3. Model Specification
3.1 Model Structure
Where impacts were able to be monetised, a spreadsheet model was developed to support the cost-benefit analysis, applying discounted cash-flow techniques. The basic structure of the model is presented in Figure 2.
Figure 2: Economic Model Structure
The cost benefit analysis has been developed to calculate the economic impact of the proposed options over the period July 2003 to June 2033.
Due to insufficient base information, economic impacts relating to social, environmental, or recreational outcomes are not included in the model. Qualitative summaries are included in this report and should be considered in conjunction with the economic modelling results.
As the decision on water allocations relates to the availability and demand for water, the spreadsheet model has incorporated a basic annual water balance using flow measurement units of cumecs (m³/s). The model is based on the hydrology data presented in Opus (2003) for the period 1927-2000, and assumes that existing demands are placed upon the system. The model allows entry of:
- minimum environmental flows in the Waitaki River below Waitaki Dam
- additional demands proposed on the Waitaki River, but assuming the water take is located on the main system carriers (i.e.. in effect ignoring tributary minimum flow limitations). The abstraction demand is estimated to be the average extraction rate over the period of one year (as opposed to the peak consent rate).
Based on these demands, the flows through the power station are re-calculated and the impacts on national generation capacity are then estimated. This information was used in conjunction with that received from Concept Consulting (2004) to determine the overall impact to the national economy.
A schematic diagram of the hydrology model structure is presented in Figure 3. The model demand locations marked represent the major trade-off locations for irrigation demand and power generation demand. The location of each irrigation demand within the model is presented in Table 6 below. It should be noted that irrigation offtakes from the Project Aqua canal will not be included unless the scenario assumes Project Aqua proceeds.
Table 6: Location of Irrigation Demands| Scheme | Can be integrated with Project Aqua? |
| Mackenzie Basin / Ruataniwha District | No |
| Aoraki Water Trust Proposal | No |
| Lake Benmore, Lake Aviemore | No |
| Other "Called in" Consents - Above Waitaki Dam | No |
| Irrigation North Otago including Downlands | Yes |
| Lower Waitaki Irrigation Scheme Extension | Yes |
| Hakataramea Valley | No |
| North Bank / Elephant Hill Area | No |
| Waihao Downs | No |
| "Called in" Consents - Below Waitaki Dam | Some South Bank schemes. Assumed "No" for model1 |
Figure 3: Schematic Diagram of Hydrology Model
→ Full size version of Figure 3 [11KB GIF file]
3.2 Analysis Period and Discount Rate
The following section outlines the key variables applied in the cost benefit analysis. A 30 year period of analysis (2003 to 2033) has been adopted with appropriate treatment of residual values, and perpetuity cash flow calculations incorporated as required.
The benefit and cost streams entered into the model are in real terms at July 2003 (i.e.. inflationary impacts have been removed), and a pre-tax real discount rate of 7.5% has been adopted under the direction of the steering committee. Sensitivity testing has been undertaken at discount rates of 5% and 10%. Some cash flows are presented in absolute terms, whilst others are presented as incremental cash flows for comparison between two scenarios. Where applicable, this will be detailed in the discussion below.
There are a considerable number of assumptions behind each of the benefit and cost streams, and the reader is directed to Appendix E, Appendix F and Appendix H for greater detail. Specific references will be provided throughout the discussion.
3.3 Benefits
3.3.1 Investment Avoided with Project Aqua
Introduction
The analysis for the electricity generation sector is dependent upon the differences in the anticipated generation installation sequence. The generation installation sequence has been forecast by Concept Consulting (2004) for scenarios that include and exclude Project Aqua from the national generation base. This forecast has considered the projected electricity demand for New Zealand over the period 2003 - 2050, the location of various generation options to allow for transmission charges and line losses, dry year security, and the projected available utilisation of each generation option. This sequence assumes that, progressively, the next "least cost" generation option is selected when demand increases above existing generation capacity (based on long run marginal cost).
Concept Consulting (2004) forecast that the base cases requires an additional 375MW of additional generation capacity in comparison to the "Project Aqua" scenario. The major differences between the scenarios are highlighted in Table 7 below.
The capital investment cash flows that were developed by Concept Consulting (2004) assumed a 5th percentile dry year for both scenarios so that the generation capacity was sufficient to meet peak demands. The operations and maintenance, fuel and emissions related cash flows have been based upon the average values experienced over a 20-year hydro sequence.
Table 7: Generation Sequence for Base Case (From Concept Consulting, 2004)| Plant Type | Without Aqua | Installed Capacity |
| Hydro (Non - Aqua) | Options Generally Advanced | +13MW |
| Cogeneration | Options Generally Advanced | +70MW |
| Geothermal | Options Generally Advanced | +105MW |
| Wind | Two Projects Advanced and a Third Included | +87MW |
| Coal | Two Projects Advanced additional capacity Provided | +100MW |
| | Total | +375MW |
While Concept Consulting (2004) perfomed evaluation over the period to 2020, the modelling undertaken by SKM extended this to 2033. While the generation installation sequence was extended for both scenarios, it was assumed there was no difference in incremental generation capacity installed (i.e.. the annual increments were the same after 2020).
Capital Expenditure
If Project Aqua proceeds, the nation's commitment to a base-line generation installation sequence is avoided. Consequently the capital investment required to install this generation sequence is also avoided, and a revised capital investment schedule representing a revised generation sequence is included as a cost (see Section 3.4.1). The cash flows are constructed to allow funds to be available in the year prior to the commissioning requirement for generation capacity (see Appendix F.3.3)
The residual values of the assets are calculated at the end of 2033 representing the present value of the future benefits and replacement costs that are forecast beyond the analysis period.
Operations and Maintenance Costs
If Project Aqua proceeds, the nation's commitment to a base-line generation installation sequence is avoided. Consequently the operations and maintenance investment required to operate this sequence is also avoided. The cash flows are constructed to reflect the operations and maintenance required for the total installed capacity (see Appendix F.3.4)
Incremental Fuel Cost
If Project Aqua proceeds, the nation's commitment to a base-line generation installation sequence is avoided. Concept Consulting (2004) estimated that with a baseline generation sequence, thermal plants would have higher utilisation than for a scenario with Project Aqua. By avoiding the baseline sequence, savings are realised with reduced requirements for gas and coal.
The incremental difference was calculated by Concept Consulting (2004) over the period 2003 to 2050. This model enters the values on an annual basis up until 2033, with the remaining benefits included in a residual calculation.
Incremental Emissions Cost
If Project Aqua proceeds, the nation's commitment to a base-line generation installation sequence is avoided. Concept Consulting (2004) estimated that with a baseline sequence, thermal plants would have higher utilisation than for a scenario with Project Aqua. By avoiding the baseline sequence, savings are realised with reduced requirements for emissions charges relating to carbon based taxes.
Information from the Ministry of Economic Development states that "although an emissions charge is currently part of the preferred policy package under the Kyoto Protocol, the Government has retained the option of introducing emissions trading as an alternative to an emissions charge if the international carbon market is functional."15 For this assessment, it has been assumed that benefits attributed to international emissions trading16 would be available.
This assumption has been tested through a sensitivity test that assumes the international carbon base charge is similar to the domestic levy that has been assumed by Concept Consulting (2004) of $15/tonne CO2.
Economy Benefit from Electricity Price Decrease
For the purposes of this assessment, water allocation decisions affecting the energy sector are assumed to result from increased allocations (such as those to allow Project Aqua). If this were to occur, the long-run marginal cost of electricity is expected to decrease. The analysis applied (see Appendix H.2) is based upon similar methodology employed by Covec (2004), however small changes have been assumed in the calculations based on updated information.
The calculation estimates the net impact to the economy of demand changes induced by decreases in wholesale generation prices that are forecast with Project Aqua. The national cost benefit analysis includes only the net impact of consumers and producers, and excludes transfers.
The elasticity of demand information suggests that a 1% decrease in price would lead to a 0.26% increase in quantity demanded in the long-run. A decrease in price benefits both consumers (through lower unit costs) as well as producers (through increased consumption). The national costs and benefits exclude the amount that transfers from one party to another, but represents the net impact to the economy.
3.3.2 Productivity Associated with Irrigation Sector Expansion
Essentially this benefit stream represents the increase in economic contribution attributed to expansion of irrigated agriculture. This must take account of:
- potential area for irrigation (see Appendix E.3.4)
- likely land use transition on that area (see Appendix E.3.5)
- the economic value of various land uses (see Appendix E.3.8)
- the timing of the transition (see Appendix E.3.10)
The typical measure of economic return for transitions is "Gross Margin", which is equivalent to the expected farm gate income, less the variable costs of production. Generally speaking the gross margin represents the cash flow available to the enterprise to cover the capital investment costs of the transition. An adjusted figure has been used in the national cost benefit analysis, as a significant part of the irrigation development is enterprise change and fixed costs are expected to change upon transition.
The modelling incorporates a modified estimate of gross margin from farm operations (based upon Earnings before Interest, Depreciation, Tax, and Amortisation, or "EBITDA") to estimate the economic contribution to the nation. This method captures the changes in cost structure resulting from irrigation transitions with greater accuracy than basic gross margin estimates alone.
The data applied in the modelling do not represent the accuracy that would be associated with the primary data collation from existing enterprises. Formal requests for each applicant to provide an economic evaluation of the consent proposal have not been undertaken.
It has been assumed that where agricultural demands are included in the analysis, this would occur in the year commencing July 2005. The modelled benefits begin one year after the commencement of capital investment. It is assumed that the benefits increase proportionally until the completion of the transition, and then remain at this level for the remaining period of the analysis.
It is acknowledged that the assumption of commencement in July 2005 is optimistic for all irrigation demands. Temporary transfer of water to the next most-valued use may be a method by which the net economic impact of commissioning delays might be minimised.
Economy Benefit from Increased Agricultural Production (Not Included)
As general equilibrium modelling has not been undertaken, the wider economic impact of increased agricultural production from irrigation has not been included in the standard output from the cost benefit modelling.
3.4 Costs
3.4.1 Investment with Project Aqua
Introduction
The generation installation sequence for the Project Aqua scenario has been developed based on a bottom 5th percentile dry year, with allowances for transmission charges and line losses, and the projected available utilisation of each generation option. As will be discussed later, both Concept Consulting (2004) and Covec Consulting (2004) have commentary with regard to additional reserve capacity in response to overall generation system volatility for a scenario with Project Aqua.
Capital Expenditure
If Project Aqua proceeds, the nation is assumed committed to a specific generation installation sequence. The cash flows are constructed to allow funds to be available in the year prior to the commissioning requirement for generation capacity (see Appendix F.3.3). The cash flows for Project Aqua total $1.2 billion, and are spread over the period 2006 - 2011. It should be noted that Sinclair Knight Merz have received detailed capital cost estimates in 2002 dollars, which were subsequently inflated to June 2003. The detailed information supports the capital investment schedule of $1.2 billion adopted by Concept Consulting (2004).
Adjustments were made to the capital cost to represent transfer payments for land acquisition and other compensation amounts. Consultation with Meridian Energy suggested that the construction cost estimate had a contingency in the order of 10%. After completion of the draft report, Meridan Energy announced they would no longer proceed with Project Aqua. At the time, the company noted that this decision was in part due to an increase in the estimated construction cost. The estimated increase in cost was not made public or available to this study, and consequently has not been included in this report. It is expected that the estimated capital cost would have changed during the refinement of construction estimates.
The residual values of the assets are calculated at the end of 2033 and incorporated in the analysis as required.
Operations and Maintenance Costs
If Project Aqua proceeds, the nation is assumed committed to a specific generation installation sequence. The cash flows are constructed to reflect the operations and maintenance required for the total installed capacity (see Appendix F.3.4). The SKM model has adopted an operation and maintenance cost of $20/kW installed/annum as stated in the Concept Consulting (2004) investigation. Detailed data provided by Meridian Energy suggested an operation and maintenance costs (with removal of compensation payments) in the order of $14/kWh. The range described above is subject to a sensitivity test.
Incremental Transmission Costs
Concept Consulting (2004) suggested that the presence of Project Aqua on the system might require the upgrade on the HVDC link to be brought forward 5 years from 2015. This judgement is considered highly sensitive to the requirements of Transpower, and it is arguable that Project Aqua would not induce any change in the Transpower's planned investment. The inclusion of this benefit has been subject to a sensitivity test. The cash flows adopted are identical to that within the Concept Consulting report (see Appendix F.3.5).
Reserve Generation Capacity
Concept Consulting (2004) recommended, as a matter of a sensitivity test, the inclusion of additional reserve plant to provide supply security. This is to meet the possible requirements of increased variability of electricity supply as a result of augmenting of existing hydro system. This is considered a separate issue to the generation installation sequence, which is based on a specified dry year capacity (see Appendix F.3.5).
Under the sensitivity test, Concept Consulting (2004) considered an upper-bound estimate of 32MW additional reserve generation capacity, adding a present cost (10%, 30yrs) to the With Project Aqua scenario of $15m. Covec (2004) suggested a mid-range estimate of $9m (representing 31MW over period to 2020) and an upper bound estimate of $85m (representing 250MW over period to 2020). The upper bound estimate is based upon no output from incremental hydro-generation and wind power, but was considered an extreme scenario as the as the existing hydro-lakes provide some capacity to manage supply shortfalls through storage planning.
While there is variation in the estimates for reserve energy, it can be concluded that should reserve requirements increase, then it is likely that the net benefits of Project Aqua will be reduced. Sensitivity tests will also incorporate an assessment of impacts associated with reserve generation requirements.
The capital cost of including this reserve generation capacity, and the residual value at the end of the analysis period (assuming a life of 30 years) is included in the cost benefit model as a sensitivity test.
Agricultural Output Contraction
It is forecast that the land designation for Project Aqua, taken over approximately 2,050ha of land, the construction zone, canal footprint, and coastal erosion could decrease the agricultural income from these areas. The impact for construction would be of a temporary nature, however permanent impacts would be associated with the canal footprint and canal erosion. The calculations for the area affected are presented in Appendix E.4.4. The timing of the cash flows represents Stage 1, Stage 2 and Post Construction periods.
For the areas impacted under the land designation, it was argued that this would restrict future land use profiles and water abstraction opportunities due to restrictions imposed by Meridian Energy. SKM discussions with Meridian Energy suggest that the majority of these restrictions might be imposed over the construction period, and restrictions after this stage would relate to maintaining the integrity of constructed assets.
The economic value of the land is based on the existing agricultural profile for the construction period and the canal footprint. However under the land designation cash flow sequence, it is assumed that this instrument prevents development of horticultural and viticultural developments. It also incorporates the avoided development costs and impact of asset residual values (see Appendix E.4.4. In the context of the analysis this represents a very small impact (< $3m in present value terms).
There is some argument that this cost is over-estimated in the context of a national cost benefit study. Every electricity generation proposal will have some degree of opportunity cost for the land it requires, and that of required buffer zones. It is unknown how the projected land impacts with Project Aqua compare with those other developments. It is considered that the inclusion of the above impact would represent an upper bound of the costs at the national level.
3.4.2 Investment for Irrigation Sector Expansion
Off-Farm Infrastructure
This represents the capital investment in irrigation supply infrastructure to the farm gate to support irrigation investment. This cost is likely to vary considerably between different irrigation demands due to the location, economies of scale, the expected time to enable transition (see Appendix E.3.9).
While detailed cost information was available for a limited number of larger schemes, or assumptions could be made regarding supply from existing canals, information was not available for smaller diversions. Consultation with various parties suggested that the likely range for this value was somewhere between zero and $2,500/ha. For basic assessment, a figure of $1,500/ha was adopted. The impact of this assumption was assessed in sensitivity tests.
It has been assumed that if included, each off-farm infrastructure construction would occur in the year commencing July 2005. The cash-flow schedule is evenly spread-out over the period of transition, and the cash-flow sequence is repeated upon the asset reaching its economic life. The value of residual values is calculated at the end of the analysis period.
It is acknowledged that the assumption of commencement in July 2005 is optimistic for all irrigation demands, and gradual take up of irrigation demand may result in water remaining available to hydro-electric generation. Temporary transfer of water to the next most-valued use may be a method by which the net economic impact of commissioning delays might be minimised, representing transfer payments within the economy.
On-Farm Infrastructure
This cash flow sequence represents the capital investment in on-farm irrigation infrastructure to support irrigation investment (see Appendix E.3.9). An identical cost is assumed for the same transition on any property requiring water diversion from the upper catchment
It has been assumed that if included, each irrigation demand construction would occur in the year commencing July 2005.
It has been assumed that if included, infrastructure construction would occur in the year commencing July 2005. The cash-flow schedule is evenly spread-out over the period of transition, and the cash-flow sequence is repeated upon the asset reaching its economic life. The value of residual values is calculated at the end of the analysis period.
On-Farm Transition
This cash flow sequence represents the capital investment in on-farm capital improvements (non-irrigation) required to enable the transition to an irrigated agricultural enterprise (e.g. dairy shed, fencing). More detail is provided in see Appendix E.3.9.
It has been assumed that if included, on-farm infrastructure construction would occur in the year commencing July 2005. The cash-flow schedule is evenly spread-out over the period of transition, and the cash-flow sequence is repeated upon the asset reaching its economic life. The value of residual values is calculated at the end of the analysis period.
Operations and Maintenance Cost
This cash flow sequence represents the annual operations and maintenance costs of supplying water through the off-farm reticulation and on-farm irrigation system. More detail on the rates adopted is provided in see Appendix E.3.9. Where available the information for specific schemes was included.
It has been assumed that if included, operations and maintenance would occur in the year commencing July 2006. It is assumed that the benefits increase proportionally to the completion of the transition, then remains at this level for the remaining period of the analysis.
Lost Generation Capacity
This cash flow sequence represents the (opportunity) cost of lost generation capacity as a result of placing an irrigation demand upon the system, and reducing the total energy generation capacity of the system as a result (see Appendix E.4). The lost generation capacity is modelled as commencing from the time of allocation, however this is likely to be an overestimate of economic impact as the irrigation demand would normally be taken up in a gradual fashion. The national impact of price induced demand change (as discussed in Appendix H.2) has been ignored in case of irrigation demands as it is insignificant at the national level.
The value of the lost generation capacity is assumed to relate to the price paths developed by Concept Consulting (2004) to represent the costs of bringing forward generation capacity to make up the shortfall created by an irrigation demand.
The analysis assumes that Project Aqua is viable in the seven different scenarios which combine Project Aqua with irrigation takes. 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.
As the energy generation capacity is lost in perpetuity, a residual amount represents this loss based on the lost generation capacity in 2033. The valuation of the lost generation capacity in the Upper Waitaki Catchment should have regard to the ability to store flows received over the summer period. It is important to note that for a scenario with Project Aqua, the unit opportunity cost of lost generation capacity decreases, however the quantity increases.
A sensitivity test has been performed to understand the implications of a gradual uptake of irrigation demand, as opposed to full immediate abstraction.
Additional Emissions from Land Use Intensification
Sinclair Knight Merz was asked to provide an estimate of the increase in greenhouse gas emissions as a result of the transition to more intensive agriculture. Based on the estimated changes in stocking rates the change in the amount of methane (CH4) has been estimated. This has been converted to an equivalent amount of CO2 using the Greenhouse Warming Potential (GWP) factors provided in the Common Reporting Format (CRF) tables of the Inter-governmental Panel of Climate Change (IPCC).
It could be assumed that the intensification in agriculture could attract a carbon-based charge similar to that of thermal power stations. For the purposes of modelling, it has been excluded from calculations relating to the assessment of financial viability.
If the entire area of irrigation proposed were developed (124,250ha), it is estimated that the annual charge associated with land-use intensification would be in the order of $3.1million/annum (see Appendix E.3.12), which is equivalent to an average of $25/ha/annum. It is expected that the charge would vary depending on the transition under consideration.
3.4.3 Non-Market Costs
As noted in Section 2.4 quantification of many of the expected outcomes in monetary terms has not been possible due to either their intangible nature (socio-economic and environmental changes) or an absence of any reliable historic quantitative data (as in the case of many recreation pursuits).
These impacts have been discussed in detail (see Appendix B and Appendix C) and a broad qualitative assessment has been completed. This is presented in Sections 4.3 and 4.4 below.
Wherever possible, the qualitative outcomes presented in the table are based on indirect or related quantitative data (such as population estimates as a proxy measure for socio-economic fortunes) or noted expert opinion (as in the case of fisheries).
3.5 Limitations of the Model
Because of the complexity of the proposals presented, and the lack of economic data that relate to some major impacts, the economic model is not able to capture all impacts comparatively. The major values attributed to the existence and values of the environment, social and recreation sectors are most likely the greatest of these, but other economic impacts also exist.
Other impacts have been identified which could be of sufficient value to warrant inclusion in the national cost benefit analysis. These might include:
- impacts associated with increased variation in river flows (including land erosion and pump infrastructure damage)
- the economic impacts associated with public sector expenditure (e.g. roads, power transmission lines) to support irrigation development. Irrigated areas tend to have much greater traffic loads, therefore additional maintenance costs would be expected in this sector
- the economic impacts associated with compliance monitoring and river management. As the demands from the river increase, it is likely that additional costs of "managing" the resource will become greater
- the development of additional water treatment systems, or alternative supply sources for water supply impacted by pollutant concentrations due to reduced instream flows, and water quality of return flows from abstractive demands
- the economic risks (sunk investment, structural adjustment) of reducing any future allocations to ensure critical environmental values can be maintained.
While additional investigation would enable these costs to be defined, the benefits of acquiring this information should be compared with the costs involved.
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