Economics of Water: Demand, Supply, and Quality

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Economics of Water Demand, Supply, and Quality
Brian C. Murray, Ph.D. Director for Economic
Analysis Nicholas Institute for Environmental
Policy Solutions Duke University New York Times
Institute Dominican Republic March 15, 2007
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Overview

• Context
• Water Quantity
• Demand
• Supply
• Markets
• Water Quality
• Underlying factors
• Markets for Ecosystem Services
• Linking climate mitigation and water

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Water as an Economic Commodity

• Basic value sustain life and input into
  household and industrial production of other
  goods and services
• Unique characteristics
• Assignment of property rights is difficult
  Common pool resource
• Non-excludable (in many cases)
• Rival
• Matching supply and demand is challenging
• Spatially
• Temporally
• Seasonal
• Stochastic (random and uncertain factors)
• Heterogeneous good
• Different sources (ground water, surface water)
• Different qualities

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Basic Challenges

• Population growth and economic activity are
  placing pressures on water
• Demand
• Supply
• Quality
• Larger economic and institutional investments
  needed to maintain status quo
• Status quo not good enough
• Many in the world do not have sufficient access
  to clean water and sanitation
• Severely undermines development, health, and
  quality of life
• Market and institutional failures

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Millennium Development Goals Water and
Sanitation

• Goal 4. Reduce child mortality
• Reduce by two thirds, between 1990 and 2015, the
  under-five mortality rate
• Goal 7. Ensure environmental sustainability
• Integrate the principles of sustainable
  development into country policies and programmes
  and reverse the losses of environmental
  resources.
• Halve by 2015 the proportion of people without
  sustainable access to safe drinking water and
  basic sanitation.
• By 2020 to have achieved a significant
  improvement in the lives of at least 100 million
  slum dwellers.

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World facing "silent emergency" as billions
struggle without clean water or basic
sanitation, say WHO and UNICEF
More than 2.6 billion people - over 40 per cent
of the world's population do not have access to
basic sanitation, and more than one billion
people still use unsafe sources of drinking water

• MDG Mid-term predictions
• The global sanitation target will be missed by
  half a
• billion people - most of them in rural Africa and
  Asia allowing waste and
• disease to spread, killing millions of children
  and leaving millions more on
• the brink of survival.
• The world is on track to meet the drinking water
  target.

The severe human and economic toll of missing the
sanitation target could be prevented by closing
the gap between urban and rural populations and
by providing simple hygiene education
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Call to ActionNicholas Institute/Aspen Institute

• Higher priority must be placed on water and
  sanitation
• Government investment in infrastructure needed
• Variety of scales centralized and decentralized
• Education is key to hygiene improvements
• Involve stakeholders at all levels, especially
  women

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Water Quantity Demand
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Trends in Global Water Use
Source UNEP http//www.unep.org/vitalwater/15.htm

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Water Use has leveled in U.S.
Source US Geological Survey, http//www.nationala
tlas.gov/articles/water/a_wateruse.html
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Cooling power plants and irrigation are largest
uses in US
Source US Geological Survey
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Water QuantitySupply
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Groundwater v Surface Water Systems in US
Surface water renewable Groundwater
non-renewable
Source US EPA. FACTOIDSDrinking Water and
Ground Water Statistics for 2005.
http//www.epa.gov/safewater/data/pdfs/statistics_
data_factoids_2005.pdf
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Cost fundamentals

• Fixed costs
• Establishing the infrastructure (capital and
  construction costs)
• Variable
• Energy, labor and materials to get the water from
  its source to its use
• Purchased water rights/access
• Quasi-fixed
• Maintenance costs of the infrastructure

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Water Pricing Challenges

• Perfect pricing scheme
• Covers full costs
• Reinforces efficiency/right signals
• Beneficiaries pay
• Ability to pay is addressed
• Polluter pays
• Simple
• What you get is usually less than perfect
• Price does not often reflect marginal cost
• Subsidization often required
• Deals made with large volume consumers
• Polluters are often external to the system and
  not explicitly charged for the costs they impose

Jeff Hughes, UNC Environmental Finance center,
comments at Future of North Carolina Water, March
1. 2007. Nicholas Institute.
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Common Pricing Approach

• Two tiered
• Fixed rate per HH per month
• Variable rate based on usage
• Increasing block price per unit rises with use
• Decreasing block price per unit falls with use
• Uniform block flat price per use
• Increasing block provides most incentive for
  water conservation
• Uniform block is most common

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Water Rights and Water Markets

• Markets for water access Can help allocate water
  more efficiently to highest valued use, and can
  move the supplies to where the demand is highest
• Depends critically on who has ownership rights or
  rights of access to the water
• Riparian attached to land adjacent to waterways
• Appropriative the first to claim the water in a
  waterway for beneficial use has first priority to
  the water
• Common in western US
• Government owned
• Some concerns about environmental and economic
  externalities with trading
• Flow affects others access costs
• affects local economic development

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Source Howitt R. and K. Hansen, The Evolving
Western Water Market. Choices 2005 20(1).
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The privatization debate

• In many places, public sector has failed to
  deliver
• Increasing emphasis on turning over water supply
  to private sector
• Hopes
• Efficiency gains
• Improved health outcomes
• Fears
• Higher prices
• Insufficient provision of quality to poor areas
  leading to worse health outcomes
• These proposals have been met with strong
  opposition in some places

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The privatization debate (contd)

• Relatively little research and assessment of
  water supply privatization,
• Most are focused on efficiency and profitability
• Exception Paper by Galiani et al (2002), looked
  at the impact of privatization in Argentina on
  child mortality and found
• Child mortality fell 5-7 in privatized systems
  (375 children per year)
• 24 in poorest municipalities
• Primarily reductions in infectious/parasitic
  diseases

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Water Quality
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Water Links Aquatic and Terrestrial Ecosystems
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Point and Non-point Sources

• Historically, water quality control was deeply
  affected by point source pollution
• Many controls in US and other countries have
  controlled these
• Further controls are more costly and less
  effective
• Non-point sources Natural and human activity on
  the landscape determine many aspects of water
  quality
• Activities
• Agriculture
• Development
• Forestry
• Pollutants
• Nutrient concentrations (esp N and P)
• Pesticides and other chemicals
• Suspended solids
• Bacteria and pathogens
• Excessive sunlight
• Consequences
• Non-potability
• Turbidity
• Impaired aquatic habitat
• Given point-non-point problems, it may be cheaper
  and more effective to pay landowners to change
  their offsite activities to enhance water quality

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Payments for Ecosystem Services

• Natural Capital Ecosystems provide a flow of
  services that are of value to society
• many go unpriced in the market place
• When (good) services go unpriced, they are
  underprovided by private landowners
• Externalities
• Marketed services win out
• Mobilizing funds to pay for the unpriced
  services, if done well, can address this problem
• Exhibit A Water quality

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New York City Watershed
The Ashokan Reservoir is a source of drinking
water for residents of New York City.AP/WWP
Photo by Jim McKnight
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NY City Watershed

• NYC water supplied by 19 reservoirs and 3
  controlled lakes in Catskill Mtns
• Water quality becoming degraded by development,
  roads, and agriculture in 80s, 90s
• NYC faced with building a filtration facility in
  response to the water quality threat _at_ 6-9
  billion
• Decided to invest in watershed protection (250
  MM over 10 years)
• Riparian buffers
• Land purchases
• Provides other ecosystem services as well
  (habitat, scenic beauty, recreation, climate
  regulation)

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Markets for Water Quality Offsets

• Premise mitigating damages caused by other
  parties/activity for a price
• Analogous to carbon offsets
• Participants
• Buyers Developers, water treatment facilities
• Sellers landowners
• Examples
• Nutrient Trading
• Wetlands mitigation
• Stream mitigation (riparian buffers)
• Price determinant
• Demand WTP for avoiding mitigation themselves
• Supply cost of mitigating action
• Also faces some of the same problems discussed
  with carbon (e.g., leakage, permanence)

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Traditional Government Landowner Programs

• Direct payments for private parties producing
  public goods (like water)
• Voluntary participation, contractually bound
• Examples Conservation Reserve Program, Wetlands
  Reserve Program, EQUIP, conservation easements
• Pricing the services
• Not typically market driven (like offsets)
• Social value-based societys willingness to pay
  for the collective services provided
• How to determine? Non-market valuation studies

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North Carolina Initiatives
EEP offsets ecosystem loss from
transportation projects in NC by requiring
restoration of habitat in other locales
Clean Water Management Trust Fund allocates
100 MM in funding For water quality protection
programs, Including watershed protection
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Lower Mississippi Alluvial Valley

• Current study co-leading with colleagues at Duke
  and ecologists from USGS
• Ecologists doing direct field measurement of
  range of ecosystem services generated by restored
  wetlands sites, agriculture, mature forests in
  region
• Carbon sequestration
• Water purification
• Biodiversity
• Recreation
• Flood water control

Economists estimating economic values of those
service flows Objectives - Estimate economic
service flows from wetlands - Evaluate success
of WRP program - Help germinate ecosystem
service markets
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GHG Mitigation and Water Quality Co-benefits

• Changes in land use to sequester carbon can
  reduce erosion, nutrient runoff, and pesticide
  use to the benefit of water quality

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Estimating Water Quality Co- Benefits from
Agriculture-based GHG mitigation

• Pattanayak et al 2005, Climatic Change
• Economic Model of the Agricultural Sector
  responds to carbon price signals (1-50/t CO2)
• Change in land use
• Change in management/cropping patterns/input use
• Fed changes into a national water quality model
  to gauge level and spatial distribution of water
  quality change

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Reduced runoff
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Changes in Water Quality Indices (WQI)
50/Tonne C Scenario

• Found overall improvements in water quality
  (relative to baseline) nationally and in most
  regions (blue is good bright red is bad pink is
  no change)

• Pattanayak et al, 2005 Climatic Change

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GHG Mitigation and Water Tradeoffs

• Jackson et al, Science 2005 (Dec 23).
• Water quantity effects from extensive plantation
  establishment for C Seq.
• Concerns
• Reductions in stream flow
• Increased soil salinization and acidification
• Methods
• Field research
• Observational synthesis
• Climate/economic modeling
• Findings
• Substantial potential reductions in stream flow
  (up to 50 in some places. 13 completely dried)
• Climate feedbacks unlikely to offset water losses

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Anatomy of a Scientific Controversy
Scientific articles in Science and Nature in late
2005/early 2006 raising questions about the role
of forest carbon sinks as a climate mitigation
strategy
Can planting trees make global warming worse
London Daily Mail
Plants bad for the environment Fox News
Carbon sinks drain water The Australian
Plants gone bad Philippine Daily Inquirer
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The Ideal Scientist
The ideal scientist thinks like a poet, works
like a bookkeeper, and, all too rarely, writes
like a journalist, Attributed to Edward O.
Wilson (conveyed to me by Don Melnick) (Carter,
L.S. Dartmouth Medicine, Winter 2002)
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What we have here Is a failure to communicate
Strother Martin in Cool Hand Luke (1967)
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Do Recent Findings Undermine the Value of Forest
Carbon Sequestration?
Water stresses from plantations R.B. Jackson,
E.G. Jobbagy, R. Avissar, S.B. Ray, D.J.
Barrett, C.W.Cook, K.A. Farley, D.C. le Maitre,
B.A. McCarl, and B.C. Murray.Dec 2005. Trading
water for carbon with biological carbon
sequestration. Science. 3101944-1947.
Methane emissions from plants/trees Keppler,
J.T.G. Hamilton, M.Bras, and T. Rockmann. Jan
2006.Methane emissions from terrestrial plants
under aerobic conditions. Nature. 439187-191.