Optimal water pricing for sustainable agriculture and electricity cooling in the European Union

The Water Framework Directive (WFD) is the primary regulatory framework for addressing water-related policy in the European Union. However, concerns regarding implementing the water cost recovery mechanisms proposed within the WFD persist among member states. One challenge is that cost recovery must account for the complex relationships between water-using sectors. In this paper, we use the Water, Energy, Food, and Ecosystems (WEFE) Nexus as a conceptual approach to address these interlinkages. We identify conditionally optimal water allocations and pricing mechanisms for agriculture and electricity cooling. To achieve this, we propose an innovative methodology that combines an optimization model with a revenue stochastic frontier analysis to derive the model parameters. To incorporate policy objectives, we explicitly consider the SDG target 6.4.2 within our optimization framework. We use country-level data from various sources for the European Union between 2000 and 2019. We find that under the assumptions of the model, while some European countries use water conservatively, at least 16 countries exhibit allocations that depart from the conditional optimum or unsustainable water use. Additionally, under different water availability and use scenarios, approximately one-third of EU countries may experience economic losses. Our findings can help the design of potential water pricing mechanisms that would support the ambitions of the WFD's cost recovery mechanisms. Furthermore, since the departures from the conditional optimum are primarily driven by higher-than-optimal water usage in the electricity supply sector, our results contribute to the debate on the economic benefits of transitioning to renewable energy sources with a lower water footprint in the European Union.