Dr. Phoebe Koundouri
Department of Economics
UNIVERSITY OF READING
Faculty of Letters & Social Sciences

Senior Research Fellow
Department of Economics/CSERGE
UNIVERSITY COLLEGE LONDON

Extended absract

This paper demonstrates how integrated water resource analysis and management in a given jurisdiction is capable of identifying feasible water allocations that generate substantial improvements in social welfare. The objectives of water resource allocation are set out as: Efficiency, Equity, and Environmental Sustainability. In this two-stage methodology we set out initially to identify efficient water allocations based on knowledge of hydrological parameters and secondly to evaluate their broader impacts. The policy maker identifies the implementing mechanism for the allocation (here, water pricing) and the welfare effects of the change in water allocation is assessed and qualified. In addition the legislative and institutional context is analysed.

The case study of the Kouris Watershed describes the implementation of the integrated watershed economics methodology described in the initial sections of this report. It shows how the approach contributed to the development of policy recommendations for the Government of Cyprus. The study combines detailed hydrological models with micro-economic data on the water using sectors. The imbalance of water demand with the natural constraints of supply is addressed in the objective manner using the two-stage process outlined above. In this case, Stage I uses a variety of economic valuation techniques: Hedonic analysis, Contingent Valuation, Travel Cost Approach, Mathematical Modelling and Distance Function, to assess the social value of water in the different sectors. This allows the determination of the efficient pricing strategy for allocating between water demands to maximise social welfare. Stage II analyses the impact of the proposed allocation policy in order to address issues of equity and sustainability.

The paper can be schematically summarised as follows:

METHODOLOGY

The methodology that was developed for determining the efficient, equitable and sustainable water allocation in Cyprus is as follows:

STAGE 1: OBJECTIVE APPROACH TO BALANCING WATER DEMANDS

I. Evaluate Demands

II. Determine Efficient Allocations

III. Ascertain Impacts of Implementing Efficient Allocation

STAGE 2: POLICY IMPACT ANALYSIS

I.Welfare Distribution

II. Market Failures and Missing Markets

III. Institutional and Legislative Analysis

RESULTS

The methodology required knowledge of the hydrological characteristics with the watersheds analysed. The hydrological analysis is summarised in Table 4.6 below. Hydrological parameters were then used in the economic modelling and to determine the hydrological links between water users and the effect of water demands on water resources such as groundwater.

Table 4.6 Hydrological Analysis: Broad Summary

STAGE 1: OBJECTIVE APPROACH TO BALANCING WATER DEMANDS

I. Evaluation of Demands

The analysis of Stage 1 provided the parameters concerning the sectoral demands for water contained within Table 4.7. If we combine these parameters with derived estimates of water scarcity in the watershed (i.e. supply availability given multi-sectoral demand), then the information is sufficient to derive broad policy conclusions concerning the allocation of water resources, e.g. in the Kouris watershed.

Table 4.7. Estimated Economic Parameters from Water Demand Valuation Exercises

II. Determination of Efficient Allocation: Balancing Costs of Supplies and Values of Uses

A positive economic value has been demonstrated for residential, agricultural and environmental demands for water. These alternative demands must be balanced objectively by reference to the parameters in Table 4.7. The following policies can be advocated to effect an efficient water allocation:

• Inter-sectoral allocation of groundwater and surface water should be based on the marginal value of the resource for each sector; in Table 4.7, the marginal value of water is higher in the residential sector than the agricultural sector at current use levels. This implies that policy should be directed towards reducing the appropriation of water resources by agriculture and increasing or maintaining the water provided to residential areas.
• Efficient pricing of the resource should take into account the opportunity cost of its source; water from surface resource should be priced given its long-run marginal cost, while groundwater should be priced according to its scarcity value: a price which includes the scarcity rent: In addition to optimal pricing for agriculture, there are social welfare improvements from the uniform pricing policy for residential sector. In the Kiti aquifer this means a water user fee, reflecting the scarcity rent of groundwater, of approximately £CY0.2/m3 of groundwater used (See Table 4.4).
• Both the quality and quantity of water are considered by sector users, so both of these dimensions should be integrated in allocation decisions; There is a small willingness to pay for unit decreases in seawater intrusion, which contributes to the scarcity value of groundwater.

STAGE 2. POLICY IMPACT ANALYSIS

I. Welfare Analysis

• The welfare impact of efficient pricing of residential water supply is seen to be welfare increasing in aggregate, however the distribution of gains and losses is unfavourable to low income groups.
• Risk aversity in the agricultural sector has been shown to exist. Welfare effects of efficient pricing policy should be further examined for impacts on variability and risk for producer groups reliant on the resource.

II. Market Failures and Missing Markets: Environment and Sustainability

• Demand for environmental services exists, hence it should be considered and integrated in resource allocation decisions. In order for regional benefits to influence the resource allocation will require a transfer mechanism: e.g. EU, Global Environment Facility, or strict adherence to EU environmental directives.
• To maintain water flows for sustainable wetland management, demands for water from traditional economic sectors can be constrained to levels to allow residual flows for environmental services, by using price and knowledge of the PED.
• Missing markets arising from the conjoined nature of surface and groundwater in the Kouris catchment must be considered further in developing an allocation policy.

III. Institutional and Legal Analysis:

Table 4.8 summarises the broad findings of the institutional and legal analysis of Cyprus.

Table 4.8. Institutional and Legal Analysis: Summary

POLICY RECOMMENDATIONS

The study has focussed on pricing as the allocation mechanism to effect the efficient allocation of water resources between competing sectors, between surface and groundwater and over time. The policy recommendations that emerge from the analysis integrate the hydrological, economic and legal aspects of the project, and can be summarised as follows:

• Water resources should be priced at the Marginal Social Cost as described in the summary of Stage 1 part II of the methodology.
• Allocation policies should consider the following 3 issues either through the pricing structure itself or through additional mitigating policies:
  1. The adverse effects on the distribution of welfare among water users demonstrated in Stage 2 of the methodology.
  2. The risk preferences held by water users which have been demonstrated for the Agricultural sector.
  3. The environmental externalities arising from demands for wetlands and other environmental resources that exist external to the watershed areas in question.
  4. Missing markets and externalities arising from the conjoined nature of surface and groundwater demonstrated for the Kouris watershed.

These largely economic policy recommendations should be supplemented by the recommendations from the institutional and legal analysis:

• The fragmented nature of water institutions and responsibilities in Cyprus must be addressed
• The piecemeal nature of Cypriot water legislation must be addressed both for the purposes of monitoring and facilitating the desirable water allocations and for harmonisation with the Water Framework Directive.