Comparing Alternative Modifications of Energy Subsidies: The Case of Groundwater Extraction

This paper analyzes the responses of profit maximizing groundwater users to modifications (elimination, reduction, decoupling) of the subsidy to electricity frequently used for water pumping. It proposes a theoretical model, and numerically derives general results for a simplified case with homogeneous users. The model is applied to aquifers in Leon, Guanajuato, Mexico and in Kern County, California. We propose a method to compare the performance of a new, innovative policy intervention—decoupling the subsidy from the electricity bill—with two traditional policy interventions, elimination and reduction of the subsidy. The results suggest that the rate of water extraction of and the level of water in the aquifer, which are undesirable under the existing electricity subsidy, can be improved by changing the subsidy structure. Furthermore, decoupling represents a politically feasible alternative to solving the overexploitation of groundwater due to electricity subsidies.