Valuation of Water Resources Glenn-Marie Lange Center for Economy, Environment and Society The Earth Institute at Columbia University.

Valuation of Water Resources

Glenn-Marie LangeCenter for Economy, Environment and Society

The Earth Institute at Columbia University

Water Policy: Treat water as an economic good

• Dublin Principles and IWRM—approach recommended for MDGs

• 2002 World Summit on Sustainable Development in Johannesburg

• 2003 Third World Water Forum

• 2006 World Water Development Report

• Human Development Report 2006 Beyond scarcity: power, poverty and the global water crisis

What do we mean by ‘economic value?’

A commodity has an economic value when people are willing to pay for it, rather than go without

Water is an essential commodity, so the value of a small/basic amount for survival is infinite—people would pay any price.This is not useful information for policymakers.

But after basic needs are met, people buy water based on its price compared to other goods they might buy.

Water’s value is the willingness to pay for waterIt is observed when people make a choice between different products

– How much will a household pay for drinking water?– How much will a farmer pay for irrigation water?– How much will a factory pay for clean water?

Why value water?Water as an Economic Good: After basic needs are met, water should be allocated to the highest value uses.

Water value provides critical information for decisions about

• Efficient and equitable allocation of water among competing users, both – within the present generation – between present and future generation

• Efficient and equitable infrastructure investment in the water sector (how much, where, when)

• Efficient degree of treatment of wastewater

• Design of economic instruments: water pricing, property rights, tradable water rights’ markets, taxes on water depletion and pollution, etc.

Water tariffs and water valueSNA values water at price of transaction. Why can’t

we just use this value?

• Because the price charged by water suppliers—if any—often unrelated to value of water, too low

• Water price often does not even reflect full costs of water supply!

• Water is not supplied by competitive markets due to natural characteristics– Necessary for human survival – Natural monopoly– Characteristics of public good– Property rights not always well defined for multiple use or

sequential use– ‘Bulky’ commodity (very high transport costs relative to value

inhibiting trade)

Water tariffs and water valueSome markets for trading water rights

are developing– Australia, – California, – Chile

but still uncommon, localPrice of tradable water rights does not yet

provide a reliable indicator of value because markets too ‘thin’ (too few traders)

So we must estimate or impute economic value of water

Can we apply economists’ techniques for

valuing water to the Water Accounts?

There are several concerns about using economists’ ‘non-market valuation’ techniques

1. Accuracy of water values and cost of valuation

2. Consistency of value concepts with SNA

3. Aggregation: scaling up site-specific values

1. Accuracy of non-market valuation

• Data requirements are very high, so valuation is costly

• Value is often uncertain, very sensitive to assumptions Results are often presented as a range of values rather than a point estimate, a single value

Values are most reliable for water used as input to– agriculture, – hydroelectric power – other uses where water is a major component of production

costs

2. Concepts of valueConsistent with the SNA?

In principle, SNA measures market values, or sometimes cost of production

Water valuation techniques were developed for Cost-Benefit Analysis of projects (not national economy):

– CBA often tries to measure of economic welfare (total economic value) not market price

– Programming models measure values in an optimizing economy which usually differs from actual economy

3. Aggregation and national water accounts

• Water values highly site-specific, dependent on local uses, as well as season, water quality and reliability

• Values are not amenable to ‘benefits transfer’—using an estimate from one case study for another area

• Little experience scaling up local values to the national level

Major Imputed Water Valuation Techniques

1. REVEALED PREFERENCE TECHNIQUES(based on observed market values)

Residual valueMarginal contribution of water to output, measured by subtracting all other costs from revenue

Production function approachMarginal contribution measured as the change in output from a unit increase in water input in a given sector

Optimization models and programmingMarginal contribution measured as the change in sectoral output from reallocation of water across the entire economy

Hedonic pricingPrice differential paid for land with water resources

Opportunity CostPrice differential for alternative (example: replacing hydroelectric power with coal-fired electricity)

2. STATED PREFERENCE(based on surveys of willingness to pay)

Contingent Valuation Method Survey of users, especially household water use and recreational services

Methods for Valuing Water’s Waste Assimilation Services

Waste assimilation services can be valued in 2 ways

• Pollution damages avoidedThis approach asks, ‘What would be the cost of damages ( to health, production activities) that would occur if we didn’t have this waste assimilation service?’

• Costs of preventing damageValue is measured as the costs of measures to prevent pollution: water treatment technologies, pollution abatement technologies, purchase of alternative goods (bottled water)

Most commonly used water valuation techniques

Frequency of water valuation studies Most common methods used

Residual value (and variations)Production functionProgramming models

Manufacturing UncommonProduction function, programming

Hydroelectric power CommonProgramming models, opportunity cost

Consumer good Common CVM, programming modelsWaste assimilation services Common

Cost of prevention, Benefits from damages averted

Agriculture Most common application

Residual Value (Value Marginal Product)The easiest & most commonly applied valuation technique

where TVP = Total Value of the commodity Produced piqi = the opportunity costs of non-water inputs to production pw = value of water (its marginal product) qw = the cubic meters of water used in production

Non-water inputs include:intermediate inputs, labor, capital costs, land

wwii qpqpTVP

w

iiw q

qpTVPp

Challenges to Implementing Residual Value Technique

• Is the quantity of water measured accurately?

• Is labor cost accurate—how to value unpaid family labor?

• Value of land—minus water rights

• Capital costs– Are all capital costs accounted for accurately?– What rate of return to capital should be used?

• Are there other inputs that have not been included?

• Do the prices of output & all inputs reflect true economic value, or are they distorted?

Example: Agricultural water use in Namibia (Stampriet area)

Farm revenue & costs (in 1999 Namibia $) Data source

Gross farm income $ 601,543 Output x market prices from survey

Inputs of goods and services $ 242,620 Inputs x prices from survey

Value-added, of which: $ 358,923

Compensation of employees $ 71,964 Wages paid + in-kind payments from

survey

Gross operating surplus, of which: $ 286,959

Imputed value of farmers’ labour $ 48,000

Imputed based on average salary of hired farm manager

Depreciation $ 66,845Depreciation rates x Farmers’ estimated

cost of capital in survey

Cost of working capital $ 17,059 Imputed as % of the value of fixed capital

Cost of fixed capital including land, 3% -7% $75,739 to $176,724

Based on farmers’ estimated cost of capital reported in survey

Residual value of water $79,316 to -$21,669

Amount of water used (m3) 154,869Farmers’ “best guess;” water is not

metered

Residual value N$/m3 $0.51 to -$0.14

Optimization models:Valuing multiple uses of water

• Residual value and related techniques are good to estimate the value of water in a single use, or several closely related uses

• To estimate the value of all uses of water in an economy, then modeling is needed– Linear programming– Computable General Equilibrium (CGE) modeling – Econometric modeling

• But these approaches are better used for evaluating changes in water allocation among users, rather than values in current allocation.

Water Asset Valuation Asset value = Net Present Value of all future benefits

(value of water services), the case of 2 uses

or

When RR is constant for all uses in all years, this formula becomes:

r

RRV

Where V = Asset value of water RR = value of water for 2 different uses in a given year, pw x qw

r = discount rate

ttt

r

RRRR

r

RRRR

r

RRRRV

)1(...

)1()1(

21

2

21

11

20

10

0

ttt

r

RRRRV

)1(

21

0

Water Asset Valuation

New Zealand & Canada (under development):

• Water resources with a single use of water: hydropower only

• Annual water service (hydropower) assumed constant in all future years

• Valuation method used: – New Zealand: Residual Valuation Method

Rent = Net operating surplus – return on fixed capital

– Canada: Opportunity Cost, difference between production cost of hydropower & cost of next alternative, thermal/coal power

Rent = (CT – CH)QEH Where

CT = cost of production per unit of electricity for Thermal power plants CH = cost of production per unit of electricity for hydropower plantsQEH = quantity of electricity produced by hydropower plants

• Asset Value: r

RRV

Hydropower & Geothermal Power Asset Value in New Zealand

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

Mil

lio

n N

Z$

Geothermal

Hydropower

Which Method is Better for Valuing Water for Hydropower?

Residual value (New Zealand)• Does the price charged for electricity reflect the

market value of electricity, or is it regulated?• If regulated, the electricity price will not reflect

the value of water (rent) and Residual Value Method is not a good technique

Opportunity cost (Canada)• Based on difference in costs of production, so it

is a good technique to estimate value of water even if electricity price is regulated

Can Water Asset Valuation be done in other countries?

Yes, but….Data requirements are considerable:• measure of water asset volume & flows over time• measure of the annual values of all uses of water over time

Water assets in most countries serve multiple purposes:

• Agriculture– Livestock watering – Irrigation of different crops

• Hydropower--Drinking water--Fisheries habitat• Sink for waste water

Will the combination of uses change in future? Will the economic value of each use change?

Approach Water Valuation Cautiously!

Value consistent with SNA: include all values but indicate type of value and robustness

Accuracy/uncertainty: start with major uses that are easiest to value (agriculture) & indicate range of values

Aggregation: implement valuation at local/river basin level

Asset value: begin with water bodies with single or few uses that can be easily valued