Economics of Natural Resource Management

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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

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High level water reform agenda
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?

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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

Market-Like Instruments Create business
opportunity to sell a service
Price
-
based

Quantity
-
based

Market friction

Lever behavioural
Lever behavioural
Lever behavioural
change by changing
change by specifying
change by making
prices in existing
the amount of new
existing private
markets

rights / obligations

markets work better

Eg Changing taxes,
Eg Introducing a cap
Eg Disclosing
Eg Auctions tenders
introducing levies,
and trade scheme or
information such as
giving subsidies

an offset scheme

via ecolabelling


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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 vs 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
• Price instruments
• Alter the prices of goods / services to reflect
  their environmental impact
• provides certainty as to compliance costs
• 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
Recharge Entitlement _at_ 70mm/ha/yr _at_ 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
Rebate _at_ 0.10 per KL
500
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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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Robust Water Allocation
Single title to Land Water
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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.

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Theoretical Design Foundations

• Tinbergen Principle (NP in 1969)
• For dynamic efficiency
• gt One instrument per objective
• Mundells Assignment Principle (NP in 1999)
• For dynamic stability
• gt Pair instruments and
  objectives for greatest leverage
• Coase Theorem (NP in 1999)
• To minimise adverse effects of entitlement
  mis-allocation on economic activity
• gt Ensure very low transaction
  costs

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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

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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

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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 gt Equity instrument
• Allocation gt Efficiency instrument
• Use licence gt Externalities instrument

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Generalised framework
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A Water Licence
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Why unbundle?
Low costtrading
WaterEntitlement
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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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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 _at_ 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
WPay
BPay
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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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A robust separated system?
Torrens title-like interest register
Bank-like Allocations
Approvals to irrigate 3rd party obligations
MortgageableShares A Two-sided
contract Risk stated transparently
Use conditions obligations (Periodic
review)
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
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A Robust System
Solution for C21?
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Water accounting
Rainfall
River
x
x
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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)
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Recharge Credits for return flows
100 ML
Extraction
Gross entitlement 100 MLReturn 50 ML
Unconfined Aquifer
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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

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A Robust Solution?
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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 _at_ not less than 2,300.00
  per ML
• Offer 2 .. ML _at_ not less than 2,100.00
  per ML
• Offer 3 .. ML _at_ not less than 2,000.00
  per ML
• Offer 4 .. ML _at_ not less than 1,950.00
  per ML
• Offer 5 .. ML _at_ 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 Fridays 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 Myers 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
DUTY OF CARE
Environmental Standard
Environmental Standard
Time
Time
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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

53

• Prof. Mike Young
• Research Chair, Water Economics
  ManagementSchool of Earth and Environmental
  SciencesThe University of Adelaide
• Friday 2nd February 2007