Urban water policy when environment inflows are uncertain

An urban water network with storage and uncertain environmental water inflows is modelled. This three period model is analytically tractable, and allows for a straightforward study of the relative economic impact of different policy regimes. The model is used to identify the water authority's first best pricing policy, and its relation to long run marginal cost pricing. The model is then used to identify the implications of adopting the most commonly used rationing method when environmental flows are uncertain: setting a smoothed priced (often LRMC exclusive of scarcity value) and using moral suasion, rather than pricing, to control the demand for water. The optimal manner to address water security is also addressed.