Applications of water economics and policy in Canada

Introduction

Water is essential for Canadian wealth and prosperity. Despite this, water resources are increasingly vulnerable to threats from pollution, climate change and increasing use (Environment Canada 2004). Canada faces a number of emerging water management challenges, including how to allocate limited water resources amongst competing human and ecological needs, how to improve water quality in lakes and rivers, and how to respond to climate change (Renzetti et al. 2011).

The purpose of this special issue is to highlight recent contributions to water economics and policy in Canada, and to stimulate further discussion and research on key emerging water challenges. The contributed papers fall into two categories. The first group of papers focuses on water allocation (including the assignment and transferability of water rights and water pricing), and its influence on water use and conservation, economic efficiency and environmental protection. The second group of papers focuses on economic and behavioural factors that influence the adoption of beneficial management practices promoted to reduce non-point source pollution from agriculture and improve water quality.

Water allocation, conservation and efficiency

The first set of papers, by Bruneau and Renzetti (2014), Mannix et al. (2014) and Weber and Cutlac (2014), deals with water allocation and pricing, the effects of these policies on water use and efficiency, and the overall social and economic benefits of water. Studies show that Canadians pay less for both water and wastewater treatment than do other countries. For the most part, the prices paid for water encourage overconsumption, threatening the sustainability of water resources, and putting pressure on delivery and treatment infrastructure which is similarly underpriced (Brandes et al. 2010). Legislation and policies governing the allocation of limited water resources result in a poor initial distribution of water in relation to demand, and a low economic value of the resource. Poor allocation aggravates scarcity challenges and constrains the ability to adapt to changing social, economic and environmental needs. In Canada, policies to transfer water are cumbersome or non-existent, locking in inefficient uses.

The first paper, Bruneau and Renzetti (2014), examines the determinants of recirculation as a water conservation strategy for the manufacturing sector. Water recirculation is a potentially significant form of water conservation that could provide water to municipalities and other sectors. Previous studies examining recirculation decisions have focused on recirculation volumes and recirculation rates as a percentage of overall water intake. This study examines the initial decision of whether or not to recirculate, focusing on recirculation frequency, defined as the proportion of plants that report recirculation activities in a particular year. A phenomenon of interest is the complex recirculation behaviour observed in manufacturing, with some plants either never or always recirculating, and others recirculating periodically.

The analysis is based on the Industrial Water Use Survey, a panel data set of 2725 manufacturing plants surveyed over three periods in 1986, 1991 and 1996. A Heckman two-stage estimation procedure is used to jointly consider both the initial decision of whether to recirculate, and the subsequent conditional decision of how much to recirculate. Factors raising the likelihood of recirculation include the scale of production, the need to pretreat intake water, location, and sector-specific technologies used in production. The marginal cost of intake water and the scale of production influence the volume of recirculation. The sensitivity of recirculation volumes to price suggests conservation pricing and recirculation subsidies could be effective at increasing the amount of recirculation; however, the capacity to recirculate must be in place for these policies to be effective. Provincial variations in recirculation capacity may reflect provincial fiscal, environmental or planning policies that affect long-run investment decisions related to scale of production and to technology choices. Further investigation of interprovincial differences in policy that could explain variations in recirculation frequencies would contribute to a better understanding of how governments could encourage water conservation in the manufacturing sector.

Mannix et al. (2014) focus on industrial water use for oil sands development. Between 1 and 4 L of water are used to produce 1 L of synthetic crude from oil sands mining, and almost none of the water is returned to the hydrologic cycle, raising public concerns about potential irreversible losses in potable water. During the mining process, fresh water from the Athabasca River is withdrawn and used in the operation of on-site utilities, then reused as process water for extracting bitumen from the mined oil sands. The water is then disposed of into tailings ponds, which present a growing environmental liability for shareholders and the public. Given the dependence of oil sands production on water, there are concerns that limits on water diversions under emerging water policies for the Athabasca River could limit future expansion of the sector.

Companies obtain licenses from Alberta Environment and Sustainable Resource Development to divert water on a first-in-time first-in-right basis, granting highest priority to senior licensees under a water shortage. The two oldest oil sands mining companies, Syncrude and Suncor, have senior licenses. The 2013 Surface Water Quantity Framework for the Lower Athabasca includes ecosystem-based flow thresholds below which most licensees would be required to stop withdrawing water, though Syncrude and Suncor would still be allowed limited withdrawals. As a result, under conditions of scarcity, the oldest licensees with the most inefficient technologies have access to the water, while newer operators that are operating at higher efficiency are forced to reduce and rely on storage. Although water transfers are allowed under Alberta’s Water Act, they can only be used where there is an approved water management plan for the basin, and thus are not currently allowed in the Athabasca. Instead, current operators are required through a water conservation regulation to agree to annual contingency plans to share water; however, sharing arrangements have tended to default to the status quo based on order of seniority. As a result, new entrants are managing future water-related risks by investing in their own storage capacity and in improved technologies that reduce water use.

Mannix et al. (2014) present an economic assessment of alternative technological and policy options to reduce risks of future water scarcity for the oil sands. This is the first economic analysis on the value of water to oil sands production for Alberta. The results show that the average value of water for oil production could be as high as CAD$80 per cubic metre by 2020 under the current allocation system, with the value to new entrants as high as $180 per cubic metre. An efficient policy would reallocate water from lower value to higher value companies. Water restrictions under the current allocation will result in lost production of approximately $790 million per year, or 1.8% of annual net revenues for the sector, with the impact borne primarily by new entrants. An efficient water allocation policy, such as water pricing or water trading, would lead to water conservation across the sector and efficiently reallocate water between operations to maximize water value.

Mining operators face a number of technological options to reduce risks of water shortage, including off-stream storage and tailings recycling. The net present value of investing in sufficient storage to avoid water restrictions is $6.4 billion, and storage is already being built for new operations. Tailings recycling reduces demands for fresh water from the Athabasca River, and is economically worthwhile for four of the seven surface-mining operations; however, the capacity of the tailings to meet water demands is not sufficient to meet all demands under water restrictions. The net present value of tailings recycling is $2.7 billion, and, if water is allocated under an efficient policy, then the combined technological-policy solution has a net present value of $4.8 billion. With both tailings recycling and efficient allocation policies in place, the incremental net benefit of storage is $3.6 billion, making the total net present value of a combined approach $8.4 billion. Although water recycling is already high in the industry, the results show that improving water allocation policies would improve the economics of recycling and increase opportunities for integrated management of source and disposal water.

Weber and Cutlac (2014) address the impact of water allocation on water value in the South Saskatchewan River Basin, and the potential impact of water trading on the distribution of water rights between different consumptive and non-consumptive uses and the economic value of water. Systems for allocating water vary between provinces, with some provinces such as Alberta, British Columbia and Ontario focusing on options for transferring water between uses, and others such as Saskatchewan and Manitoba focusing on water planning and prioritization of water uses during periods of scarcity (Percy 1986). In Alberta, the South Saskatchewan River Basin faces significant water challenges due to growing demands and climate-related changes in flow. The current allocation in the basin exceeds median flow in many years, and most sub-basins are closed to new allocation. As in the oil sands, water is allocated on a first-in-time first-in-right basis. Historically, agriculture received several large senior irrigation licenses making up the bulk of the allocation. Over time, demands for new municipal and other uses have been met with junior licenses that frequently face restrictions in low-flow years. The seniority system is viewed by some as inequitable since water risks are borne primarily by junior licensees, and there have been calls to change the allocation to a share system that would make water available to all licensees during a shortage, on a prorated basis. While water transfers are allowed, concerns have been raised about the impact of transfers on instream flows and third parties. Some have also argued that a share system would better protect instream flows and the environment.

Weber and Cutlac (2014) ask whether the existing allocation system in Alberta is flexible enough to adapt to changing economic and social demands, particularly non-consumptive demands for instream flows. The study examines the relative merits of water transfer under a share versus a seniority-based allocation system. The paper distinguishes impacts from changes in the initial allocation of risk under a share versus a seniority allocation rule from impacts due to water trading, highlighting the difference between distributional and efficiency issues. The study shows that the initial allocation under either a share or seniority rule results in poor economic outcomes, but the seniority policy performs particularly poorly, with more than half of licensees receiving no water while large senior irrigation licenses receive their full entitlement. The percentage of potential water value captured under the seniority system is only 41%. Efficiency is not much better under the share system, increasing the portion of total value captured to 56%. Efficiency improves with water trading as licensees respond to opportunities to reallocate water to higher value uses. The efficiency from trading is independent of the rule used for the initial allocation; however, there are distributional consequences as senior licensees capture more gains from trade under the seniority rule. The share system per se did not result in improved environmental outcomes. On the other hand, water transfer improved instream flows, as water is reallocated from downstream agricultural uses which have lower return flows to upstream municipal uses which have higher return flows. The conclusion that tinkering with the allocation system is not going to do much for either the environment or the economy is important, and suggests that the more politically feasible strategy of improving institutions for water transfer would be a more effective reform.

While Canadians may still have relatively abundant water supplies, these papers show that they are not being managed efficiently, resulting in regional shortages and constraints. Mannix et al. (2014) and Weber and Cutlac (2014) demonstrate the inefficiency of initial allocation policies without opportunities for water transfer. It is important to note that these inefficiencies are not unique to Alberta, but would arise under any initial distribution system in any jurisdiction simply because governments are not privy to the information required to determine the most efficient allocation, and allocation needs evolve over time. That so few jurisdictions in Canada have mechanisms to transfer or price water efficiently could partially explain the declining value of water in Canada observed by Renzetti et al. (2011). A second important implication of this set of papers is the role of technology and location choices in the economics of recycling water. Both Bruneau and Renzetti (2014) and Mannix et al. (2014) show that long-run decisions related to plant capacity and technology choices determine whether the capacity to recycle will be economical. The interaction between fiscal and regulatory policies and plant investment decisions is an important area for future research in understanding recycling behaviour. Overall, the papers in this section highlight the need for regional integrated water management strategies that link the costs of sourcing and disposal of water and that better integrate opportunities to transfer water between entities.

Better management practices and agricultural use of water

Most irrigation is undertaken in the relatively more arid parts of Canada (that is, the provinces of Alberta, [the interior of] British Columbia, Manitoba and Saskatchewan). The most recent agricultural census data show that more than 60% of irrigated land in Canada is in Alberta alone. Agriculture and Agri-Food Canada’s National Agri-Environmental Health Analysis and Reporting Program noted in its 2010 report that water quality has been declining since 1981. While this may be attributable in large measure to the increased use of nutrients in irrigated agricultural operations (Agriculture and AgriFood Canada 2010), it has been exacerbated by the loss of wetlands that have been converted to agricultural or urban uses. Wetlands provide many ecosystem services, including those of purifying water (Natural Resources Canada 2014). This situation illustrates an important tension between the private benefits that landowners can earn from their use of land and the public benefits of ecosystem services to all.

There is a growing body of literature on best management practices, but relatively little of it has looked at the Canadian situation. A key area of investigation that has been missing is an analysis of private costs and benefits for producers who may consider adopting agriculturally related environmental stewardship practices that support the provision of ecosystem services. Very little is known about whether the financial costs and benefits of adoption accurately reflect producer needs for compensation – that is, their willingness to accept. Even less research has been done to quantify levels and values for relevant ecosystem service production associated with riparian and wetland areas in western Canada. The papers in this special edition address a number of different aspects of these issues and suggest that research is needed in order to make informed policy decisions.

Baird et al. (2014) set the stage by identifying five performance-based (as opposed to input-based) approaches for addressing water quality improvements within agricultural landscapes: water quality trading/permitting, differentiated payments for ecosystem services, reverse auctions, emissions charges, and cross-compliance (a hybrid measure). Each approach is assessed according to a number of institutional and socio-cultural contextual factors in order to identify circumstances that have facilitated performance-based policy instrument adoption. In order to summarize their findings, the authors develop a tool, the Performance-based Measures Framework. The framework describes performance capacity using measurement method and payment/penalty structure as the metrics. Baird et al. (2014) note that policy makers need to be aware of the role of risk in farmer willingness to participate in performance-based approaches.

Larue et al. (2014) continue the focus upon risk with their stated-choice experiments. These are designed to estimate the willingness to pay of Quebec farmers for uncertain (risky) phosphorus and coliform reductions stemming from the adoption of best management practices. While there may be private economic benefit accruing to farmers from expected water quality improvements stemming from the adoption of best management practices, the paper illustrates that farmers still need to be subsidized through some type of cost-sharing program. Moreover, the results show that there is significant heterogeneity in farmers’ attitudes towards uncertain improvement outcomes, with the majority of farmers showing some level of risk aversion. One important implication of this work is that willingness-to-pay estimates are downward-biased when risk is ignored in the model. This is an important aspect to include in future work in this area.

The last two papers employ different approaches to evaluate the adoption of beneficial management practices in three Prairie provinces: Alberta and Saskatchewan (Jeffrey et al. 2014) and Manitoba (Mann et al. 2014). Jeffrey et al. (2014) employ Monte Carlo simulation methods to construct net present value estimates that would be associated with the adoption of wetland and riparian restoration and protection measures. They combine farm-level results for representative cropping and mixed farm operations with estimates of public values for improvements to ecosystem services. Their results highlight the relatively high costs to farmers for undertaking these types of protection and restoration activities, largely associated with the opportunity cost of removing land from agricultural use. The presence of high public values supports the use of subsidy-type incentives for encouraging farmer uptake of beneficial management practices.

This finding is echoed in the work of Mann et al. (2014) who analyze the Alternative Land Use Services (ALUS) program adopted for one municipality in the province of Manitoba. The ALUS approach involves a payment to farmers who voluntarily withdraw land from agricultural practice for the purpose of providing environmental services from wetlands for the general public. The paper documents how financial incentives encouraged higher participation rates in the program. The paper then illustrates how the program could be evaluated in terms of its ability to enhance environmental services from wetlands through the use of the Agri-Environmental Footprint Index (AFI), an index developed in the European Union. While the assessment period is too short to provide definitive results, the paper notes the importance of adopting ex-post measurement of outcomes and benefits from better management practices or other forms of public policy intended to encourage agriculturally related environmental stewardship practices that support the provision of ecosystem services.

Summary

Public policy and economics play an important role in water management in Canada. Water conservation, economic efficiency and environmental protection are influenced by water allocation and water rights, and water pricing influences water use. Adoption of beneficial management practices to reduce non-point source pollution and improve water quality is influenced by economic and behavioural factors. This special issue reporting recent Canadian research in these areas in Canada should support further research and discussion on these key emerging water challenges.