, we will build distinct models for water supply and wastewater, which are often bundled together in spite of significa nt differences between them, namely their environmental costs a nd the possibility of third-party access in wastewater infrastructures. Also, unlike previous literature, where models are mostly continuous, we will concentrate on discrete models of nonlinear pricing, so as to develop practical methods for the determination of the number and size of blocks in both services. Empirically, we will take advantage of the team's experience in previous research to provide new estimates of demand elasticities, allowing us to test severa! assertions. Loss aversion theoretically generates asymmetric price elasticities, yet this has never been tested for water demand since it requires a comparison between conditional and unconditional price elasticities. To that aim, we will gather, for the first time in Portugal, infra-annual data at the household levei, essential when there are block tariffs as it allows the simultaneous modelling of the discrete choice of block and the continuous choice of consumption. This data will also let us provide an improved test of the conditions developed by [RoMo08J for the efficiency of nonlinear prices under scarcity, and to take seasonal demand variability into account, enabling improvements in year-round management of the resource. Separately, we will complement existing utility-level data bases with new data on the information included in water bills, in arder to look for specific reactions to price structures, price changes, and resource saving campaigns. Finally, through the use of quantile regression methods (Ko05), we will study the impact of the explanatory variables of water demand on the full distribution of consumption leveis, essential for the definition of block tariffs. 

ln order to provide a good assessment of the water management framework, the project will also estimate cost functions that include quality of service indicators, to separate the opposing effects of production efficiency and quality of service effort. Based on cost function estimations, we will look for scale and scope economies and determine the utilities' optimal size and the adequate level of horizontal and vertical integration. The peculiar vertical structure of this industry makes it possible to analyze the entire value chain, from the water source to the consumers' home through the wholesale and retail concessionaries, and turns it into a unique transfer pricing case study wíth interestíng financial analysís implicatíons. Thus the project will provide solíd recommendations on pricing structures, not only in terms of final prices but also for transfer prices. 

The main research question is how to price water and wastewater services in a context of persistent environmental problems. This requires a look at both sides of the water market, assessing the demand for and the costs of providing water, so as to provide pricing techniques that take into account several goals (efficiency in resource use, financial sustainability of water utilities, equity concerns for household incomes, and tariff simplicity). We will move along severa! paths to develop new theoretical insights and to provide recommendations that can improve current practices. 

This analysis is important on severa! accounts. First, the economic analysis of water use, the implementation of cost recovery and the move towards efficient water pricing are legal obligations imposed by the European Water Framework Directive 

(Directive 2000/60/EC, art. 9) and by Portuguese Water law {Law 58/2005, art. 77), and they haven't been sufficiently developed (ECO?). Second, there are new theoretical issues on nonlinear pricing that haven't been handled in the literature, some of which are specific to the water sector. Third, current Portuguese pricing practices are exceedingly complex and neither promote efficiency, cost recovery [MoRo07], nor equity [MaQuPi09]. Moreover, this problem is prevalent in many other countries (OECD03, OECD09). 

Our approach is to split the analysis into four dimensions: theoretical models, demand and cost estimation, financial sustainability assessment, and welfare analysis. 

Our first concern is the definition of the tariff schedule, where academic research and practical implementation have been often separated. Although !BT are seen to provide additional reductions in water consumption when compared to higher uniform prices, no theoretical model has explained this effect so far. We propose that loss aversion may play a role. ln particular, pricing for loss averse consumers requires special attention to the reference point, the definition of which is a significant issue 

[HeKo0S]. We believe that block tariffs provide the consumer with a natural reference point, in the price of the first block, so that higher subsequent prices can be seen as large losses and foster conservation behaviour. We will also assume that consumers do not exactly control their consumption leveis, so that their choice is the central location of a probability distribution. This new framework combined with the loss aversion effect and the fact that consumers may emphasize small probabilities (for example, of unexpectedly moving between blocks) may further contribute to water conservation. On the other hand, utilities could benefit from IBT in terms of revenues if consumers are overconfident in their ability to predict and control consumption leveis in the presence of convex tariffs [Gr09]. Properly designed water tariffs should take behavioural responses into account (paper 1). 

While published articles on water pricing models deal with linear or continuously nonlinear prices, reality shows the widespread use of discrete !BT. This is simpler but may also reflect the discrete nature of consumer heterogeneity. Thus we will use use of discrete IBT. This is simpler but may also reflect the discrete nature of consumer heterogeneity. Thus we will use nonlinear optimization techniques [Wi93] to develop a discrete model of the optimal determination of the number and length of the blocks, considering seasonal variations. We will explicitly separate water and wastewater prices, as the second need to take into account: the differentiated composition of sewage and its corresponding impact on the environment; the role of access fees in a context of system extension; and the possibility of third-party access in interconnected wastewater networks. (paper 2) Results from the theoretical models will be used in the subsequent tasks of the project. 

The second element of the research project is estimation, starting with water demand, based on panei data techniques. Our focus will be on residential water demand, overcoming the estimation problems under block pricing with aggregate data by collecting household-level data from a sample of utilities from different river basin districts (infra-annual periodicity to investigate seasonal variations in demand). This will allow us to consider the distribution of consumers along blocks and to jointly model the discrete choice of block and the continuous choice of the consumption levei. We will also test for asymmetric price elasticities in water demand stemming from the loss aversion effect and its implications for the optimal frequency of pricing updates. (paper 3) 

Although consumption data can be collected directly from the utilities, the implementation of a household survey is necessary to account for relevant household characteristics such as income leveis, water-using appliances, garden existence and size 

[OIHa5t07]. We plan to explore the impacts of the different explanatory variables not only on average water consumption, but also on the full distribution of consumption choices. Clearly the distribution, not the average, is relevant for the definition of the tariff blocks. For this purpose we will apply the method of quantile regression [Ko0S] to demand estimation, thus making a significant contribution to the literature in the field. (paper 4) We will also combine previously used aggregate data on water consumption and tariffs with new data on the information conveyed in the water bili regarding prices and water saving campaigns, to assess its impact on consumer behaviour [Gau06] (paper 5). We will benefit from the contacts established with water utilities in mainland Portugal in previous research projects, but also rely on the support of and participation in the project of the economic regulator, IRAR. 

The participation of the regulator in the project will also allow us to analyse supply data from utilities. Hence we will be able to estimate cost functions for the water and wastewater industry, overcoming previous data difficulties found by the research team. We propose the use of simultaneous equation and panei data methods, with service and water quality data, thus separating the impacts on costs from service quality effort, on the one hand, and efficient operation, on the other. One additional question we aim to answer is the optimal levei of integration in the industry, by calculating scale, scope and vertical integration economies 

[GaMoRe07]. This should provide guidance to current efforts towards system mergers, promoted in national investment plans for the sector. (paper 6) 

Another output of the supply-side analysis will be the study of the impact of the industry's vertical structure on operators' financial situation. Using the cost estimates developed above in conjunction with the pricing structure set in the industry 

(considering the entire wholesaler-retailer-final consumer linkage), we expect to find evidence to explain the financial distress in which a lot of concessionaries are currently finding themselves. We will apply empirical finance and accounting methodologies to the water sector, as a perfect case study of transfer pricing. The potential contribution of our work relates to the fact that the usual transfer pricing solution suggested in the literatu re (using externai market price) often does not apply in these industries, leading to negociated transfer prices. Often, we see that downstream parties (mostly municipalities) use other financial mechanisms, such as delaying payments, to compensate for bad price negotiations. Thus we aim to study the financial situation of the concessionaries on several dimensions: cost recovery and profitability, tariffs as a transfer pricing problem, and other relevant financial issues, such as payment delays. (paper 7). 

The fourth and final dimension will combine estimated demand and cost functions with the developed block pricing methods to assess welfare impacts of price structures, using measures developed explicitly for nonlinear pricing and kinked budget constraints ([Ru09],(ReWh06]). (paper 8). 

We expect to deliver eight published articles in the field of water economics and finance. The research team brings together experienced researchers, with published work in peer-reviewed scientific publications and past experience collaborating with Portuguese authorities in the water sector, and younger researchers with proven potential in the field. We want to contribute to the accumulation of knowledge in the national research community, and also to provide policy recommendations that are solidly grounded in the best available research. 

The core partners for the research, developing the models and the estimations, will be UNIDE and FEUC. UNICEE will be involved mainly in the financial analysis and data collection. IRAR will provide support for data gathering and valuable policy discussions. We plan to sign upa young researcher at UNIDE to be in charge of the household survey implementation, the development of databases, and to be involved in other research activities. 

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With the objective to increase the research activity directed towards the achievement of the United Nations 2030 Sustainable Development Goals, the possibility of associating scientific projects with the Sustainable Development Goals is now available in Ciência_Iscte. These are the Sustainable Development Goals identified for this project. For more detailed information on the Sustainable Development Goals, click here.