Water Resources Management

, Volume 27, Issue 9, pp 3209-3225

First online:

Optimising Reliability: Portfolio Modeling of Contract Types for Retail Water Providers

  • Renée KidsonAffiliated withC/O Center for Integrated Water Research, University of California Santa Cruz Email author 
  • , Brent HaddadAffiliated withEngineering for Technology Management, Environmental Studies, Baskin School of Engineering, University of California Santa Cruz
  • , Hui ZhengAffiliated withEconomics and Business Building (H69), The University of Sydney Business School, The University of Sydney
  • , Steven KasowerAffiliated withDigital Transportation Corporation, Strategic Economic Applications Company (SEACO)
  • , Robert RaucherAffiliated withStratus Consulting

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This paper considers the retail water provider’s purchasing decision of a portfolio of permanent contracts from wholesalers with multiple volatile water sources. We consider the reliability of two contract types: (1) fixed annual quantities, and (2) an inflow harvest function with storage. Our four-reservoir case in Sydney (Australia) has cross-correlated inflow data. To accommodate multi-reservoir cross-correlation we adapt Portfolio Theory from finance to lognormal reservoir inflows, re-framing traditional storage theory from the wholesaler’s optimal operating policy to the retailer’s optimal purchasing policy. We find that Reliability improves with access to a source pool (cf. fixed quantities from separate sources), demonstrating the ‘insurance effect’, and the portfolio that minimises lognormal variance also minimises harvest (and thus environmental impact). Reform direction in Australian (and other international) water markets is towards multi-provider vertical disintegration, which may reduce pool opportunities and negate the insurance effect. We consider diminishing reliability returns as reservoir harvesting increases, and conclude a retail portfolio of permanent contracts from reservoirs, plus short-term contracts from alternative sources (either independently or negatively cross-correlated) efficiently secures high reliability. The challenge in incomplete water markets remains in encouraging and sustaining supply diversification that may only be needed aperiodically during extreme droughts.


Reliability Retail water provider Contract Hydrological volatility Water supply system Portfolio theory Optimisation Storage Cross-correlation