Economic and Financial

Instruments for IWRM

Water valuation methods and economic

instruments

Goal and objective of the session

To know about main water

valuation methods for supporting

the use of economic instruments.

To be able to evaluate the pros and

cons of using specific water

valuation methods in different

water situations.

Outline

A cost benefit-analysis framework

Supply and demand

Main approach: full cost recovery

Description of main water valuation methods

Introduction

Economic instruments are important for water management,

especially when there are notorious supply-demand

imbalances and misallocations.

As markets are seldom available for solving these problems,

water authorities will decide about levels and features of

water tariffs in order to influence behaviour and allocations.

In deciding about this, information is required regarding how

users value different water services.

Multi-sector use and water valuation

Importance of cost-benefit analysis

To reallocate water among

alternative uses or type of users;

To expand water infrastructure;

To improve the quality of water;

To expand the water service to

include sanitation and

wastewater treatment;

To include water management

actions at the basin level (very

important for IWRM);

These decisions will generate potential benefits but also costs for water stakeholders

The main objective of cost-benefit analysis is to appropriately measure and attribute these benefits and costs.

Water valuation and economic instruments

Even if a market is not in place for water service, demand and WTP exist and reflect how much are the water services valued by users.

Costs are the value of the opportunities or resources

foregone in the process of generating the benefits.

Challenge for valuation methods is how to measure benefits of water services given situations in which there are not observable markets or prices for those.

Equally important are correct estimation of costs and appropriate levels of tariffs to be charged directly to main beneficiaries.

Demand function and residential use (1)

Close to be a private good but under monopolistic provision Demand can be estimated looking at consumer behaviour and

tariff changes:

Qw = Qw(Pw,Pa,P;Y;Z)

where

Qw: the individual’s level of consumption of water in a specified time period; Pw: price of water; Pa: price of an alternative water source; P : average price index representing all other goods and services;Y : consumer’s income, and Z : vector representing other factors, such as climate and consumer preferences.”

Demand is estimated using econometric methods

applied to data from water use, tariffs and local and

users´ attributes.

When this type of data is not available (or for new

projects), hedonic price methods and contingent

valuation methods are also used

Demand function and residential use (2)

Hedonic price estimations

Although there is no market for a water service to be evaluated,

there are other markets in which these benefits are embedded

(for instance, real property transactions near an water aesthetic

place will somewhat incorporate these benefits, although bundled

with other attributes of the property).

This method is based on the assumption that the price of a

marketed good is a function of its different attributes, and an

implicit price exist for each of these.

Travel cost methods

Most amenity and recreational water sites charge a fixed entrance fee to users, there is no variation according to demand for those services. Estimation of demand is problematic.

Travel cost incurred by visitors is an indirect way to estimate this demand since there is variation among visitors in travel expenses.

When this is possible (using special surveys, for instance) a demand can be inferred giving a measure of total benefits generated by the site.

Contingent valuation methods

These methods have become very popular to estimating the values of water related goods for which there are no markets or when the water service is to be created. Since consumers do not have a clear idea about the nature of the service, the researcher has to explain it very clearly and ask questions regarding the willingness to pay for these services.

Valuation of water as intermediate good

Often water is not directly consumed but enters a productive process like agriculture, industry or hydroelectric power generation.

Producers will demand an input according to its marginal productivity.

When there is no market for the input, like for water, special methods of valuation are needed: • Hedonic price method (when a surrogate market

can give information on MVP of water); • Residual imputation approach and• Alternative cost approach.

Residual method for water valuation

Is the most-frequently used, particularly to irrigation water.

Uses a production function approach.

A total production function is estimated and the marginal contribution of all relevant inputs (including water) are estimated with production data and prices for the non-water inputs.

If these prices correctly reflect their scarcity (well working markets), the remainder of total value is considered the contribution of water to total value

Think about it

How useful are water valuation methods for designing water pricing policies?

Do you have in your countries human and financial resources to make water valuation studies? Which studies seem more useful for policy applications?

What is needed to value water at the source from water values at each sectoral use?

End

Chapters 1-3 have introduced IWRM and the need for economic and financial instruments. For them to be effective, contributing to sustainability, and improved access to basic services, they need to be applied.

Their application will be examined in the next two chapters.