Skip to main content.

3. Methodology

3.1 Cost benefit analysis and economic impact analysis

This report undertakes both a cost benefit analysis (CBA) and an economic impact analysis (EIA). These are different types of analysis:

  • A CBA measures whether we are better or worse off as a result of a particular decision. This is called a 'change in welfare', and is measured by combining all of the costs and all of the benefits into one equation. Where the answer is positive, we can say that society is, in aggregate, better off as a result of a decision. CBA uses techniques such as discounted cash flow analysis to make costs and benefits commensurate across different time periods.
  • EIA measures the change in activity in an economy as a result of a particular decision, rather than whether we are better off as a result of those changes. Thus a change in output or a change in value added (GDP) will contain an element of benefit, but will not all be a benefit. An EIA allows decision makers to understand how an economy will react, and to draw their own conclusions as to the desirability of those changes. For example a large increase in employment demand may not be desirable if demand cannot be met.

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 on-going operation). The 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.

3.2 Regional costs and benefits

Any new investment project, whether for irrigation, electricity generation or other productive activity, brings new money into the locality and impacts on local business patterns, manifested in increases in the volume of output, in income generated, and jobs created in the region. Appraisal of societal issues (such as allocation of public resources like water) usually employs cost benefit analysis (CBA), which focuses on the net effect on resource use efficiency and economic welfare (or wellbeing) brought about by the new project.

The outcome of a CBA is always dependent on the point of view from which the analysis is undertaken. When an individual undertakes a CBA they do not take into account effects that fall on other parties (externalities), and costs and benefits which are transferred to them from other parties (transfers) represent real gains. However as we take a wider view of the community whose welfare is of interest, distinguishing externalities and transfers becomes more important in establishing net outcomes.

SKM have undertaken a national CBA. This takes into account all changes to all parties affected in the country. Matters such as investment in new electricity generation are represented as changes in the investment profile and price of electricity generation, rather than a straight return through selling electricity. This is because at the national level the investment in new hydro-electricity generation on the Waitaki river transfers benefits from an alternative generation type to the new Waitaki hydro-electricity project, and the gain to the nation is the degree to which the specific project is cheaper than the alternative.

Regional interests, however, experience a change in welfare in a different way. They are less impacted by the change in generation profile, they receive only a share of some national benefit, and they regard transfers from outside the region as a real gain. Their experience of the costs and benefits is different, and it is important that these differences are understood and incorporated in any decision on the way water is allocated from the resource.

3.2.1 Components of a regional analysis

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. This is relatively straight-forward for economic impact analysis, because the regional input-output model is designed to trace how activities in the region give rise to further rounds of spending in, and leakage from, the target region. It is less straightforward in the case of cost benefit analysis that estimates effects on economic welfare, because there is no inherent process in such analysis for identifying welfare flows into, and out of, the region.

A very important consideration is the question of how we define a community. The reality is that an entity which has property in an area, which employs people locally, and which pays local taxes such as rates, is legitimately a member of the community. We cannot distinguish between these entities simply as a matter of degree, and therefore we include assets such as those owned by Meridian whose ownership is largely outside the region, as well as farms and processing companies which may also be partly or wholly externally owned. The alternative approach of using ownership fails on the basis that it is neither practical nor consistent. The practical difficulties arise because of the mobility of labour, capital and owners - it would be extremely difficult to trace the residence of owners of the factors of production, particularly where part ownership occurs privately. Micro-tracing of ownership therefore rarely occurs unless it is the specific purpose of the study, such as assessments of foreign investment proposals.

This analysis focuses on businesses and consumers as representing the region affected by Waitaki water uses.. This also means that at the regional level, generation benefits need to be valued as output times unit price, because this revenue, net of costs, is capitalised into the value of generation property and determines its contribution to local community activities through rateable values.

3.2.2 Regionalising a national cost benefit analysis

To produce a regional cost benefit analysis consistent with the SKM national analysis, it is necessary to attribute the items within that analysis to the region or elsewhere according to whether they affect proprietary interests in the study area. Such attribution is outlined below. Recreational, tourism and social benefits were attributed in a qualitative sense. This exercise used only desktop material because of time constraints.

Benefits

  • investment avoided with New Hydro in place (ie the present value benefit of delaying investment in more costly alternative generation):
    • includes capital, operations and maintenance, incremental fuel cost
    • is assumed to occur entirely elsewhere in New Zealand and is excluded from the regional analysis
  • value of electricity produced by new use of water for generation: at a national level this is subsumed within the investment avoided item, as this is the opportunity cost of water diverted from hydro-generation; at a regional level the value of electricity needs to be estimated directly, as this is the benefit from the costs incurred in new generation investment
  • economy-wide benefits of reduced electricity charges (ie the reduction in price and increased consumption from having more low cost hydro-capacity in the market):
    • as calculated by SKM, these are very small - about 0.1% of the total benefits resulting from New Hydro
    • most of the benefit would accrue elsewhere in New Zealand
    • some benefit would be enjoyed by property-occupying consumers in the Waitaki region, in proportion to the region's share of electricity use; this is not publicly recorded, but the share of national business activity or population (1.9%) could be used as a proxy in the regional analysis
  • increased agricultural output from expanded irrigation:
    • equivalent to increase in net cash surplus from additional farm production for export
    • accrues to local farm businesses, and would raise capital value of properties in study area so is included in the regional analysis [Note SKM does not distinguish any welfare gain to processing or marketing activities associated with this increased output as this would require complex general equilibrium modelling to estimate fully. Ignoring such welfare gains would be justifiable if any such processing is insufficient to generate efficiency improvements, or if there is no significant processing within the region. The increase in capital value is not included in the analysis as this would result in double counting of the benefits.].

Costs

  • electricity investments with New Hydro installed:
    • capital expenditure, operations and maintenance of New Hydro: although expenditures originate from outside the region, they are enhancing the value of property within the Waitaki region, and hence contribute to the economic surplus for the region and have been included in the regional analysis
    • incremental transmission costs: costs accrue beyond the region and are not included in the regional analysis
    • reserve generation plant: costs (if any) accrue outside the region and have been excluded from the regional analysis
    • agricultural contraction on land acquired for hydro development: a reduction in land value to counter the increase in value from generation development, that accrues within the Waitaki region
    • on-farm mitigation infrastructure: these maintain the welfare of neighbouring farms against disruption, and are a distinct part of the cost of electricity generation that affects welfare within Waitaki region
    • operations and maintenance of mitigation infrastructure: as for mitigation infrastructure, these affect welfare in the Waitaki region.
  • irrigation development investment:
    • off-farm infrastructure: costs incurred from within the Waitaki region
    • on-farm infrastructure: costs incurred from within the Waitaki region
    • on-farm transitional effects: costs incurred from within the Waitaki region
    • operations and maintenance: costs incurred from within the Waitaki region
    • lost generation capacity: reduces value of existing dams in the region so is included in the regional analysis; this lost generation also affects power price elsewhere, but by negligible amount.

Key differences

The principal differences between a national and a regional cost benefit analysis in the Waitaki water case are therefore:

  • value of new generation capacity:
    • in a regional analysis this is the difference between the revenue stream from new generation within the Waitaki region, and the costs incurred in the region in providing that revenue. We have used the wholesale price series at Benmore developed by Concept Consulting (February, 2004) to represent the stream of benefits from new generation capacity
    • in a national analysis this is the difference between the investment cost incurred across New Zealand if New Hydro proceeds in the Waitaki Catchment, and the avoided additional investments in higher cost generation capacity that would be necessary to meet future demand in the absence of the hydro-electricity project in the Waitaki Catchment
  • only a fraction of the economy-wide gain from reduced power prices accrues as a benefit in Waitaki region: in this analysis 1.9% of the national estimate is attributed to Waitaki, in proportion to its share of national population.

For the sake of clarity in understanding the results, we have provided the results as a breakdown of the costs and benefits at the national and regional level using this approach, but also give a breakdown of the regional costs and benefits to different subgroups in the community - the general community, primary production sector and the energy sector.

3.2.3 Modifying the SKM model from a regional perspective

The SKM model was obtained and modification made to accommodate the attribution of the costs and benefits into regional and national impact. Where possible the base format has been retained, and the model analytical process is entirely consistent with the SKM approach. As such the national results reported in this study are the same results SKM would report using the same assumptions. However some alterations have been made which mean the national results differ from those in the SKM report. These are:

  • some minor changes to SKM's assumptions in regard to gross margins, capital costs of transition, water use, on-farm infrastructure costs and land use mixes. Changes were kept to a minimum, and only made where information came to light in the course of our research which indicated that changes were required. The changes to the SKM assumptions are detailed in Appendix B
  • some changes to the model approach used by SKM in their draft report (March 2004). These include altering the stream of electricity generation opportunity costs to reflect the uptake of the irrigation water [Modelled by matching it to the stream of capital expenditure], and matching the electricity losses from New Hydro to the profile of generation installation. SKM use the same approach in their final report (November 2004).

The model develops both regional and national costs and benefits, and stratifies the costs and benefits by sector to allow the information to be incorporated in the model of the regional economy as outlined above.

Individual interviews were undertaken with 19 farmers covering a range of land uses and geographic distribution, and including both dryland and irrigated properties. These interviews involved a general discussion of farming practice, followed by a detailed analysis of accounts [Or a modal budget where accounts were not available] to identify the sectoral and geographic nature of each item of income and expenditure. This data was aggregated into a grazing, arable and dairy budget, using weightings to reflect the geographic and land use spread in the aggregated budgets. Development budgets were stratified in the same way using case studies of actual on-farm development, and using local consultant experience.

The model was altered to report results at the national and regional levels, and by groups within the region. Within the region we report results at the level of the general community (no specific sector), primary production and energy.

The net present values of the different scenarios are calculated using two discount rates: 7.5% real pre-tax discount rate, consistent with that used in the SKM model; and 10% real before tax, in accord with long-standing Treasury practice.

3.3 Economic impact modelling

3.3.1 Regionalising an economic impact analysis

Economic impact analysis is generally based on an input-output model of the economy under study. Such a model describes the interrelationships between sectors within the economy and the relationships of these sectors to economic activities outside the economy of interest. The economy being studied may range in size from the national economy down to a single city or some entity even smaller (subject to reliability of data). Using a matrix or tabular format, it can be shown how the outputs from each sector of the economy are distributed among other sectors of the economy, and the portion that flows out of the economy. In addition, it shows how each sector procures its production inputs from the other sectors within the economy, and from outside the economy.

The essence of the input-output analysis is a set of accounts representing the transactions among the sectors being considered. Given this basic accounting framework, input-output analysis can estimate the impacts of various changes on the economy of interest together with the analysis of the effects of resource constraints, labour and capital requirements, economic multipliers, and a variety of similar areas of analysis.

Regionalising an input-output model has two principal stages:

  • creating a model of input-output relationships in the region of interest, usually by 'downsizing' a national model according to the relative size of different sectors in the regional economy, as indicated by sectoral employment or output figures
  • improving on the generalised input-output model to allow for spending and productivity characteristics specific to the impacts being investigated.

In the Waitaki study, the first point is addressed by constructing an inter-industry model of a regional economy comprising the four territorial authorities of Waimate, Waitaki, Mackenzie and Timaru [Further disaggregation to smaller sub-regions or TLA areas is fraught by problems with limited data, and the complete absence of a statistical basis for assessing the flows of inputs and outputs between these sub-regions.]. The second point is addressed by seeking advice from a variety of sources about the expenditure implied by different scenarios, and its likely sourcing within and outside the Waitaki region.

3.3.2 High regional development scenario

In the course of initial consultation on the project, it became clear that regional stakeholders were concerned about the extent to which allocation decisions would foreclose future options for them. This reflects a concern that while we may base a decision on the best information available now, there is no way of telling what will happen in the future. The particular concern among the regional stakeholders was that the SKM analysis does not take account of the potential options that irrigation development offers for a region. This includes the potential to develop a range of downstream processing and value chain initiatives, and the potential new uses for the irrigated land that are not currently considered feasible or realistic. In this latter context the vineyard development in Marlborough is cited as something which could not have been foreseen 20 years ago. Countering this to some extent, much primary product processing exhibits strong economies of scale and there is no guarantee that any new processing will take place within the local economy. The place of options and high value development in the context of the analysis, therefore, requires some careful thought, together with the institutional reforms which would allow their real world development.

To address these concerns this analysis has developed a 'what if" scenario of regional development. This aims to demonstrate the potential offered by irrigation to the region to develop high value land uses and other added value processing. The SKM model does not lend itself to staged development such as would be required to incorporate a subsequent move from low value irrigated land use to high value options in future years. However the model has been altered to incorporate a separate scenario which addresses the impact on the region of a future high value development scenario. This scenario allows us to calculate the annual outcomes from such a development and overall impact on the regional economy. This scenario has not been assessed in a cost-benefit sense, because of the difficulties in accommodating two transition states within the model. However it does allow decision makers to understand the magnitude of the regional impacts of such a future development scenario. The assumptions used in the high regional development scenario are detailed in Appendix C. Note that we make no judgement regarding the likelihood of the scenario occurring, merely that the results are those which would be derived if the land use mix and returns were as assumed.

3.3.3 Constructing an input-output model of the Waitaki economy

The essence of the input-output schema is a set of accounts representing the transactions among the sectors being considered. Given this basic accounting framework, input-output analysis can be used to estimate the impacts of various changes on the economy of interest together with the analysis of the effects of resource constraints, labour and capital requirements, economic multipliers, and a variety of similar areas of analysis. It is therefore useful to give an indication of the likely consequences, both for the entire economy and across the individual sectors, of a major injection of activity into a regional economy, such as that provided by construction and operation of a new hydro-generation plant, or by the lift in agricultural production enabled by a new irrigation scheme. More detailed discussion of the construction of the regional model is given in Appendix F.

3.3.4 Attribution of expenditures inside and outside the Waitaki region

Attribution of expenditure on energy inside and outside the Waitaki region was made with reference to information provided by Meridian Energy Ltd and its own assessment of the proportions spent within the North Otago/South Canterbury region (58%), that spent elsewhere in New Zealand (10%), and that spent on imported goods and services (32%). This information also provided a breakdown of spending across different sectors. These within-region proportions were then applied to a profile of capital investment on Project Aqua from 2006 to 2012 (drawn from the SKM model modified for the regional analysis), to derive local sectoral spending within the region brought about by a scheme like Project Aqua.

Attribution of expenditures on off-farm irrigation inside and outside the region was made with reference to costing information for various schemes, and with discussion with some of the scheme proponents on the source of purchases made, suggesting a roughly equal split between equipment purchases from outside the region (eg on pipes, screens and so on) and expenditures made within the region (eg on construction and ancillary works). Applying this and a broad breakdown of type of expenditure to a profile of capital costs under different irrigation scenarios (drawn from the SKM model modified for this analysis) provided estimates of direct impacts from the different irrigation scenarios.

Because economic impact analysis depends on the expenditures incurred with each option rather than on the surpluses generated by each one, there is no direct way in an input-output model to allow for the investments in one option encroaching on another. For instance, input-output models do not show the price impacts that may arise if demand for construction staff by both irrigation and hydro-works should coincide and raise the cost of labour in the locality. Nor are they dynamic, in the sense of showing how increased profits in one year flow through to enhanced expenditure in subsequent years.

The forward impact profiles are therefore a combination of the separate scheme proponents' expectations of their own schemes, regardless of the extent to which each scheme is affected by other schemes at the same time. Unlike the cost benefit analysis, in which water abstracted for irrigation can have a negative effect on generation potential, input-output models do not show any 'crowding out' of one investment by another. The practical implication of this is that impact estimates are likely to be at the top end of likely impacts for the region, because they conceal the extent to which individual schemes may be reduced because of resource constraints and price effects that change their economic viability. They also conceal the extent to which local resource scarcities are met by bringing resources in from outside the region, increasing the amount of 'leakage' associated with the scheme.

3.4 Social impacts

Different water allocations and development scenarios will have different impacts on parts of the community. The scope of the study and timing of the study did not allow for any detailed analysis of social impacts, and this part of the study is therefore somewhat restricted compared with the ideal. Taylor Baines and Associates have used information compiled from previous studies on development in rural communities to understand the implications of hydro and irrigation development on demographic and social changes in local communities. This was combined with the data on land use change, business structure and employment changes generated through the regional modelling to detail the likely nature of change in these communities.

[ | ]