Shadow Pricing: Pricing water for what it’s worth

Published on: 05/11/2025

By Catarina Fonseca and Dr. Alex Money

This month’s Connect Finance gathering focused on water shadow pricing. In this conversation, Dr. Alex Money unpacks why the way we price water today doesn’t line up with the value it creates—and how shadow pricing might help regulators, utilities, and companies make smarter, fairer decisions.

Alex is a Principal Investigator on the FCDO-funded Climate Compatible Growth (CCG) programme, which supports the mobilisation of investment to meet development priorities in the global south. A former fund manager, he has over 25 years of experience in finance, enterprise and academia. He is also a Founder in Residence at the Smith School at Oxford University. He is interviewed by Catarina Fonseca IRC Associate, Founder of Pulsing Tide and Lead of the Connect Finance discussions. She has over 28 years of experience in development cooperation and non-profits, particularly in the water and sanitation sector. 

Q: Alex, you opened this discussion by distinguishing between the average price of water and the marginal price people actually pay. Why does that matter?

Alex: Volumetrically, the global average price paid for water as a service (not as a resource) is low—especially compared to the economic and social value extracted from its use. This is based on GWI dataset on utility prices.

However, many low-income households frequently pay a very high price for the last unit consumed (marginal prices) relative to their disposable income. In contrast, users who capture the highest economic value from water – for cooling data centres, for example - often pay some of the lowest prices. There is a real mismatch in what people actually pay for water, versus the economic value they derive from its use.

Q: “Shadow pricing” sounds really abstract. Tell us, what is it?

Alex: I think the concept as used in the environmental economics literature can indeed be quite abstract. But we use it specifically as a basis to quantify the economic and societal welfare value that different users get from water. A shadow price is a method for signalling the relative value of water to different users.

Q: What problem does shadow pricing solve?

Alex: Our rationale for using shadow pricing is to support the transfer of value from users deriving the greatest economic benefit from marginal consumption, to users who would derive the greatest societal welfare benefit. We’re not proposing prescriptive prices for water. Regulators and policy makers ultimately decide who pays how much for what. Rather, we propose shadow pricing as a decision-support tool, that can help reveal the value of water across users, time, place, and purpose—so that price structures (or other policy tools) can support the transfer of that value. It’s about aligning incentives to fund access and resilience at scale.

Q: Where is this concept of water shadow pricing being applied?

Alex: Let me summarise the five largest uses of water shadow pricing:

1. Policy & regulation: We’re supporting governments revising water acts and tariff structures. This is about value transfer from high-value users to meet societal needs—its not about raising tariffs for everyone and charging the poorest more. Our analysis reveals that many industrial users (for example in food, beverage and agriculture, mining, infrastructure, technology) are willing to pay multiples of current water tariffs if it improves supply security and creates social license. A corporate social license relates to reducing operational and strategic risk through corporate engagement/ stewardship.

2. Utilities & infrastructure:  Where shadow prices inform tariff adjustments, this can offer financial incentives for utilities to invest in improving asset efficiency and reducing non-revenue water.
3. Humanitarian settings & procurement: Setting reference price ranges to expedite vendor contracting, for example;
4. Payment for ecosystem services: In Asia, we’re working with a development bank on a revolving fund paying upstream land stewards to reduce sediment loads. Shadow pricing quantifies the downstream avoided costs (extended asset life, reliable hydropower) against upstream payments—often revealing very high benefit-cost ratios of investments;
5. Corporate capital allocation: Helping firms optimise where they make capital investments to improve efficiency and strengthen resilience

Q: Let’s zoom in on the industry that uses shadow water pricing. You recently analysed how companies reported on their internal water pricing to CDP. What did you learn?

Alex: CDP asked about 8,500 companies whether they set an internal water price. From those, 426 said yes - which is about 5% of responders. That compares with about 15% who disclose that they set an internal carbon price. Companies that set an internal water price disclose that this is primarily to support operational efficiency and capital allocation decisions.

Q: What are the numbers?

Alex: Across many sectors, even the maximum internal prices cluster under about $1.20/m³. Median internal water prices varied significantly by industry and geography. Companies in our sample from the food, beverage and agriculture industry group set some of the highest internal water prices. The caveat, of course, is that the overall sample size is quite small.

Q: If firms are shadow-pricing water at, say, $5/m³ internally, but paying $1/m³ on water bills. How should we interpret this?

Alex: That’s exactly the point regulators can leverage. For example, in the food, beverages and agriculture disclosures, we see that internal water prices applied for some locations are over five times the water tariff being paid. That gap suggests some capacity (and willingness) to pay more, provided the benefits of doing so are clear to them.

Q: But are companies actually using these numbers to make decisions?

Alex: Yes. Across the whole sample, for roughly two-thirds of relevant decisions, companies disclosed that incorporating the internal water price was actually mandatory for at least some decisions.

Q: How sophisticated are the methods being used by the companies?

Alex: It’s a spectrum. Some simply mark up the utility tariff. Others add treatment/distribution costs or expected regulatory changes. The most advanced do genuine shadow pricing—sometimes with climate scenarios and richer risk modelling. There’s no standardization, so it’s not apples-to-apples. And there is a pretty steep sophistication gradient across industry groups.

Q: Isn’t water scarcity the point? Where does scarcity show up in water shadow pricing?

Alex: Scarcity is one input — but not the only one. Competing uses, relative scarcity, infrastructure availability and welfare outcomes—all can be parameterized. Different policy objectives (growth, equity, environmental resilience) will produce different optimal values for different user groups. The approach can help optimise for questions such as “what are the value-reflective tariff structures that enable the sector to meet its investment needs with only essential subsidies”.

Q: What should regulators, utilities, and investors take away from your work on water shadow pricing right now?

Alex: Shadow pricing is presented as a decision support tool to establish a basis for different water structures and inform price discovery, rather than setting a universal "should be" price. It really depends on the objectives decision-makers are trying to achieve (e.g., pro-growth, pro-equality, environmental resilience).

Shadow pricing can bridge value discovery and policy design—so high-value users pay closer to the value they unlock, freeing resources for equity and resilience.

Also, I would argue that we shouldn’t get sucked into relying on just volumetric pricing if we want scaled impact. This approach moves beyond simple volumetric framings – including ‘replenishment’ -  to consider who is using water, when, where, and for what purpose.

Q: I can understand how shadow pricing affects the high-value users (like the industries mentioned), but not how it affects actors in the water and sanitation sectors (WASH). Could they potentially benefit?

Alex: I don’t have a good answer to this. We haven’t focused on the role shadow pricing can play directly in improved WASH outcomes. Indirectly, of course, if it improves financial sustainability within the (public) sector, then that in principle improves public sector capacity to invest in better WASH outcomes. Our approach to shadow pricing is more about differentials in the value of water for different users. For instance, I am not sure if there are similar differentials in the value of sanitation. At least, it’s not something we have looked into yet.

Q: Are these ideas feeding into upcoming sector meetings?

Alex: Yes. The UN Water Conference in 2026 lists the value of water among its themes, and the World Water Forum in 2027 is also exploring value and use cases. It is worth stating, though, that the policy context is certainly evolving, and so is our thinking .

Q: Final message to our readers?

Alex:  If we want scaled outcomes for WASH and resilience, we need users that derive a high economic value from water to pay more for it – and probably quite a lot more. Done right, value-reflective pricing can unlock transformative societal outcomes. For us at least, that’s the game that really matters.

For more information read the CDP report, Valuing water: corporate engagement with internal water pricing.

Download it here