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Regional Economic Analysis - Uses of Water in the Waitaki Catchment

Acknowledgements

Executive summary

1. Background

2. Study objectives

3. Methodology

4. Cost benefit results

5. Regional economic impact results

6. Conclusion

7. Bibliography

8. List of interviewees and other contacts

Appendix A Technical discussion of the differences between CBA and EIA

Appendix B Agricultural assumptions used - base case

Appendix C Agricultural Assumptions Used - High Regional Development Scenario

Appendix D Regional economic model results

Appendix E Economic results sensitivity testing

Appendix F Methodology for regional economic impact analysis

Executive summary

1. This report extends the National Cost Benefit Analysis of Proposals to Take Water from the Waitaki River by Sinclair Knight Merz (SKM 2004). In this report, we seek to understand how the regional benefits and costs differ from the national costs and benefits and to understand matters such as distributional impacts of the costs and benefits, including social impacts.

2. The report describes analysis of various allocation scenarios for water from the Waitaki River, from the region's point of view. The region is defined as North Otago and South Canterbury, covering the Waitaki District Council, Waimate District Council, Mackenzie District Council and Timaru District Council areas. The report comprises regional cost benefit analysis (is the allocation efficient?) and a regional economic impact analysis (how does the regional economy change?). The report is intended to be read in conjunction with the National Cost Benefit Analysis (SKM, 2004), and should not be viewed as a stand alone document.

3. This report therefore combines two separate, but complementary, types of economic analysis. The cost benefit analysis compares the stream of benefits and costs that are expected to flow from the different scenarios under consideration over a 30 year time period, discounting effects in different years to arrive at a net present value (NPV) for each scenario. In comparison, the economic impact analysis traces the effects of new activity (irrigation and/or new hydro-electricity development) through a model that provides static snapshots of the local economy at different phases in each scenario (eg construction and ongoing operation). The economic impact analysis provides estimates for the regional economy of changes in gross output (ie the value of new production), value added (gross output less the value of inputs consumed) and consequent effects on employment. Net present value, which seeks to identify the scenario that maximises the worth derived from water over a period of years, is not the same as value added, which identifies the maximum productive value at specific points in time. The two types of analysis may point to different scenarios as being the most preferred, depending on whether efficiency (NPV) or locally distributed impacts are the primary consideration.

4. The SKM model was revised to reflect regional as well as national outcomes. Some minor changes were made to assumptions and the way in which the model estimates some parameters. It was run under the set of seven irrigation scenarios used by SKM, with and without the installation of new hydro-electricity development on the lower Waitaki (modelled on the former proposals for Project Aqua). SKM developed the scenarios based on resource consent applications that were current in late 2003. In the case of the New Hydro scenario, the example costs and benefits were based on the costs and impact stream generated during investigation of Project Aqua. As Project Aqua is no longer proceeding it is likely that the final format of any hydro development will be different from that of Project Aqua. The New Hydro scenario should therefore be considered an example of a hydro scheme, rather than a definitive case of how hydro-electricity capacity would develop in the Waitaki Catchment.

5. The analysis tests the sensitivity of its results to changes in key assumptions. It also illustrates the potential offered by irrigation to the region to develop high value land uses (for instance more horticulture and seed crops and less grazing) and other added value processing through an additional 'high agricultural output' scenario. This latter scenario has not been assessed in a cost-benefit sense in the modified SKM model.

Economic impact analysis

6. The economic impact analysis tracks the changes in economic activity resulting from the injection of new activity from either new hydro development or new irrigation. These can be viewed in context against a regional economy (as defined for this study) that in 2003 produced $3.8 billion of output and $1.5 billion of value added, and was home to around 2% of the national population. Primary production and food processing together accounted for around 33% of the region's value added and employment. The utilities sector (predominantly electricity generation and distribution) accounted for around 3% of value added and 0.2% of employment, reflecting its greater capital intensity.

7. Changes in the study area economy as a result of the different scenarios assessed are shown in Table 1, Figure 1 and Figure 2 below. Table 1 shows the estimated changes in annual output, employment and value added in the peak year under each scenario (which varies between the different scenarios). The figures show the annual changes (peak and non-peak) tracked over time. Figure 1 excludes value added from the New Hydro generation, as this has little engagement in the local economy, and low employment impact after the construction phase. Figure 2 includes this value added from new generation to illustrate its relative scale.

Table 1. Input-output scenario analyses: Summary results of changes to the regional economy

Source: NZIER

8. The economic impact analysis shows significant change in the economy of the study area, given the limitations of assumptions and methodology used. Irrigation produces enduring change spread widely through the regional economy, with a relatively small boom during construction. Hydro development produces large impacts in the short term, but with little in the way of ongoing increase in economic activity outside the energy sector.

9. Of the irrigation scenarios, the 'All' irrigation scenario has the largest long run impacts. The New Hydro-only scenario more than matches the 'all irrigation' scenario in terms of economy-wide impact on value added. However, over 90% of New Hydro scenario's value added increase is a return on capital, which depending on ownership largely accrues to owners outside the region. To the extent that farm businesses are more likely to be owned by local residents, agricultural value added increases are more likely to be spent and re-spent in the local economy.

10. There are well-documented limitations in the economic impact methodology, because of its inability to distinguish real trade creation from trade diversion effects in the region. This makes the predicted level of impact likely to be higher than that which will actually occur, because high impacts will result in some resource input prices rising, increasing costs for, or drawing resources away from, other parts of the economy. Similarly, the methodology does not allow the tracking of impacts over time in Figure 1 and Figure 2 to reflect dynamic effects (eg. the dependence of particular years' activity on previous years' profitability) so these results cannot be compared to a discounted analysis. However, these limitations are common to all the options considered in this study, so the impact analysis is still informative of the relative outcome across the different scenarios.

11. The addition of a 'high agricultural output' scenario illustrates the potential offered by irrigation to the region to develop high value land-uses (for instance more horticulture and seed crops). Under this 'blue skies' scenario, the impacts from irrigation are significantly higher in the long term future beyond 2020 showing almost a 30% increase in value added (over and above the current situation) and a comparable 38% increase in employment. Such a scenario would imply profound changes in the local market for labour and other resources, with correspondingly higher offsetting impacts on other sectors.

Regional cost benefit analysis

12. A regional cost benefit analysis requires identifying not only what benefits and costs arise from different water uses in the Waitaki valley, but also where they are incurred. Regional effects have been defined for this study as those which enhance or restrict the income prospects (and value) of properties and individuals in the Waitaki region, including farms, residential and commercial premises. The key feature of this approach is that returns to both energy and farming have been included in the analysis, regardless of where they are owned. In effect we have regarded the owners of energy assets, new and existing, as members of the community because they have assets there, employ people, and pay property taxes (rates) in the same way that any other business entity does in the region.

13. There are limitations to cost benefit analysis, in that it gives an indication of the efficiency of resource allocation, but does not reflect the way in which the benefits from the development accrue as a result of ownership of the assets. It measures the benefits of increased production but not whether those benefits will stay in the region. Whether benefits stay in a region depends on ownership of assets. Cost benefit analysis is neutral over who owns the assets. Decision makers should refer to the economic impact analysis to understand the implications of the way in which the developments influence the wider regional economy.

14. The analysis has also revealed limitations in undertaking regional cost benefit analyses as opposed to national cost benefit analyses. Although there is a well established literature on conducting national cost benefit analyses, there are few precedents for regional cost benefit analyses except in the case of investment appraisal for local government bodies, which is a different context from that considered here. The results below show that although numbers derived may differ between the national and regional levels, the rank ordering of preferences has not been altered by the use of a regional viewpoint.

15. Table 2 shows the outcome from the New Hydro scenario discounted at real rates of 7.5% (consistent with that used in the SKM national cost benefit analysis) and 10% (consistent with the Treasury's long-standing practice). The New Hydro scenario produces an additional net present value (NPV) of $904m at a discount rate of 7.5% and $426m at a discount rate of 10% relative to the status quo in a regional analysis.

Table 2. Net present value of New Hydro, (30 year period of analysis) ($million)

16. Table 3 shows the outcomes of irrigation when no new hydro generation capacity has been installed. It shows that at a 7.5% discount rate irrigation scenarios mostly produce a positive NPV on a regional basis with a maximum positive value of $111 million. The irrigation scenarios show substantial gains to primary production in the region, but this is offset by large costs in terms of lost energy production. However at 10% the values are almost all negative, with some primary production values negative even before the energy losses are included (Table 4).

Table 3. Net present value of irrigation with New Hydro not installed (7.5% discount rate, 30 year period of analysis) ($million)

View net present value of irrigation with New Hydro not installed (7.5% discount rate, 30 year period of analysis) (large table)

Table 4. Net present value of irrigation with New Hydro not installed (10% discount rate, 30 year period of analysis) ($million)

View net present value of irrigation with New Hydro not installed (10% discount rate, 30 year period of analysis) (large table)

17. Table 5 and Table 6 outline a similar analysis to Table 3 and 4, but this time with New Hydro installed together with the irrigation schemes. In order for an irrigation option to add value the combined outcome must have a higher NPV than that of New Hydro alone because New Hydro is also contributing to the outcomes. To show this more clearly the New Hydro results have been subtracted from the irrigation scenario results. The resulting Net Regional Outcomes show that without integration the irrigation does not add value nationally or regionally in the presence of New Hydro. Only the scenario where irrigation is integrated with New Hydro produces a NPV greater than the outcome with New Hydro alone, and this only at a 7.5% discount rate.

Table 5. Net present value of options with New Hydro installed (7.5% discount rate, 30 year period of analysis) ($million) (irrigation minus New Hydro outcome)

View net present value of options with New Hydro installed (large table)

Table 6. Net present value of options with New Hydro installed (10% discount rate, 30 year period of analysis) ($million) (irrigation minus New Hydro outcome)

View Net present value of options with New Hydro installed (large table)

18. Sensitivity testing for the discount rate and the assumptions of agricultural production (Table 7) indicates that the New Hydro outcomes are positive at the regional level under all the changes made. The table shows the absolute level of outcome of each scenario, not the movement relative to the results under the core set of assumptions. The sensitivity results should be qualified with the comment that the final costs of the New Hydro scheme may be higher even than the +50% tested in this report. The net present values of the irrigation options are very sensitive to assumptions about agricultural gross margins and discount rate applied.

Table 7. Summary of regional outcomes with changes to assumptions

View summary of regional outcomes with changes to assumptions (large table)

Social and environment impacts

19. Both irrigation and hydro have significant environmental and social impacts. The regional impact of these is shown in Table 8 below.

Table 8. Summary of regional implications of social and environmental impacts

Adapted from SKM (2004)

Summary

20. Regional analyses require different components to inform different resource use objectives: cost benefit analysis to indicate relative efficiency of resource use options, economic impact analysis to illustrate likely spread of new activities, and environmental/social impact assessment to inform on effects on community wellbeing that cannot readily be assessed through monetary measures. The different analyses' approaches will not necessarily point to the same preference ordering amongst the potential options: the option that creates the most jobs may not be the most valuable or efficient.

21. In these circumstances the choice between options can be informed by comparing each option's relative performance under each type of analysis. This allows explicit comparison of the relative weight to be given to each criterion - efficiency, distributional impact, and environmental effect - and the trade-offs to be made in the decisions that are made between the achievement of each one.

22. This study has revealed limitations in both cost benefit analysis and economic impact analysis in addressing the question of how best, from a regional perspective, to allocate and use water. As these limitations are common to all the options examined here, the results can be considered more indicative of the relative ranking of different options than of the absolute levels that any particular option is likely to realise.

23. Results from the economic impact analysis indicate significant change in the economy of the study area. Irrigation produces enduring changes felt widely across the regional economy, with a relatively small boom during construction. Hydro development produces large impacts in the short term, but with little in the way of ongoing increase in economic activity outside the energy sector.

24. In terms of economy-wide impact on value added, the New Hydro-only scenario more than matches the All irrigation scenario. However, more than 90% of the New Hydro scenario's value added increase is a return on capital, which, depending on ownership, is likely to accrue to owners outside the region. To the extent that farm businesses are more likely to be owned by local residents, agricultural value added increases are more likely to be spent and re-spent in the local economy.

25. The regional cost benefit results make no assumptions as to whether the benefits stay in the region, which is to a large extent dependent on ownership. Given that caveat, New Hydro shows a large positive outcome in the regional cost benefit analysis under those items quantified, and the positive nature of this outcome appears relatively insensitive to the assumptions used. However New Hydro has a number of negative unquantified outcomes. Of these:

• The environmental outcomes are negative and mostly national, with significant regional impacts such as lowering groundwater tables alongside the river, flooding and erosion changes.
• The recreational impacts are mixed, but there are a number of negatives which are disproportionately borne by the regional community, because of limited substitutes available at the local level.
• The social impacts are significant and negative and are all borne by the regional community. Employment impacts will occur during construction with some benefit to the local economy. Population effects associated with this employment will be short term and may cause more complications than benefits for the host community and their social services in the absence of mitigation measures to accompany the new hydro development.
• The economic impacts are primarily value added through energy, with limited engagement in the regional economy, and very limited employment creation. Economic impacts in the construction phase are significant but not enduring.

26. The quantified irrigation regional outcomes are largely positive at the lower discount rates in the without-New Hydro scenarios. However when New Hydro is added to the system, the quantified results become largely negative because of the additional costs of the hydro generation system losing access to the water. The irrigation takes also produce some unquantified outcomes. Of these:

• The environmental outcomes are mixed, with some positives in terms of soil erosion, but negatives in terms of water quality, landscape and potentially some impacts on the braided river ecosystems. These impacts are of mixed national and regional incidence.
• The recreational outcomes are largely neutral, and those impacts which do occur are of mixed regional and national incidence, with some bias toward regional.
• The social outcomes are significant and positive, although there are some short term impacts such as community structure changes and management of change strategies may be required at the regional and local levels. These benefits are all experienced regionally.
• The impacts on the regional economy are significant and ongoing. Employment creation is expected to be significant, and the economy is expected to be larger and possibly more diverse post development.

27. The analysis at the regional level presents a contrast of two types of proposal. The New Hydro scenario is a robust proposal in terms of the monetary cost benefit analysis outcomes but has some negative social, recreational and environmental impacts and limited regional economic impacts. The irrigation proposals are more marginal in terms of monetary cost benefit outcomes because they are very sensitive to assumptions, and while they have some environmental impacts, there are significant and positive social impacts in the region and significant and ongoing regional economic impacts in terms of changes to the regional economy's size and structure.

28. A key point is the fact that the irrigation proposals are viable without New Hydro but not with New Hydro at the lower discount rates. So crucial considerations from a regional perspective are whether New Hydro is likely to proceed in the near future, and what form it will take, as this will determine the size of the net benefit (or cost) of irrigation takes.

29. If New Hydro is not to proceed then from a regional point of view allocation to irrigation is desirable in most respects with a 7.5% discount rate, but not at 10% discount rate.If a New Hydro project were to proceed, allocation to irrigation becomes less desirable in terms of monetary cost benefit outcomes apart from the integrated proposals. However irrigation has positive regional social and economic impacts.

Further research

30. These outcomes are predicated on the New Hydro scenario being based on a Project Aqua type development as proposed. Given that Aqua did not proceed, it can be inferred that the costings used here are unrealistically low. If smaller projects at this location were viable in future the opportunity costs of competing takes would be lower and the combined energy project/irrigation allocations would be more attractive. Further analysis could be undertaken of smaller hydro projects to assess their feasible scale and impact on the combined irrigation/hydro development scenarios.

31. The irrigation demands from above Tekapo (based on the Aoraki Water Trust proposal) are based on demand modelling, and use water at approximately 60% of the rate per unit area as used for the other schemes in the modelled scenarios. Independent demand modelling could be undertaken for three generic areas (South Canterbury, Mackenzie and North Otago) to develop more accurate estimates of irrigation requirements for other schemes so that irrigation demand was treated on a more consistent basis across all schemes.

32. More detailed area-specific social impact assessments would also help to better understand the nature of the social changes likely to occur with irrigation development.

33. There are limitations in the estimates of energy losses associated with irrigation takes in both the national and regional studies. The underlying model does not incorporate the seasonality of takes, their association with seasonality of energy prices, and the consequent variation in national costs of any energy losses. Consideration of flows at time steps which are finer than the annual level, and include irrigation demand modelling, would help further describe the magnitude of energy losses associated with irrigation.