Economics of Natural Resource Management
Prof. Mike Young
Research Chair, Water Economics & ManagementSchool of Earth and Environmental SciencesThe University of Adelaide
Friday 2nd February 2007
2
High level water reform agenda
Year Major policy
1994 COAG Water Reform Framework within National Competition Policy
1995a1995b
MDB Cap introducedWater reform implementation linked to competition payments
1998 MDBC commenced Pilot Interstate Water Trading Trial
2001 National Action Plan for Salinity and Water Quality
2002 MDBMC started Living Murray process
2003 COAG agreed, in principle, to implement a NWI
2004 COAG finalised NWI
2007 Howard Water $10 billion Plan
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Natural resource management instruments
The Key Question
How do we, at any location, get the right intervention
at the right location
at the least cost,
so as to facilitate, from a social perspective optimal land use change
optimal land and water use?
4
The full range of opportunities
Outcome-orientated Informational instruments
Motivational instruments
Regulatory instruments
Market-based instruments
Financial instruments
Property-right instruments
Process orientated Governance arrangements
Consultative arrangements
5
What are Market Instruments?
… policy tools that use market signals and processes to encourage behaviour
Seek to induced behavioral change
Foster change
Offer compliance flexibility
Through variation in compliance costs exits
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Types of market instruments
MBIs ‘encourage behaviour through market
signals rather than through explicit directives’
Price-based
Lever behavioural change by changing
prices in existing markets
Quantity-based
Lever behavioural change by specifying the ‘amount’ of new rights / obligations
Market friction
Lever behavioural change by making
existing private markets work better
Eg: Changing taxes, introducing levies, giving subsidies
Eg: Introducing a ‘cap and trade’ scheme or
an offset scheme
Eg: Disclosing information such as
via ecolabelling
Market-Like InstrumentsCreate business opportunity to sell a service
Eg: Auctions & tenders
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Biodiversity Benefits Index
0
10
20
30
40
50
60
70
0 0.025 0.05 0.075 0.1 0.125 0.15 0.175 0.2
Habitat Service/$
Bio
div
ers
ity
Sig
nif
ica
nc
e
Actual (HSS/$)
Power ((HSS/$) needed
for BBI Gold)
Landholder BBI
BBI Threshold
for $400,000
Market-like instruments
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Market Friction Instruments
Best left in private sector with catalytic inputs from Government
Typically start in niche markets Fisheries
Timber Certification
Organic Food Markets
Supply to large wholesale businesses
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Price v’s Quantity design choice
In theory, both approaches can yield the same outcome at the same cost
… in practice many factors influencing instrument type and design a key factor is relative uncertainties
1. Price instruments Alter the prices of goods / services to reflect their
environmental impact
… provides certainty as to compliance costs
2. Quantity instruments Control the quantity of the good / service to socially desired
level
… provides certainty as to environmental outcome
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Instrument choice
Screen for feasibility
Assess potential to deliver environmental goals On their own?
In combination with other instruments
Recognise variation in human response to same instrument
Assess potential to combine instruments to reduce cost of achieving outcome
Design and develop implementation sequence
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Recharge Accounts Trading
Land use Recharge rate Area Recharge mm ha KL
Native vegetation 5 100 500
Plantation Timber 5 300 1,500
Dryland lucerne 10 400 4,000
Other Dryland 80 3,000 240,000
Irrigated 120 200 24,000
Total Groundwater load 4,000 270,000
Rebate @ $0.10 per KL $500
Recharge Entitlement @ 70mm/ha/yr @ 4,000 ha = 280,000 KL
Farm Credit/Deficit 10,000 KL
Less credits sold 5,000 KL
Credits available for sale 5,000 KL
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Off-set schemes
Most cost-effective when impacts is linked to a development or controllable land-use change
Conflict with Planning Culture of protection for existing uses
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Tradeable Rights Price
Single title to
Land & Water
WaterLand
Robust Water Allocation
Robustness
Robust (adj.) Said of a system that has demonstrated an ability to recover gracefully from the whole range of exceptional inputs and situations in a given environment.
One step below bulletproof. Carries the additional connotation of elegance in addition to
just careful attention to detail. Compare smart, oppose brittle.
Robust systems Endure without the need to change their foundations. They last for centuries. Inspire confidence. Produce efficient and politically acceptable outcomes in
an ever changing world.
Theoretical Design Foundations
Tinbergen Principle (NP in 1969)
For dynamic efficiency
=> One instrument per objective
Mundell’s Assignment Principle (NP in 1999)
• For dynamic stability
=> Pair instruments and objectives for greatest leverage
Coase Theorem (NP in 1999)
To minimise adverse effects of entitlement mis-allocation on economic activity
=> Ensure very low transaction costs
Practical Enduring Experience
Structures that have stood the test of time
• Limited liability share companies
• Money
• Banking systems
• Double entry book keeping
• Torrens Land Title System
Partitioning the Problem
Need instruments for
• Managing individual users Entitlements Allocations Use approvals
• Managing aggregate consequences Water allocation plans to allocate equitably Trading Protocols to allow efficiency production Catchment management plans to manage
environmental impacts
Goals, Objectives & Targets
• Distributive Equity
• Economic Efficiency
• Manage Environmental Externalities
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The CoAG Communiqué
“A key focus of the National Water Initiative will be to implement a robust framework for water access entitlements
…. while ensuring that there is sufficient water available to maintain healthy rivers and aquifers.
…. Under the National Water Initiative, jurisdictions will establish a robust, transparent regulatory water accounting framework that protects the integrity of entitlements.”
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Three Part Separation
Entitlements => Equity instrument
Allocation => Efficiency instrument
Use licence => Externalities instrument
Entitlements
Allocations Use Approvals
Generalised framework
Catchment Plans
Trading Protocols & Accounting Rules
Water allocation plans
Total System
Use licences(approvals)
AllocationsEntitlements
Individual
ExternalitiesEconomic Efficiency
Distributive Equity
Policy Objective Scale
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Seasonal Variability Risk
Split Environment & Consumptive Use
Climate Change Risk
Salinity Pollution Right
Carry over rules (NSW)
Integrity of Register, mortgages
etc
Trading opportunity - Temporary
Delivery Charge
River Capacity Management Rules
Channel Capacity Shares
Administrative Dilution Risk
Return Flow & Drainage Rules
This Feburary Delivery
Register integrity
Bulk water licence & ownership
Trading Fees
Administrative Error Risk
Trading opportunity - Permanent
Impact of use - on river
Impact of use - on groundwater Impact of use -
LocalAccess to Sales
Water (Vic)
A Water Licence
Why unbundle?
WaterEntitlement
DeliveryPriority
Expected Reliability
Registered interests
Tenure
OwnershipRestrictions
Delivery charges
Salinity obligations
Return flow &drainage
Low costLow costtradingtrading
WaterAllocation
Volume for use or trade
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Casting the Net Critical Concepts
1862 – Companies Act Limited Liability
1857 – The Torrens Title System
?000 - The Banking System
Jan Tinbergen – 1st Nobel Lauriat in Economics
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Whereas the inhabitantsof South Australia are subjected to loses, heavy costs, and much perplexity, by reason that the laws relating to the transfer and encumbrance of freehold and other interests in land are complex, cumbrous and unsuited to the requirements of the said inhabitants, it is therefore expedient to amend the said Act
Defining entitlements
• Unit shares that define an entitlement to a proportional of a defined consumptive pool
• Unbundled from other part of the system
• Share Registers guaranteed and mortgageable
• Fully tradable anyone can own/invest
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Risk Specification
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Risk - A community guarantee?
Guarantee to only use market mechanisms to change allocations
Effectively, insure water users against change in their share of the pool in return for a small return to the Community
Start in 2015 @ 0.5% pa
increase gradually to rate for crown agricultural leases
Place returns in an Environment Trust
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Periodic Allocations & Trading
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Allocation Trading
Pay ____________________________________________
The sum of ________________________________ ML of 2000/01 Water
Water Trading Australia
Signature______________________
807512 085 249:0223 7851
Date ____________
________ML
WPayBPay
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Robust Use Licences
Permission to irrigate to “use” water
Irrigation conditions eg Not more than 300 ha or 1500 ML pa
Only use drip irrigation
Obligations to third parties Other irrigators
Urban water users
The environment
Pollution right reserved to the Crown
Use managed separately from entitlements
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Bank-like Allocations
Torrens title-like interest register
MortgageableShares
A Two-sided contract
Risk stated transparently
This licence authorises the holder of this permit to do xxx on area AAA provided
1. The holder has a valid permit to do XXX
2. XXX is done in a manner consistent with the …. management plan
Use conditions & obligations (Periodic review)
Approvals to irrigate & 3rd party obligations
A robust “separated” system?
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A Robust System
Water
Tradeable Rights Price
Single Title to
Land & Water
Land
Entitlement Shares
in perpetuityBank-like Allocations
Use licences with limits & obligations
Channel Capacity Shares
Channel Capacity Allocations
SalinityShares
SalinityAllocations
CoAG’s 1990’s Vision
Solution for Solution for C21?C21?
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StorageLand use Water Yield
River
Wetlands
Rainfall
Ground water
Base flow
Surface Drainage
GW Recharge
Water Extraction
Irri
gati
on
, u
rban
&
ind
ustr
ial u
se $
xx
x
Water accounting
x
35
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Two new MDBC reports on 6 “risks”
In 20 years, a further reduction in flow of around 2,500 – 5,500GL.
Effects below dams and hence outside release rules erode flows most.
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Possible reduction in mean annual River Murray flow as a result of incomplete accounting (baseline 1993/94)
Unmanaged flow reducing effect Nett effect
Water use efficiency savings - 723 GL
Reduced water yield (Trees and dams) - 600 GL
Salinity Interception Schemes -20 GL
Increased groundwater use -349 GL
Estimated nett reduction in mean river flow and allocations to irrigators -1,692
GL Add back 500 GL
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100 ML
Unconfined Aquifer
50 M
LWater that returns to the aquifer
Extraction
45 ML
Actual amount used
5 ML
Evapo-transpiration
Drainage
Gross entitlement = 100 MLReturn = 50 ML
Recharge Credits for return flows
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Known accounting solutions
Offset the flow reducing effects of establishing permanent vegetation, clay spreading etc by surrendering an entitlement equivalent to the expected mean effect
Defining tradable entitlement as a “nett” entitlement to prevent increased WUE erosion (return flow reduction)
Defining salinity interception as a water use and acquiring the necessary water from below the cap. Changes the cost benefit of most schemes!
Amending the cap to include all unconfined groundwater within, say, 10kms of the River as part of the system
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Water allocation plans
Rules to partition water into “use” pool (share pool)
“flow” pool
Dam management rules
Share pool reliability and partitioning High security shares
“General” security
Inter seasonal carry forward and borrowing rules
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Catchment plans
Rules for Applying water to land
Managing drainage and salinity impacts
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Pricing
Water supply charges Fixed charge to cover infrastructure and management
Variable charge to cover costs of supply
Market Value Allocation prices reveal seasonal opportunity cost
Entitlement prices reveal value of long term economic opportunity
Environment costs Via salinity and other policies
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Regional governance
1997 Establish a Catchment Management Board with local representatives
Employ own staff and offices
Funded via a levy on water users
Duties preparing and implementing plans that set water sharing,
trading and use rules advising Minister and local govt councils on water
management promoting public awareness
2005 Converted into a Natural Resource Management Board
A Robust Solution?
Water
Tradeable Rights Price
Single Title to
Land & Water
Land
Entitlement Shares
in PerpetuityBank-like Allocations
Use licences with limits & obligations
Delivery Capacity Shares
Delivery Capacity Allocations
SalinityShares
SalinityAllocations
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Regional governance
1997 Establish a Catchment Management Board with local representatives
Employ own staff and offices
Funded via a levy on water users
Duties preparing and implementing plans that set water sharing,
trading and use rules advising Minister and local govt councils on water
management promoting public awareness
2005 Converted into a Natural Resource Management Board
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Over allocation
Exists because Entitlements are defined in volumes and not as
shares of available water in a pool
Plans assume that constant technology and land use change
Introduction of trading that activated previously unused water
Solutions Buy back
Pro-rata reduction
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Illustrative buy back offer form
Type of Licence South Australian River Murray Licence
Offer conditional upon lease back of water until …..
Offer 1 …………….. ML @ not less than $2,300.00 per ML
Offer 2 …………….. ML @ not less than $2,100.00 per ML
Offer 3 …………….. ML @ not less than $2,000.00 per ML
Offer 4 …………….. ML @ not less than $1,950.00 per ML
Offer 5 …………….. ML @ not less than $1,900.00 per ML
Signatures
Licence holder …………………………………………
Registered interest (if any) …………………………..
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Coles-Myer Schedule
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Extracts Coles Myer “2005” Press Release
• Off-market buy-back price $8.30
• 9.2% discount to Friday’s closing share price of $9.14
• 70.4 million shares bought back for a total of $585m
Under the off-market buy-back a total of 70.4 million shares were bought back for $585 million – approximately 5.7% of Coles Myer’s shares
• All shares tendered in the buy-back at or below $8.30 were bought back.
• Shares tendered into the buy-back at a price above $8.30 were not bought back.
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Duty of care, penalties & ecosystem service payments
Env
ironm
enta
l Sta
ndar
d
Time
Env
ironm
enta
l Sta
ndar
d
PENALTIES &DISCOURAGEMENT
REWARD & ENCOURAGEMENT DUTY OF CARE
Time
Ecosystem service payments
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Natural resource management instruments
The Key Question
How do we, at any location, get the right intervention
at the right location
at the least cost,
so as to facilitate, from a social perspective optimal land use change
optimal land and water use?
52
The full range of opportunities
Outcome-orientated Informational instruments
Motivational instruments
Regulatory instruments
Market-based instruments
Financial instruments
Property-right instruments
Process orientated Governance arrangements
Consultative arrangements
Prof. Mike Young
Research Chair, Water Economics & ManagementSchool of Earth and Environmental SciencesThe University of Adelaide
Friday 2nd February 2007