SHADOW PRICES METHODOLOGY FOR VALUATION OF EXTERNALITIES. Francesc Hernandez Sancho

Transcription

1 SHADOW PRICES METHODOLOGY FOR VALUATION OF EXTERNALITIES Francesc Hernandez Sancho

2 Motivation It is well-known that economics, particularly the valuation of externalities, plays a crucial role in fulfilling the environmental objectives of the WFD. The integration of these externalities into feasibility studies allows to have a complete information of the investment projects helping to make decision.

3 Motivation In order to contribute to achievement of a good ecological status of water bodies, we propose a methodology to quantify the cost and environmental benefits from improving water quality. We also analyse the issue of disproportionate costs of WFD implementation using the case study of a Mediterranean river basin.

4 Introduction In order to support instruments when implementing policies and selecting measurements, cost benefit analysis (CBA) is probably the most accepted and used. The benefits of each proposal are compared with their costs by using a common analytical methodology. In the context of the WFD, a CBA is made to identify cases where the adoption of measures for achieving a good water quality in lakes and rivers involves a disproportionate cost.

5 Introduction CBA should be performed to compare the costs of the measures with the benefits of improved water quality. These benefits and costs should be made in monetary units. The net profit of each option is the result of the difference between benefits and costs. Proposals are economically viable only when they generate net profit. The best option offers the highest net profit.

6 COST BENEFIT ANALYSIS: Any investment project or evaluation of a policy that is analyzed through the CBA tool should follow a series of steps. Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Specify the set of alternatives to the project Identify the costs and benefits of the project Quantify in monetary units the benefits and cost Calculate the net present value Carry out a sensitivity analysis Make recommendations based on the NPV

7 COST ANALYSIS Cost functions are a useful tool because allow understand the relationship between investment and operating costs and the most representative variables of the project. Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Sort data according technology Choose a reference year Select cost components Choose the functional form of the function Adjust available data regarding cost components Generate the cost function

8 COST FUNCTION MODELLING: The relationship between the dependent variable and the independent variables is assessed by ordinary least squares regression analysis. Example: wastewater treatment project C A V b e i x i Power adjustment A, b and α are parameters; C is total OMC per year; V is volume of wastewater treated per year and, the x i are different kind of variables representative of the treatment processes.

9 BENEFIT ANALYSIS: CBA requires that all costs and benefits, market and non-market ones, must be assessed and estimated in an economic way. To achieve this aim, there are basically TWO APPROACHES: METHODS BASED ON THE DEMAND responding to the view that economic value of an environmental asset is an expression of individual preference. An hypothetical market is created through a surveying process where individuals declare their willingness to pay for an improvement of the quality of the environmental good.

10 Due to the limitations of these methods, other approaches has been developed. Therefore, THE COST OF PRODUCTION PERSPECTIVE can be used to estimate shadow prices of undesirable outputs. They represent the value of external effects that could damage the environment if pollutants, for example, are inadequately managed.

11 The suitable of each approach (demand perspective and cost of production perspective) will depend upon several factors. The stated preference methods require expensive survey processes which are a strong limiting factor. Shadow prices are calculated based on objective parameters associated with the production process, i.e., the wastewater treatment or industrial processes.

12 Example: wastewater treatment project Environmental benefits through shadow prices approach: Wastewater treatment is a productive process in which a desirable output (treated water) is obtained together with a series of undesirable outputs (SS, N, P ) using inputs. Pollutants extracted from wastewater are considered undesirable outputs because if they are uncontrolled dumped into the environment they would generate a negative impact. Inputs Desirable output Undesirable outputs

13 Environmental benefits through shadow prices approach: Some empirical applications of this method have been made in the field of atmospheric pollutants, industrial wastes, and the removal of pollutants from wastewater. In the context of the WFD, the shadow prices approach could be applied, for example, when measures to achieve water quality targets are based on increasing the quality of effluent produced from wastewater treatment plants (WWTPs). In the Mediterranean region, a vast majority of river basins are characterised by a very low flow rate, particularly in summer when both the demand and air temperatures are higher.

14 Environmental benefits through shadow prices approach: Pollutants extracted from wastewater are considered an undesirable output because if these untreated materials are dumped in an uncontrolled manner they would generate a negative environmental impact. A shadow price for these undesirable elements would be the equivalent of the environmental damage avoided. If we assume that the marginal cost equals marginal benefit, therefore the shadow prices of the undesirable outputs can be interpreted as an estimation of the environmental benefits gained from the treatment process.

15 ADVANTAGES OF THE SHADOW PRICES APPROACH: Shadow prices could be used to determine income gained in case of the privatization of some resources. Authorities can use the information to set rates for the use of environmental services, or to compare the currently rates with the marginal revenue generating. Can help society to understand the benefits generated as a result of environmental improvement programs. Has very low costs in comparison to surveying processes.

16 LIMITATIONS OF THE SHADOW PRICES APPROACH: Stated preference methods are the only techniques that in theory are capable of estimating both use and non-use values.

17 Assessing Disproportionate Costs to Achieve Good Ecological Status of Water Bodies in a Mediterranean River Basin AIM: Address the issue of disproportionate costs of WFD implementation using a Mediterranean River Basin. Illustrate the usefulness of the cost function and shadow prices approach to predict the costs and environmental benefits from improving water quality at river basin level.

18 Assessing Disproportionate Costs to Achieve Good Ecological Status of Water Bodies in a Mediterranean River Basin DISPROPORTIONATE COSTS IN THE WFD. - To achieve the good ecological status of water bodies, a program of measures must be established. However, member states are permitted to request a postponement of the environmental objectives (time or level stringency) by proving that the costs of implementing measures are disproportionate to their benefits. CBA tool for assessing disproportionate costs

19 Assessing Disproportionate Costs to Achieve Good Ecological Status of Water Bodies in a Mediterranean River Basin CBA TOOL FOR ASSESSING DISPROPORTIONATE COSTS: - From an economic perspective, CBA is the obvious tool for assessing disproportionate costs. Environmental benefits from implementing measures: - The set of measures defined to achieve good ecological status in the river basin consists of improving the quality of effluent from two WWTPs (CHJ, 2008). - The quantification of environmental benefits was made by using the shadow prices approach. - The value of shadow prices after the implementation of the measures will be greater than obtained under current treatment methods.

20 Assessing Disproportionate Costs to Achieve Good Ecological Status of Water Bodies in a Mediterranean River Basin Environmental benefits from implementing measures: - The difference between the value of the current shadow prices and that resulting from the adoption of measures provides information on the economic value of environmental benefits derived from achieve the good ecological status of water bodies. ALCOY WWTP FONT DE LA PEDRA WWTP Current BM SM Current BM SM SS BOD N P Shadow prices of pollutants in /kg.

21 Assessing Disproportionate Costs to Achieve Good Ecological Status of Water Bodies in a Mediterranean River Basin Final Remarks According WFD, the concept of disproportionate costs is a key aspect to achieve the good ecological status of water bodies. CBA represents an appropriate tool for addressing the issue of disproportionate costs allowing policy and decision makers to be informed. The quantification of shadow prices of pollutants removed during wastewater treatment process presents an equally good alternative to conventional monetary valuation methods.

22 MAIN CONCLUSIONS Water management requires an interdisciplinary perspective in which economics should be considered in the decision-making process. It is crucial to integrate the environmental benefits when the economic feasibility of water management project is assessed in order to justify investment policies.

23 MAIN CONCLUSIONS Shadow prices approach constitutes a good alternative to conventional valuation methods. Cost modelling allows a better understanding of cost structure and help in the planning of new investment. The integration of the environmental benefits in the economic assessment of water management projects plays a vital role to favor them.

24 MAIN CONCLUSIONS To justify the economic feasibility of nutrients recovery projects, the benefits without market value must be incorporated in feasibility studies. The CBA is an appropriate tool for addressing the issue of disproportionate cost. In specific conditions, shadow prices approach can be used to predict environmental benefits at river basin level.

25 THANK YOU VERY MUCH FOR YOUR ATTENTION