Groundwater Economics and Management: Valuation technicques and hydroeconomic modeling

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1 DRAFT VERSION Groundwater Economics and Management: Valuation technicques and hydroeconomic modeling Policy Brief #2 Key role of economics in the implementation of the Water Framework Directive (WFD) and Groundwater Directive (GWD) To meet the environmental objectives, the WFD calls for the application of economic principles (e.g. Polluter Pays), approaches (e.g. cost effectiveness analysis) and instruments (e.g. water pricing). WFD requires cost recovery of water services including not only financial cost (capital, Operation-Maintenance-Remediation (OMR) and administrative costs), but also environmental and resource costs. Cost-effective combinations of measures should be implemented to achieve good groundwater status. When disproportionate costs are identified, time derogation or less stringent objectives are allowed. The Directives require the economic characterization of the water uses. The economic analysis shall contain enough information to make the relevant calculations necessary for taking into account the principle of cost recovery of the costs of water services, including environmental and resource costs. The economic characterization will be also used for making judgments about the most cost-effective combination of measures to be included in the programme of measures. The analysis of key economic drivers influencing pressures and water uses is essential to project how these pressures might evolve in time. of the total economic value of the resource. As a consequence, groundwater is often mis-managed and increasingly under threat of pollution and depletion. Quantifying the economic value of groundwater resources is essential for a sound groundwater management. Value estimates can play a major role in focusing policy-makers and public attention on threatened undervalued resources. Value estimates are also critical in order to evaluate the level of investment in groundwater development, protection, monitoring and management that can be economically justified. The total economic value of groundwater includes not only use values (for example, extractive and in situ values), but also non-use values (for instance, bequest and existence values). There are a number of techniques for assessing the value of both use and non-use values. Market-based valuation techniques These techniques measure values through actual prices in market transactions. For example, groundwater supply in irrigation there is a market value for this water, so it is possible to use statistical techniques (econometric methods) to infer this. Unfortunately, there are many effects that are not reflected in market transactions (groundwater quality improvements, impact on groundwater dependent ecosystems, etc.) What is the economic value of groundwater? Water is often under-valued and under-priced. Stakeholders and policy makers are often unaware 1

2 Case 1: Production functions in Vosvozis, Greece. Econometric approach. In the Vosvozis case (Greece), groundwater level decline induces recharge from Vosvozis River and Ismarida Lake, diminishing thus an important water source for the life of the wetland ecosystem. Another threat due to groundwater level decline is the intrusion of seawater in the wetland area, causing a serious alteration in the initial character of this protected ecosystem. Data from production surveys to farmers in the Vosvozis area were used to estimate the marginal value of groundwater in the aquifer (shadow price) through a microeconomic approach (distance-function approach). This value is central to the implementation of the EU WFD and GW Directive, because it allows the calculation of the current level of cost recovery (as the difference between the current price charged for groundwater and its marginal value) or the marginal impacts of groundwater quality changes due to potential policy measures. This study offers the opportunity to reveal individual farmer s valuation of groundwater and provide policy recommendations for water pricing that provides adequate incentives for users to use groundwater resource efficiently considering groundwater dependent ecosystems. Results show that groundwater in our case study area is undervalued and economic instruments should provide incentives to use it more efficiently by agricultural sector incorporating the notion of total economic value and therefore groundwater s indirect (ecosystem) value and non-use values in water management. Case 2 part 1: Production functions in Mancha Oriental, Spain. Agronomic simulation. In Mancha Oriental case study, irrigation is the main water use by far (98%), the main crops being wheat, maize, alfalfa, onion and barley. Crop yield (production functions) and nitrate leaching functions were estimated with a GIS-based crop growth model integrating a bio-physical EPIC model. The integration with the GIS tool was necessary in order to simulate the spatial and temporal dynamics of the major processes of the soil-crop-atmosphere-management systems. The model uses six types of input data: information on location (latitude, longitude and slope), climate data, soil physical parameters, land use data, plant parameters, and management data, such as irrigation and fertilizer application. The crop yield functions were used to estimate crop the benefits, while the nitrate leaching functions provided the nitrate input in the groundwater system needed to assess the resulting groundwater nitrate concentrations. Both types of functions have been embedded in the hydro-economic model described in box 5. Non-market valuation techniques These techniques are used where there is no price available or where prices for groundwater goods and services do not reflect the real value, but we still need to estimate the value of the resource for the purpose of decision-making. There are two main groups of techniques: revealed and stated preference methods. The first infers the values from observed market transactions implicitly related to groundwater (for example, hedonic pricing 2

3 to determine the economic value of groundwater dependent ecosystems). The second estimates willingness to pay for services from hypothetical markets (for example, contingent valuation or choice experiments). Some applications to groundwater valuation are the assessment of the benefits of groundwater quality improvements, or the full cost (environmental and resource costs) of groundwater deterioration or depletion. Examples of applications of choice experiments to the valuation of groundwater resources within the GENESIS project are given in cases 3 and 4. The application of these techniques is often expensive and time-consuming, and requires very specific expertise. One alternative will be to infer the value of groundwater by translating the results obtained from other locations. Benefit transfer provides a quick and cheap alternative to original valuation studies, but we have to be cautious in their application because some conditions must be met in order to provide reliable estimates. GENESIS will provide a database of public access with all relevant bibliographic information concerning studies that concern groundwater valuation (within deliverable 6.4). Case 3: Nonmarket valuation (choice experiment) in the Rokua esker, Finland. Rokua in Northern Finland is a groundwater dependent ecosystem very sensitive to climate change and natural variability. As such, the water level of most of the lakes is a function of the level of the groundwater table of the esker which is naturally recharged. Human activities (mainly peatland drainage by forest industry) are provoking decreased groundwater and lake levels, inducing losses of ecosystem services and recreation. There is high uncertainty on the actual system dynamics, potential climate change effect, and long-term impacts. Water resources in Rokua provide a diverse array of goods and services which can be translated into direct (forestry, recreation, irrigation, energy resources, etc.) and indirect (pollution abatement, soil erosion control, etc.) values, nonuse values (biodiversity, cultural heritage, bequest, existence). We have applied a choice experiment (CE) and contingent valuation method regarding ground water quantity. General public s elicited values highlight the importance of water management policy which contributes to the sustainability of groundwater dependent ecosystems. Five attributes were considered in the CE: water quantity, recreation (sum of all values - direct and indirect - derived from recreational activities), land income, investment in research, price. The results reveal that there is a high willingness-to-pay for scientific research (33-37 /household), showing the value of uncertainty reduction from improved scientific information. 3

4 Case 4: Nonmarket valuation (choice experiment) in Zagreb, Croatia The economic analysis of this case study aims to characterize the value of improving water quality and quantity in the Zagreb aquifer, main source of potable water for the city of Zagreb. The three main polluters are urban uses (aging sewage system), agriculture (pesticides and nitrate), and industries (heavy metals). The chosen approach for the economic analysis is choice experiment in order to capture the important non market benefits that can be attributed to water quantity and quality. The nonmarket valuation scenario describes the following technical interventions: replacement of the aging sewerage network to mitigate pollution from residential sources, monitoring of pesticide and nitrate use in agriculture to mitigate pollution from agricultural sources, monitoring industrial wastewater treatment activities to mitigate heavy metal contamination of water resources, replacing the distribution network to minimize water loss during transfer. Our results indicate that significant values can be attributed to the Zagreb population from improving water quality and quantity in the aquifer. The implementation of this scenario in a way that achieves near zero pollution and prevents water service restrictions is valued at HRK (70.9 /household). In the case where industrial monitoring is not implemented, the willingness to pay is HRK (48.8 /household). These values are significant when aggregated over Zagreb households and justify the implementation of measures for water quality improvement. These results can be used in a Cost-Benefit Analysis to access potential technical measures to mitigate water resources degradation on economic efficiency grounds. The surveys Economic instruments, where used appropriately, can be effective tools for meeting some of the enviundertaken within the context of this case study point out to some interesting facts. First, the general public accepts the need to sustain or even improve water quality in the aquifer. Second, the public accepts the measures that are proposed. Third, the public is willing to pay higher water rates for the implementation of the proposed measures. These outcomes of the study suggest that implementing the technical policies for improving the water status of the aquifer is desirable. Two more case studies have been used to test the approach. The first one, the Vosvozis case (Greece), aimed to estimate nonmarket benefits from improving GW chemical (NO3/salinity) and quantitative (size of the lake) status. The purpose of the other application, in Czestochowa (Poland), was to assess nonmarket benefits from reducing NO3 pollution. The results illustrate the value attached to improving water quality in the region. Hydro-economic models and groundwater management The combination of economic concepts and indicators with the modelling of the groundwater systems provides results and insights more relevant to management decisions and policies. Hydro-economic models can be used to assess economic impacts of certain policies or to simulate hydrologic implications of the application of economic instruments. The tools can be used to estimate the cost of certain policies and their effectiveness in meeting the environmental objectives of the WFD. They can also assist in the design of effective economic instruments for certain targets or objectives or to meet certain requirements. 4

5 ronmental objectives of the directive. Hydro-economic models can assist in the design and assessment of effective economic instruments. One alternative approach for hydro-economic modelling for water resources management is the use of Bayesian networks (BNs). BNs are increasingly being used to model environmental systems, due to its advantages to incorporate and explicitly represent uncertain information (the uncertainty in the model inputs is propagated to the model outputs), integrate data and knowledge from different sources, and handle missing or qualitative data. The modular architecture facilitates iterative model development, based on a relatively simple causal graphical structure; the network can be built without highly technical modelling skills and be understood by non-technical users and stakeholders. This is a very valuable feature of BNs, particularly in the context of natural resource management, which benefits from interdisciplinary and participatory processes. Case 5: Application of hydro-economic models to derive optimal fertilizer taxes in Mancha Oriental A hydro-economic modelling framework has been developed and applied to the Mancha Oriental case study or exploring optimal management of groundwater nitrate pollution from agriculture. An optimization model suggests the spatial and temporal fertilizer application rate that maximizes the net benefits in agriculture constrained by the quality requirements in groundwater at specific control sites. The analysis accounts for key underlying biophysical processes linked to the dynamics of nitrogen in the soil and the aquifer, as well as the crop yield responses to water and fertilizer application. The approach allows to assess the tradeoffs between two alternative economic instruments for diffuse pollution control: fertilizer quotas and fertilizer price. The cost of applying fertilizer standards was estimated as the difference between the private net revenues from current applications and the scenarios generated considering the application of the standards. The cost of applying fertilizer standards was compared with the cost of taxing nitrogen fertilizers in order to reduce the fertilizer use to a level that the nitrate concentration in groundwater was below the limit. The results show the required reduction of fertilizer application in the different crop areas depending on its location with regards to the control sites, crop types and soil plant conditions, groundwater flow and transport processes, time horizon for meeting the standards, and the cost of implementing such a policy. An integrated Bayesian network Decision Support System (DSS) has been also developed to assess the impact of several policies for integrated groundwater management in Mancha Oriental. In order to cover the different requirements of the EU Water Framework Directive, water quality, and economic, hydraulic, legal and ecological issues are integrated. The main advantage of the application of the BN approach to this case is the great amount of available information on the groundwater system behavior (including groundwater flow and mass transport models, agronomic simulation, hydroeconomic model, etc.) and especially, on the impact of several water management policies that have been recently implemented. However, the approach is very flexible and can be applied to deal with different groundwater issues in other case studies in which less information is available or there is more uncertainty on the impacts. 5

6 This page is not final and the layout will be altered. GENESIS Full title: Groundwater and Dependent Ecosystems: New Scientific and Technological Basis for Assessing Climate Change and Land-use Impacts on Groundwater. Contract number: Contact persons: Manuel Pulido-Velazquez, Universitat Politecnica de Valencia (Spain), (WP leader) Phoebe Koundouri, Athens University of Business and Economics (Greece), aueb.gr Johannes Sauer, Univ. of Kiel (Germany), 6