That is the view of industry experts, the City of Sydney and the property development industry, who fear the proposed prices will cruel attempts to develop alternative water supplies for neighbourhoods across the city.

"That is a scandal," said the Sydney Lord Mayor, Clover Moore. "We should just be encouraging people on the driest continent on earth to be recycling water."

The issue relates to the manner in which Sydney Water prices are determined for developers and developments that re-use water, such as, for instance, using recycled water to nurture parks and public spaces, or in the toilet systems in new buildings.

Even developments that have significant water recycling facilities, such as Barangaroo and Central Park, need to interact with Sydney Water. They either need to access Sydney Water's drinking water, which then gets recycled, or access Sydney Water's sewerage system for waste from recycled water.

In the past, these developers or the companies that run their systems have reached independent agreements on the cost of accessing Sydney Water's infrastructure.

But the Independent Pricing and Regulatory Tribunal and Sydney Water are pushing for access to water infrastructure to be provided under a complicated formula called "retail minus".

"Under the new pricing arrangements, those schemes would be under threat," said Stephen Albin, the chief executive of the NSW branch of the developer group, the Urban Development Institute of Australia.

Lisa McLean, the executive manager of corporate affairs at Flow Systems, a company that acts as a water utility for the Central Park development near Broadway and elsewhere, said there would be multiple negative impacts of the proposed prices.

Water bills would be higher, she said, because recycled water is cheaper. The proposal would also prevent innovation in the water industry to help reduce reliance on Sydney Water during the next drought.

"The really bad thing is that you won't see this in western Sydney," said Ms McLean of major new land releases. "The whole of western Sydney would just get shut out of this innovation."

Under water recycling schemes, buildings can be fitted with dual pipes that ensure recycled water is used on gardens and common areas and in toilets and laundries. Doing so can reduce reliance on Sydney Water's drinking water by 70 per cent or more.

The issue is pressing now because of the vast number of major housing developments, such as at North Parramatta, the Bays Precinct and around Waterloo, that can be built with recycling schemes. Sydney Water's proposal, critics say, will lock water recycling schemes out of these developments.

One of Sydney Water's concerns is that, because all retail water users in the city pay the same rate – under the so-called "postage stamp" pricing model – if it loses revenue from customers in areas that are cheaper to supply, that will undermine its ability to provide more expensive infrastructure elsewhere.

But Mr Albin, the City of Sydney and Flow Systems all say these issues should be addressed in a broader review of water supply across the city, not in a pricing review that can have significant negative consequences.

IPART's draft report into "wholesale" water prices is due next month, and a final report by the end of the year. An earlier issues paper had reflected a Sydney Water proposal that, critics say, would have made recycling schemes unviable.

A spokesman from the Water Minister Niall Blair said: "The NSW government supports the IPART process, which encourages efficient competition in the water sector where it provides valued added services and lower prices to customers."