Water Cba Paper

7/29/2019 Water Cba Paper

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Economic Evaluation ofWater Supply &

Waste Water Projects Cost-Benefit AnalysisMethodology Paper

Final Report

DKM Economic Consultants Ltd.Aquavarra Research Ltd.

ESRI

August 2004 DKM Economic Consultants Ltd.,

Davy House,

49 Dawson Street,

Dublin 2.

Telephone: 353 1 6797755

Fax: 353 1 6796379

E-mail: [email protected]


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CONTENTS

1 Introduction 1

2 Literature Review 2

2.1 Background 2

2.2 Methodological Issues 3

2.3 CBA Manuals 6

3 Proposed Methodology 21

3.1 Introduction 21

3.2 General Principles 24

3.3 Stages in the CBA 25

3.4 Notes on Specific Investment Types 29

APPENDICES

A Bibliography 37

B Valuing Fossil Fuel-Related Externalities 39

C The Importance of Pricing to Infrastructure InvestmentDecisions

42

D Benefits Transfer 43

D.1 Quality Assessment of Water 43

D.2 Valuing Water Quality 49

D.3 Method for valuing environmental effects of Irish schemes Benefits

transfer using Environment Agency (England and Wales) Guidance

56

D.4 Water Quality Measurement 79


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Section 1: Introduction

A requirement of the Economic Evaluation of Water Supply & Waste Water Projects

assignment is to:

a) Carry out a literature review of current approaches to economic appraisal of waterand wastewater projects, both nationally and internationally;

b) Propose a Cost-Benefit Analysis (CBA) methodology(ies) to meet the requirements ofEU Council Regulation 1164/94.

Article 13.4 of the Regulation states:

After their (the projects) completion, the Commission and the beneficiary

Member State shall evaluate the manner in which they have been carried out

and the potential and actual impact of their implementation in order to assess

whether the original objectives can be, or have been, achieved. This evaluation

shall inter alia, address the environmental impacts of the projects, in compliance

with existing Community rules.

The proposed methodology is to have regard to the findings of the literature review and to

national and EU guidelines on CBA of water projects1, and should also address:

The developing framework for financing such projects in Ireland; The values of benefits arising during the implementation of the projects; The benefits of the projects to tourism, industry, commercial development, fishing, etc.; The direct and indirect employment effects of the projects; The environmental benefits and future impacts of the projects, having regard to national

and EU requirements;

The economic viability of the projects; The economic and social benefits commensurate with the resources deployed on the

projects;

The contribution made to EU Community policies;

The contribution of the projects to balanced regional and rural development; Establish the Internal Rate of Return of the projects.This paper addresses this requirement. Section 2 summarises the Literature Review, while

Section 3 sets out the proposed methodology.

1 Notably:

Proposed Working Rules for cost-Benefit Analysis CSF Evaluation Unit, Dublin. June 1999.

Guidelines for the Appraisal and Management of Capital Expenditure Proposals in the Public Sector

Department of Finance, July 1994.

Guide to Cost-Benefit Analysis of Investment Projects Evaluation Unit, DG Regional Policy, European

Commission, 2001 edition.


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Section 2: Literature Review

2.1 Background

Good public investment requires sound appraisal. Cost-Benefit Analysis (CBA) is a well

established and widely applied methodology for appraising public investment projects.Appropriately in the current context, much development of the method took place on water

projects under the US Flood Control Act of 1936. This Act stated that projects should proceed

if the benefits to whosoever they accrue are in excess of the estimated costs, in otherwords, if the project would represent a net benefit to society.

Improving public sector efficiency has been the major stimulus to the development of CBA,

especially in the US. In Europe, CBAs are often required of projects funded by the EU

Commission, and many European Treasury Departments and Finance Ministries lay down

guidelines for the economic pre-appraisal of public investment projects using CBA techniques.

CBA tries to incorporate all social costs and benefits of an investment in monetary terms

(whether they have a market price or not), and in doing so determine whether benefits

exceed costs. Where market prices are not available, some other means of arriving at

monetary values must be used.

An important advantage of CBA is that by reducing everything (environmental and non-

environmental, private and social) to monetary terms and assessing them with a consistent

methodology, Governments can effectively compare apples and oranges. That is, they can

compare projects within and across different fields of public policy (e.g. roads, hospitals,

water treatment plants) and prioritise public investment policy according to which projects

give the greatest return to society.

The systematic use of CBA appraisal is becoming more common in Ireland, but practical

problems and differences of view arise in its implementation. A few of the more importantmethodological issues are discussed in Section 2.2, namely

Valuation of Non-Market Costs & Benefits Treatment of Future Costs & Benefits Discount Rates Timeframe Calculation of Net Benefit Benefits Transfer


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Efficiency and Equity.

This is followed by a review of CBA manuals in Section 2.3.

2.2 Methodological Issues

2.2.1 Valuation of Non-Market Costs & Benefits

This is perhaps the most controversial aspect of CBA. Environmental characteristics that are

not normally bought and sold in the marketplace cannot readily be valued. Growing

recognition of the importance of these characteristics has been matched by increased

attempts to develop monetary valuations of them, however. This is particularly pertinent in

the economic evaluation of water supply and wastewater treatment projects.

A variety of approaches has been developed to address this. Two broad categories are

Stated Preference and Revealed Preference techniques. The former involve administering

carefully controlled questionnaires that ask people their monetary valuation of particular

attributes. A sample of the public are asked how much they are Willing To Pay (WTP) for an

environmental improvement, or how much they are Willing To Accept (WTA) in compensation

for environmental disimprovements. These responses can then be used to generate an

estimate of societys valuation of the attribute. One point to note is that WTP cannot exceed

total income. There is no such limitation on WTA, of course, and it is often the case that WTA

studies generate higher valuations than WTP studies, though in theory they should not, and

study design is concerned among other things with ensuring that the two equate.

Revealed Preference techniques on the other hand try to elucidate values for environmental

attributes via actual markets related to the attribute in question, notably

a) the Hedonic Price method, based on the fact that house prices can reflect differing localenvironmental attributes. If we can isolate these price effects, we can estimate societys

valuation of (the equivalent of WTP for) the environmental attribute in question.

b) The Travel Cost method, which measures how much people are willing to spend on travelto enjoy a particular attribute. Again, isolating this can enable us to estimate societys

valuation of the attribute (the equivalent of WTP).

One needs to be careful in defining the group of beneficiaries (or losers) from an

environmental change. While the people living in the vicinity are an obvious group, those who

occasionally visit the area will also be affected, as indeed will those who never visit it, but put

a value on its continued existence and quality. Indeed, the latter two groups often outnumber

the first, though their individual valuations may be less. Hedonic and Travel Cost methods

have limitations in measuring these non-use valuations.


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2.2.2 Treatment of Future Costs & Benefits Discount Rates

An important issue in CBA is the choice of discount rate. People generally prefer present

benefits to future benefits. Comparison of costs and benefits with different time-paths is

facilitated by discounting them to their present day values using a discount rate, which iscomparable to an interest rate. The further into the future the cost or benefit, the lower its

present value, and raising the discount rate will lower the present value. The rate

traditionally used in Ireland for public projects, as recommended by the Department of

Finance (1994), is 5% real (i.e. net of inflation). Controversy arises because many

environmental benefits and costs accrue long into the future, and discounting means that

their present values can be negligible.

It is usually the case also that future costs and benefits are estimated on the basis that there

is no inflation, so that everything is valued at the prices in a particular year, usually the year

the project is taken to commence or becomes operational.

2.2.3 Timeframe

An investment will have a certain lifespan, and in general this should determine the time-

frame used in the CBA, although in many cases a standard timeframe such as 30 years is

used. Sometimes the lifespan will vary for different parts of the investment, e.g. a waste

water treatment plant will have longer-lived buildings and shorter-lived pumps and electronic

equipment. This can be accommodated in CBA as follows: incorporate the full capital cost of

the asset at the start of the project as normal, then

for assets that will last longer than the timeframe of the CBA, include estimated residualvalues in the final year, as a receipt that year;

for shorter-lived assets, include replacement costs in the year the assets are replaced.Replacement may happen more than once during the CBA timeframe.

2.2.4 Calculation of Net Benefit

CBA usually involves calculation of:

a) Cost Benefit Ratio (CBR), the ratio of the PV of benefits to the PV of costs (onesometimes sees the ratio of undiscounted benefits to costs, but this is a less useful

measure).

b) The Internal Rate of Return (IRR), which estimates the actual return on the project,expressed as a percentage or interest rate.

c) The Net Present Value (NPV), which is the PV of benefits minus the PV of costs.


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These enable projects to be compared and prioritised. The most widely used are NPV and

IRR, and they give slightly different information. NPV gives an indication of the size of the net

benefit, and will tend to be higher for larger projects (subject to passing the hurdle discount

rate). IRR on the other hand is independent of size: a project could be very small or very

large but have the same IRR.

This can be relevant if one is deciding between larger and smaller (more or less expensive)

projects which are aimed at substantially the same problem, and where choosing the smaller

project eliminates the possibility of undertaking the larger project. The task is to identify

whether the additional benefits of the larger project are worth the additional cost. In this

case another measure can be useful:

d) The Incremental Benefit Cost Ratio (IBCR).IBCR = (PV of Benefits of Project A PV of Benefits of Project B)

(PV of Costs of Project A PV of Costs of Project B)

Where Project A is larger (i.e. more expensive) than project B.

2.2.5 Benefits Transfer

Sometimes policy makers require cost-benefit analyses to be undertaken, without wishing to

commit the time and resources to analyse directly the benefits or costs arising on the specific

project. On these occasions, valuations are generally taken from studies undertakenelsewhere, a technique known as Benefits Transfer.

Methodological issues with Benefits Transfer have provoked a lively debate and empirical

testing (Brower and Spaninks, 1999). A notable case in the UK was the 1998 Public Inquiry

into a proposal to extract borehole water from near the River Kennet in Wiltshire, located in

an Area of Outstanding Natural Beauty and a Site of Special Scientific Interest. The Inquiry

rejected the Environment Agencys CBA on the proposal, which had based its valuations on a

Benefits Manual prepared by the Foundation for Water Research (1997). The lesson to

emerge from this is the need to calibrate values of benefits and costs that have been taken

from elsewhere.

The risks of poor practice in using Benefits Transfer in CBA are high. But with virtually no

valuations available for Ireland2, its use will be unavoidable in most cases. Among the various

approaches to Benefits Transfer, it is better where possible to avail of the function that

expresses the benefit in terms of characteristics of site and users. (Brouwer and Langford,

1997, Bateman et al., 2000). Notably, adjustment in values found in other countries may be

necessary for differences in average income levels and income distribution.

A more detailed discussion of Benefits Transfer is contained in Appendix D.

2 Studies by Clinch (1999) and Curtis (2003) being notable exceptions but in only remotely related

fields.


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2.2.6 Efficiency and Equity

CBA implicitly accepts the existing distribution of income and wealth in society, and is

concerned simply with whether the benefits of an investment are greater than the costs,

regardless of who gains and loses. From a policy point of view, one might be moreconcerned, for example, about benefits (or costs) that accrue to lower income groups or

groups in particular regions.

Another complication is that the valuation of environmental benefits by the public (particularly

with WTP methods) is generally highly related to income levels. Thus, all other things being

equal, an investment that brings environmental benefits to low income groups may be valued

at less than an investment that benefits higher income groups.

2.3 CBA Manuals

Many CBA manuals have been developed over time and in various jurisdictions. Here we

review in detail the most relevant and up-to-date, in the context of Cohesion-funded projects

in Ireland, namely:

1. The Economic Appraisal of Environmental Projects Supported by the EU Cohesion Fund,by Fehily Timoney Weston in association with DKM, for the Department of the

Environment, November 1995.

2.

Guide to Cost-Benefit Analysis of Investment Projects (Structural Fund-ERDF, CohesionFund and Instrument for Structural Policies in Pre-Accession Countries [ISPA]), Prepared

for the Evaluation Unit of the Regional Policy DG of the EU Commission, 1999 Edition.

3. The UK Environmental Agency (EA) Assessment of Benefits for Water Quality and WaterResources Schemes in the PR04 Environment Programme.

2.3.1: Fehily Timoney Weston Study

This study was commissioned in the context of the EU Commissions requirement for CBA of

projects requesting Cohesion funding. It comprised two parts

1) assisting the Department in examining data submitted by the Local Authorities,evaluating the projects and preparing reports on the projects for the EU Commission;

2) formulating an agreed methodology, with the Department and the Commission, foreconomic evaluation of environmental projects.

The methodology developed had three elements -

Quantify all identified costs


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Quantify direct and indirect benefits Ascribe values to project benefits

The valuation of scheme costs was considered to be relatively straightforward, and was to

include marginal operating costs (discounted at 5% real per annum) over the life of the

assets, which was assumed to be 20 years. However, the report highlighted the lack of Irish

data on the valuation of benefits, and recommended the use of Contingent Valuation Methods

(CVM) to generate these benefits. It acknowledged that this was not practicable within the

timeframe of the study.

Detailed methodologies were then set out for wastewater projects and water supply projects,

as follows:

(i) Wastewater Projects

To facilitate the quantification of costs and benefits in wastewater projects, a

questionnaire was designed, which also sought to identify the degree to which the

project was necessary for compliance with the UWWTD, and current compliance

levels.

Where operating costs could not be identified, standard levels were assumed to

apply. Standard operating costs were based on experience in a number of existing

schemes, set out in IR per Population Equivalent (pe). Benefits were quantified in

terms of standard reductions in Biological Oxygen Demand (BOD) and Phosphorous(P) for primary, secondary and tertiary treatment.

In the absence of valuation of benefits, the effectiveness of the projects was to be

assessed in terms of total discounted cost per kg of BOD and P removed.

(ii) Water Supply Projects

Quantitative information to be collected comprised

Pre- and post-project demand broken down into domestic, commercial,industrial and agricultural,

Pre- and post-project population serviced, Pre- and post-project design demand and population.

The degree to which the project was necessary for compliance with national

legislation under the EU Drinking Water Directive, as well as existing compliance

levels, was to be established. Existing water quality was taken from the EPAs 1994report on the Quality of Drinking Water in Ireland.


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Marginal operating costs were to be calculated by applying a standard level of

IR0.05 per m3.

Benefits were assumed under three headings

1. quality improvements2. extension of supply to new customers3. waste elimination and control.

Quality improvements were valued at IR13 per household per annum (1989 prices,

for domestic demand only) based on a UK CVM study (Turner et al., 1992). Extension

of supply and leakage reduction were to be valued at IR0.70/m3, based on costs in

Wales and the South-West of England (OFWAT, 1994). Cost/benefit ratios were then

to be calculated, which was to allow ranking of projects.

The methodologies were then applied to a number of water supply and wastewater projects

and to the Integrated Suir Valley Catchment project.

2.3.2: EU Guide to Cost-Benefit Analysis of Investment Projects

This is a detailed CBA manual, covering projects in a very wide range of areas, including

water and wastewater, which are eligible for assistance under the Structural and CohesionFunds and the ISPA (Accession country fund) over the period 2000-2006.

It gives a set of steps for a project evaluator, from an ex antestandpoint:

a) Objectives Definition

b) Project Identification

c) Feasibility & Options Analysisd) Financial Analysis

e) Economic Analysis

These are discussed in terms of general principles, and then applied to a wide range of

investment types, from hospitals to telecommunications, including water projects. We set out

below a synopsis of the general principles and their application to water projects.


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General Principles

a) Objectives Definition

Projects should be defined in terms of the socio-economic benefits to flow from them,as well as their contribution to EU Fund and sectoral objectives. Questions to be

addressed include

Are the objectives clearly defined in terms of socio-economic variables? Haveall the variables been considered, and the means of measuring them

indicated?

Are they attainable with the implementation of the project? Are they logically connected? Are the overall welfare gains worth the cost?


The project should be identifiable as a self-sufficient unit of analysis, where the

constituent parts are mutually dependent, regardless of whether one or more are

eligible for grant aid. Various elements should only be included, however, if they are

actually implemented. If say a water treatment plant is built in order to enable

another development, they should be considered together only if the other

development is actually built.

c) Feasibility & Options Analysis

The feasibility of the project must be demonstrated, and alternative options

adequately considered. At least three options should be considered Do Nothing, Do

minimum (e.g. up-grade the existing infrastructure), and Do something (usually using

a different technology to achieve the end, e.g. build a new road as opposed to a new

railway).

d) Financial Analysis

This is concerned with financial inflows and outflows. The Guidelines give detailed

layouts of tables for this purpose, which will generate the financial NPV (FNPV/K)

and IRR (FRR/K) on Capital. The Guidelines note that these financial assessments

of environmental projects will generally turn out negative. The following points are

made regarding the financial analysis:

Operating costs these should exclude anything that is not an actual cashpayment, specifically depreciation and amortisation, transfers to future

replacement cost reserves, and to contingency reserves.


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Taxes and Subsidies costs and benefits should exclude VAT. Subsidies (e.g.from other authorities) should be excluded from revenues.

Residual Value this is effectively the liquidation value. It may be calculatedin one of two ways (1) the residual market value of the investment, if it wereto be sold, or (2) the residual value of all assets and liabilities. Subsequent

net receipts should be included in the residual value.

In project analysis, constant prices (i.e. with inflation netted out) aregenerally used. However, in the analysis of financial flows, current prices (i.e.

with inflation included) are recommended by the Guidelines. If constant

prices are to be used, corrections must be made for changes in relative prices

(i.e. different inflation rates applying to difference costs and benefits), if

significant.

The discount rate to be used should reflect the opportunity cost of capital.The Guidelines suggest an indicative rate of 6% real.

An important issue is the lifespan of the project. The report highlights Cohesion Fund

guidelines, which indicate that - where different elements of the project have

differing lifespans, one should assess the project over the lifespan of the principal

infrastructure. Where other elements last for a shorter period, their replacement

costs (as well as their initial costs) should be included. Lifespan may also be

determined by some administrative or legal criterion such as the length of a

concession or licence. ISPA guidelines indicate that infrastructure would not normallybe evaluated beyond 30 years. If an investment lasts longer than that, its residual

value should be included as a receipt in the final year of the analysis. An ad hoc

survey of CF projects in the early Nineties indicated that the average lifespan used for

47 water and environmental projects was 29.1 years. The Guidelines recommend

using a lifespan of 30 years.


This is the next step after the financial analysis, and converts from financial flows to

real resource flows, by correcting for distortions caused by market imperfections,

notably external costs and benefits. There are three stages:

(i) Fiscal corrections. Notably, prices should be net of VAT, other indirect taxes(unless their function is to correct for an externality) and transfer payments

(e.g. social security payments), and gross of direct taxes.

(ii) Externalities corrections. Inclusion of environmental and other external costsand benefits (unless already adequately dealt with by taxes); where these

cannot be valued they should be at least listed and physically quantified to

the degree possible.


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(iii) Conversion of market prices into accounting prices, which reflect socialcosts and benefits. These correct for market imperfections that can be

caused by monopoly provision or regulatory restrictions, which mean that the

market price for particular goods and services is not equal to the marginal

social cost (i.e. shadow price). Examples cited include provision of electricityat above or below long run social marginal cost, minimum wages set above

the market-clearing rate for unskilled labour, public sector wages above or

below the equivalent private rates, and subsidised land3. In the case of

internationally traded goods, border prices are often a good indicator of

accounting price.

The appropriate social discount rate is used to generate the economic NPV

(ENPV) on investment, and the economic IRR (ERR) should be calculated. The

Guidelines suggest a 5% European social discount rate. The Guidelines note that

the expected ERR for 51 EU-funded water and environment projects was 15.8%.

Other points noted include:

Existing publicly-owned assets (including land) used for the project should bevalued at their opportunity cost, i.e. the alternative use value.

The Guidelines discuss the issue of the benefits of additional employment.They highlight that in the first place, employment is a cost of the project,

since it involves the usage of labour resources which are not then availablefor use in the rest of the economy. The benefit of employment, the incomes

that flow from the project, are accounted for by the valuation of the outputs

of the project. They list two mutually exclusiveways of accounting for the

social benefits of increased employment (1) using a shadow price of labour

lower than the market price and (2) applying an income multiplier to the

project output, thus increasing the value of the output. The latter is best

applied at macro-economic level or for (a) very big investment program.

f) Multi-Criteria Analysis

This can be useful where certain objectives are not amenable to valuation, such as social

equity, equal opportunities and environmental protection (though many individual

environmental benefits will be measurable). These can be listed, scored, and given weights,

which when summed can give a means of comparing alternative projects for these objectives.

g) Sensitivity and Risk

3 It may be the case that land in Ireland is in some cases priced at more than the marginal social cost,

due to restrictive planning regulations.


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This is important as different levels of uncertainty attach to forecasts of variables within and

between projects. The Guidelines define a risky project as one where there is a high

probability that the project will not overcome a certain IRR threshold, rather than one where

there is simply a high level of variability in the forecasts. They recommend a two-step

approach:

1) Sensitivity Analysis, which measures the impact of changes in the forecast values ofvariables on the financial and economic IRR and NPV, and identifies the critical

variables. As a general rule the Guidelines recommend that variables for which a 1%

change will cause a one percentage point change in IRR or 5% change in NPV be

considered critical.

2) Risk Probability Analysis, which involves attaching a probability distribution to each ofthe critical variables, and using these to build up a probability distribution of IRR or

NPV. This can be very complex where there are even a few critical variables, but

statistical techniques such as the Monte Carlo method can be used to generate the

distribution.

A shortcut (but not substitute) procedure is Scenario Analysis, which can be used to

generate optimistic and pessimistic outcomes, by taking the extreme positive and negative

values for the each of the critical variables.

Application to Water Projects

These general principles are then applied to a wide range of sectors, including water projects(Guidelines Chapter 3, Section 2). The main points in this regard are:

a) Objective Definition

Usually it will be in terms of improving the quality, effectiveness and efficiency of the service.

Significant parameters would include, for instance

Extension of numbers of customers serviced Volumes of water saved Reductions in quantities taken from polluted sources Improvements in continuity of service Removal of polluting load Reduction in operating costs Improvement in environmental parameters.


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A definition of currently available services, or a territorial framework will often provide an

appropriate definition of the project. It should also address the projects consistency with the

economic-financial planning for the sector, with national sectoral policies (e.g. industrialpolicy), and with EU, national and regional policies.

c) Feasibility and Options Analysis

Feasibility

The following need to be considered

Analysis of demand in terms of quantity and usages, leakages where relevant, andprice elasticity of demand (which may vary by user).

Forecast of actual and potential demand, and the relationship between the two. The economic and environmental sustainability of the project, including capacity to

provide for demand, and capacity of receiving waters in the case of wastewater

treatment.

The institutional, administrative, managerial and technical capacity to deliver the project.

Options

Mainly the various physical and technical options for meeting the objectives of the project.

d) Financial Analysis

The main point here is to incorporate the revenues that will flow from the infrastructure.

Where net revenues will be generated, it is appropriate that a significant amount of the

funding should come from the promoters own funds.


The accounting price of water can be ascertained by means of the users Willingness to Pay

(WTP). One way of estimating WTP is by reference to the market price of alternative services.

In the case of water for industrial or agricultural purpose, the added value of the industrial or

agricultural outputs made possible by the water supply will give guidance for valuation.

Where the project will address problems of water sanitation and pollution, the reductions in

illnesses and deaths can be valued, via inter aliahospital costs, loss of earnings, and Value of

a Statistical Life (VOSL) techniques. Where flood control is involved, the damage avoided to


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property and land can be considered. Where the specific costs and benefits of the project are

difficult to value, values from similar projects can be used.

Specific externalities that can be considered include

the increase in the value of land as a result of providing the infrastructure increased incomes from collateral activities (tourism, fishing, coastal agriculture, etc.) negative impacts in terms of soil consumption, spoilage of scenery, etc. negative impacts during construction, particularly in urban and sensitive contexts.

f) Other Evaluation Criteria

Additional techniques such as Multi-Criteria Analysis may be appropriate where for example

the location for the project is environmentally sensitive, e.g. national parks, protected areas,

or where particular fauna are going to be affected.

g) Sensitivity & Risk Analysis

Critical factors include

unexpected occurrences during construction, which can affect cost of the investment. Factors affecting demand forecasts, including population growth, migration and tourist

flows, etc.

Rate of change in tariffs (often dependent on decisions by regulatory bodies). Lack of capacity to respond to shock in the investment (which often requires excess

capacity in the (early) operating periods).

the influence of collateral interventions (for example, the effectiveness of water supplyis strictly related to the state of distribution networks).

Management efficiency. Future costs of critical inputs, e.g. energy, chemicals, and sludge disposal.

A detailed case study of an Integrated Water Supply Service (IWS), which includes supply

and wastewater treatment, is then presented, which goes through the procedure outlined

above


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2.3.3: UK Environmental Agency Guidance

Introduction

The UK Environmental Agency (EA) has recently produced very detailed updated guidance forcarrying out CBAs on a range of water infrastructure projects, entitledAssessment of Benefits

for Water Quality and Water Resources Schemes in the PR044 Environment Programme,

produced by Risk & Policy Analysts Ltd. (RPA). This builds on a number of earlier studies and

guidance from the EA and its predecessors. The main focus is on Benefits Transfer

techniques, based on a comprehensive review of (mainly) UK literature, and on developing a

methodology that can be applied to a large number and wide range of projects, with

relatively little time (no more than a few days) and resources to apply to each, to be used by

those who have little or no experience of economic evaluation.

The Guidance defines objectives or Drivers, which it is hoped to achieve in the scheme. The

EA divides these into environmental and policy drivers. Policy drivers refer to compliance

with particular regulations with respect to the water body in question.

There are separate sections in the Guidance on

Water Quality and Flows in rivers and groundwater Reservoirs, Lakes and Broads5, Coastal Waters and estuaries Impacts from scheme-related Construction works.

The CBA methodology is first described. A five-step approach to appraisal is recommended

1. Identify which benefits or costs are likely to apply;2. Describe the benefits or costs qualitatively;

4 At the moment we understand the Guidance has the status of a Working Document. PR04 is Ofwats

Periodic Review 2004 of planned investments in the Water Industry. The periodic-review process

requires a five-year cycle of fixing the capital investment programme of the water industry. This

programme is the outcome of considerations of the legal requirements (typically defined by EU

directives), desirable environmental improvements and the willingness of consumers to pay. Defra has

the role of striking this balance in its guidance to the EA and Ofwat; the EA has the role of proposing

the requirements; and Ofwat has the duty to set the prices and hence determine the functions that are

to be financed. (Economic Appraisal and Assessment of Benefits in the PR04 Environment Programme,

Findings of an Environment Agency seminar, January 2003, Benefit Assessment: The Context, Dieter

Helm.)

5 A Broad is defined as an expansion of a river.


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3. Describe them quantitatively;4. Where impacts are significant, apply monetary valuations, either directly or via Benefits

Transfer;

5. Undertake sensitivity analysis.

In general, the Guidance is in agreement with the other documents already discussed, but a

number of differences in emphasis are raised, including:

a) The environmental impact of an investment can relate to improving current conditions orpreventing future deterioration. This is incorporated in the CBA via the use of discount

rates, but various studies indicate that the public view maintenance of an existing

environmental asset differently from the creation of a new one; in many cases they

appear to be willing to pay more to preserve an existing asset.

b) Discount rate for public sector projects, the UK Treasury recommended discount rateshould be used (3.5%), while for projects by privatised water companies, the cost of

capital rate set by Ofwat should be used. This highlights one of the differences between

the Irish and UK water industries, in that the latter is commercialised and largely

privatised.

c) The Guidance indicates that CBA be applied only to non-statutory schemes, orimprovements over and above statutory requirements. The UK Environmental Secretaryhas indicated that any water improvements in excess of EU requirements over the period

2005-2010 will have to pass rigorous CBA tests6.

d) The Guidance draws attention to the fact that any positive discount rate will affect therecorded impacts of schemes that have environmental benefits or costs a long time into

the future. Where such costs or benefits exist and are considered significant, they should

be highlighted in a qualitative manner.

e) Economic analysis implicitly accepts the current distribution of wealth and income. Inother words, questions of equity do not enter into the analysis. They can be incorporated

qualitatively. However, a more sophisticated approach is to incorporate distributional

effects into estimates of NPV through the use of weights that reflect the additional gains

in wellbeing to lower income groups of an increase in income. Instead of treating each

unit of benefit or cost as being equal, these would place greater weight on those to low

income groups than those to higher income groups. The identification of appropriate

weights is also controversial, however.

f) The timeframe should be matched with the lifespan of the assets; alternatively, a defaultperiod of 25 years should be used.

6 Initial Guidance from the Secretary of State to the Director-General of Water Services, 2004 Periodic

Review of Water Price Limits, reported in The ENDS ReportJanuary 2003, issue No. 336.


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g) Future benefits and costs should be measured in constant prices. In general, inflationcan be assumed to affect all prices equally and does not need to be considered.

h) The main concerns with the use of Benefits Transfer are "the reliability of the original estimate a difficulty, given the lack of relevant studies. the similarity of the environmental change being valued in terms of end outcome and

its significance and magnitude; and

the similarity of the environmental characteristics of the target site to which the valueis to be applied.

i) Biodiversity and Non-Use ValuesThese are difficult to measure quantitatively, and biodiversity impacts should also be

discussed in qualitative and descriptive terms. Issues involved in considering non-use

values include

problems in defining what is the relevant population for aggregating non-use values,where this includes the potential need to separate users from non-users to avoid

double counting; and

ensuring that the inclusion of non-use values in individual scheme assessments doesnot result in total household budgets for non-use being exceeded. There are few

studies which have estimated total budgets for non-use values. It is obviously hard to

take account of such a budget at the individual scheme level, but as schemes are

pulled together at the catchment level, these budgets should be given more detailed

consideration.

There are suggestions in the economic literature that non-use values should only besignificant when a resource (environmental attribute, site or habitat) is scarce or

unique. This follows the principle that if there are a number of close alternatives,

then the value attached to a resource will be less.

The population over which a non-use value should be aggregated is another area ofuncertainty. Varying assumptions have been made in the past, ranging from

applying a value to the whole population to applying the value to a local population

beyond which the willingness to pay is believed to reduce to zero, known as distance-

decay. Uniqueness is an important factor here.

j) Use Values and Relevant Population

The relevant population will vary with type and relative importance of the site, andsettlement patterns in the surrounding area. Seasonal patterns of usage are also


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important. Annualisation of visitor numbers observed on a particular day or time of year

must be undertaken with caution. Various annualisation factors are given in the Guidance

for this purpose. For example the coastal bathing season is taken to last 150 days, i.e.

roughly 5 months. A different (possibly shorter) period might be appropriate in Ireland.

It is recommended that reality checks be undertaken to determine:

(i) whether the site could support the estimated number of visitors;(ii) if the number of visitors estimated fits in with what would seem to be realistic; and(iii)if the number of estimated visitors is comparable with known visitor numbers to other

similar sites.

It (is) important .. to carry out sensitivity analysis on these assumptions. assuming

only 50% of the rates predicted are realised (particularly where common sense and the

reality checks say that the predicted rates are too high). Or, the number of visitor days

required for a project to break even.

k) Avoid Double CountingThere are three potential sources of double counting in an economic assessment:

(i) overlap between categories;(ii) using the same population for different impacts (particularly use and non-use); and(iii)use of Benefits Transfer values that include more than just the specific impact being

valued.

There is a significant risk that double counting could be introduced, in particular where

impacts may be experienced in more than one environmental compartment (rivers and

groundwater, reservoirs, lakes and broads, coastal waters and estuaries).

l) UncertaintyFailure to take uncertainty into account can result in an option being chosen which

appears best, but which has a high likelihood of providing a lower level of net benefits

than predicted. A range of different uncertainties may surround different aspects of a CBA.

Those of most relevance (include):

scientific uncertainty, for example, on the effectiveness of a particular controlmeasure, or on the period over which an environmental impact will occur;

uncertainty over populations (users and non-users) for use in aggregation; and


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uncertainty on the robustness and applicability of the transfer values being used toestimate costs and benefits.

One approach to sensitivity testing is to calculate the degree of variation in a particular

variable which would by itself reduce the net benefits of an action to zero, or result in achange in preference between competing options.

m) Energy UsageWhere investments will lead to substantial energy usage, either in construction or

operation, the environmental (including global warming) implications will need to be

considered. However, where environmental taxes including the climate change levy are in

place and are taken into account in the costs, this may obviate the need to include further

costs.

The Guidance gives detailed instructions on how to put together the CBA, and discusses

benefits under categories. Benefits categories are listed for each broad type of impact in

Table 2.1 overleaf.

The Guidance shows how to assess each of these benefit types, either directly or using

default values from appropriate studies, and suggests valuation, based on relevant studies.

For instance, it sets out likely attraction levels for types of improvements, taking into account

the importance of the waterway, the availability of alternatives, visitor seasonal patterns and

part of the country (which impacts on population densities and hence likely visitor levels).

These indicators are likely to be very valuable in the Irish context, but the following provisos

are necessary if they are to be used

1. population densities are in general much higher in the UK than in Ireland, and this needsto be kept in mind in terms of likely visitor numbers and affected populations;

2. Relative popularity of different pastimes (e.g. angling) needs to be considered.3. Valuations need to take into account average income levels, income distribution and

purchasing power parity in the year and country of the original study compared with

those in Ireland in the current context.


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Table 2.1: Benefit Categories Included in each Part of the Guidance

Part 2: Rivers and Groundwater Part 3: Reservoirs, Lakes and Broads Part 4: Coastal Waters and Estuar

Informal recreation

Angling

Commercial fisheries

In-stream recreation

Heritage, archaeology and landscape

Amenity

Abstractions

Biodiversity and non-use

Recreation (informal and water sports),

Heritage, archaeology and landscape

Amenity

Land take (for new reservoirs)


Informal recreation

Coastal bathing

Water sports

Recreational fishing

Shellfisheries


Notes:

1. Informal Recreation incorporates activities such as walking/hiking, photography, bird-watching, etc.2. Bathing is a separate heading under coastal waters because of its relative importance; care is needed not to double-count b


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Section 3: Proposed Methodology

3.1 Introduction

In the current context we are concerned with ex postanalysis of investments where ex ante

CBAs have already been (or were supposed to have been) carried out. In a number of cases,

notably water conservation investments, ex antestudies were not carried out, so they fit into

a somewhat different category for this study.

This arises out of the following requirement in the Terms of Reference for the Study:

The consultants are required to .. propose a Cost-Benefit Analysis (CBA) methodology(ies)

to meet the requirements of EU Council Regulation 1164/94. Article 13.4 of the Regulation

states:

After their (the projects) completion, the Commission and the beneficiary

Member State shall evaluate the manner in which they have been carried out

and the potential and actual impact of their implementation in order to assess

whether the original objectives can be, or have been achieved. This evaluation

shall inter alia, address the environmental impacts of the projects, in compliance

with existing Community rules.

CBA in its essence is a decision tool designed to help in determining whether an investment

should go ahead or not. Since in the current case all the projects have already gone ahead,

this particular function of CBA is redundant; however, the technique can be used to review

the rationale for a particular investment, and perhaps generate lessons for assessment of

future investments.

For studies where ex anteCBAs have been undertaken, our function is to review the position,

to see how the forecast costs and benefits have turned out. These CBAs were carried out at

various points in time (usually the mid-1990s), by a range of individuals/firms and for variousinvestment types around the country. This leads to a number of issues, notably:

a) The Celtic Tiger" boom has intervened, leading to greater population growth andeconomic activity than was perhaps anticipated (some parts of the country will have been

affected more than others). What have been the consequences for the investments and

their costs and benefits?

b) CBA techniques are evolving. Do these developments have implications for themethodology and/or valuations used in the ex antestudy?

Two questions will thus need to be addressed: (i) how accurate and valid was the ex anteCBA, and ii) with the benefit of hindsight, was this project worth undertaking? As stated,


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some investments were not subject to ex ante CBAs (notably on water conservation

investments). Hence there is no analysis to review. In these cases only the second question

will be addressed.

The Terms of Reference for this study also require that the following be specifically

addressed:

1. The developing framework for financing such projects in Ireland;2. The values of benefits arising during the implementation of the projects;3. The benefits of the projects to tourism, industry, commercial development, fishing, etc.;4. The direct and indirect employment effects of the projects;5. The environmental benefits and future impacts of the projects, having regard to national

and EU requirements;

6. The economic viability of the projects;7. The economic and social benefits commensurate with the resources deployed on the

projects.

8. The contribution made to EU Community policies;9. The contribution of the projects to balanced regional and rural development;10.Establish the Internal Rate of Return of the projects.

Some of these points fit easily into economic CBA methodology, while others do not. Two

that require additional consideration are attainment of EU/national regulations and

employment impacts:

Benefits from Meeting EU/National Requirements

There is clearly a political benefit in meeting regulations, and at some level a financial

benefit may exist if fines are avoided. However, meeting regulations per se is not

amenable to inclusion in CBA as a benefit. Only the actual physical benefits

generated, converted to a monetary valuation in an appropriate manner, can be

included.

Where water investments help to meet EU or national regulations, this should be

noted as one of the qualitative results of investment, but it does not obviate the need

for a full CBA to be carried out7.

7 It is worth noting that in the UK, CBA is not used where projects are necessary to meet EU

requirements. The following quotation (Helm, 2003) in a UK context raises the point that the regulations

themselves should have been subject to CBA before implementation:


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Direct and Indirect Employment Effects, and Regional Development

Direct employment effects are those generated in the construction of or manufacture

of materials for the project in question, while indirect effects relate to employmentgenerated or sustained by the benefits that flow from the project.

Employment generation - direct or indirect - is not amenable to inclusion in CBA as a

benefit. In CBA, labour is a resource and its usage is a cost, which may be less (or

more) than the actual wages paid.

Policymakers who remember the days of high unemployment may look upon the

generation of employment as a benefit. But where it is done via public investment

(which must be paid for by taxation) the likelihood is that one is merely displacing

private sector employment with public sector employment. In any event, where the

economy has full or near full employment, the issue is of less importance. The

presumption, endorsed in the CSF Evaluation Unit's guidelines, is that in current Irish

circumstances, the market price (i.e. wages) and shadow price (i.e. resource cost) of

labour coincide.

If identifiable employment impacts are sizeable, however, they should be noted as

one of the non-valued results of the investment.

Measuring indirect employment impacts can be problematic. To what degree is the

water project critical to the generation of economic activity in the wider economy, or

could alternative investment have equivalent results? Are we simply moving activityfrom one part of the country to another, or is there a net gain for the economy as a

whole? What is the net benefit where the economy is at or near full employment?

The same points can be made about regional development effects.

the EA (Environmental Agency) argues that much of the capital programme is statutory: that there is

no option but to carry out the necessary works, because they are mandated by EU Directives. In many

respects, this is correct, although in most cases there are important issues in timing and the forms of

compliance. But, of perhaps greater concern, is whether these Directives themselves pass the cost

benefit test. Often environmental quality requirements are laid down with regard to problems of

countries with inland waterways and geographical and climate conditions very different from the UK

with its short, fast-flowing rivers and extensive coasts. It is a serious issue that many of these Directives

have not been tested against proper costbenefit assessments; but it is perhaps more serious that there

is little account taken of the different locations. Common European standards of environmental

outcomes do not necessitate common approaches to environmental inputs.


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3.2 General Principles

While each CBA will be somewhat different, we would list the following as general principles

that should apply in most cases. Where deviations from these principles are made, they

should be explicitly justified.

1. The lifespan of the investment should be taken as 30 years from the time theinfrastructure is commissioned, i.e. becomes operational. Residual values should be used

where assets last longer. It may be appropriate to consider each major element of the

investment separately. In the absence of better information, the following formula could

be used:

Residual Value = (Capital Cost as defined in Year Zero) x (Useful Life-30)/(Useful Life)

This implies a straight-line depreciation of the asset over its life. A reducing balance

approach could alternatively be used, where appropriate. Replacement costs can be

incorporated where some assets last less than 30 years, though care is required not to

double count this if it is also included in O&M contracts.

2. All costs and benefits incurred since the decision was taken to go ahead with the project(which will usually be a number of years before commissioning) should be included.

3. Year Zero should be the year the infrastructure is commissioned8. All monetised costs andbenefits should be stated in Year Zero prices, using the appropriate deflator (i.e. inflation

index). Capital costs already incurred should be deflated using the Water & Sanitary

Services Output Price Deflator9. All other costs and benefits (internal and external) should

be deflated using the CPI. The prices of costs and benefits due to occur in the future canbe converted to Year Zero by taking their current year price levels and then deflating

them back to Year Zero using the appropriate deflator.

4. The discount rate to be used is 5% real, i.e. net of inflation (CSF Evaluation Unit, 1999).Once the costs and benefits arising in each year are deflated to Year Zero prices, they

can be discounted to year Zero at 5% per annum.

5. All monetary values used should be net of VAT.6. Financing costs (i.e. interest charges) should be excluded. As we are applying a social

discount rate to all costs and benefits, to include interest charges as well would be

double-counting.

7. Operating costs should be included on a cashflow basis. Thus, accounting entries such asdepreciation and amortisation of grants should be excluded. As stated, unrecovered VAT

paid and interest charges should also be excluded. Where O&M contracts are in place,

8 When carrying out an ex anteCBA, Year Zero is generally taken to be the year the decision is taken to

go ahead with the project. However, with an ex postCBA it is easier to use year of commissioning. The

results will be the same in any event.9 As published in the annual Review and Outlook for the Construction Industry, by the Department of

the Environment, Heritage & Local Government. (See Table A2.7, p.119, in the 2003 edition).


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the payments under these can be used, though care is needed in the treatment of VAT,

capital replacement, amortisation of grants, interest, etc.

8. The value of extra land used should be included at its alternative use value. This mightbe less than was actually paid (e.g. possibly under compulsory purchase, or where the

value includes capitalised agricultural subsidies) or more than was paid (e.g. if the localauthority used land it already owned).

3.3 Stages in the CBA

The following should be the stages undertaken in the CBA process:

3.3.1: Define the Objectives, the Project and the Counterfactual

Most of the schemes we are required to review contain a number of sub-projects.

Aggregating the projects before working out the costs and benefits runs the risk of hiding

elements that are more or less worthwhile. On the other hand projects should not be

disaggregated below the level at which they can stand as independent entities. Engineering

assessment will play a part here. The ability to identify benefits separately may be a factor in

how the project is defined, from a practical point of view.

The counterfactual represents the alternative course of action against which to test the

project. There can be a whole range of counterfactuals, and the definition of some of them

might be quite complex. They generally fall under the following headings

do nothing, i.e. continue with the existing situation, which may generate increasingcosts in the future.

do minimum, in many cases similar to the do nothing, where the minimum that canbe gotten away with is done. Again there can be increasing cost implications in the

future.

do something, perhaps an alternative technology. This itself might be tested against ado nothing or do minimum scenario.

In the current circumstances, given the limitations on time and resources, and the fact that

we are looking at these investments from an ex postviewpoint, the counterfactual should be

do nothing or do minimum, unless there is an obvious alternative.

3.3.2: Identify and evaluate internal (i.e. monetary) Costs and Benefits

Internal Costs

These are the capital and operating costs of the scheme. They should be relatively

straightforward to value, particularly when looked at from an ex postviewpoint. Future costswill have some uncertainties attached, as discussed already.


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Internal Benefits

Internal benefits as those that accrue to customers of the water industry, and which are

charged for or should be charged for. We include residential water services in the latter.

The flow of benefits over the lifetime of the investment will need to be quantified. This will

involve making forecasts about number of customers and consumption rates over 30 years,

which is of course highly speculative. Demographics and economic growth rates are likely to

be important variables. The CSO produces long term population forecasts for Ireland as a

whole and for the regions, and the ESRI produces medium-term economic growth forecasts10,

but these are unlikely to sufficiently detailed information for specific projects. The local

authorities are likely to have some indications of medium-term trends from their planning

function. Beyond that we would recommend a conservative approach of low annual growth

rates unless there is specific information to suggest otherwise.

Benefits would also include avoided costs related to the counterfactual. For example, if sludge

disposal at sea has been replaced by treatment and disposal on land, then the avoided cost

of sea disposal should be treated as a benefit. Likewise, if basic treatment has been replaced

by more advanced treatment, the avoided cost of continued basic treatment should be

included as a benefit11.

An important consideration in measuring internal benefits is that project definition cannot be

separated from the pricing policy relating to its output. This is because demand for a product

or service is a function of (among other things) its price. Where a product or service is under-

priced (or free), as much of the output of the Irish water industry is, consumption is likely tobe excessive, and the marginal value of an extra unit of output may be very low. Unless a

change in pricing policy is explicitly part of the project, as is the case with some waste water

treatment plants, the implication is that current pricing policy will continue.

Particular care is needed when using values from other countries in these circumstances. It is

not appropriate to value the benefits of under-priced output in Ireland at the price/marginal

benefit level of fully priced water in other jurisdictions. The marginal benefits in Ireland are

likely to be lower, all other things being equal. See Appendix C for further discussion.

What falls out of this analysis is that proper pricing of water services should be the first

response to capacity constraints, and only then should extra investment be undertaken, if

there remains a demand for it. This is a counter-argument to the predict and provide

approach to public infrastructure.

10 The latest versions are CSO, Population and Labour force Projections 2001-2031, July 1999, and

Regional Population Projections 2001-2003 June 2001; it needs to be kept in mind that these forecasts

have been superseded by the results of the 2002 Census of Population. ESRI, Medium Term Review

2003-2010, July 2003.11 An alternative approach is to net avoided costs off against the internal costs of the new investment,

but it may be preferable to allow the two to remain separately identifiable.


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3.3.3: Identify external (i.e. non-monetary or non-market) costs and benefits and

quantify them to the degree possible

External Costs

These could come under a number of headings, such as noise, odour, visual intrusion, trafficcongestion and increased accidents during the construction and operation of new plant. The

extent of the impact will be determined by the number of people affected, which in turn is

dependent on location (urban or rural, amenity value of the area). They should be expressed

net of the counterfactual position.

In most cases, planning conditions may have taken account of most of these effects.

However, there may be some cases (such as large plants in urban locations) where significant

costs exist.

Some modern plants are energy intensive, and the environmental externalities from the net

increase in energy usage should be considered. The main pollutants from combustion,

whether on site or from electricity generation, are SO2, NOx, N2O and CO2. There are

standardised emission factors which can be gleaned from ExternE, (EC 2003) as well as EPA

and ESRI publications for estimating pollution quantities from fuel usage (Appendix B).

External Benefits

These will mainly relate to benefits to the environment as a result of the investment. It is

important to note that they relate to the actual improvements to the environment, e.g.

receiving waters, rather than output of the investment, e.g. the condition of output from awaste water treatment plant.

3.3.4: Put monetary valuations on the significant external costs and benefits

This is probably the most controversial and uncertain part of the process. We are not in a

position to put valuations on the actual external costs and benefits generated in the schemes

in question, and very few valuations have been generated in Irish studies. Hence we are

forced to use valuations generated elsewhere, and the obvious source, as discussed in the

Literature Review, is the UK. A wide range of valuations exists, and it is not possible to

compile a list that will apply in all cases. Appendix D contains a more detailed discussion.

3.3.5: Calculate NPV, IRR, BCR and where appropriate IBCR

Having generated the flow of internal and external costs and benefits over the 30 years, the

data can be discounted and the various measures of return on investment can be generated.


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3.3.6: Undertake risk/sensitivity analysis

This will be a less substantial exercise than would have arisen from an ex anteviewpoint, as

many of the uncertainties (notably with capital costs) will have been resolved. Our main

concern is, what are the chances that the hurdle rate of return (i.e. 5%) will not be achieved.

Given that we know the capital cost and we also should have a good indication of the currentimprovement in water quality as a result of the investment, and of likely operating costs, the

main sources of uncertainty should have been eliminated. Remaining possibilities include -

1. Operating costs might increase by significantly more than the general inflation rate inthe economy. Energy, chemicals and monitoring are some of the possibilities. Price

increases of (say) 50% could be tested. Some of these price increases might

represent the internalisation of environmental costs, and so should already have been

included in our calculations.

2. Plant might not continue to operate as designed, and may require greater expense tomaintain or replace parts.

3. The predicted increase in population or industrial load may not materialise, meaningthat the improvement in water quality might have been achieved at lower cost.

These are difficult to predict. Conservative predictions in the first place should minimise the

scope for surprises in the future. The nature of O&M contracts may give protection against

increased operating costs. Given the population increases in recent years, the scope for over-

sizing plants has been reduced. Unless there are specific reasons to suspect that these or

other eventualities might arise, there is probably limited benefit in undertaking a detailed riskor sensitivity analysis.

Where undertaken, risk analysis (where probabilities are attached to various forecasts) is

preferable to sensitivity analysis, as it allows us to assess the likelihood of the various

outcomes, and even to generate a spectrum of probabilities. Where there are more than a

few critical factors, however, risk analysis can become very complex. Sensitivity analysis is

simpler, testing for changes in the critical factors without attaching probabilities in a

systematic way.

3.3.7: Compare Results with ex ante CBA

As stated, in some cases ex anteCBAs will have been undertaken, while in others none will

exist. Reviewing some of those that have been done highlights a wide range of approaches

and levels of detail. We have also highlighted that there has been a number of developments

both in the Irish economy and CBA methodology in the interim. In view of this, we feel there

may be limited value in trying to assess these CBAs line by line, with the benefit of

hindsight. It would be better if in all cases new CBAs were drawn up using a standardised

methodology for each main type of investment (wastewater treatment, supply, conservation,

etc.). The results could be compared with the NPV, IRR or BCR generated in the originalstudy, and a general commentary made on reasons for differences. One issue worthy of


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specific comment is the comparison of actual demand with that predicted in the ex ante

analysis, and its implications for rate of return on the investment.

3.3.8: Non-CBA Notes

The following, though not included in the CBA calculations as such, should be specified and

details given as appropriate -

Engineering assessment. Assessment of technology used. Capacity planned anddelivered, actual throughput (e.g. population served) planned and delivered, now and

over the lifetime of the investment. Reasons for differences between actual and planned

values. Assessment of Costs per unit of output.

Means of procurement - traditional, DB, DBO, etc. O&M contracts where used. Notes onthe implications (e.g. for costs), should be included.

Contribution to Irish/EU environmental regulations, both actual and planned. Direct employment generated. Industries affected. This would include significant industrial customers of the water

infrastructure, and industries such as tourism for whom water supply, quality, etc. is

important. Measures of the significance of the industries, for example Population

Equivalent (PE), Value Added and employment should be stated.

Sources of finance, divided between EU fund, Central Government, Local Authorities ownresources, capital contributions from local industry, private investment, etc.

3.4 Notes on Specific Investment Types

The schemes and projects to be considered come under the following categories:

a) Wastewater Treatment Worksb) Water Treatment Worksc) Water Distributiond) Water Conservatione) Sewerage Infrastructuref) Water Resources Management.Each will have specific issues that are peculiar to them, some of which are discussed below.


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3.4.1: Wastewater Treatment Works

Define the Objectives, the Project and the Counterfactual

Objectives could include meeting the requirements of the UWWTD, and/or improving thequality of receiving waters.

Wastewater treatment works will generally be well defined, but a complication arises when

sewerage works are also being undertaken. Are the latter an essential part of the former?

This might be the case where areas that previously had other means of disposal become

connected to the treatment plant, and without which the plant would be unviable. Renewal of

existing sewerage on the other hand might be considered a separate project, as might

additional connections above and beyond connection of the most important urban areas.

Common sense should provide the answer in most cases. The relative investment cost of the

sewerage compared to the treatment works might also give an indication.

The counterfactual should in general be the continuation of the position pre-investment, with

the minimum expenditure needed to maintain the pre-existing infrastructure.

External Benefits

The most important benefit of a wastewater treatment plant will usually be improvements in

the quality of receiving waters. This does not equate to improvements in the outflow of the

plant, or elimination of (say) sludge disposal at sea, though these should be included in the

non-CBA notes.

Actual water quality improvements achieved should be quantified. The EPA has a database of

water quality at a large number of points going back over the last decade or so, and the local

authorities themselves monitor water quality. Thus, in most cases it should be possible to

identify before and after data. Care is needed in identifying locations of water testing. As

a general rule, a location as near as possible to the outfall should be used. More than one

location might be worth investigating, for example if there were water abstraction

downstream of a wastewater treatment plant, or if there were a number of different amenity

areas affected. Where this is not possible, experience from similar investments elsewhere

may be useful.

Benefits can be expressed in terms of the usual water quality measures BOD, Suspended

solids, N and P content where appropriate. Colour and odour should also be considered if

possible, though these will be difficult to measure objectively. Care is needed to avoid

double-counting benefits. The flow of net benefits over the lifetime of the investment,

compared to the counterfactual, will need to be quantified.


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3.4.2: Water Treatment Works


Objectives could include meeting the requirements of the Drinking Water Directive, and/or

specific improvements in the quality of water to be supplied to customers.

These plants will often form part of a larger scheme, which might include new abstractions,

possibly reservoirs, pumping stations and supply networks. The degree to which the projects

can stand as independent entities or that their objectives can be achieved independently

should inform the degree of aggregation/disaggregation. A treatment plantper se is no use

without a network bringing water to it, and from it to customers. This network may or may

not pre-exist. If it does, one might consider the treatment plant on its own as a separate

project; if not, it is probably appropriate to include it in a larger project.

The counterfactual should in general be the continuation of the position pre-investment.

Internal Benefits

The output of the plant, i.e. improved water quality, will have customers, for whom that

improvement has a value. Care needs to be taken to distinguish between the supply of water

and the quality of the water. In general, treatment plants are concerned with quality, while

networks are concerned with supply. This needs to be considered if we are treating the two

investments as separate projects.

Some customers pay for water and some (i.e. the residential sector) do not; often those whodo pay are not paying the full economic price. As discussed earlier, where this is the case, the

benefit of an extra unit of water (or water quality) to the customer is likely to be low. Care

must thus be taken in valuing the extra output from the investment.

External Benefits

Most of the benefits of a water treatment plant should be internalised, or be capable of

internalisation, via customer charging. There may be some health benefits due to the

improved water quality, but these are likely to be difficult to quantify.

3.4.3: Water Distribution


The objective will usually be to provide (or improve the provision of) water to customers. The

water distribution network, pumping stations, etc. may or may not sit logically with a

treatment plant or other investment as part of the same project. The counterfactual should in

general be the continuation of the position pre-investment.


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Capital costs

Where we are considering piping only, and it is clear that the network will have a life well in

excess of 30 years, it may be simpler to use the actual useful life as the timeframe for the

CBA, leaving no residual value at the end.

Internal Benefits

The most important benefits of a network investment will usually be improvements in water

supply to existing customers, supply of water to new customers, or both. Improvements can

be in terms of flow and/or reliability. The Local Authorities data on these should be adequate

for quantification purposes.

Care needs to be taken to distinguish between the supply of water and the quality of the

water. New networks are unlikely to have an impact on water quality, unless they reduce

contamination. In general, water quality is a function of the source and treatment rather than

networks. If we are treating the network as a separate project, we need to be able to

separate the benefits also.

External Benefits

It is likely that most benefits will be internalised or be capable of internalisation. Some health

benefits may arise where network supplies replace private supplies such as wells.

External Costs

Since networks are for the most part underground, ongoing external costs are likely to be

limited. Noise, visual intrusion, traffic congestion and increased accidents during construction

may arise to some extent, mainly in urban areas. In most cases, the planning process should

take account of most of these effects.

A major potential external cost relates to the impacts of abstraction. This impact will need to

be measured. Again, the planning process may have accounted for this to some degree.

3.4.4: Water Conservation


Water conservation projects generally attempt to cut leakages by a certain percentage, with

one or more of the following objectives:

To provide a more reliable service to customers;

To cut maintenance costs;


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To avoid or postpone the need to increase abstractions; To reduce contamination, thus improving water quality.

The project generally consists of

a. replacing supply networks;b. installation of a network of meters (often with telemetry) to enable improved control of

the network;

c. development or purchase of computer systems to map the network and process the datafrom the meters;

d. possibly hiring additional IT and maintenance personnel;e. Pumping stations may possibly be included.

The counterfactual might be the continuation of the position pre-investment, or investment in

new water abstraction. The condition of the network pre-investment and likely demand

conditions will inform this.

Capital costs

Where we are considering piping only, and it is clear that the network will have a life well in

excess of 30 years, it may be simpler to use the actual useful life as the timeframe for the


IT assets will generally have a much shorter life, and their replacement should be accounted

for, though by their nature it is very difficult to predict future IT costs. The replacement cost

of assets with a life of less than 30 years should be included (e.g. meters and telemetry

stations), though care is required not to double count this if it is also included in O&M

contracts.

Operating Costs

Care is needed in defining the operating costs of the project, as there may be an overlap

between ongoing work on conservation and ongoing maintenance.

Internal Benefits

Reduced leakage can lead to improved water supply (better reliability and/or pressure). The

Local Authorities should be in a position to supply data on this. Where water quality isimproved, this also needs to be taken into account.


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There could also be avoided costs related to the counterfactual. For example, if an old

network has been replaced, the avoided cost of operating and maintaining the old network

should be included as a benefit.

External Benefits

It is likely that most benefits will be internalised or be capable of internalisation. The

exception is where new abstractions are avoided. The level of avoided abstraction may

increase significantly over time.

External Costs

As with water distribution, since networks are for the most part underground, ongoing

external costs are likely to be limited. Noise, visual intrusion, traffic congestion and increased

accidents during pipe and meter laying may arise to some extent, mainly in urban areas. In

most cases, the planning process takes account of most of these effects, however.

3.4.5: Sewerage Infrastructure


Sewerage infrastructure investment will generally be concerned with the removal of

wastewater from a location, to a new or existing treatment plant, or indeed to an untreatedoutfall (though this would be rare in the context of new investment). The objective may be to

enable the development of the location, or to reduce pollution from existing infrastructure

such as septic tanks.

The project may be stand-alone, may include pumping stations, or be part of a larger

investment including a wastewater treatment plant.

The counterfactual should in general be the continuation of the position pre-investment, or

the minimum required to maintain existing infrastructure.

Capital costs

Where we are considering sewerage only, and it is clear that the network will have a life well

in excess of 30 years, it may be simpler to use the actual useful life as the timeframe for the



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Internal Benefits

The main internal benefit will be the removal of wastewater from those customers connected

to the sewerage. The flow of net benefits over the lifetime of the investment will need to be

quantified, by reference to forecasts of residential and other developments.

There may also be costs avoided due to the removal of the need for septic tanks

(maintenance of the tanks and disposal of waste from them). These are market services that

should be readily amenable to pricing, and should be added to the benefits of the new

infrastructure.

External Benefits

There might be some reduction in pollution due to the removal of septic tanks, or redirecting

of untreated outfalls. However, if the septic tanks are properly maintained, and the cost of

this is incorporated above, the scope for pollution would be limited.

External Costs

As with water networks, since sewerage networks are for the most part underground,

ongoing external costs are likely to be limited.

3.4.6: Water Resources Management

Two water resource management sub-projects are included in those to be reviewed:

1. The Lough Derg/Lough Ree is part of the Lough Derg Water Quality Improvement andLough Ree Catchment schemes, mainly covering sewerage investments.

2. The Three Rivers Monitoring and Management System report deals with the Rivers Boyne,Liffey and Suir schemes (the River Suir scheme is not covered by the Cohesion Fund).

These will not be amenable to standard CBA, since they will not have physical outputs as

such. It may be appropriate to allocate the costs of these reports to the CBAs of the various

physical investments included in the relevant schemes. In any event, we will undertake an

assessment of the reports, covering the following headings:

Technical assessment of report findings Potential benefits Where practicable, implementation costs


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For future reference, where water resources management projects are set up, which also

involve capital investment, CBA should be used in line with the methodology described above

for the various elements of the scheme.


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Appendix A: Bibliography

Bateman I. J., A. P. Jones, N. Nishikawa, R. Brouwer, 2000. Benefits transfer in theory and

practice: a review and some new studies. CSERGE and School of Environmental Sciences,

University of East Anglia.

Brouwer, R. and I. Langford, 1997. The validity of transferring environmental benefits:

further empirical testing, WP 97-07, CSERGE, University of East Anglia.

Brouwer, R. and F. A. Spaninks, 1999. The validity of environmental benefits transfer:

further empirical testingEnvironmental and Resource Economics.Vol 14 No. 1.

Clinch, J. P., 1999. Economics of Irish Forestry, Coford.

CSF Evaluation Unit, 1999. Proposed Working Rules for Cost-Benefit Analysis, Dublin.

CSO, 1999a. Population and Labour force Projections 2001-2031, July 1999.

CSO, 1999b. Regional Population Projections 2001-2003 June 2001.

CSO, 2002 et seq. Census of Population, various volumes.

Curtis, J., 2003. Demand for leisure based water activity, Journal of Environmental Planning

and Management,Vol 46, No. 1, Jan, Carfax.

Department of the Environment, Heritage & Local Government, various years. Review and

Outlook for the Construction Industry. Dublin.

Department of Finance, 1994. Guidelines for the Appraisal and Management of Capital

Expenditure Proposals in the Public Sector, Dublin.

Environmental Agency (UK), 2003. Assessment of Benefits for Water Quality and Water

Resources Schemes in the PR04 Environment Programme. Working Document (due for

finalisation in 2004).http://www.environment-

agency.gov.uk/business/444304/444643/425378/425401/425411/507669/?lang=_eEPA (Bowman et al.), 1996. Water Quality in Ireland 1991-1994. Dublin.

EPA (Lucey et al.), 1999. Water Quality in Ireland 1995-1997. Dublin.

EPA (McGarrigle et al.), 2002a. Water Quality in Ireland 1998-2000. Second (revised) edition.

Dublin.

EPA, (Page et al.) 2002b. The Quality of Drinking Water in Ireland A Report for the Year2001. Dublin.


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EPA, (Mahony et al.) 2002c. Feasibility study for centralised anaerobic digestion for treatment

of various wastes and wastewaters in sensitive catchment areas. Dublin.

ESRI, 2003. Medium Term Review 2003-2010, July 2003, Dublin.

European Commission, 2003. External Costs, Research results on socio-environmental

damages due to electricity and transport, DG for Research, Directorate J-Energy. Available at:

http://europa.eu.int/comm/research/energy/gp/gp_pubs_en.html

Evaluation Unit of the Regional Policy DG of the EU Commission 1999. Guide to Cost-Benefit

Analysis of Investment Projects (Structural Fund-E

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