Innovative Water Sector FinancingInnovative Water Sector Financing

Water Valuation

BYCUSH NGONZO LUWESI

bfz Expert

Mombasa ,Kenya

7-11 November 2011

•To introduce the concepts of water value

•To provide some tools to valuate water in a formal market

Goals of this Lesson

•To explore different ways of estimating water value in areas where there exists no market price for water

Learning objectives

•They are also expected to understand non-market techniques of water valuation: (i) residual imputation of shadow prices; (ii) Hedonic method; (iii) Travel cost method; (iv) Avoidance cost method; (v) Benefit transfer method; and (vi) contingent valuation method.

• At the end of this lesson, participants shall be able to explain the difference between water valuation and its evaluation

• They need to be keen with basic market concepts of water valuation: (i) value in use; (ii) Exchange value; (iii) value in capital; (iv) value added; and (v) Benefit.

CONCEPTS RELATED TO WATER CONCEPTS RELATED TO WATER VALUATIONVALUATION

•The quality (positive or negative) that renders something desirable or valuable

•A numerical quantity measured or assigned or computed•The amount (of money or goods or services) that is considered to be a fair equivalent for something else

Value & Valuation

E.g. A precious stones; Shakespeare ’s masterpiece; the dubious value of modern churches"

E.g. An estimate of the price

E.g. the value assigned to the time: 3600 seconds = 1 hour = 1/24 day

•A numerical or qualitative method used to determine, compute, measure or assign a certain value.

•E.g. Economics for the price; Operational research for the cost of inventories; Accounting for the value of assets; Hydrology for water quantity; biochemistry for water quality; Geomorphology for erosivity; Statistics and econometrics for contingent values…

Value

Valuation

Question

What is the difference between (i) Value and Price? (ii) Valuation and Evaluation?

Question

What is the difference between (i) Value and Price? (ii) Valuation and Evaluation?

Water ScarcityQuestion

What does the presence of water vendors mean to you?

Question

What does the presence of water vendors mean to you?

The natural water resource is finite and vulnerable

Only 0.4% of the world reserve is available for production and to fill the needs of the ever growing 7 billion people

There will be high sectoral competition on water resources leading to more exclusion and rivalry, especially between irrigation expansion, business and industrial production growth

Besides water withdrawals, environmental disasters may be occuring more than expected. Thus, the need for sustainable policy limitations.

Three categories of water stress that would be exacerbated by climate change: (i) Too little (I (ii) Too much (iii) Too dirty (Zbigniew W. Kundzewicz 2007)

Question

Do you recall the three categories of water stress?

Question

Do you recall the three categories of water stress?

1.High water demand for irrigation and food production, hydropower generation and industrial uses due to population and economic growth

2.High variability of the available water resource due to the impact of pollution, environmental degradation and climate change

3.Lack of adequate infrastructure and technologies to, maintain and conserve water

4.Increasing risk of failure of socio-economic activities in the course of climate change

5.Insufficient funds available for cleaning and channeling water for domestic and industrial consumption as well as sanitation purpose.

6.Insufficient technical and technological competence from water users to ensure efficiency

7.Lack of water use efficiency metrics (thresholds)

8.Lack of coordination of water abstraction among private users, especially in rural areas

1.High water demand for irrigation and food production, hydropower generation and industrial uses due to population and economic growth

2.High variability of the available water resource due to the impact of pollution, environmental degradation and climate change

3.Lack of adequate infrastructure and technologies to, maintain and conserve water

4.Increasing risk of failure of socio-economic activities in the course of climate change

5.Insufficient funds available for cleaning and channeling water for domestic and industrial consumption as well as sanitation purpose.

6.Insufficient technical and technological competence from water users to ensure efficiency

7.Lack of water use efficiency metrics (thresholds)

8.Lack of coordination of water abstraction among private users, especially in rural areas

Water Scarcity, Cont‘dQuestion

Do you recall the three drivers of economic water scarcity?

Question

Do you recall the three drivers of economic water scarcity?

Rivalry and Exclusion in Water useLOW HIGH HIGH

Private aesthetic Recreational uses(Club goods)

Drinking,Cooking,Sanitation

FishingHydroelectric IndustrialTransportation

Public aesthetic Crop IrrigationRecreational uses Livestock

Ecological Base FlowAvoidance or control of water-related risks Waste Assimilation Protected areas

RIVALRY

Water Value in Use / Human benefits

E

X

C

L

U

S

I

O

N

MEDIUM

HIGH

MEDIUM

LOW

Environmental services

Box 3.1: Definitions of rivalry and exclusion

Rivalry: A good or service is said to be rival in consumption, if one person’s use thereof in some sense precludes or prevents uses thereof by other individuals or businesses. It refers to the nature of the consumption process. Food, for example, is a typical rival good, as consuming one unit of bread implies that one fewer unit of bread is available for the rest of potential consumers. Light from the sun (to some extent) has low or no rivalry, as consumption by one does not necessarily reduce availability for others.

Exclusion: refers to the possibility of excluding persons who are not entitled from using the good or service. A good is excludable if there is some mechanism (physical or institutional) that restricts potential users from consuming it at some time or place. Property rights are institutional devices to restrict or exclude potential consumers (or users) from goods or resources, which are generally supported by some physical mechanism to restrict access by third parties (fences, access codes, etc.). Land is generally an excludable resource, whereas “air” (not necessarily clean air) is a resource with very low, or no, excludability. (Source: Young, 1996)

Box 3.1: Definitions of rivalry and exclusion

Rivalry: A good or service is said to be rival in consumption, if one person’s use thereof in some sense precludes or prevents uses thereof by other individuals or businesses. It refers to the nature of the consumption process. Food, for example, is a typical rival good, as consuming one unit of bread implies that one fewer unit of bread is available for the rest of potential consumers. Light from the sun (to some extent) has low or no rivalry, as consumption by one does not necessarily reduce availability for others.

Exclusion: refers to the possibility of excluding persons who are not entitled from using the good or service. A good is excludable if there is some mechanism (physical or institutional) that restricts potential users from consuming it at some time or place. Property rights are institutional devices to restrict or exclude potential consumers (or users) from goods or resources, which are generally supported by some physical mechanism to restrict access by third parties (fences, access codes, etc.). Land is generally an excludable resource, whereas “air” (not necessarily clean air) is a resource with very low, or no, excludability. (Source: Young, 1996)

Question

Why is there rivalry and exclusion?

Question

Why is there rivalry and exclusion?

Different Values of FreshwaterQuestion

For what purposes do we need water in each of these pictures?

Question

For what purposes do we need water in each of these pictures?

Please! give me a cup

Go to stream ... There is plenty of it.

I’d better go to the fountain … A rice field

A dam

Different Values of Freshwater, Cont’d

•Economic value = Water is a scarce resource used in production and consumption ; it is also essential for recreation, transport, poverty alleviation and development.

Question

What else?

Question

What else?

•Environmental value = water conserves the natural Ecosystems and the hydrological cycle

•Industrial value = water is an important input and output for industrial production and power generation•Anthropologic value = water preserves ancient civilizations and their cultures

• Biological value = water determines the existence of living creatures and is vital for health, sanitation and aesthetics

•Agricultural value = water is the most important input in cropping, livestock keeping and fishery, and is vital for irrigation and the conservation of marine and sun-marine fauna and flora

•Chemical value = water is a dissolving and cleansing agent

MARKET METHODS OF WATER VALUATION

• Yet, in valuating water, one needs to distinguish its “inner value” (as a natural resource) from its “Value in use” (utility), “exchange value” (market price), its present and future “value in capital” (investments), its “value added” (in production), and its “Benefit”

Water ValuationEconomic value of water depends on its specific use, the amount that

the user is willing to pay, and the benefit that the provider expects from his/ her service.

WATER WITHDRAWALS

(in Cubic Km)

1950 1995 2025

Agriculture 1,100 2,500 3,200

Industries 200 750 1,200

Households 90 350 600

Evaporation from reservoirs

10 200 270

Total Withdrawal

1,400 3,800 5,270

Water Value in Use

QUOTEThere is not enough water to grow crops and support livestock; the need for long, and at least daily, journey to carry water from stand- pipes, ponds or springs; having to wash in, and sometimes drink, dirty water that other have recently washed in or drunk; having dirty clothes, dirty dishes and being thirsty; and people with little money having to spend too much of there tiny income on water vendors (Clark & king 2004, p. 19)

The value of water in use is a measurement of its utility for domestic use, agriculture, livestock, industry, power generation and other uses

Clark & King (2004) predicted that by 2025, water withdrawals arise by 5,270 km3 with a population growing by 4.623%/ annum and irrigation expanding by 39% while businesses will keep growing in the same speed as now without policy limitations .

Water Exchange Value

OFFICIAL VENDORS

Bangladesh 0.08$ 0.42$. Indonesia 0.16$ 0.31$0.16$ 0.31$Pakistan 0.14$ 0.18$.Philippines 0.11$ 4.74$.Cambodia 0.09$ 0.64 $.Mongolia 0.04$ 1.51$.Source: Clark & King (2004)

PRICE OF A CUBIC METER (2003)

Question

What do arbitrary prices by water vendors mean to you?

Question

What do arbitrary prices by water vendors mean to you? Water service has a cost that determines the

provider’s ability to bring water up to the user’s tap

If governmental charges or tariffs do not meet the cost of provision, this is likely to result in challenges in terms of both quality and quantity of water services delivered bu public utilities , as well as in informal vendors practicing arbitrary prices.

Water price (charge or tariff) is officially regulated by the state, and does not often result automatically from the market game (Demand and supply)

The present water value in capital (PV) will likely determine its “ Future Value” (FV) to cater the needs of the growing world’s population and mitigate the threats of climate change after accumulation of “values added” (VA)

Water value in capital is measured in terms of the cost of storage and distribution infrastructures, the cost of other materials and immobilisable used by water providers to treat and recycle water plus the balance of their re-evaluation.

The value of water in capital is its ability to generate future utilities (in terms of income) through additional investments.

Water Value in Capital

Question

According to Engel, why is water likely to become a “luxury” like diamond?

Question

According to Engel, why is water likely to become a “luxury” like diamond?

“Water value-added (VA) is the difference between water price and the cost of all its inputs used during the treatment and recycling process

Water value added determines its high price and contribution to the macro-economy through notably the Tax on Value Added (TVA)

Value added water resources are to climax with a “benefit” or a “profit”, meaning excess revenues over all expenses (overheads and variable costs).

Water Value Added & BenefitQuestion

Why do you remember why water price is a catalyser to its efficient use?

Question

Why do you remember why water price is a catalyser to its efficient use?

This is the final result that a water service provider can expect to increase its future “value in capital”.

Cost-Benefit Analysis

Cost–benefit analysis is an evaluation of the viability of a projected investment in the long run. It is a necessary and sufficient step to make a rational decision to adopt a certain price, buy a technology, acquire materials and infrastructure or make any other kind of investment that will improve the water service provider’s business. This analytical method considers the costs that the investment will incur and the benefits that will accrue to it after the decision has been made.It is mainly based on an estimation of “benefits” resulting from the investment (“present value”) in the long run (“future value”) if the intervention was adopted or implemented in the present conditions.

Cost-Benefit Analysis: How to go About It?

COST-BENEFIT ANALYSIS - NORMAL Scenario

1. CALCULATE THE PRESENT VALUE (PV) 1.1 Transaction Cost (TC) Cost of water at source Cost of pipes Cost of water storages Labour Fuel Other operating costs

1.2 Opportunity Cost (OC) OC under NOR Scenario take a best alternative use that would result in more benefits 1.3 PV = CT + OC

2. ESTIMATE THE FUTURE VALUE (FV) This is the expected income from the new intervention FV = PV (1+i)n , where i = the cost of capital (interest rate)

3. COMPUTE THE BENEFIT (B) B = FV-PV

4. DETERMINE THE DISCOUNT FACTOR (DF)

From FV formula, PV = FV*(1+r)-n , where, r = the discount rate

DF = (1+r)-n

5. CALCULATE THE BENEFIT DISCOUNTS (BD) BD = B*DF

6. COST DISCOUNTS (CD) CD = PV*DF

7. DETERMINE THE B/C RATIO B/C RATIO = ΣBD/ ΣCD

8. DECISION FACTOR: B/C RATIO >1

If you have alternative choices of investment, the one with the Highest B/C RATIO will be retained

QuestionIn the perspective of a Below Normal Rainfall Regime (BNOR) or an Above Normal Rainfall Regime (ANOR) how will you do your Cost-Benefit Analysis?

NON-MARKET METHODS OF WATER VALUATION

Residual Imputation of Shadow Prices

The residual imputation approach derives water value from the difference between the total cost of production and the cost of all other inputs, based on estimated production data and prices of non-water inputs.

Often, water is not directly consumed but it enters a productive process like agriculture, industry or hydroelectric power generation, which are examples of intermediate good use.

The producers’ demand for water will be according to its Marginal Value of Product (MVP), which is here replaced by “shadow prices”, since there is no formal market of water in the nature.

Hedonic Price MethodHedonic Price Method is also used where no water price exists, especially in rural areas and in production sectors using water as an intermediate good

Based on the theory of consumer behaviour, it may be possible to estimate water users’ Willingness To Pay (WTP) after identification of factors that affect hedonic prices (e.g. Taste, Colour, odour, distance from house, time to fetch water...

This method suggests that one’s valuation of water be based on its characteristics rather than the resource itself.

Travel Cost Method

The cost of travel takes into account the number of visits, the cost of each trip and the entrance fee paid. This indicates the extent to which this individual is willing to pay for water services.

The value of water in this case is not simply the entrance fee but the amount of money the water user incurs in enjoying the benefits of the resource.

This method values water from its users’ expenditures associated to recreation activities, especially the cost to travel the swimming pool, lake or river.

Question

Why is the demand curve descendant while the utility curve is ascendant?

Question

Why is the demand curve descendant while the utility curve is ascendant?

The Avoidance Cost Method

Question

At point , would you use this method to valuate water in your catchment?

Question

At point , would you use this method to valuate water in your catchment?

This method is mainly used to prevent the adverse effects of water pollution or drought.

For instance people near a river have to walk long distances to go to fetch potable water from springs because the river nearby is polluted by industrial or human wastes. Others use purification methods to avoid water borne diseases.

It takes into account the cost that individuals incur to prevent or avoid water polluted or water shortage, and thus measures the social cost of water stress disutility.

Yet, attention shall be paid on certain aspects of the study that could not begeneralized or applied locally

services and distribution of natural resources to enhance accessibility and equity

Benefit Transfer Method

E.g. if a coffee factory is planned to be established in a certain watershed, results of studies on water pollution by similar industries from other locations can be Availed to local people to assist them Make a rational decision.

It is used to values preferences expressed by other people on the effect of a certain intervention on water resources.

This method consists of transferring knowledge from studies conducted in other areas to the place where decision n water value is to be made.

But non-use value cannot be assessed using implicit prices. Thus, CVM suggests a proposed or contingent value based on : (i) option value; (ii) bequest value; and (iii) existence value

Contingent Valuation MethodThis is the most popular method applied to

estimate value both value in use and non-use

Value of new water projects or regulations.

Question

Which method do you prefer to use when planning to set an irrigation scheme?

Question

Which method do you prefer to use when planning to set an irrigation scheme?

The suggested value will be evaluated by local water users based on their knowledge of the environment

To measure value in use, WTP is estimated along with water users’ Willingness To Accept compensation (WTA) to inquire about potential economic benefits and damages that the project is likely to bring to the people, based on their perception

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