Pricing water quality
improvements with auction
mechanisms
John Rolfe
Focus of this talk
• Water quality tenders as a type of market based
instrument
• Water quality tenders have two key roles
– Improving resource allocation
– Addressing problems of asymmetric information
• Tender mechanisms can reveal opportunity costs
– Help policy makers to improve resource management
• Four case study applications
for the Great Barrier Reef
in Australia
In the beginning …..
• Three key roles for environmental
economists
– Identify why environmental problems occur
• E.g. externalities explain many pollution problems
– Identify if they are worth addressing
• Compare the public benefits of fixing a problem
with the costs incurred to do so
– Develop policy tools
• E.g. property rights, regulation, Pigovian taxes
• Market based instruments (MBIs)
Two key families of MBIs
• Price based instruments
– Taxes
– Tenders to purchase environmental services
• Quantity based instruments
– Cap & Trade, offsets, bubble schemes
• Key benefits of MBIs
– Provide more tailored incentives
– the incentives are dynamic and ongoing,
– provide more flexibility
Using MBIs to predict opportunity costs
• Normal focus is MBIs as policy tool
• But need prior information about potential
supply function of landholder actions
before design and implementation
• Options to estimate landholder supply
– Existing trading schemes – very rare
– Bioeconomic modelling – tends to be general
– Experiments and trials of water quality
tenders
Experiments with water quality tenders
• Three main types possible
• Laboratory experiments
– Experimental economics approach,
underpinned by bioeconomic modelling
• Field experiments
– Simulated farms with farmers as participants
• Field trials
– Smaller scale trials to test market operation
– Focus of this presentation
The case study: Great Barrier Reef
The problem – poor water quality from
agriculture
Pollutants move out from
catchments
-Sediments
- Nutrients
- Nitrogen
- Phosphorus
-Pesticides
- Lead to reef damage
What governments have been doing
• Several major funding programs to reduce
emissions from agriculture
– Diversity of catchments, climate & agriculture
• New ‘Reef Rescue’ program ($200 M)
• Funding allocated through NRM and
industry groups
• Focus on
– fixed grants
– Supplying inputs
– Maximising participation
4 separate water quality tenders trialled
• A tender for recycle pits for sugarcane growers
run in the Mackay Whitsunday
• A dairy water quality tender in the Mary River
catchment (Burnett Mary)
• A horticultural water quality tender in the Kolan
River catchment (Burnett Mary)
• A sugarcane and beef grazing
water quality tender in the
lower Burdekin catchment
Land uses
• Beef cattle is
dominant use by area
• Sugar cane is major
emitter of nutrients
and pesticides
• Horticulture and dairy
account for very small
areas of land use
Tender design
• Call for landholders to put in proposals and bids
• Auction design
–
–
–
–
–
single bidding round,
sealed bids,
discriminatory pricing,
an (unspecified) reserve price,
multiple bids allowed from landholders,
• Metric design
– Assessed cost efficiency of bid proposals
• Contract design
– one year contracts for successful bidders,
– simple contracts used to secure agreements, and
– simple monitoring and reporting processes.
Metric Design
• Focused on assessing relative reductions
in pollutants compared to cost
• Summed impacts of different pollutants in
step 4
– Identified proportion of catchment target for each bid,
then added proportions for different pollutants
Assess onfarm
reduction in
pollutants
for each
proposal
→
Make
adjustments
for farm
and
distribution
factors
→
Account
for
impacts
over time
→
Represent
impacts in
a single
index
→
Rank
proposals
by ratios
of index /
cost
Key issues to test
• 1. Do opportunity costs vary within a
reduction program?
– Identifies if MBIs will be more efficient than a
simple grants approach
• 2. Do opportunity costs vary across
industries, regions and pollutants?
– Provides information about where funding
should be targeted and potential reserve
prices
– Essential information to design
new policy instruments
Relative bid values – sugarcane at Mackay
$582,000 in incentives
relative bid value ($/score)
250
200
150
100
50
0
0
10
20
30
40
Bids
50
60
70
80
Dairy industry tender in Burnett-Mary
$165,000 in incentives
Funding cutoff
Horticulture tender in Burnett-Mary region
$100,000 in incentive funding
Fuding cutoff
Cane and grazing tender in lower Burdekin
$605,000 in incentives
Funding cutoff
Relative bid value ($/score)
250
200
150
100
50
0
Did opportunity costs vary ? Yes
• Variation shows importance of targeting
the best proposals
• Example from the Burdekin tender
– 10 most highly ranked projects cost $180,574
• were modelled to capture 47,510 kgs of Nitrogen
($1.70/kg), 51.6 kgs of Pesticide ($1,579/kg), and
29.8 tons of Sediment ($117.4/ton).
– 10 lowest ranked projects would have cost
$495,808
• were modelled to capture 870 kgs of Nitrogen
($290.78/kg), no Pesticides and 18 tons of
Sediment ($13,480/ton
Sediment reduction costs
500
450
Cumulative cost ($1000s)
400
Burdekin: Grazing
350
Burnett Mary: Horticulture
300
Mackay: Cane
250
200
150
100
100
50
80
0
0
200
400
Cumulative tons sediment reduction (100s)
600
800
1000
1200
60
40
20
0
0
100
200
300
400
500
Nitrogen reduction costs
Cumulative cost ($1,000s)
450
400
Burdekin: Cane
350
Burnett Mary: Dairy
300
Burnett Mary: Horticulture
250
Mackay: Cane
200
150
100
50
0
120
0
50
Cumulative nitrogen reduction (tons)
100
150
200
100
80
60
40
20
0
0
10
20
30
40
50
60
Phosphorus reduction costs
80
70
Cumulative cost ($1000)
60
50
40
Burnett Mary: Dairy
30
Burnett Mary: Horticulture
20
Mackay: Cane
10
0
0
5
10
15
20
Cumulative P reduction (tons)
25
30
35
Average cost of reducing pollutant by tender
• Includes only the funded proposals
Burnett
Mary:
Dairy
Burnett
Mary:
Horticulture
Burdekin:
Cane + Grazing
Mackay/
Whitsunday:
Cane
$165,000
$100,000
$605,000
$582,000
Sediment reduction
Average price ($/ton)
-
$1.62
$89.22
$4.06
Nitrogen reduction
Average price ($/kg)
$0.44
$0.23
$4.56
$1.40
Phosphorus reduction
Average price ($/kg)
$2.40
$1.78
-
$10.80
Pesticide reduction
Average price ($/kg)
-
-
$1,689
-
Total cost
Comparing reduction costs
• Large variations in opportunity costs
– Range for reducing N from $0.03/kg to $17.43/kg
• Significant variations across sectors
– Horticulture and dairy cheapest
• Opportunity costs may vary across
catchments
– Sugar in Mackay cheaper than in Burdekin
• Large difference in costs between pollutants
– Cost of kg of pesticide in Burdekin
• > 7000 more expensive than N in Burnett Mary
Conclusions
• Water quality tenders have important role
for price revelation
– Help policy makers to evaluation and design
• Estimate opportunity costs for performing CBA
• Setting reserve prices, designing tenders
• Policy implications for GBR
– Funding allocation can be improved
• Equate marginal improvements per last dollar
invested
• Check if benefits of improvement
outweigh the costs