IWA International Conference on
Water Economics, Statistics, and Finance
Rethymno, Greece, 8-10 July 2005
The economic value of water and the EU Water Framework
Directive: how managed in practice?
I. Heinz*
* Institute of Environmental Research (INFU), University of Dortmund, Germany,
(E-mail: iheinz@infu.uni-dortmund.de
Abstract
The following text gives an overview of currently existing concepts discussed in the context of
the cost recovery principle. The contribution will be based on the paper, that deals with similar
issues, which has been prepared for the Second International Workshop on Implementing
Economic Analysis in the Water Framework Directive, on 17-18 February 2005 in Paris
(organised by the Seine-Normandy Water Agency and the DG Environment of the European
Commission). The results of the analysis and conclusions outlined here should be further
substantiated on the basis of case studies. This work is ongoing.
Keywords
Water Framework Directive, cost recovery, water pricing, environmental costs, resource costs
INTRODUCTION
According to Article 9 of the EU Water Framework Directive (WFD) the financial costs, environmental
costs and resource costs should constitute the total costs of water services in the near future. However,
currently these cost categories are not sufficiently well-defined. In addition, there is a wide range of
methodological options for calculating the costs. This can lead to confusion in implementing the costrecovery principle. This contribution for the IWA Conference intends to highlight these problems by
exploring existing cost concepts. In particular, it aims to provide a better clarification of the costrecovery principle in the water sector.
The first section of the presentation will introduce the problems mentioned above. In the following
section, the cost definitions currently discussed, and the methodologies in assessing the cost-recovery,
will be analysed. Of special interest here is which cost categories are currently considered, and how they
are defined and calculated. Are the resource costs (e.g. charges on water abstractions) equated with the
environmental costs? The discussion of the cost recovery principle requires an analysis the different
compositions of charges levied for water services. The key question is which deviations between the
currently available concepts and the cost-recovery requirements of the WFD exist.
In the next section, the WFD cost categories will be examined using a case study. Of special relevance
are river basins (including pilot river basins), where these categories are being tested for compliance
with the WFD cost-recovery principle. Further case studies should be investigated. The discussion of the
various approaches has to consider the different definitions of the cost categories and calculation
methods. For instance, how are the environmental costs distinguished from the financial costs? Are there
overlaps between environmental costs and resource costs? Which methods are applied to estimate the
environmental costs (such as the contingent valuation method).
Conclusions are to be drawn regarding the possibilities of obtaining better distinction between the WFD
cost categories. Overlaps or mix-ups between the categories should be avoided as far as possible. Of
special significance will be the possibilities and limitations of applying the cost-recovery principle in
river basins. How far should the implementation of the cost-recovery principle in the EU Member States
be standardised? Are decision support systems, such as computer-based water management models,
helpful in finding the true economic value of water?
THE ECONOMIC VALUE OF WATER
Since the availability of water is limited and the provision of water services is costly, water has to be
assessed by an appropriate economic value. There is a large scientific literature dealing with various
methodologies to evaluate water in economic terms. The common insight is, that the use of water must
be charged according to the costs of water services that meet the requirements of the water users.
Otherwise, water resources would not be used efficiently and the incentives to improve continuously
water utilization would be too weak. In addition, the infrastructure needed to provide sufficiently the
required water services could not be installed and maintained. In the EU Water Framework Directive
(WFD) of October 2000, the principle of cost recovery in providing water services and water pricing
policies play a key role. The Guidance Document “Economics and the Environment. The
Implementation Challenge of the Water Framework Directive” contains advices how to perform the
appropriate economic evaluation of water services. In particular, different components of the economic
value of water according to Article 9 of the WFD are explained: financial costs, environmental and
resource costs. However, as the following-up documents produced by the infomal working groups DGECO2 have confirmed, there is a need for a better clarification of these different cost categories in terms
of definition and evaluation methodologies. Such a clarification could help to harmonise the approaches
undertaken in the EU member States in implementing the principle of cost recovery (including the
polluter pays principle) and the appropriate pricing policies.
DEFINITIONS AND EVALUATION METHODOLOGIES
A clear distinction between the financial costs, environmental and resource costs is difficult as there are
risks of overlap and even mix-up with the consequence of double counting. Those risks became apparent
already in the activities of the EU Member States to characterise the existing water uses, impacts and
pressures, and to analyse the economic implications of water use (according to the WFD Article 5). The
economic analysis of water use includes an assessment of the current levels of cost recovery. Although
the mentioned Guidance Document provides useful advices how to define and calculate the different
cost categories, a clear-cut procedure is lacking. Rather a range of possible approaches can be found.
Consequently, the procedures applied in the Member States distinguish sometimes considerably. This is
especially true with regard to the economic analysis in river basins. The application of different cost
definitions and calculation methods is documented, for instance, in the proceedings of the workshop
“Environmental and Resource Costs and the Water Framework Directive” on 26 March in Amsterdam
(Brouwer and Strosser, 2004). As the proceedings shows, the differentiation of the environmental and
resource costs from the financial costs plays only, if any, a minor role. Rather the contributions deal
mainly with the environmental costs. This may indicate that the definition and measurement of resource
costs cause special problems in contrast to the financial costs.
In the contribution “Practical experiences in Sweden” (Larsson, 2004), the environmental costs are
defined as costs of damage to the environment as a result of human activities. This can include damages
to ecosystems as well as health impacts. However, with regard to the tight time limit for the
characterisation requirements of the WFD (Article 5), as a temporary approach the actual and planned
expenditures for achieving existing environmental standards are used as a proxy for the environmental
costs. The assumption is that these expenditures are reflecting, to some extent, the society’s preferences
and the economic costs prevented by the standards. On the other hand, the overlap with financial costs is
obvious. As mentioned by the author, these preliminary estimates can be revised and replaced by more
rigorous estimates over time. More difficult is the calculation of resource costs as a more pragmatic
approach is not available. Resource costs can be caused by an inefficient water use in terms of
unnecessary economic losses (opportunity costs). These losses may be avoided by changing the
allocation of water use rights among the water users. As in the paper mentioned, in Sweden such
economic consideration have traditionally not been taken into account in, for instance, the granting of
abstraction rights. In addition, it is emphasized that the evaluation of the ressource costs requires
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information about the cost and benefits resulting from each of the different water uses. This can cause
further problems as the costs should consider also the environmental costs, and the benefits also the nonmonetarised benefits of water use (e.g. aquatic ecosystems in contrast to e.g. increased productivity in
agriculture). Here again, the risk of an overlap is apparent between environmental and ressource costs.
In another contribution to the workshop the resource costs are related to the current system for allocating
water resource abstraction licenses in England and Wales (Fisher, 2004). Inefficiencies in water
allocation are being caused by a system of hystorically granted abstraction licences in perpetuity and on
the “first come first” basis. However, currently some progress have been made with converting these
historical licenses into time limited licences. Furthermore, the potential benefits of trading abstraction
licencses to tackle the problem of inefficient water allocation have been analysed. With regard to the
environmental costs the author focuses on the environmental damage costs (such as health impacts from
poor water quality at bathing water, damage to ecosystems, impaired recreation values of waters) rather
than on the costs of controlling discharges and abstraction to meet good status. In this case, a clear
differentiation between the environmental costs and financial costs exists. As pointed out by the author,
there are considerable problems in measurements the control costs (that are usually used as a proxy for
the environmental costs) as well. Furthermore, it is argued that the measurement of the environmental
costs will be required anyway in deciding whether the costs of measures to achieve a good status are
disproportionate in relation to the economic value of the environmental damage prevented (according to
the WFD Article 4). Because of the uncertainties (also due to the limited information about the potential
reduction of environmental damage in the future), there is no reporting in 2004 on the current level of
cost recovery that includes the environmental costs.
In contrast to the previous contribution, in the paper of Beckers (2004) “Practical experiences in
Belgium” the environmental costs in the context of cost recovery are identified with the costs related to
environmental measures, which have already been taken and/or which are planned to be taken in the
future. Resource costs are limited to costs linked to the depletion (over-consumption) of resources, as
well in a qualitative as in a quantitative way. It is argued, that the term environmental costs in the WFD
Article 9 refers not necessarily to the environmental damage costs but to the control costs (already taken
or planned in the future). The different views between the workshop contributions indicate clearly the
uncertainties in interpreting, in particular, the components of cost recovery. Moreover, divergent
interpretations may also exist with regard to the cost effective programmes of measures. In Becker
(2004), the environmental costs in the context of Article 11 are identified exclusively with the control
costs, whereas other interpretations may also consider the environmental damage costs related to the
programme of measures.
In the contribution “Practical experiences in France”, with regard to the 2004 districts characterisation
the environmental costs of water services are being understood as control costs (avoidance costs, i.e.
investment and operational costs which communities have to pay over and above what they are already
paying in order to minimize pressures and impacts on the water environment by water services). These
costs include costs of treatment of the residual pollution in order to reduce this pressure, the costs of
pressure mitigation in order to rduce water withdrawals and the costs of impact mitigation such as cost
of bypasses for fish migration, river bed restoration costs, etc. (Fredefon and Laurans, 2004). This
interpretation refers to the additional costs required in order to meet good status. The costs of measures
already adopted do not count to the environmental costs. Referring to the Guidance Document this type
of costs are included in the financial costs (Annex IV.1.21). Counting them as environmental costs
would be doubling counting. Nevertheless, the environmental damage costs still are considered as being
important, and the need for further clarification of the different calculation methods and the
corresponding economic values is emphasized. As in the paper pointed out, some of the damages result
in technical monetary costs for water services that use the environment as a resource (e.g. when having
to treat polluted water prior to distribution) or for water uses (e.g. bathing prevented by pollution). In
addition, the environmental damages per se (i.e. non-use values) have to be considered as well. To
evaluate especially this type of damage and further non-monetarised impacts, the contingent valuation
method proves to be as an appropriate approach. It measures the willingness (WTP) of individuals or of
the society to pay for mitigation and prevenative measures. The author demonstrates the implementation
of cost recovery in the Seine-Normandie district as example. In this case, the environmental costs
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include the amount of the present actual environmental restoration expense (without pollution abatement
costs, because as financial costs they are already part of water service prices), a gross potential
contingent valuation of improving the quality of rivers (based upon existing British studies) and the
potential restoration costs of the environment (according to Annex IV.1.21 of the Guidance Document).
These values cannot be simply added up because they are complementary information. The restoration
measures and corresponding costs refer to damaged wetlands, dams disabling fish migration and
pollutions. The WTP for improving water quality of rivers in the district has been estimated roughly to
6-12 Euro per inhabitant per year. The estimate of the potential costs of tackling the major sources of
pollution and abating their pollution amounts to 26 Euro per inhabitant per year. As this paper shows
clearly, the preferences or social “demand” for good status are important information for evaluating the
environmental costs. Furthermore, it demonstrates the importance of incorporating the stakeholders
(such as consumers associations, representatives of municipal services operation and public bodies) in
discussing the implementation of cost recovery and water pricing policies.
There are follow-up documents produced by the informal working groups DG-ECO2 (Brouwer, 2004;
ECO2, 2004). Environmental costs are identified with the costs of preventing and mitigating damage,
and the costs of compensation for injured parties. However, this definition can lead to an overlap with
the financial costs, especially if the control costs already adopted will be included. Consequently, there
is a risk of double counting. The costs of measures needed to prevent and mitigate damage to reach a
certain target (planned control costs) are considered as a proxy for what society is willing to pay for
environmental measures, and evaluate indirectly the economic value of environmental damage. On the
other hand, the not-internalised environmental damage costs, and the methods needed to evaluate them,
are mentioned as well. Obviously, again there is a risk of double counting, if the latter costs will be with
the planned control costs. Resource costs are interpreted as economic losses caused by non-optimal
water use both with regard to different water users (e.g. agriculture versus hydro-power) and different
times (present versus future water use). However, environmental damage costs are also included in
cases, where an alternative water use (e.g. conservation of ecosystems) has an higher value than the
current water use (e.g. recipient for effluents). As the authors pointed out, environmental and resource
costs cannot simply be added since there is a risk of doubling counting. Furthermore, it is argued that the
advice provided in the Guidance Document confines the resource costs to water resource depletion only
and on the subsequent forgone opportunities that other uses suffer.
As the documents mentioned above indicate, there exist various definitions and methodologies for
evaluating the environmental and resource costs. But even with regard to the financial costs different
evaluation concepts exist. The Guidance Document provides alternative calculation methods concerning
the capital costs, the operating and maintenance costs, and the depreciation allowance. The lacking of a
guideline with clear rules how to measure the different cost categories may cause problems in
implementing the cost recovery and the water pricing policies as suggested in the WFD.
CASE STUDY
A prominent example, where the environmental and resource costs have been estimated, is the Jucar
pilot river basin (Maesto and Andreu Alvares, 2004; Andreu Alvares et al., 2005). Because of the
methodological difficulties in estimating the environmental damage costs, the costs of measures needed
to obtain a desired environmental objective are regarded as a proxy or indicator of this type of costs. The
resource costs are identified with the economic benefits that are forgone not only due to an inefficient
distribution of water resources among different water uses (such as abstraction, discharge and recreation)
but also due to an inefficient allocation of water use permits (abstraction and discharge) at a given set of
environmental standards. As the authors emphasize, overlaps between between both cost categories
exist, so that the environmental and resource costs cannot simply added up. In order to capture the
complex interrelationships between the different water users and water uses a computer model is used
for estimating the costs of water services. Both in terms of environmental and resource costs the shadow
prices of changes in the environmental objectives (e.g. tightened water quality standards) can be
computed. The economic losses (opportunity costs) due to inefficient measures to obtain such objectives
(environmental costs) and due to inefficient water allocation (resource costs) can be estimated.
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The modeling approach applied in the Jucar pilot river basin can provide potentially information needed
for the determination of the appropriate economic value of water according to the WFD cost recovery
principle. Moreover, the best combination of measures can to be defined through a cost-effectiveness
analysis. Integrated hydro-economic modeling proves to be as an useful tool to evaluate the
environmental and resource costs. The gap between the resource values from economically optimal
water use (optimization model) and simulated resource values (simulation model), given current water
allocations and operations, allows assessing the economic benefits lost and precise explanations for these
losses. Optimization model results can provide insight on possible operating rules or strategies to
improve the economics results in the system, such as a correct water pricing policy (including water
scarcity rent).
CONCLUSIONS
The economic analysis of water use according to the WFD requires a guideline that contains clear and
feasible advices how to estimate the financial, environmental and resource costs. Otherwise, the
principles applied in the EU Member States to calculate the economic value of water services will differ.
This may hamper the implementation of the cost recovery principle. Currently, there exist a wide range
of various cost concepts. With regard to the environmental costs it must be clarified whether the costs of
measures needed to obtain the WFD environmental objectives should be used, and whether and how
environmental damage costs should be additionally included. An overlap with the financial costs and
double counting must be avoided. The resource costs should be clearly distinguished from the
environmental costs. The calculation of resource costs may refer to a given set of limit values
concerning water abstraction and discharge. Hydrologic-economic models can provide the information
needed to determine the appropriate economic value of water services. Thus, the cost recovery principle
could contribute to a more efficient water utilization in the EU Member States.
REFERENCES
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