Economics of Natural Resource Management

1. 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. Year Major policy 1994 COAG Water Reform Framework within National Competition Policy 1995a1995b MDB Cap introduced Water 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 High level water reform agenda 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

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

6. 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

7. Market-like instruments

8. 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

9. 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 • 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

10. 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

11. 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 @ 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 Rebate @ $0.10 per KL $500

12. 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

13. Water Land Tradeable Rights Price Robust Water Allocation Single title to Land & Water

14. 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.

15. 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

16. 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

17. 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

18. Goals, Objectives & Targets • Distributive Equity • Economic Efficiency • Manage Environmental Externalities

19. 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.”

20. Entitlements Use Approvals Allocations Three Part Separation • Entitlements => Equity instrument • Allocation => Efficiency instrument • Use licence => Externalities instrument

21. Scale Policy Objective Distributive Equity Economic Efficiency Externalities Individual Entitlements Allocations Use licences(approvals) Total System Water allocation plans Trading Protocols & Accounting Rules Catchment Plans Generalised framework

22. A Water Licence

23. OwnershipRestrictions Delivery charges Tenure Salinity obligations Registered interests Expected Reliability Return flow &drainage DeliveryPriority WaterAllocation Volume for use or trade Why unbundle? Low costtrading WaterEntitlement

24. 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

25. 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

26. 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

27. Risk Specification

28. 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

29. Periodic Allocations & Trading

30. Water Date ____________ Pay ____________________________________________ ________ML The sum of ________________________________ ML of 2000/01 Water Water Trading Australia Signature______________________ 807512 085 249:0223 7851 Allocation Trading WPay BPay

31. 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

32. 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

33. Single Title to Land & Water CoAG’s 1990’s Vision Water Land Tradeable Rights Price Entitlement Sharesin perpetuity Use licences with limits & obligations Bank-like Allocations Channel Capacity Shares Channel Capacity Allocations SalinityShares SalinityAllocations A Robust System Solution for C21?

34. x Storage Water Yield Land use x Ground water Base flow Water Extraction Irrigation, urban & industrial use $ Surface Drainage GW Recharge Wetlands Water accounting Rainfall River x x

36. 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.

37. Unmanaged flow reducing effect Nett effect Water use efficiency savings - 723 GL Reduced water yield (Trees and dams) - 600 GL Salinity Interception Schemes Add back 500 GL -20 GL Increased groundwater use -349 GL Estimated nett reduction in mean river flow and allocations to irrigators -1,692 GL Possible reduction in mean annual River Murray flow as a result of incomplete accounting (baseline 1993/94)

38. Evapo-transpiration 45 ML Actual amount used 5 ML Drainage 50 ML Water that returns to the aquifer Recharge Credits for return flows 100 ML Extraction Gross entitlement = 100 MLReturn = 50 ML Unconfined Aquifer

39. 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

40. 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

41. Catchment plans • Rules for • Applying water to land • Managing drainage and salinity impacts

42. 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

43. 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

44. Single Title to Land & Water Water Land Tradeable Rights Price Entitlement Sharesin Perpetuity Use licences with limits & obligations Bank-like Allocations Delivery Capacity Allocations SalinityShares SalinityAllocations Delivery Capacity Shares A Robust Solution?

45. 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

46. 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

47. 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) ………………………….. Illustrative buy back offer form

48. Coles-Myer Schedule

49. 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.

50. REWARD & ENCOURAGEMENT Ecosystem service payments PENALTIES & DISCOURAGEMENT Duty of care, penalties & ecosystem service payments DUTY OF CARE Environmental Standard Environmental Standard Time Time