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A National Cost Benefit Analysis of proposals to take water from the Waitaki Catchment has been undertaken by Sinclair Knight Merz on behalf of the Ministry of Economic Development. The major objective of the national cost benefit analysis is to identify the economic contribution to the national economy that might be generated by alternative allocations of the water resource.

This report develops an economic framework for the evaluation of proposals for water allocation. There are still a number of information gaps and a significant level of uncertainty in many assumptions. Because of this the information in its current form cannot be used to make recommendations on the merits of any resource consent application.

A cost benefit analysis undertaken at the national level must consider when impacts are of national consequence. This occurs where there is a tangible, expected change in the level of national welfare. Regional and local impacts are excluded from the analysis where impacts are substitutable between localities or regions.

The results from this study will be used to "inform the development of a water allocation framework and the decision making process for resource consent applications" in the Waitaki River catchment (MfE, 2003).

Through the study it has become clear there are two different allocation issues on the Waitaki River. The first of these is specific to the catchment area upstream of the Waitaki Dam. With increasing irrigation demands upstream of the Waitaki Dam, the existing consent process makes it difficult to issue new consents or reallocate existing consents.

Downstream of the Waitaki Dam, there is a question as to whether additional allocations are warranted given the prevailing environmental and social attributes along the Waitaki River and surrounding areas. If it can be demonstrated that economic benefits of these applications outweigh the costs (including those of environmental and social values), then the decision becomes that of selecting the portfolio of consents which provide the greatest benefit from the water allocation.

Feedback from consent-holders indicated that there is very limited independent information with regard to annual water availability throughout the catchment. Information regarding the current utilisation of consents is virtually non-existent. The absence of this information makes economic valuation more difficult, and considerably more qualitative. Consultation also highlighted the problems faced by existing consent-holders, who are becoming concerned about the maintenance of supply security in the long term and the risk of over-investment due to poor information.

The ability to rank various allocation alternatives for the purpose of water allocation is limited by the lack of a standard consent item that relates to actual usage (or share) of Waitaki River inflows. Because this definition does not exist, then the economic contribution of various uses cannot be compared to the amount of resource allocated.

The base case (which other development scenarios are compared with) assumed that all existing consents within the Waitaki River catchment cannot be optimised further, and are renewed indefinitely. The sole exception to this is the inclusion of the Downlands irrigation area, which was recently granted its consent but development has not commenced. It is assumed that all existing power generation plants continue to operate in the base case.

After completion of the draft report (March 2004), Meridian Energy advised that they would not proceed with Project Aqua. For the purposes of the analysis the Project Aqua proposal is included so that analysis can be carried out on potential hydro generation.

Economic modelling was completed for the following independent scenarios, and compared to the base case scenario:

• Project Aqua with no additional irrigation
• All possible irrigation demands without Project Aqua
• All irrigation demands with Internal Rate of Return greater than 5% without Project Aqua
• Additional irrigation above Waitaki Dam at the following locations:
  • upstream of Tekapo,
  • upstream of Ohau
  • upstream of Benmore.
• Additional irrigation below Waitaki
• Additional irrigation below Waitaki integrated Project Aqua

For each of these scenarios it was assumed that the new developments were technically feasible, and financially viable. The study methodology did not extend to confirmation of these criteria.

This report is unable to determine whether any additional allocations of water downstream of the Waitaki Dam are justified on economic grounds alone, as environmental existence value measures for the Waitaki River valley and surrounds is not available.

The results from the economic analysis are presented in Table 1 below. The results indicate that if additional water allocations were made to Project Aqua in isolation with no additional development in the catchment, this would return a value of $329.1m to the economy assuming a discount rate¹ of 7.5% and a 30-year analysis period.

Generally, the viability of irrigation demands improves for the irrigation takes that are located lower in the catchment due in part to a reduction in the opportunity cost of lost power generation, but also reflecting the higher value agricultural transition that would be expected to occur in the lower areas of the catchment due to dairy and arable developments.

a) This table presents 7 different scenarios which combine Project Aqua with irrigation takes and assumes that Project Aqua is viable for each. At some point, however, irrigation takes would mean that Project Aqua would not be financially viable. The point where this would occur has not been calculated in this analysis and it is assumed that a reduction in flow through existing or proposed turbines is simply calculated on the cost of providing an alternative electricity supply.
b) A coarse estimate of financial viability was used to identify those irrigation schemes that were able to return sufficient funds to represent a commercial loan, and thus encourage private enterprises to pursue development. A first-order filter was applied to schemes that could return a positive NPV at a real pre-tax discount rate of 5% (representing a commercial loan in the order of 7% p.a. in nominal terms). The estimated irrigation area satisfying this rule is approximately 76,250ha. However, tests of financial viability are far more complex given that individual enterprises must realise gains from irrigation development. This result cannot be developed using the aggregate of the demands presented subsequent.

In accordance with standard New Zealand Treasury guidance¹, the results are also presented assuming a discount rate of 10% and analysis period of 30 years.

a) A coarse estimate of financial viability was used to identify those schemes that were able to return sufficient funds to represent a commercial loan, and thus encourage private enterprises to pursue development. A first-order filter was applied to schemes that could return a positive NPV at a real pre-tax discount rate of 5% (representing a commercial loan in the order of 7% p.a. in nominal terms). The estimated irrigation area satisfying this rule is approximately 76,250ha. However, tests of financial viability are far more complex given that individual enterprises must realise gains from irrigation development. This result cannot be developed using the aggregate of the demands presented subsequent.

For the competing demands downstream of the Waitaki Dam, the results from Table 1 indicate that irrigation development alone is likely to deliver less benefit than can be achieved from hydroelectric generation. However, below the Waitaki Dam, integration of irrigation and hydroelectric development would provide a greater economic contribution than for either development type alone. It should be noted that while irrigation delivers a lower net benefit to the nation, this benefit is using only 3% of the annual water volume of Project Aqua, and significantly less capital investment. This becomes an important consideration as the demands are not mutually exclusive in that it is technically feasible for the Waitaki River to supply both demands albeit with different environmental and social consequences.

While the results indicate that some proposals are economic, technical feasibility and financial viability must also be proven for the schemes to proceed.

Sensitvity tests were also performed as part of the assessment for different development options. For hydro-electric generation, this included variations to cost estimates and exclusion of emissions benefits. The sensitivity tests for irrigation development included varations to cost estimates, gross margins, volume and the timing of increases of irrigation demands. The impact of changes in the assumed discount rate was also investigated.

Assuming a discount rate of 7.5%, the results showed that the net economic benefit of Project Aqua is sensitive to capital cost assumptions. If the capital costs were to increase by 20% in real terms, it is expected that the proposal would reduce the net benefits by approximately $150m. The opposite result (i.e. an increase of approximately $150m) is observed if the alternative generation sequence increases in cost by 20%.

By comparison, the economic contribution from irrigation development appears most sensitive to changes in the gross margins adopted.

For the regions between Benmore and Waitaki Dam, the viability of irrigation schemes is influenced by their proximity to the river and tributaries or existing hydro-electric canals. The modelling for this region indicated a negative economic contribution compared with other demands due to the opportunity cost of lost generation capacity and the lower value irrigation transitions (as compared with the Lower Waitaki area for instance).

While the proposed diversions from Lake Tekapo are able to benefit from relatively low off-farm capital costs, their overall economic viability is also reduced by the large amount of lost generation capacity. At the national level, the loss in generation capacity from this demand is estimated to be of the order of 0.4 - 0.6%.

It is assumed the consents for irrigation take are taken up at the beginning of each project. A sensitivity analysis was carried out on the gradual takeup of consents as the irrigation projects developed which improved the overall viability of the irrigation projects.

The impact of irrigation uptake on lost generation is significant for takes above Tekapo. If there is an assumed transition of 7 years for the uptake of water above Tekapo, and that the water is available for generation, then the cost of lost generation is reduced by $23.1 million. Commercial manufacturing also competes for water and analysis of this sector was considered separately from the uses above due to the relatively small volumes of water forecast. It is estimated that the value of water to commercial manufacturing uses is well in excess of that of hydroelectric generation and irrigation purposes provided that existing efficiencies of water use and economic productivity are maintained.

Social, cultural and environmental impacts associated with further development of irrigation and hydroelectric generation have been included in the national cost benefit analysis using qualitative indicators. A summary of the qualitative assessment is provided in Table 3 below.

Notes:
1) See Table 15
2) See Table 16

The conclusions drawn on the net economic benefit to the nation of the various proposals are limited by significant information gaps used to develop assumptions. It is recommended that information gaps could be addressed through the following actions:

1. Preparation of a separate study of the environmental existence values relating to environmental attributes of the Waitaki River catchment.
2. The development of a single independent hydrological model for the Waitaki River and tributaries.
3. Seeking a greater amount of quality information from applicants for irrigation consents so as to better understand the nature of each development including: the current agricultural profile of the consent, the likely transition, the period over which this transition might be achieved, and the average annual volume of water required.
4. Independent farm economic model case studies at key locations within the catchment should be undertaken to improve assumptions to support irrigation transition assumptions.
5. Development of a general equilibrium model to extend coverage of the national cost benefit analysis.

Given the deficiencies in the information available, any conclusions drawn at this time should be considered indicative.

¹The discount rate adopted for analysis and discussion is 7.5% to reflect a public sector discount rate closer to that used by other countries, however, the results for a 10% discount rate are also presented in accordance with Treasury Guidelines for Costing Policy Proposals). Sensitivity analyses were also conducted for a discount rate of 5%.