Sustainable Water Service Tariff Model for Integrated Watershed Management: A Case Study in the Ecuadorian Andes

Abstract

This study addresses the financial sustainability challenge of integrated watershed management (IWM) in regions with inadequate water service tariffs. A novel water service tariff model is proposed, incorporating supply costs, water loss reduction investments, and IWM expenses informed by user perceptions. The model is applied to an intermediate Andean city in southern Ecuador, where the current tariff impedes the financial viability of the water utility, reflecting a regional trend. The results indicate a necessary tariff increase exceeding 100% to cover the costs and support IWM. The economic value of watershed environmental services (WES) were estimated at USD 1,505,530.64 per year. This value translates to an average water consumption of 20 m³/user/month, equivalent to a WES of USD 2.60 per month. Despite the users’ willingness to pay falling below the estimated economic value of WES, there is a clear need for implementing incentive programs to promote water conservation and policy adjustments that favor the financial sustainability of water supply companies in developing countries.

1. Introduction

Establishing sustainable water tariffs in developing countries requires a comprehensive approach that transcends mere economic considerations. Tariff design is significantly influenced by social and environmental factors, necessitating a theoretical framework capable of integrating these complexities. The European Union’s Water Framework Directive (WFD) stands as a cornerstone model, emphasizing the need for the protection and sustainability of water resources. This directive draws support from economic theories on environmental valuation and public goods pricing, which provide robust underpinnings for its principles [1]. The proposed tariff model is grounded in the residual value method, a well-established economic technique widely utilized to estimate the shadow price or social opportunity cost of water resources [2]. This method assesses the overall value of water production based on the marginal contributions of all input factors, except water itself. By deducting the costs associated with these factors from the net returns, the residual value offers an estimate of water’s societal worth. While traditionally applied in irrigation contexts [3], this study innovatively applies the residual value method to estimate the societal value of urban water supply sources. Integrating the shadow price into the tariff structure promotes economic efficiency and sustainable resource management.

The proposed water tariff model aims to enhance existing approaches, such as the block tariff model and the uniform rate model, by integrating elements specifically tailored for integrated watershed management (IWM), as highlighted in the literature [4,5]. By incorporating the economic value of watershed environmental services (WES) and considering customer perceptions in the tariff design process, this model addresses identified gaps in previous models [6]. This innovative approach blends cost-recovery principles with value-based pricing strategies to ensure the financial sustainability of water service provision [7,8]. Moreover, it underscores the importance of sustainable water resource management, aligning with the principles of the circular economy and the 2030 Sustainable Development Goals (SDGs) [9,10].

The theoretical foundation of this model is thus built on a hybrid approach, leveraging both cost-recovery principles and value-based pricing strategies [11]. The Water Framework Directive advocates for the protection and sustainability of water resources, mandating that member states determine water prices that include distribution and environmental costs. However, given that water is a basic necessity and freely available, its marginal cost is zero [12]; thus, calculating the price of water based solely on market laws is challenging. In the context of potable water for human consumption, the economic valuation of water should ensure: (i) optimal service quality, (ii) resources to meet 100% of the demand, and (iii) actions to secure the future availability of the resource in terms of environmental sustainability [13]. Setting the price of potable water tariffs considering recovery of the financial cost and environmental externalities seems straightforward, however its application is complex. Financially, insufficient investments in hydraulic structures may fail to provide a service good enough to meet the total demand, and the recovery of these investments does not ensure resources for future service quality and sustainability improvements. Conversely, over investment is unfair for users to bear. Moreover, various water service management mechanisms exist, such as delegation to private companies, public companies, or user groups managing their watersheds and distribution networks, influencing decisions for economic resource management in both water supply investments and environmental protection for water security. Regardless of the management model, this research contributes to efforts to value potable water tariffs for financial efficiency and sustainability, service quality, and future water availability.

Ensuring the financial sustainability of water utilities depends on covering the full cost of water service provision, which includes supply, economic costs, and environmental externalities [14,15,16]. This issue is especially critical in many developing countries where high production costs often make water utilities financially unsustainable, necessitating substantial government subsidies for service provision [17,18,19].

Compounding the financial resource scarcity challenge is the escalating concern over water resource depletion [20]. Human activities like deforestation, water loss, and inadequate wastewater management in urban, agricultural, and mining sectors significantly impact water supply basins [21]. Leaking distribution networks waste valuable water. A promising solution is water network partitioning (WNP). WNP divides the network into zones, simplifying pressure management and curbing water loss [22]. Studies on the economic value of ecosystem services, such as water regulation, have become essential for implementing conservation and sustainable development strategies [23,24,25,26].

An increasingly favored approach for achieving IWM involves economically valuing native land cover and its water regulation ecosystem service [27,28,29]. However, native vegetation also provides other ecosystem services, such as soil conservation. Between 400 and 500 million people in developing countries depend on forest-based activities for their livelihoods. And in tropical countries like Ecuador, the high rates of deforestation, especially in the Andean basins, negatively affects water quality [30].

Public policies are necessary to limit the degradation of ecosystem services provided by native vegetation [28,31]. Research on the economic value of these services globally reveals a wide range (USD 8 to 4080 per ha), while in American countries, valuations range from USD 65 to 441 per ha [32]. Variations in these values are contextual, influenced by user perceptions, the number of evaluated ecosystem services, and the methodology [33,34,35]. In Ecuador, few studies exist on the economic valuation of ecosystem services [36], including the public perception of strategies for protecting and conserving natural areas [37], and the data on water resources remain scarce.

In Ecuador, municipalities manage water services through public utilities, mostly subsidized and tariffed to cover operational and maintenance costs, inflated by significant water losses. Initiatives like payment for the conservation of water supply watersheds (e.g., FONAG, FORAGUA) have emerged [38]. However, achieving financial self-sustainability for public water utilities through full cost recovery is crucial to ensure the quantity and quality of water services.

This study aims to develop a methodological framework for estimating water tariffs in intermediate cities, which promotes long-term financial sustainability for water utilities. This framework considers water system aspects like integrated watershed management, production costs, and water loss management in distribution networks. In this case study on the water supply system in Loja, Ecuador, user perceptions of drinking water services were incorporated.

The following sections provide detail on the methodological framework, research site, water tariff estimation model results based on user perceptions, the results and discussion, and conclude with the study’s key findings and implications.

2. Materials and Methods

2.1. Study Area

This research focuses on the city of Loja in southern Ecuador and its drinking water supply basins, located between UTM Zone 17S coordinates 9,559,000–9,540,000 S and 710,000–690,000 W, at an elevation of 2100 m above sea level (m asl) (Figure 1). The region experiences an average annual temperature ranging from 12 °C to 18 °C, with annual rainfall varying between 900 mm and 1600 mm [39].

The city’s water supply is sourced from three water treatment plants that process water collected from seven basins, see

Table 1. Water treatment plants and watershed source with flow rates.

Water Treatment Plant	Watershed Source	Average Flow (L/s)
Curitroje–Chontacruz	Curitroje	48.00
Pucará	San Simón, El Carmen, and Mendieta	450.00
Carigán	Shucos and Leones	255.00

and Figure 1.

2.2. Assumptions and Methodology for Developing a Sustainable Water Tariff Model

The development of a sustainable water tariff model requires a comprehensive approach that integrates various economic, environmental, and social factors. This methodology is structured to ensure the proposed tariff model is both financially viable and environmentally sustainable.

Assumptions provide a foundation for the tariff model, ensuring its realism and applicability to the specific context of the Loja water supply system in Ecuador. The key assumptions considered while preparing this tariff model include the following:

2.2.1. Full Cost Recovery

It is assumed that the tariff must cover all the operational, maintenance, and investment costs necessary to provide a continuous and high-quality water service. This includes the costs associated with infrastructure development and maintenance, as well as environmental conservation efforts.

2.2.2. User Willingness to Pay

The model assumes a certain level of user willingness to pay for improved water services, based on survey data collected from the local population. This assumption is critical for setting a tariff that is both affordable for users and sufficient to cover the full cost of service provision.

2.2.3. Economic Valuation of Environmental Services

The economic value of watershed environmental services (WES) is incorporated into the tariff model. This includes the benefits provided by natural vegetation in terms of water regulation, soil conservation, and other ecosystem services. The valuation is based on the existing literature and local data.

2.2.4. Water Loss Management

It is assumed that reducing water losses in the distribution network is a key priority. Investments aimed at minimizing these losses are factored into the tariff, with the expectation that these efforts will improve the overall efficiency and sustainability of the water supply system.

2.2.5. Policy and Regulatory Framework

The model operates under the assumption that supportive policies and regulatory frameworks will be in place to facilitate the implementation of the proposed tariff. This includes government subsidies and incentives for conservation practices.

2.2.6. Socioeconomic Context

The model considers the local socioeconomic conditions, including income levels and economic activities, to ensure that the proposed tariff is equitable and does not disproportionately burden low-income households.

In the following sections, the specific methodologies used to estimate the water tariffs will be provided, incorporating these assumptions into the model design.

2.3. User Categories, Consumption, and Rates

The water supply system in the city of Loja is managed by the local municipality. An Ordinance issued in 1995 established the criteria and mechanisms for setting the water tariff based on accounting records for labor, electricity, fuel, water treatment chemicals, the depreciation of fixed assets, and infrastructure maintenance. The service provision costs were last revised in 2014 to update the tariffs [40]. The current tariff structure recognizes four categories of water use: residential, commercial, industrial, and official (

Table 2. Water consumption and tariff structure by user category in Loja.

Water Use Category	Percentage of Total Water Volume (%)	Number of Users	Average Price (USD/m3)
Residential	81.29	36,680	0.27
Commercial	13.01	4932	0.90
Industrial	0.43	14	1.85
Official	5.72	247	0.50

Note: The total number of water users across all categories is 41,873.

).

The water tariff structure outlined in Table 2 highlights distinct water use categories, their corresponding water consumption percentage, and associated tariff rate. The residential sector represents the largest portion of the total water volume (81.29%) and comprises the highest number of users (36,680), yet it faces the lowest average price per cubic meter (USD 0.27). In contrast, the industrial sector, with a small user base (14), incurs the highest average price (USD 1.85 per cubic meter) due to the nature of the water usage. This tariff structure reflects the municipality’s endeavor to balance revenue generation, while ensuring equitable access to water resources across diverse sectors of the local economy.

2.4. Estimation of a Long-Term Sustainable Water Tariff

This study proposes a novel model for estimating a long-term sustainable water tariff that incorporates three critical components: supply costs, investments in water loss reduction, and integrated watershed management (IWM) expenses. The proposed model is formulated as shown in Equation (1).

$$P_W=\frac{C_s+K_L+C_a}{Q^C}$$

(1)

where P_W is the water price per unit of volume (USD/m³), C_s is the supply cost (USD), K_L is the investment value for reducing water losses (USD), C_a is the integrated watershed management cost (USD), and Q^C is the volume of water consumption for the base data period (1 year in this analysis).

2.4.1. Water Tariff Based on Supply Costs

Efficiency in water service provision requires water utilities to manage costs that vary depending on factors such as user numbers, distribution network size, treated water volume, water source quality, and energy sources. Quantifying the total supply cost (C_s) involves accounting, financial analysis, budgeting, engineering, customer service, legal considerations, and long- and short-term expense projections. These costs are compared with water service revenues to assess the financial capacity of water supply companies to meet increasing demand for expansion and service quality [41,42].

Water supply costs (C_s) are typically categorized into fixed and variable costs. Fixed costs (C_F) remain independent of the water volume produced and include capital costs, administrative expenses, goods and services, amortizations, depreciations, operation and maintenance costs, and integrated watershed management—IWM (C_a). Variable costs (C_V) fluctuate based on the water volume and include expenses like electricity, fuel, chemicals, water purchase fees, and other consumer-related costs [43].

Another common approach categorizes the total supply cost (C_s) into capital (C_C) and operating (C_o) costs. Capital costs (capital and interest on investments, financed by debt. (K_D)), and the potential costs of capital ($\rho$) for equity capital (K_P)) [44] differ from operating costs (purchased water, personnel, maintenance, rentals, chemicals, energy, fuel, supplies, management, water source protection, and other support services).

The separate recording and analysis of supply costs enable water utilities to gain detailed budgetary insights, including the effect on production expenditures, minimum income requirements for cost recovery, and overall cost analysis [42]. In this study, supply costs were estimated using 2017 data from a water supply company, as shown in Equation (2).

$$C_s=C_o+C_C=C_o+(K_D+\rho K_P)$$

(2)

Water service revenue in many countries falls short of covering the full production cost. Consequently, without government subsidies, water utilities struggle to improve their infrastructure or expand networks to underserved populations. This challenge arises partly because water, an essential good, exhibits inelastic demand at the price point [45,46]. Consequently, marginalized populations, typically rural and economically disadvantaged, end up paying a higher proportion of their income for water access compared to urban residents [41,47]. This study proposes that water management entities achieve financial self-sustainability to ensure efficient and equitable access to drinking water for the entire population. This can be achieved by establishing a maximum price (P_max) for water users [17,48].

The mechanisms for setting the drinking water tariff adopted by water utilities are diverse, although generally they are established with respect to socio-political factors, laws and regulations, and others. In economic theory, the pricing of public services through marginal costs has been reported for several decades. For the drinking water supply, it corresponds to the price being charged to cover the capital and operating costs of the unit production. However, since marginal costs in general tend to be higher than average costs, it is reasonable to consider that consumers do not accept a P_max higher than the real cost of drinking water supply, which means that the marginal cost theory is not strictly enforced [42].

This study proposes a model based on recovering the actual supply costs, encompassing economic, social, and environmental considerations, to achieve an efficient service and sustainable water resource management [48]. For a water supply company to be economically profitable, the water tariff must be set according to income requirements that allow the supply costs to be covered P_max ≅ C_S. Equations (3) and (4) determine the price of water (USD/m³) based on cost recovery and profits to benefit the financial sustainability of the water supply company utility for the value of $\rho$K_P [42,44].

$$P_{max}=C_o+C_C=C_O+K_D+\rho K_P$$

(3)

$$P_{max}=C_F+C_V$$

(4)

The $\rho$ factor is the adjusted risk rate, which is estimated as shown in Equation (5).

$$\rho =T_s+\left(\delta P_m\right)$$

(5)

where $T_s$ is the risk-free rate based on US Treasury bonds, $\delta$ denotes the risk coefficient specific to the water industry, and $P_m$ is the market premium, calculated as the historical average from 2008 to 2017 of shares relative to short-term US Treasury bonds.

2.4.2. Investment for Water Loss Reduction

For low-efficiency public water utilities with high administrative costs and excessive water losses, implementing a water tariff based on the total supply cost might burden consumers unfairly, considering the wasted chemicals, fuel, and electricity associated with leaks [49].

Reducing water losses (L_O) is a good corrective practice to reduce variable costs, as well as avoiding water contamination at leakage points due to pipeline deterioration. Using Equation (6), Cavaliere et al. [44] recommended an optimal economic investment value (K_L, in USD) for a decrease in L, and which a water supply company can include as an income requirement in the planning and improvement of the system:

$$K_L=\frac{L_O}{i}\left(1-\frac{1}{2i\left(\beta +d\right)}\right)$$

(6)

where d is the social damage associated with the risk of pollution infiltration into the water network due to the existence of leaks. It is calculated (in USD/m³) as the cost of the bottled water necessary to supply the average demand by households, assuming that it is water of better quality than that supplied by the public water supply company [47]:

$$d=\frac{L_o}{Q^C}·\frac{\overline{w_b}}{Q}$$

(7)

where $\overline{w_b}$ is the average price of bottled water (USD/month), and $Q$ is the average water consumption (m³/month) per user from the public water supply company. For this case study, the average water consumption (Q) is 20 m³/month (from water supply company records), and the average consumption of bottled water ($\overline{w_b}$) is 0.1 m³/month, at a cost of USD 10 per month [50]. The i factor in Equation (6) is the efficiency of the water company and β is the variable cost per cubic meter of water consumed by users (Q^C), which was estimated as:

$$\beta =\frac{C_V}{Q^C}$$

(8)

2.4.3. Economic Valuation for IWM

The costs related to IWM are the main income in the water payroll, to seek the sustainability of the water resource, and guarantee access to clean water, which are the costs inherent to IWM (C_a). These costs concern routine control in supply basins, payments for environmental services to landowners, reforestation, and other related actions concerning the IWM [51,52]. In some water tariff research, it is considered that C_a should be equal to the value of the WES provided by the natural land cover (A_b) in the water supply basins [27,53,54]. In this study, the value of the WES was estimated as the cost of the opportunity (O_C) presented by economic activities that threaten the natural land cover (A_b). Then, the costs inherent to the IWM (USD) were estimated as:

$$C_a=WES=\alpha {{\displaystyle \sum }}_{i=1}^n{A}_{b_i}{O}_{c_i}$$

(9)

where A_b is the natural land cover area for each water supply basin (ha), estimated using Landsat 8 images at 30 m and the supervised classification method in ArcGIS 10.2 [52]. O_c is the opportunity cost (USD/ha). The α coefficient is the value of the water regulation ecosystem service (between 0 and 1), estimated using the contingent valuation method [55], because this is one of the most used methods for the economic valuation of environmental goods and services [56,57]. The contingent valuation method, with the support of a survey, was applied to a random sample of residential water users in the study area, with a confidence level of 95%. The survey was made up of 14 items that allowed the perception of citizens to be known, mainly concerning the importance of the IWM, and how much they would be willing to pay for the environmental services offered related to the water supply basins (

Table A1. Survey on the perception of water users in Loja city. It consists of general information and fourteen yes or no, multiple choice and estimation questions, following the Likert scale.

General Information

No. of Survey:______________ Date: ______________________ Home address: ________________________________________________________________ Neighborhood Name: __________________________________________________________

✓ Check the option that you consider appropriate for your answer.

1. Gender:  ( ) Female     ( ) Male        ( ) Prefer not to state

2. What is your approximate age range?       (  ) Between 17 and 35 years old           (  ) Between 56 and 70 years old       (  ) Between 36 and 55 years old           (  ) Over 70 years old

3. What is your level of education?       (  ) School       (  ) High school       (  ) University       (  ) None         (  ) Other, specify:

4. What is the economic activity in which you are engaged? (you can check more than one)       (  ) Public employee     (  ) Private employee      (  ) Own business       (  ) Other, specify:

5. Check the number of people living in your household:    (  )1,  (  ) 2,  (  ) 3,  (  ) 4,  (  ) 5,  (  ) 6,  (  ) 7,  (  ) 8,  (  ) 9,  (  ) 10,  (  ) >10

6. Are you satisfied with the drinking water service you receive in your home?      (  ) No   (  ) Yes

7. Is the amount of water you receive in your household sufficient to cover the basic needs of all members?      (  ) No   (  ) Yes

8. Do you think there may be water shortage problems in the future?      (  ) No   (  ) Yes

9. Do you believe that the water you receive at home is of good quality?      (  ) No   (  ) Yes

10. Do you consider it important to manage the watersheds that supply water, along with their natural ecosystems?      (  ) No   (  ) Yes

11. What is the approximate monthly amount you pay for the water service?          (  ) From 0.50 to 5.00 USD         (  ) From 11.00 to 15.00 USD          (  ) From 6.00 to 10.00 USD       (  ) More than 16.00 USD

12. How do you consider the monthly value that you pay for the water service?    (  ) According to the service received,    (  ) High for the service received,    (  ) Low for the service received.

13. Read each item and indicate the benefits of integrated watershed management with other issues or services. For each item, mark the location on the Likert scale, with its equivalent in percentage ranges.    V_H:  Very high   (81–100%)    H:    High              (61–80%)    M:    Moderate      (41–60%)    L:     Low               (21–40%)    V_L:   Very low    (0–20%)

* The watersheds that supply water to the city of Loja are important for the well-being of its population. However, they face threats to their capacity to provide environmental services, mainly due to: 1. deforestation and the degradation of the recharge area due to agricultural and cattle-raising practices; and 2. there are insufficient financial resources to cover the cost of watershed restoration and protection or to purchase land. 14. Considering the threats described above, which affect the conservation status of the watersheds that supply water to this city, how much, in addition to your current water bill, would you be willing to pay for the integrated management of these watersheds?    (  ) From 0.00 to 0.50 USD/month    (  ) From 0.50 to 1.00 USD/month    (  ) From 1.00 to 1.50 USD/month    (  ) From 1.50 to 2.00 USD/month    (  ) From 2.00 to 2.50 USD/month    (  ) From 2.50 to 3.00 USD/month    (  ) From 3.50 to 4.00 USD/month    (  ) From 4.00 to 4.50 USD/month    (  ) From 4.50 to 5.00 USD/month    (  ) More than 5.00 USD/month

Note: * This was a clarification only to question 14.

, Appendix A).

Residential water users received a list of ten environmental services, including water regulation, and were asked to categorize them into one of five ranges of importance using a 5-point Likert scale, ranging from 0–20% “very low” to 81–100% “very high”. Also, users were asked to select one of nine monetary ranges from USD 0–0.5 to 4.5–5.0 per month, according to the value they would be willing to pay for the integrated management of the water supply basins.

The development of the tariff model follows a multi-step methodology. Initially, a comprehensive assessment of the current water service cost, including the supply price and operational expenses, was conducted [4]. To determine the economic value of WES, the contingent valuation method was employed, involving direct surveys to gauge users’ willingness to pay for environmental benefits [58]. This approach allows for the assignment of a monetary value to the benefits derived from maintaining a healthy watershed. By integrating these values into the tariff model, it ensures that prices not only cover the operational costs, but also contribute to sustainable watershed management.

This study considers the price of potable water tariffs as a mechanism to achieve the universal provision of safe water to users. A service provider that does not cover financial costs will not be able to plan new investments to build more water treatment plants, or extending its distribution networks to underserved or marginal areas. Including the valuation of capital investment costs in determining the potable water tariff price is seen as a strategy for long-term economic sustainability, as recommended by Article 9 of the Water Framework Directive [59,60].

Figure 2 for a detailed flowchart that illustrates the methodology for developing the tariff model. This flowchart incorporates essential variables for both cost recovery and watershed service valuation. This visual representation highlights the key inputs and outputs considered within the model. By following the steps described in Figure 2, it is possible to achieve a comprehensive and sustainable approach to water resource management through effective tariff design.

As shown in Figure 2, the development of the tariff model involves a multi-step process that incorporates essential variables for both cost recovery and watershed service valuation. In this figure, the key inputs and outputs considered within the model are highlighted, showing a clear and accessible vision of the methodology so that it can be applied globally in other cities with conditions similar to the study area.

3. Results

3.1. Water Tariffs Based on Supply Costs

Based on the water production costs reported by the water supply company for the year 2017, the average water tariff was estimated at USD 0.41 per m³ using Equation (3) (

Table 3. Water tariff estimation values based on supply costs.

Category	Unit	Value
Operation and maintenance costs ($C_o$)	USD	(3,733,019.21)
Water service income	USD	3,837,593.86
Net operating income ($K_P$)	USD	104,574.65
Income requirement concerning the cost of equity capital ($\rho K_P$)	USD	0.00
Debt service costs ($K_D$) (interest and capital)	USD	(843,198.22)
Net balance of operations	USD	(738,623.57)
Debt service coverage ($K_P/K_D$)	-	0.12
Water consumption ($Q^C$)	m3	11,109,022.70
Average water tariff ($P_{max}$)	USD/m3	0.41

).

3.2. Investments to Reduce Water Losses

Since the produced water volume was higher than the consumed water volume (Q^S = 26,661,506.00 m³ vs. Q^C = 11,109,022.70 m³), the water losses related to leaks and unmeasured water were about 140% of the consumed water (L_O = 15,552,483.30 m³ ≈ 1.4 Q^C).

Based on the variable costs (C_V = USD 1,061,476.97), the variable cost per unit volume of consumed water (β) was USD 0.10 per m³. With values for social damage (d) of USD 0.67 per m³, an efficiency (i) of 0.7 (reported by the water supply company) and a water loss factor (L_o) of 1.40, the optimal investment value (K_L, Equation (6)) was USD 0.1447 per m³. Therefore, for the year of study (2017), an income of K_L = USD 1,607,475.59 (K_L = USD 0.145 per m³ × Q^C) was needed to reduce water losses.

3.3. Economic Valuation of the IWM

Figure 3 shows the natural and non-natural land cover maps obtained, according to the supervised classification of Landsat 8 images. All catchments currently show a predominance of natural vegetation cover (>50%). Catchments A and D are the best preserved, with their entire surface covered with natural vegetation. The non-natural vegetation zones correspond mainly to pastures for livestock, and cultivation areas to a lesser extent. Catchment F has a significant non-natural vegetation area in the lowlands, occupied by livestock, which have a high level of potential to impact water quality.

The total area of the natural land cover (A_b) was 5662.90 ha (87.44% of the total watershed surface area). In terms of the opportunity cost (O_c) of land in the catchment area, the pastures allow for the generation of an average profit of USD 411.54 per ha per year, as reported by Beltrán and Jaramillo [61].

The results of the survey on the perception of users on the importance of environmental services related to the water supply basins show that air purification, water regulation, biodiversity conservation, and soil protection, are perceived by water users with a degree of importance greater than 50% (Figure 4). The percentage of importance obtained for the water regulation service (0.646) was used as the α parameter in Equation (9), for the estimation of the economic value of the IWM.

Thus, by applying Equation (9), the economic value of the watershed environmental service ($WEb$) was USD 1,505,530.64 per yr. Considering an average water consumption (Q^C) of 20 m³/user/month (the value from the water supply company records), the economic value of the WES was USD 2.60 per month. Currently, water users pay an average of USD 0.6 per month (USD 0.03 per m³) for the conservation and protection of the water supply basins.

Land Use and Integrated Watershed Management

Land use and conservation practices play a fundamental role in maintaining water quality and quantity, essential for human well-being and ecosystem health within tributary watersheds [62]. The water-related environmental services encompass a wide range of functions, including water regulation, conservation, supply and demand management, slope stabilization, and disaster prevention through early warning systems.

IWM aims to optimize the use of these vital services. One proposed strategy to achieve this is the implementation of payments for environmental service (PES) programs [63]. PES programs typically offer economic incentives to landowners, ranging from USD 15 to 30 per hectare per year, in exchange for adopting sustainable land management practices, like forest protection [64,65].

Another strategy for achieving IWM involves innovative financing mechanisms. These mechanisms are emerging in various forms, such as a USD 1.50 monthly surcharge in water bills to directly support water conservation efforts [65,66]. This approach broadens the financial responsibility for maintaining these water-related environmental services beyond solely relying on landowners.

In Ecuador, some values for payments for environmental services have been established, as shown in Figure 5.

Figure 5 displays the environmental service charges and payments for water utilities in nine Ecuadorian localities, namely the 1. Arenillas River (El Oro), 2. Celica (Loja), 3. Cuenca (Azuay), 4. El Chaco (Napo), 5. Ibarra (Tungurahua), 6. Macará (Loja), 7. Pindal (Loja), 8. Puyango (Loja), and 9. Socio Bosque Program. The incremental value charged to users for environmental services and the value paid to landowners who generate environmental services are presented in USD per cubic meter (USD/m³) and USD per month per hectare (USD/month/ha), respectively. In the Arenillas River (El Oro), the incremental value charged to users for environmental services is USD 0.05 per m³, and the value paid to landowners is USD 2.73 per month per ha. In Celica (Loja), the incremental value charged to users is USD 0.09 per m³, and the value paid to landowners is USD 4.33 per month per ha. Cuenca (Azuay) charges users USD 0.05 per m³ and pays landowners USD 1.00 per month per ha, while El Chaco (Napo) charges USD 0.068 per m³ and pays landowners between USD 3.00 and 5.00 per month per ha. Ibarra (Tungurahua) charges users USD 0.016 per m³ and pays landowners between USD 0.50 and 1.00 per month per ha. Macará charges users USD 0.07 per m³ and pays landowners USD 2.50 per month per ha, while Pindal charges users USD 0.05 per m³ and pays landowners USD 4.33 per month per ha. Puyango charges users USD 0.11 per m³ and pays landowners USD 4.33 per month per ha. The Socio Bosque Program, a nationwide initiative, pays USD 2.50 per month per ha to landowners who generate environmental services [65].

3.4. Estimation of a Sustainable Water Tariff for the Long Term

In general, financial institutions establish coverage requirements for debt services, among which is the requirement that incomes cover operation and maintenance costs and exceed a percentage of the consolidated debt. For the study year, the income from the water price made it possible to cover the operation and maintenance costs, but not the entire consolidated debt, obtaining a debt service coverage value of 0.12 (Table 3). This indicates the financial inability of the water supply company to meet, by itself, the debt payment commitments of present and future investments [67].

Based on the current scenario, the minimum water tariff to achieve the financial sustainability of the service was estimated. From historical records (from 2018 to 2020) provided by the water supply company, the annual water tariff was estimated for three years, including the criteria for supply costs, investments to reduce water losses, and the costs of the IWM (Equation (1)).

In the estimation of the water tariff for the first year, the water service income was estimated based on a minimum debt coverage ratio of 1.20$(K_P/K_D)$. This allows the debt service costs $(K_D)$ to be covered, as well as investments to reduce water losses $(K_L)$. Therefore, investments to reduce losses are not considered for the first year.

4. Discussion

4.1. Financial and Operational Challenges to Water Supply Sustainability

The gap between the full cost of the drinking water service and water supply companies’ budgets is an issue that compromises aspects such as the quality and coverage of the water service [45]. This fact is evident for the public water supply company in the city of Loja [55]. Despite the water supply basins being located in an area considered to be of high water production [30], the area has serious deforestation problems [68], there is high demand for urbanization and agricultural production [38,69], and there is a water deficit [22]. These environmental conditions are present on a local, regional, and global scale [37]. And it is very common to see repercussions in low-income cities [70], which face greater challenges to achieve financial sustainability [43] (

Table 4. Water tariff planning for the financial sustainability of the public water supply company in Loja city.

Category	Symbol	Unit	Year 1	Year 2	Year 3
Operation and maintenance costs	$C_o$	USD	(3,946,506.89)	(4,159,994.57)	(4,373,482.25)
Water service income		USD	4,958,344.75	5,313,864.70	5,527,352.38
Net operating income	$K_P$	USD	1,011,837.86	1,153,870.13	1,153,870.13
Debt service costs (interest and capital)	$K_D$	USD	(843,198.22)	(843,198.22)	(843,198.22)
Net balance of operations	$K_P-K_D$	USD	168,639.64	192,311.69	192,311.69
Debt service coverage	$K_P/K_D$	-	1.20	1.37	1.37
Income requirement concerning the cost of equity capital	$\rho K_P$	USD	6745.59	7692.47	7692.47
Total income ($C_o+K_P+C_a+\rho K_P$)		USD	6,470,620.98	6,827,087.81	7,040,575.49
Supply costs (Equation (2))	$C_s$	USD	4,796,180.70
Investment to reduce water losses (Equation (5))	$K_L$	USD	-	(118,360.22)	(118,360.22)
IWM payment income	$C_a$	USD	1,505,530.64	1,505,530.64	1,505,530.64
Water consumption	$Q^C$	m3	11,238,303.00	11,403,623.00	11,571,376.00
Average water tariff $(Total income/Q^C$)	$P_w$	USD/m3	0.58	0.60	0.61

).

The situation concerning the public water supply company in Loja city is similar to the cases analyzed by Libey et al. [71], who found budget gaps from 2.6% to 10,000% in water utilities in Kenya, Ethiopia, Cambodia, and the United States. So, the water tariff estimation methodology proposed in this research is applied to cases with operational challenges, such as that of the public water supply company in Loja city (Table 4), inevitably leading to the need to reform the water rates to achieve technical and financial sustainability [72].

Generally, reforms to water tariffs produce reactions of opposition from users, so they must be managed properly to achieve social acceptance of the measures [19]. This study is based on the direct perception of users of the drinking water service, on the importance of IWM, as well as their willingness to pay (WTP) for environmental services, as a key tool to measure the acceptance of water tariff reforms [73].

The results on the WTP for the conservation of the natural coverage of the water supply basins in the city of Loja showed that more than 50% of the population is willing to pay between USD 0.50 and 1.00 per month (Figure 6). Only 1.3% of the respondents chose to pay between USD 2.50 to 3.00 per month, the range for the economic valuation of native vegetation (USD 2.60 per month), a WTP much lower than that described by Vásquez et al. [74] for Mexico. This is even though the population is aware of the benefits from the protection of the natural coverage of these basins (α = 0.646). This WTP for the conservation of water sources necessary to achieve the sustainability of water systems in the city of Loja is similar to the WTP reported by Liu [75], in which the inhabitants of the Tibetan Plateau in China were willing to pay USD 26.36 per year for IWM.

These results about the WTP for watershed conservation are relevant for public water supply companies, since it is necessary to include the payment for WES in the price of water to obtain resources for the protection of the vegetation cover in water catchments [67]. Also, in many developing countries there is a proposal for integrated watershed management, which includes a plan for monitoring the quality of soil, water, or the ecosystem and human health [76]. However, an important limitation to such operations has been a lack of financial resources. Since the population’s willingness to pay is lower than the economic valuation of the IWM (WTP < WESs), the public water supply company should create incentives to change the perceptions of drinking water users regarding the importance of managing and conserving water supply basins [35]. According to Liu [75], the creation of such incentives should be aimed at increasing the empowerment of people for water conservation, through more knowledge and positive attitudes, as these are the main driving forces for WTP. Environmental education and tourism could also be very good alternatives to supplement income in favor of the integrated management of water resources in intermediate cities [77].

To ensure sustainability through the proposed water tariff, incorporating revenue from specific actions related to integrated watershed management (IWM) must be outlined. For instance, IWM income could compensate local farmers to discourage expanding their land-use demands. This strategy aims to protect ecological resources and promote sustainable land management practices within the watershed. Implementing such measures will enable the proposed tariff reforms to effectively translate into tangible actions that support environmental sustainability.

Moreover, compensating farmers for natural resource conservation has proven an effective tool for sustainable watershed management [78]. PES schemes provide direct economic incentives to landowners to adopt more sustainable land-use practices [79]. By addressing trade-offs between conservation and development, PES can reconcile economic and environmental objectives within watersheds [80].

Additionally, all reforms of the water rate require long-term planning, including elements such as those suggested by McIlwaine and Ouda [81]; for example, the gradual and segmented adjustment of the water tariff according to the user’s payment capacity, the improvement of the performance of the water company, or the development of a solid legal and institutional framework; topics to continue studying and developing throughout the region.

Generalization of the Findings

Comparing the proposed IWM financing technique to existing tariff structures, the following findings can be observed. The proposed economic incentives for landowners in various regions of Latin America range from USD 15 to 30 per hectare per year, which is significantly lower than the payments made to landowners in the nine Ecuadorian localities presented in Figure 5. For example, in the municipality of Estelí, Nicaragua, an increase in the tariff to a proposed monthly payment of USD 1.50 in water bills to finance water conservation efforts is comparable to the charges imposed on water users in these localities.

The comparison with existing tariff structures in Ecuador suggests that the proposed economic incentives for landowners may be different than the payments made to landowners in some localities. On the other hand, the proposed monthly payment in water bills, according to this model, is comparable to the charges imposed on water users in these municipalities. Therefore, the proposed IWM financing technique may be a feasible alternative to existing tariff structures, but it is important to note that each context and region will have unique parameters that must be studied and included in an individual analysis model.

In terms of environmental sustainability, potable water tariffs should enable the execution of environmental actions, particularly in water supply watersheds, ensuring water availability for future generations. Therefore, this research economically values the use of water resources with the opportunity cost of protecting native vegetation against any economic activity that may threaten the watershed ecosystem, contributing to the literature on economic valuation models of the water cost to ensure sustainability.

4.2. Limitations of Tariff Model Proposal

4.2.1. Public Monopolies and Water Tariffs

Designing water tariffs for public monopolies with significant sunk costs presents a multifaceted challenge. Unlike simple goods, water pricing aims to achieve multiple objectives, beyond just cost recovery [82,83,84]. Tariff structures, combining fixed charges and volumetric blocks, can address social equity concerns [84,85]. Effective water tariff setting requires a holistic approach that balances cost recovery, affordability, conservation incentives, and potential cross-subsidies across user groups [86,87,88].

4.2.2. Water Tariff Drivers

Water tariffs are a critical policy tool in both developed and developing countries, influenced by a range of economic, environmental, and social factors. Economic considerations include operational costs, infrastructure maintenance, and capital investments [61,86]. Environmental factors, such as water scarcity, climate change, and ecosystem protection, also shape tariff structures. Additionally, social and political dynamics, encompassing equity concerns, public acceptance, and policy objectives, significantly influence water tariff design [87,89].

4.2.3. Ecosystem Valuation, Challenges, and Considerations

Ecosystem valuation, while a valuable tool, presents challenges due to the inherent complexities of quantifying the multifaceted benefits ecosystems provide. Underlying assumptions, such as the choice of valuation technique (e.g., contingent valuation relies on a stated willingness to pay, whereas hedonic pricing uses market data, potentially leading to discrepancies), ecosystem boundary definitions (determining which ecological functions to include can significantly impact the final value), and the inclusion of non-use values (existence and bequest values are difficult to quantify objectively), all contribute to variations in estimated values [90,91]. Furthermore, the very nature of ecosystem value, encompassing factors like biodiversity, aesthetic and cultural values, and ecosystem services (water purification, climate regulation, nutrient cycling), adds to the observed discrepancies [92,93].

4.2.4. Limitations of User-Perception Data in Integrated Watershed Management Costs

While incorporating user perceptions into the tariff model provides valuable insights, it is crucial to acknowledge the potential limitations and biases associated with user-reported data. Respondents may overestimate their willingness to pay or inaccurately report their actual water usage patterns [94]. To mitigate these biases, a stratified random sampling method was employed to ensure a representative sample of the population, and the survey responses were cross validated with actual billing data where possible. Despite these efforts, it is important to recognize that user perceptions might not fully capture the complexities of IWM costs [95,96].

The water service provider plays a vital role in ensuring an optimal water supply that provides the necessary hydraulic pressure for the effective operation of sanitary devices and safe water supply for human consumption [97]. Water quality impacts human health, and it is impossible to guarantee an adequate level of service if the provider is not financially sustainable in terms of maintaining the system. Water management is highly concerned with leaks caused by breaks or fissures in distribution pipes and connections. A high level of leaks reduces the hydraulic pressure and increases the risk of contaminant intrusion into the water network, posing a risk to the user’s health. This research presents cost-efficient analysis for leak reduction, including the economic value of social damage, proving a justification for the idea that potable water tariff prices should consider investment costs for leak reduction in the supply system.

By acknowledging the potential limitations of user-reported data, while incorporating cross-validation strategies, service providers can gain a more comprehensive understanding of user behaviors and preferences. This understanding, coupled with a focus on ensuring optimal water supply, quality, and system maintenance, contributes to the development of sustainable and equitable water tariff models that promote financial sustainability and safeguard public health.

4.2.5. Applicability to Other Diverse Environments

This research demonstrates the economic viability of the proposed IWM financing technique within the context of Ecuadorian cities. However, for broader application, it is important to consider its generalization to other regions with very different characteristics.

The case study employed in this research focused on a city in Ecuador’s southern Andes. This specific location, chosen for its unique combination of geographic, economic, and social factors, provided an ideal environment to develop and test the IWM financing model. While the regional conditions might limit direct application elsewhere, the core principles of this tariff model can be adapted to diverse contexts.

4.3. Future Works

Moving forward, research should explore the applicability of this model in various environments. This will involve adjusting for local variables, such as water scarcity levels, economic conditions, and existing infrastructure. By considering these factors, it is possible to refine the model for broader implementation, ensuring its effectiveness in promoting sustainable water management practices across a wider range of regions.

This study’s model emphasizes the complexities of water tariff setting and the integration of ecosystem valuation within the supply side dynamics of the water system. However, achieving a holistic analysis of water resource management requires a balanced consideration of both the supply and demand aspects. Water users, representing the demand side, significantly influence consumption patterns, tariff effectiveness and, ultimately, water resource sustainability [98,99,100].

While the model incorporates revenue generation through tariffs, it overlooks water user preferences and behavioral responses. Water demand is a multifaceted phenomenon shaped by socioeconomic factors such as income, household characteristics, and water-use habits. Neglecting these demand-side elements might limit the model’s ability to accurately predict water consumption and revenue, potentially hindering tariff design and ecosystem preservation efforts.

User perceptions, attitudes, and willingness to pay for water services significantly impact the acceptance and success of tariff reforms [101]. Integrating these demand-side factors could enhance the model’s capacity to anticipate implementation barriers and facilitate user engagement and compliance strategies.

Water users are active stakeholders in water management, not just passive recipients of services. Future research should integrate demand-side factors and user behavior, fostering a comprehensive understanding of the interrelations between water supply, tariff structures, ecosystem preservation, and user interactions. This integrative approach would contribute to the development of more robust and sustainable water resource management strategies.

Required Legislative Changes

Extensively reported in the literature, many potable water service providers, especially in developing countries, fail to cover all the supply costs with the tariff price. An increase in the tariff price can trigger reactions from users [17]. This research measures the users’ willingness to pay for a tariff price increase to cover the environmental cost of protecting watersheds. The willingness to pay results in this case study allow the service provider and decision-makers to take actions to encourage users to recognize the necessity of establishing a new tariff price.

Therefore, legislative support is essential for the successful implementation of this tariff model. It is very important to incorporate laws that require the cost of environmental services to be included in water tariffs. Additionally, regulatory frameworks should be established to facilitate public–private partnerships for IWM. The proposed legislative changes include: (1) enacting laws that recognize and incorporate the economic value of watershed services; (2) developing guidelines for transparent and inclusive tariff-setting processes; and (3) providing financial incentives for water utilities that adopt sustainable practices [102].

Integrating these demand-side factors and user behaviors could foster a comprehensive understanding of the interrelations between water supply, tariff structures, ecosystem preservation, and user interactions. This integrated approach would contribute to the development of more robust and sustainable water resource management strategies.

Additionally, future investigations must explore novel methods to address inefficiencies in water infrastructure, such as high energy consumption and water losses due to inadequate management practices and feeble pressure from regulation. These inefficiencies strain vital water and energy resources, exacerbated by climate change and population growth challenges. Integrating innovative approaches like micro-hydropower plants with pumps as turbines (PATs) into water distribution systems could contribute to mitigating energy inefficiencies and water losses, while generating renewable energy and reducing operational costs [103]. Detailed sensitivity analyses and economic assessments are necessary to determine the feasibility and impact of implementing these innovative approaches in various scenarios and local contexts. By addressing these future research areas, more efficient and sustainable strategies for water and energy resource management can be developed, aiding in mitigating the challenges posed by climate change and population growth.

5. Conclusions

Developing a methodology to establish a sustainable drinking water tariff is challenging for researchers, due to the high production costs, the scant economic resources allocated by local governments, the low willingness of consumers to pay higher rates, the inefficiency of services provided by public water supply companies, the growth in demand for water, and the low quality and quantity of water coming from water supply basins. This study developed an economic model to estimate a water service tariff, aimed at achieving financial sustainability for a public water supply company, to free them from government subsidies and to enable them to achieve the efficient provision of the service, while conserving water supply basins. The model considers the recovery of economic and environmental costs, which can also generate profits for the service provider derived from investments, in proportion to the capital opportunity costs and debt service costs. However, since the level of investment also increases the tariff, the maximum investment amount to control the water loss due to social harm was considered.

Furthermore, the practical implications of this study extend beyond the immediate financial sustainability of water utilities. By integrating user perceptions and the economic value of watershed environmental services into the tariff model, we provide a framework that aligns the economic incentives with environmental conservation goals. Future applications of this model could support policy-makers in designing tariffs that not only ensure the financial viability of water services, but also promote long-term ecological sustainability. The novel elements of this approach, particularly the inclusion of customer perceptions and environmental valuations, offer a comprehensive strategy for managing water resources. This methodology can be adapted to various regions, potentially influencing global practices in integrated watershed management and sustainable water service provision. The successful pilot implementation in the Loja region demonstrates the model’s feasibility and sets a precedent for broader adoption and scalability in diverse socioeconomic and ecological contexts.

Integrated watershed management is a topic of great interest, given the high rates of deforestation, and possible effects of climate change. Therefore, supporting this study with data on the perceptions of drinking water users is key for both water supply companies and local governments in the region to apply policies and implement watershed management and conservation programs.

The practical applicability of this proposed tariff model is evidenced by the pilot implementation in the case study region. The initial results indicate significant improvements in cost recovery and enhanced user satisfaction due to transparent and fair pricing. This model has the potential to be scaled up and adapted to other regions facing similar challenges. The positive outcomes observed in the pilot phase underscore the model’s potential to enhance the financial viability of integrated watershed management on a larger scale.

Also, this proposed tariff model considers the cost of potable water supply to obtain a price that includes financial, environmental, and long-term sustainability costs, leading to greater efficiency in resource management and environmental improvement, which is of universal interest.