Australian urban water utilities face a significant challenge in designing appropriate demand management and supply augmentation policies in the presence of significant water scarcity and climate variability. This article considers the design of optimal demand management and supply augmentation policies for urban water. In particular, scarcity pricing is considered as a potential alternative to the predominant demand management policy of water restrictions. A stochastic dynamic programming model of an urban water market is developed based on data from the ACT region. Given a specification of the demand and supply for urban water state dependent optimal price and investment policies are estimated. The results illustrate how the optimal urban water price varies inversely with the prevailing storage level and how the optimal timing of investment differs significantly between rain dependent and rain independent augmentation options.

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One of the key economic issues faced by the managers of the two water boards in the Burdekin River Delta is the allocation of surface water between immediate use on farm for irrigation and storage in the aquifer for future use. Because of the significance of the interaction between surface water and groundwater and the return flow externalities within the delta, policies on surface water and groundwater need to be determined simultaneously. A model is formulated of the dynamic system of surface water and groundwater in the delta with water demand, groundwater extraction cost and stochastic recharge and surface water availability. The optimal pumping/artificial recharge policies for each state of the joint surface water and groundwater system is derived for the southern part of the delta and this policy is applied over a large number of years to derive the expected development over time of extraction/ artificial recharge and the state of the groundwater system. The implications of the optimal pumping/artificial recharge policy for any review of existing allocations of surface water and groundwater are discussed.

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