Beyond the Drought: Water Allocation in the UK

Posted on May 1, 2012 by Adam Bailey

Water allocation in the UK needs reform.   Current arrangements rely too much on administrative controls – such as hosepipe bans – and not enough on prices.

There is said to be a drought in much of southern and eastern England.  In reality, there are challenges arising from the combination of:

  • A long period of below-normal rainfall;
  • The water requirements of a dense population and its economic activities;
  • The need to protect freshwater environments;
  • Inadequate water allocation arrangements.

A return to more normal rainfall will probably ease the situation.  But in the longer term, population growth and climate change may lead to much severer challenges.

Water allocation comprises the taking (abstraction) of water from rivers, groundwater, etc., and its distribution to users.  In England and Wales the Environment Agency controls abstraction via a licensing system.  About half of total abstraction is by water companies, which distribute treated water to households and other users.  Electricity generators, other industries and fish farms abstract large quantities of water for their own use.  The Cave Review, the Walker Review and a recent White Paper have recognised the inflexibility and inefficiency of current allocation arrangements.

Addressing Over-Abstraction

Most abstraction rights are under old licences granted in perpetuity (1). The case for treating them as property rights is strong.   But action is needed where over-abstraction results in water scarcity or harms the environment.  Currently there is a lengthy administrative process to decide which abstractors will lose rights (2). Losers are then paid compensation. To minimise compensation costs and ensure that rights are retained by abstractors who value them most, the Cave Review proposes instead the use of reverse auctions.  Abstractors would offer prices to give up rights, and those offering the lowest prices would lose their rights and receive compensation at their offered price (3).

However, retention of rights by abstractors who value them most is only one aspect of efficient water allocation.  The marginal value of water to an abstractor will fall as the volume it abstracts increases.  For efficient allocation, the marginal value to each abstractor (from the same river, etc) should be the same.  The obvious way to achieve this is a volume-related scarcity charge (in other words, a price).  To counter the objection that this would be an unacceptable attenuation of property rights, such a charge could be combined with fixed compensation payments.  The Cave Review presents scarcity charges as a last resort where over-abstraction cannot be addressed in other ways (4).  Instead, they should be promoted as both an economically efficient and a lower cost solution.

Managing Household Demand

Only 37% of households have a water meter (5).  Most households pay on a basis unrelated to use, with no incentive to use water efficiently.  Unable to adjust charges to moderate demand when water is scarce, water companies have little choice but to rely on administrative measures such as the current hosepipe bans.

Extending metering involves installation and other costs.  To minimise these, the Walker Review recommends a more systematic approach to meter installation, rather than – as largely happens at present – reacting to requests from individual households (6).  With universal metering, water companies could charge all households on a volume-related basis, and set higher charges in summer when water is usually scarcer.

The efficiency of allocation could be further enhanced, and hosepipe bans avoided altogether, if charges per volume were quickly adjustable in response to supply circumstances.  This could be achieved with the use of smart meters, transmitting frequent readings, together with appropriate policies by the regulator, OFWAT. The Walker Review acknowledges the potential of smart meters, and sensibly recommends coordination between water, gas and electricity companies to exploit any available synergies (7).  Would it perhaps be advantageous to leap a technological generation, rolling out smart meters as quickly as possible and discontinuing the installation of further non-smart meters?

Conclusion

The two reviews and the White Paper move debate in broadly the right direction.  The case for using prices to make water allocation more flexible and efficient could however be made more strongly.  This is not to advocate laissez-faire.  The state and its agencies have essential roles in protecting the environment, ensuring the quality of drinking water, and protecting consumers where suppliers have a local monopoly.  Also important is their role in establishing the pre-conditions for allocation by prices such as metering and a suitable legal framework.

References

1.  Anglian Water & Frontier Economics 2011  A Right to Water?  p 18    http://www.anglianwater.co.uk/_assets/media/a-right-to-water-full-report.pdf

2.  DEFRA White Paper 2011  Water for Life p 41       http://www.official-documents.gov.uk/document/cm82/8230/8230.pdf

3.  Cave, M  2009  Independent Review of Competition and Innovation in Water Markets  p 33     http://archive.defra.gov.uk/environment/quality/water/industry/cavereview/documents/cavereview-finalreport.pdf

4.  Cave, as above  p 116

5.  DEFRA, as above  p 51

6.  Walker, A  2009  Independent Review of Charging for Household Water and Sewerage Services  p 78     http://www.defra.gov.uk/publications/files/pb13336-walker-water-review-091205.pdf

7.  Walker, as above  p 81

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A Key Text on Water

Posted on April 4, 2012 by Adam Bailey

Some thoughts from an economic perspective on  Water for Food: Water for Life: A Comprehensive Assessment of Water Management in Agriculture (1)

The publication of this book in 2007 was an important event in the field of water resources management.  The outcome of a research programme by the International Water Management Institute (IWMI), its claim to be comprehensive is justified in many ways including:

  • recognition of the legitimate claims on scarce water supplies of agriculture and of the natural environment;
  • regard for political and institutional as well as scientific and technical considerations in water management;
  • a global perspective, drawing examples from many countries and different climate zones;
  • consideration of gender issues in water use and management.

The book contains much careful analysis, and the occasional strong judgment – as on p 197 where progress in reforming water management policies and institutions is described as “embarrassingly bad”.  It is not light reading, but the reader is helped by overviews at the start of each chapter, and by many well-chosen tables, charts, maps and illustrations, all in colour.  An annoying omission, when using the book for reference, is the lack of an index.  At the beginning is a 37-page Summary for Decision Makers, also available as a free download on the IWMI website (2).

The book’s conclusions are wide-ranging.  Here is a small personal selection:

  1. In its projections to 2050, there are as might be expected various scenarios relating to crop yields, areas under cultivation, and irrigation, but also (pp 119-126) a “trade scenario” with increased food production in water-abundant countries supporting higher exports to those where water is scarce.  Trade can make an important contribution to the alleviation of water scarcity.  For example, it is stated (p 122) that global demand for irrigation water in 1995 would have been 11% higher, had it not been for trade in cereals.
  2. The importance of rainfed agriculture is emphasised (pp 316-347).  There is huge potential for environmentally-friendly and relatively low-cost productivity improvements in rainfed agriculture through improved soil conservation techniques and small-scale supplemental irrigation.
  3. A chapter on water and livestock (pp 485-511) explains why many poor people keep animals and why they may be rational in doing so.  I incline to the view that large-scale meat production is a wasteful use of resources, but this gave me pause for thought.  It seems for example that little is known about water productivity in livestock production (pp 507-508).

Although the book refers sometimes to economic considerations, it does not pretend to be a work of economics.  It would however provide valuable background for anyone studying or researching water from a natural resource economics perspective.  To an economist, the book’s use of the term “water scarcity” appears a little odd.  Its definition (p 62) brings together three elements: whether people in an area can access sufficient water to meet their needs (including food production as well as drinking and washing), whether the water is affordable to them, and whether sufficient water is left over for minimum environmental requirements.  But a lack of consistency is apparent when a map of areas of water scarcity (p 63) refers not to “need” but to “demand”.  That there are major problems regarding human access to water and environmental degradation in many parts of the world is not in question.  But needs are often flexible, as the cereal trade example illustrates.  Affordability is a matter of degree reflecting the other claims on a person’s income.  And the assessment of environmental requirements inevitably involves value judgments.  There is a need here to clarify concepts, and one essential element that is missing is the relationship between demand and price.

Overall, this is a very good book.  Five years on, its many statistics are slightly out of date, but its analyses and conclusions will surely remain of value for some time.  I do not know if the IWMI plans to issue an updated edition, or even to repeat the full underlying research programme (its website gives no indication in this respect).  But water is such a key resource that a regular assessment of this kind would be very worthwhile.

Notes and References

  1. Comprehensive Assessment of Water Management in Agriculture (2007)  Water for Food, Water for Life: A Comprehensive Assessment of Water Management in Agriculture  London: Earthscan, and Colombo: International Water Management Institute
  2. http://www.iwmi.cgiar.org/assessment/
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An Industry at a Tipping Point?

Posted on March 21, 2012 by Adam Bailey

Name an economic activity which will soon be overtaken by a more dynamic competitor based mainly in Asia?    Answer:  catching wild fish for food.

According to the FAO, “by 2012 more than 50% of global fish consumption will originate from aquaculture” (1).  Let’s look at the basis for this prediction.

The trends in global fish production are shown below, 2009 being the latest year for which figures are available.  These figures are compiled by the FAO from those supplied by individual countries, and are unlikely to be highly accurate, but the trends should be fairly reliable.  The message is clear: capture fishery production is no longer growing and may be beginning to decline, while aquaculture is growing rapidly.

                                               1980        1990        2000        2009

Capture fisheries         67            85             94             89
Aquaculture                     5            13             32             56
Total                                  72            98           126           145

Global Production of Fish, Shellfish and Molluscs 1980-2009 (Mt) (2)

Of the total 2009 production, 23 Mt was not for human consumption (3).  Most of this was used to produce fish meal and fish oil, and most was from capture fisheries (indeed, some was used as feed in aquaculture).  When this is allowed for the FAO prediction (which relates to human consumption, not production) can be seen to be plausible.

Why is this happening?  The limits on production from capture fisheries, arising from over-fishing and declining wild fish stocks, are well-known.  Perhaps less familiar are the innovations that have contributed to the growth of aquaculture.

Technological Innovation in Aquaculture

Much aquaculture is undertaken by small-scale commercial operations (4). The physical infrastructure for containing the fish and ensuring clean water with adequate oxygen, though sometimes sophisticated, is often low-tech (earthen ponds, brush parks).  However, three key innovations have been:

  1. Selection of fish species that feed low in the food chain, reducing requirements for fish meal and fish oil for feed production.
  2. Breeding of genetically improved species with higher yields.
  3. Establishment of hatcheries supplying young fish of many species, avoiding dependence on unreliable wild sources (5).

Other than cultural factors and consumer tastes influencing preferences for particular species, there seems to be no reason why these innovations could not be exploited on a large scale in many parts of the world.  However, it is in Asia that they have been most widely exploited to date.  Of the total fish production from aquaculture in 2009 of 56 Mt, 50 Mt was in Asia, of which 35 Mt was in China (6).

Some Implications for the Study of Economics

The growth of aquaculture is an interesting example in the context of the strong / weak sustainability debate (7). To a considerable degree, aquaculture substitutes non-natural assets such as man-made infrastructure and young fish from hatcheries for natural fisheries.  To that extent it is consistent with the weak sustainability view that there is a high degree of substitutability between natural and non-natural assets.  However, aquaculture still requires natural resource inputs such as land and water, and at a global level its production to date is not substituting for but adding to that from capture fisheries.

The growth of aquaculture calls into question the relative prominence often given to fisheries within the study of natural resource economics.  A textbook I have used – Hartwick & Olewiler (8) – devoted no less than 130 out of 432 pages to fisheries.  Aquaculture received only a brief mention on one page.  Aquaculture now merits more attention within introductory natural resource economics, as a substitute for fisheries, and alongside agriculture as an activity using and influencing demand for land and water.

References

(1) FAO  http://www.fao.org/fishery/regional-aquaculture-reviews/reviews-2010/en/

(2) FAO Yearbook: Fishery and Aquaculture Statistics 2009
http://www.fao.org/fishery/publications/yearbooks/en  p xxii

(3) FAO Yearbook as above, p xvi

(4) FAO No. 1061/5  Regional Review On Status And Trends In Aquaculture Development In Asia-Pacific – 2010
http://www.fao.org/docrep/014/i2311e/i2311e.pdf   p iv

(5) FAO Fisheries and Aquaculture Circular as above, pp 33-37

(6) FAO Yearbook as above, pp 25-26

(7) For a simple explanation of strong and weak sustainability see http://www.sustainablemeasures.com/Training/Indicators/WeakStrg.html

(8) Hartwick J M & Olewiler N D, 2nd edn 1998  The Economics of Natural Resource Use   Addison Wesley

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The Price of Oil and the Price of Food

Posted on March 9, 2012 by Adam Bailey

The price of oil has long had an influence on the price of food.  The recent rapid expansion of biofuel production has made the relationship both more significant and more complex.

Effect of an Increase in the Price of Oil

Oil is a source of energy for mechanised agriculture and food processing, and an input in the production of pesticides.   An increase in the price of oil has a direct effect on the price of internationally-traded food commodities through its effects on production costs.

There is also an increasingly important indirect effect via the markets for those food crops which have alternative uses as biofuel feedstock.  Examples are corn (maize) and cane sugar, food crops now also used on a large scale to produce ethanol for use as a petrol substitute.  In the US, 40% of the corn crop is now used to produce ethanol (1).

Given free markets, two conditions are necessary for production of biofuels by profit-maximising farmers and processors:
1. The overall production cost of a unit of biofuel must be below the price of its energy-equivalent in oil.
2. The return from growing crops as biofuel feedstock must be at least as high as that from growing crops for human or animal consumption.
Whether these conditions are met at any particular time and place will depend on various circumstances including soil, climate, labour costs, processing capacity, and market conditions.  An IEA study in 2007 estimated Brazilian sugarcane-based ethanol to be competitive with oil, based on an oil price of $40-50 per barrel (2).  US corn-based ethanol, which costs more to produce, was not then competitive without subsidy, but is probably now competitive at the current oil price of c $120 per barrel.

A sustained increase in the price of oil will lead to:
a) an increase in the share of corn and sugarcane production used for biofuel production, with a corresponding reduction in the proportion used for human and animal consumption;
b) a shift in the pattern of cultivation towards growing crops suitable for biofuel production.
Thus there will be a reduction in food production and an increase in the price of food.  Admittedly, conflict between biofuel and food production can sometimes be mitigated by bringing more land into cultivation.  However, this is often precluded by the lower productivity of marginal land, water scarcity, or conflicts with forest conservation or urban requirements.

Effect of an Increase in the Price of Food

What of the converse – the influence of the price of food on the price of oil?  This used to be fairly small.  A sustained increase in the price of food encourages an expansion of agriculture, raising demand for agricultural inputs including oil.  This tends to increase the price of oil.  But the effect is small because scope for expansion of agriculture is limited and because the demand for oil for use in food production is only a fraction of the total demand for oil.

However, an increase in the price of food will also increase the relative profitability of growing corn for food.  This will lead some farmers to switch back from biofuel to food production.  Thus a food price shock would send the substitution process into reverse, reducing the supply of biofuels.  This would increase demand for oil, raising its price.

Should the possibility of such a reversal of substitution be viewed with concern?  In terms of food supply it seems benign.  Switching corn from biofuel production to food would dampen the initial increase in the price of food.  From an energy perspective, however, it represents a new risk factor, implying that poor harvests could drive up the price of oil.

References

(1) The Economist, 4th February 2012, p 27

(2) International Energy Agency, Energy Technology Essentials, Brief ETE02 January 2007 p 1  http://www.iea.org/techno/essentials2.pdf

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