1. © K.Fedra 2007 1 DSS for Integrated Water Resources Management (IWRM) Water economics DDr. Kurt Fedra ESS GmbH, Austria kurt@ess.co.at http://www.ess.co.at Environmental Software & Services A-2352 Gumpoldskirchen DDr. Kurt Fedra ESS GmbH, Austria kurt@ess.co.at http://www.ess.co.at Environmental Software & Services A-2352 Gumpoldskirchen

2. © K.Fedra 2007 2 IWRM: Integrated Water Resources Management Problems: Not enough, too much Wrong time and place Insufficient quality Information requirements: How much water is/will be available where and when, of which quality, at which cost ? Problems: Not enough, too much Wrong time and place Insufficient quality Information requirements: How much water is/will be available where and when, of which quality, at which cost ?

3. © K.Fedra 2007 3 IWRM: Integrated Water Resources Management Inherently multi-attribute, requires the simultaneous consideration of: Surface and groundwater Quantity and quality Watershed and waterbodies Hydrology, environment, policy and socio-economics Multiple sectors, actors, generations Inherently multi-attribute, requires the simultaneous consideration of: Surface and groundwater Quantity and quality Watershed and waterbodies Hydrology, environment, policy and socio-economics Multiple sectors, actors, generations

4. © K.Fedra 2007 4 Conceptual framework for water economics Dublin Statements: Managing water as an economic good is an important way of achieving efficient and equitable use … EU Water Framework Directive: economic analysis of water uses cost recovery of water services, cost effective combination of measures

5. © K.Fedra 2007 5 Water resources optimization Design or select policies to Maximize the benefits Minimize the costs Meet the constraints Using multiple criteria in parallel: 1.physical/hydrological 2.monetary (socio-economic) 3.environmental Design or select policies to Maximize the benefits Minimize the costs Meet the constraints Using multiple criteria in parallel: 1.physical/hydrological 2.monetary (socio-economic) 3.environmental

6. © K.Fedra 2007 6 Socio-economic criteria Benefits of water use vs Multiple criteria (ecological) with explicit cost considerations: –Cost efficiency of use –Cost effective combination of measures –True/full cost of services, cost recovery, water pricing

7. © K.Fedra 2007 7 WFD Water Economics That the polluter should pay; Take into account the economic and social development of the Community; Carry out an economic analysis of water uses; Use economic instruments as part of the programs of measures; Apply the principle of cost recovery of water services (including environmental and resource costs) in accordance with the polluter pays principle;

8. © K.Fedra 2007 8 WFD Water Economics Make the relevant calculations necessary for taking into account cost recovery of water services: a) Estimates of the volume, prices and costs associated with water services b) Estimates of relevant investment Make judgments about the most cost effective combination of measures in respect of water uses … based on estimates of the potential costs of such measures.

9. © K.Fedra 2007 9 Economic valuation Value of water: Market value (pricing) Production benefits (hydropower, agriculture) Repair and replacement Travel costs (observed) Contingent valuation (assumed) Bequest and existence values Value of water: Market value (pricing) Production benefits (hydropower, agriculture) Repair and replacement Travel costs (observed) Contingent valuation (assumed) Bequest and existence values

10. © K.Fedra 2007 10 Economic valuation Value of water: Market value (pricing) Water is bought and sold:  established market value But: subsidies may lower the cost for water for political reasons. (e.g., low cost for water for domestic use or agriculture). Value of water: Market value (pricing) Water is bought and sold:  established market value But: subsidies may lower the cost for water for political reasons. (e.g., low cost for water for domestic use or agriculture).

11. © K.Fedra 2007 11 Economic valuation Value of water: Production benefits (hydropower, agriculture) Hydropower: kWh/m3 and m of head Agriculture: fraction of the value of crops: Everything else being equal, how does (crop) production increase with water input ? What is the value of water used ? What would a rational farmer pay ? Value of water: Production benefits (hydropower, agriculture) Hydropower: kWh/m3 and m of head Agriculture: fraction of the value of crops: Everything else being equal, how does (crop) production increase with water input ? What is the value of water used ? What would a rational farmer pay ?

12. © K.Fedra 2007 12 Economic valuation Production benefits

13. © K.Fedra 2007 13 Economic valuation Value of water in goods production (producer benefit): WV < TPC (total production cost) WV = TPC – (C 1 +C 2 +C 3, ….C i ) Production depends on TWO indispensible inputs: WHAT is their share of TPC (50%, 100% ???) Value of water in goods production (producer benefit): WV < TPC (total production cost) WV = TPC – (C 1 +C 2 +C 3, ….C i ) Production depends on TWO indispensible inputs: WHAT is their share of TPC (50%, 100% ???)

14. © K.Fedra 2007 14 Economic valuation Valuing producer’s uses of water: Young, R.A.: Determining the Economic Value of Water (RFF, 2005) Producer welfare (economics), theory of the firm (production functions) Basic residual methods: –Product exhaustion theorem –Economic rents ….. IN SHORT: water input must PAY Valuing producer’s uses of water: Young, R.A.: Determining the Economic Value of Water (RFF, 2005) Producer welfare (economics), theory of the firm (production functions) Basic residual methods: –Product exhaustion theorem –Economic rents ….. IN SHORT: water input must PAY

15. © K.Fedra 2007 15 Economic valuation Repair and replacement: Value of clean water = cost of treatment Value of a natural habitat (beach, lake, wetland) = cost of “re-building it”, offering an alternative Value of urban water supply: substitution cost (in the extreme, providing bottled water ….) Repair and replacement: Value of clean water = cost of treatment Value of a natural habitat (beach, lake, wetland) = cost of “re-building it”, offering an alternative Value of urban water supply: substitution cost (in the extreme, providing bottled water ….)

16. © K.Fedra 2007 16 Economic valuation Travel costs (observed behavior) Measures the value of “environmental (non- market) service functions”, recreation: Asks visitors about the costs of visiting (travel cost) some environmental feature. High level of uncertainty: diverse personal reasons for visiting specific sites ! Basic idea: social constructivism Travel costs (observed behavior) Measures the value of “environmental (non- market) service functions”, recreation: Asks visitors about the costs of visiting (travel cost) some environmental feature. High level of uncertainty: diverse personal reasons for visiting specific sites ! Basic idea: social constructivism

17. © K.Fedra 2007 17 Travel cost method Count visitorsCount visitors Interview:Interview: –Determine distance traveled (travel cost based on mileage) –Determine other expenditures Estimate total expenditures from recreational users == value of the resourceEstimate total expenditures from recreational users == value of the resource Count visitorsCount visitors Interview:Interview: –Determine distance traveled (travel cost based on mileage) –Determine other expenditures Estimate total expenditures from recreational users == value of the resourceEstimate total expenditures from recreational users == value of the resource

18. © K.Fedra 2007 18 Travel cost method: uncertainty An experimental program allowing US national parks … to raise their fees has significantly boosted revenues without affecting the number of visitors = substantial increase in the “travel cost”

19. © K.Fedra 2007 19 Travel cost method: uncertainty Four agencies reported... recreational fee revenues nearly doubled from 93 M$ in 1996 to 179 M$ in 1998. (= + 92%) Number of visitors to sites with higher fees increased by 5%. (IHT, December 5, 1998) DID THE “intrinsic” VALUE OF THE PARKS DOUBLE ? (positivist answer: NO, constructivsit answer: YES !)

20. © K.Fedra 2007 20 Economic valuation Contingent valuation (CVM) Assumed “market”, ask stakeholders about: willingness to pay Easy and flexible Very uncertain, biased Basic idea: social constructivism Contingent valuation (CVM) Assumed “market”, ask stakeholders about: willingness to pay Easy and flexible Very uncertain, biased Basic idea: social constructivism

21. © K.Fedra 2007 21 Money and time For DSS, need to evaluate and compare costs and benefits at different point in time, long project life times: discount rate (shadow price of capital) Net Present Value, Annual Equivalent Cost For DSS, need to evaluate and compare costs and benefits at different point in time, long project life times: discount rate (shadow price of capital) Net Present Value, Annual Equivalent Cost

22. © K.Fedra 2007 NPV net present value compound interest equation: compound interest equation: V t = V 0 (1+r) t V t = V 0 (1+r) t V t value at end of year tV t value at end of year t V 0 present valueV 0 present value r interest rater interest rate t time in yearst time in years

23. © K.Fedra 2007 NPV Net Present Value V t V t V 0 = V 0 = (1+r) t (1+r) t for example, the NPV of 1,000,000 US$ to be received or due in 25 years at 8% interest or discount rate is …..

24. © K.Fedra 2007 NPV net present value V t V t V 0 = V 0 = (1+r) t (1+r) t for example, the NPV of 1,000,000 US$ to be received or due in 25 years at 8% interest or discount rate is ….. 146,018 (or 14.6 %) 146,018 (or 14.6 %)

25. © K.Fedra 2007 25 Discounting future payments

26. © K.Fedra 2007 NPV net present value where: n - project duration duration r - discount rate Ct - the net cash flow (income) at time t. C0 – initial capital outlay t - the time of the cash flow

27. © K.Fedra 2007 NPV net present value Assume a hydroelectric project: Building costs 28 M $ Power benefits 2 M $/year Life time 25 years Discount rate 6% Project NPV 3.5 M $

28. © K.Fedra 2007 NPV net present value Assume a hydroelectric project: Building costs 28 M $ Power benefits 2 M $/year Life time 25 years Discount rate 8% Project NPV - 3.5 M $

29. © K.Fedra 2007 EAC equivalent annual cost Calculate annual investment cost: where: i = interest rate (fraction) n = number of years

30. © K.Fedra 2007 EAC equivalent annual cost Investment: 150,000 Life time:8 years OMR:7,500/year Discount rate:5% Capital Recovery factor ( 5/8 ): 0.155 Annual capital cost: 23,250 EAC: 23,250 +7,500 = 30,750

31. © K.Fedra 2007 31 Estimating benefits and costs Economic valuation with CVM, TCM: Not to get it “right” (highly subjective, error prone, theoretically questionable)Not to get it “right” (highly subjective, error prone, theoretically questionable) But to get it organised, structured, complete, consistent, plausibleBut to get it organised, structured, complete, consistent, plausible

32. © K.Fedra 2007 Economy of decision making The effort in making a decision must be small compared to the expected benefit, cost, or risk. Simple decisions: can fully be automated (thermostat, traffic light) Complex decisions: regulations, DSS