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

3

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

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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