Economics of Natural Resource Management Prof. Mike Young Research Chair, Water Economics & Management School of Earth and Environmental Sciences The University of Adelaide Friday 2nd February 2007

2 High level water reform agenda YearMajor policy 1994COAG Water Reform Framework within National Competition Policy 1995a 1995b MDB Cap introduced Water reform implementation linked to competition payments 1998MDBC commenced Pilot Interstate Water Trading Trial 2001National Action Plan for Salinity and Water Quality 2002MDBMC started Living Murray process 2003COAG agreed, in principle, to implement a NWI 2004COAG finalised NWI 2007 Howard Water $10 billion Plan

3 Natural resource management instruments The Key Question How do we, at any location, get  the right intervention  at the right location  at the least cost, so as to facilitate, from a social perspective  optimal land use change  optimal land and water use?

4 The full range of opportunities Outcome-orientated  Informational instruments  Motivational instruments  Regulatory instruments  Market-based instruments  Financial instruments  Property-right instruments Process orientated  Governance arrangements  Consultative arrangements

5 What are Market Instruments? … policy tools that use market signals and processes to encourage behaviour Seek to induced behavioral change  Foster change  Offer compliance flexibility  Through variation in compliance costs exits

6 Types of market instruments MBIs ‘encourage behaviour through market signals rather thanthrough explicit directives’ Price-based Lever behavioural change by changing prices in existing markets Quantity-based Lever behavioural change by specifying the ‘amount’ of new rights / obligations Market friction Lever behavioural change by making existing private markets work better Eg: Changing taxes, introducing levies, giving subsidies Eg: Introducing a ‘cap and trade’ scheme or an offset scheme Eg: Disclosing information such as via ecolabelling Market-Like Instruments Create business opportunity to sell a service Eg: Auctions & tenders

7 Market-like instruments

8 Market Friction Instruments Best left in private sector with catalytic inputs from Government Typically start in niche markets  Fisheries  Timber Certification  Organic Food Markets  Supply to large wholesale businesses

9 Price v’s Quantity design choice In theory, both approaches can yield the same outcome at the same cost … in practice many factors influencing instrument type and design  a key factor is relative uncertainties 1.Price instruments  Alter the prices of goods / services to reflect their environmental impact  … provides certainty as to compliance costs 2.Quantity instruments  Control the quantity of the good / service to socially desired level  … provides certainty as to environmental outcome

10 Instrument choice Screen for feasibility Assess potential to deliver environmental goals  On their own?  In combination with other instruments Recognise variation in human response to same instrument Assess potential to combine instruments to reduce cost of achieving outcome Design and develop implementation sequence

11 Recharge Accounts Trading Land use Recharge rate Area Recharge mm ha KL Native vegetation Plantation Timber ,500 Dryland lucerne ,000 Other Dryland 80 3, ,000 Irrigated ,000 Total Groundwater load 4, ,000 $0.10 per KL $500 Recharge 4,000 ha = 280,000 KL Farm Credit/Deficit 10,000 KL Less credits sold 5,000 KL Credits available for sale 5,000 KL

12 Off-set schemes Most cost-effective when impacts is linked to a development or controllable land-use change Conflict with Planning Culture of protection for existing uses

13 Tradeable RightsPrice Single title to Land & Water Water Land Robust Water Allocation

Robustness Robust (adj.) Said of a system that has demonstrated an ability to recover gracefully from the whole range of exceptional inputs and situations in a given environment.  One step below bulletproof.  Carries the additional connotation of elegance in addition to just careful attention to detail.  Compare smart, oppose brittle. Robust systems  Endure without the need to change their foundations.  They last for centuries.  Inspire confidence.  Produce efficient and politically acceptable outcomes in an ever changing world.

Theoretical Design Foundations Tinbergen Principle (NP in 1969)  For dynamic efficiency => One instrument per objective Mundell’s Assignment Principle (NP in 1999) For dynamic stability => Pair instruments and objectives for greatest leverage Coase Theorem (NP in 1999)  To minimise adverse effects of entitlement mis-allocation on economic activity => Ensure very low transaction costs

Practical Enduring Experience Structures that have stood the test of time Limited liability share companies Money Banking systems Double entry book keeping Torrens Land Title System

Partitioning the Problem Need instruments for Managing individual users  Entitlements  Allocations  Use approvals Managing aggregate consequences  Water allocation plans to allocate equitably  Trading Protocols to allow efficiency production  Catchment management plans to manage environmental impacts

Goals, Objectives & Targets Distributive Equity Economic Efficiency Manage Environmental Externalities

19 The CoAG Communiqué “A key focus of the National Water Initiative will be to implement a robust framework for water access entitlements …. while ensuring that there is sufficient water available to maintain healthy rivers and aquifers. …. Under the National Water Initiative, jurisdictions will establish a robust, transparent regulatory water accounting framework that protects the integrity of entitlements.”

20 Three Part Separation Entitlements => Equity instrument Allocation => Efficiency instrument Use licence => Externalities instrument Entitlements Allocations Use Approvals

Generalised framework Catchment Plans Trading Protocols & Accounting Rules Water allocation plans Total System Use licences (approvals) AllocationsEntitlementsIndividual ExternalitiesEconomic Efficiency Distributive Equity Policy ObjectiveScale

22 A Water Licence

Why unbundle? Water Entitlement Delivery Priority Expected Reliability Registered interests Tenure Ownership Restrictions Delivery charges Salinity obligations Return flow & drainage Low cost trading Water Allocation Volume for use or trade

24 Casting the Net Critical Concepts 1862 – Companies Act Limited Liability 1857 – The Torrens Title System ?000 - The Banking System Jan Tinbergen – 1 st Nobel Lauriat in Economics

25 Whereas the inhabitants of South Australia are subjected to loses, heavy costs, and much perplexity, by reason that the laws relating to the transfer and encumbrance of freehold and other interests in land are complex, cumbrous and unsuited to the requirements of the said inhabitants, it is therefore expedient to amend the said Act

Defining entitlements Unit shares that define an entitlement to a proportional of a defined consumptive pool Unbundled from other part of the system Share Registers guaranteed and mortgageable Fully tradable anyone can own/invest

27 Risk Specification

28 Risk - A community guarantee?  Guarantee to only use market mechanisms to change allocations  Effectively, insure water users against change in their share of the pool in return for a small return to the Community  Start in 0.5% pa  increase gradually to rate for crown agricultural leases  Place returns in an Environment Trust

29 Periodic Allocations & Trading

30 Allocation Trading Pay ____________________________________________ The sum of ________________________________ ML of 2000/01 Water Water Trading Australia Signature______________________ : Date ____________ ________ML WPay BPay

31 Robust Use Licences Permission to irrigate to “use” water Irrigation conditions  eg Not more than 300 ha or 1500 ML pa Only use drip irrigation Obligations to third parties  Other irrigators  Urban water users  The environment Pollution right reserved to the Crown Use managed separately from entitlements

32 Bank-like Allocations Torrens title-like interest register Mortgageable Shares A Two-sided contract Risk stated transparently This licence authorises the holder of this permit to do xxx on area AAA provided 1. The holder has a valid permit to do XXX 2. XXX is done in a manner consistent with the …. management plan Use conditions & obligations (Periodic review) Approvals to irrigate & 3rd party obligations A robust “separated” system?

33 A Robust System Water Tradeable RightsPrice Single Title to Land & Water Land Entitlement Shares in perpetuity Bank-like Allocations Use licences with limits & obligations Channel Capacity Shares Channel Capacity Allocations Salinity Shares Salinity Allocations CoAG’s 1990’s Vision Solution for C21?

34 Storage Land use Water Yield RiverRiver Wetlands Rainfall Ground water Base flow Surface Drainage GW Recharge Water Extraction Irrigation, urban & industrial use $ x x x Water accounting x

35

36 Two new MDBC reports on 6 “risks” In 20 years, a further reduction in flow of around 2,500 – 5,500GL.  Effects below dams and hence outside release rules erode flows most.

37 Possible reduction in mean annual River Murray flow as a result of incomplete accounting (baseline 1993/94) Unmanaged flow reducing effectNett effect Water use efficiency savings- 723 GL Reduced water yield (Trees and dams)- 600 GL Salinity Interception Schemes-20 GL Increased groundwater use-349 GL Estimated nett reduction in mean river flow and allocations to irrigators -1,692 GL Add back 500 GL

ML Unconfined Aquifer 50 ML Water that returns to the aquifer Extraction 45 ML Actual amount used 5 ML Evapo- transpiration Drainage Gross entitlement = 100 ML Return = 50 ML Recharge Credits for return flows

39 Known accounting solutions Offset the flow reducing effects of establishing permanent vegetation, clay spreading etc by surrendering an entitlement equivalent to the expected mean effect Defining tradable entitlement as a “nett” entitlement to prevent increased WUE erosion (return flow reduction) Defining salinity interception as a water use and acquiring the necessary water from below the cap. Changes the cost benefit of most schemes! Amending the cap to include all unconfined groundwater within, say, 10kms of the River as part of the system

40 Water allocation plans Rules to partition water into  “use” pool (share pool)  “flow” pool Dam management rules Share pool reliability and partitioning  High security shares  “General” security Inter seasonal carry forward and borrowing rules

41 Catchment plans Rules for  Applying water to land  Managing drainage and salinity impacts

42 Pricing Water supply charges  Fixed charge to cover infrastructure and management  Variable charge to cover costs of supply Market Value  Allocation prices reveal seasonal opportunity cost  Entitlement prices reveal value of long term economic opportunity Environment costs  Via salinity and other policies

43 Regional governance 1997 Establish a Catchment Management Board with local representatives Employ own staff and offices Funded via a levy on water users Duties  preparing and implementing plans that set water sharing, trading and use rules  advising Minister and local govt councils on water management  promoting public awareness 2005 Converted into a Natural Resource Management Board

A Robust Solution? Water Tradeable Rights Price Single Title to Land & Water Land Entitlement Shares in Perpetuity Bank-like Allocations Use licences with limits & obligations Delivery Capacity Shares Delivery Capacity Allocations Salinity Shares Salinity Allocations

45 Regional governance 1997 Establish a Catchment Management Board with local representatives Employ own staff and offices Funded via a levy on water users Duties  preparing and implementing plans that set water sharing, trading and use rules  advising Minister and local govt councils on water management  promoting public awareness 2005 Converted into a Natural Resource Management Board

46 Over allocation Exists because  Entitlements are defined in volumes and not as shares of available water in a pool  Plans assume that constant technology and land use change  Introduction of trading that activated previously unused water Solutions  Buy back  Pro-rata reduction

47 Illustrative buy back offer form Type of Licence South Australian River Murray Licence Offer conditional upon lease back of water until ….. Offer 1 …………….. not less than $2, per ML Offer 2 …………….. not less than $2, per ML Offer 3 …………….. not less than $2, per ML Offer 4 …………….. not less than $1, per ML Offer 5 …………….. not less than $1, per ML Signatures Licence holder ………………………………………… Registered interest (if any) …………………………..

48 Coles-Myer Schedule

49 Extracts Coles Myer “2005” Press Release Off-market buy-back price $ % discount to Friday’s closing share price of $ million shares bought back for a total of $585m Under the off-market buy-back a total of 70.4 million shares were bought back for $585 million – approximately 5.7% of Coles Myer’s shares All shares tendered in the buy-back at or below $8.30 were bought back. Shares tendered into the buy-back at a price above $8.30 were not bought back.

50 Duty of care, penalties & ecosystem service payments Environmental Standard Time Environmental Standard PENALTIES & DISCOURAGEMENT REWARD & ENCOURAGEMENT DUTY OF CARE Time Ecosystem service payments

51 Natural resource management instruments The Key Question How do we, at any location, get  the right intervention  at the right location  at the least cost, so as to facilitate, from a social perspective  optimal land use change  optimal land and water use?

52 The full range of opportunities Outcome-orientated  Informational instruments  Motivational instruments  Regulatory instruments  Market-based instruments  Financial instruments  Property-right instruments Process orientated  Governance arrangements  Consultative arrangements

Prof. Mike Young Research Chair, Water Economics & Management School of Earth and Environmental Sciences The University of Adelaide Friday 2nd February 2007