Water utility network loss reduction and service quality under price cap and rate of return regulation

Abstract

Water utilities in Eastern Europe are regulated under different schemes and achieve different water utility network loss reductions and service quality levels. Through a theoretical model, we analyse a water utility’s response to price-cap or rate-of-return regulation when setting their levels of water loss reduction and service quality. Lower price caps induce the firm to reduce water losses when demand is inelastic, while higher rates of return lead the firm to reduce water losses only from low levels of the ROR model. Service quality increases in the price cap but shrinks in the ROR model. We show that PC regulation is a superior policy when the cost of capital is not too high, as the firm can efficiently supply at a low price and provide some level of quality.