A water pricing overhaul is on the way for NSW.

Household water bills in Sydney will be determined by how full the city's dams are from next month.

Officials say the new threshold will provide “a stronger reward to households who conserve water in drought”.

The Independent Pricing and Regulatory Tribunal (IPART) says that if dam levels are above 60 per cent, water will cost $2.35 a kilolitre, but if they fall below that level, the prices will increase to $3.18.

Currently Sydney Water users pay $2.11 a kilolitre. With dams at above 80 per cent capacity, bills are expected to drop slightly next month.

IPART expects the average Sydney water bill will drop by $80 or 7 per cent next month.