The Value of Water as an Economic Resource in the Greater Letaba River Catchment Report to the Water Research Commission by CJ Williams, GA Veck and MR Bill Economic Project Evaluation (Pty) Ltd WRC Report No. 989/1/2008 ISBN 978-1-77005-746-3 NOVEMBER 2008 DISCLAIMER This report has been reviewed by the Water Research Commission (WRC) and approved for publication. Approval does not signify that the contents necessarily reflect the views and policies of the WRC, nor does mention of trade names or commercial products constitute endorsement or recommendation for use DEDICATION The finalisation of this report was delayed due to circumstances and the personal health of the lead author, Chris Williams. Through his personal perseverance a final copy was eventually handed to the Water Research Commission but, sadly, Chris passed away in July 2008, before this report was published. Executive Summary EXECUTIVE SUMMARY BACKGROUND Nieuwoudt, Backeberg and Du Plessis (2004) states “As South Africa is a drought-prone, water poor region it seems probable that water shortages will redirect economic development. As water scarcity increases, the need to manage water as a national asset and for overall social benefit becomes imperative. During the past number of years the South African Water Research Commission initiated a number of economic research projects aimed at determining the value of water in different sectors of the economy and in different parts of the country.” This project is one of those initiatives and it explores the value of water as an economic resource in the Groot, Middle and Klein Letaba river catchments. The Letaba water management area lies entirely within the Limpopo Province and forms an integral part of the Limpopo Basin. The study area comprises the Groot, Klein and Middle Letaba catchments. The Groot Letaba area forms part of the Lowveld Region of the Limpopo Province and represents the heart of the provincial economy, whilst the Klein and Middle Letaba can be classified as rural with a strong bias towards agriculture and retail. The overall picture of the study area is that of a region which is largely arid, which is mainly low income, but which has opportunities for commercial farming and forestry. The need for water is an important issue in every part of the region and the need for effective water management is great. The ability to obtain economic values for water, and to use these for management decision support, is clearly a matter of importance. OBJECTIVES AND HYPOTHESES The aims and objectives of this study are, amongst others, to: i Determine the water balance in the catchment; taking into account the confluence of the Klein, Middle and Groot Letaba; ii Determine the water demand schedules for the irrigated agriculture, forestry, eco-systems and household sectors; iii Use these demand schedules to determine the economic value1 of water by establishing willingness-to-pay; iv Determine the supply schedules for the same sectors in order to compare the cost of water with its value; and v Generate water use scenarios and evaluate their impact. 1 When we consider the value of water in this study, it is always the economic value which is being referred to. The economic value encompasses the complete value of water to the economy, not just the infrastructural costs associated with making water available to end users. In essence, it also incorporates the “value of the water drop”; the value of water itself as a commodity. page i Executive Summary The following hypotheses underpin the research described in this report: i Is it necessary to research the value of water because water is scarce South Africa’s water laws have recently changed, and knowledge of the value of water can assist with allocation decisions? ii The value of water is embodied in the user’s willingness to pay, which is revealed by the consumer surplus associated water demand schedules associated with different uses of water, where water demand may be direct (i.e. municipal and ecological usage), or derived (i.e. industrial, agricultural and forestry usage. iii Water demand schedules can be synthesised using Contingent Valuation techniques for direct demand situations, and Linear Programming and Crop Production Functions for derived demand situations. iv Water allocation, according to the principle of maximisation of social welfare, can be effected by optimising the consumer surpluses that arise from all uses, using linear programming techniques. The Letaba River Catchment with its varied climatic zones, diverse agriculture and range of municipal areas provides a rich fabric for exploring the objectives above and for testing the validity of the hypotheses put forward. METHODOLOGICAL APPROACH The value of an economic good can be approximated by a measure of users’ willingness-to-pay to have the good rather than go without it. This value can be expressed in terms of the money that can be exchanged for the commodity provided an explicit market for it exists. Hence, if it is possible to estimate a market demand curve, the value of a good may be approximated as willingness-to-pay by measuring consumer surplus. These water demand curves are simulated through the use of various modelling techniques. The approach employed is to use contingent valuation methods for direct demand (municipal water), and enterprise budgets and linear programming, or enterprise budgets with crop water production functions for derived demand (forestry and agricultural water). For the purpose of integrating these curves and evaluating scenarios, a model which allocates water according to the principle of maximisation of social welfare is used. The output of the models is water demand schedules for different water user groups, from which consumer’s surpluses and water value are imputed. The scenario evaluation model reallocates water and sets appropriate prices, as page ii Executive Summary well as provides a benchmark which indicates the extent to which the welfare- maximising objective of the exercise is met. SUMMARY OF RESULTS The base date for this study is 2002. There have been considerable changes in some of the critical inputs to the research, so the reader should be cautious about trying to transport the results presented below directly into the present without careful consideration. After discussion of the water balance, results are discussed in terms of the major water use sectors considered in the study. It should be noted that values for water presented represent annual rentals for water, and not capitalised values (which might be equated with the value of associated water rights). Water Balance The distribution of water use within the catchment was found to be as represented in the diagram below. Composition of water use in the Letaba Basin Households Transfers out 8% 6% Industry 0% Ecology 28% Irrigation 47% Afforestation 11% The total water use was estimated to be 316.5 Mm3 and in terms of annual run- off there is still an annual surplus of 183 Mm³. According to the National Water Resource Strategy the base scenario for the project area in terms of use would be 226 Mm³ in 2023 and the high scenario 228 Mm³. It is therefore evident that presently there is no surplus yield available and that the position can only deteriorate in future if no extra provision is made to increase the yield. Agricultural Water The linear programming approach used to develop water demand schedules for agricultural water use provided water demand schedules which are consistent with existing norms, and which deliver results consistent with other exercises in this field. page iii Executive Summary Some detail is lost in linearising the schedules, but this is necessary in order to be able to present them to the integrating model, as well as to provide some smoothing of the intrinsically lumpy curves. These water demand schedules demonstrate a value for water of R0,97/Mm3 at current (2002) usage level of 151 Mm3. When the value of water is imputed from the value of the land, based on the net return of the enterprise, a figure of R0,80/Mm3 is obtained, which is consistent with the value developed from the water demand schedules. Forestry Water Water demand schedules for forestry were developed using enterprise budgets and water production functions for gum and pine in the area. Water value was calculated in terms of stream-flow reduction and is set out in the table below: Area Streamflow Annual Values Planted Reduction ha Mm3 R/m³/annum GUM 29 365 21.513 0.27 PINE 19 935 14.768 0.66 The water values for gum seem to be uncharacteristically low when compared with those for pine. A study by Tewari (2003) in KwaZulu-Natal shows water value for gum roughly twice those for pine. This could be attributed to the fact that the forestry budgets for 2002 used in this study reflect a very low value of attainable profit compared with that of pine for similar streamflow reduction values. Municipal Water The value of municipal water was determined by means of a contingent valuation survey where user reaction to the change in price of water is tested directly in the field. The water demand schedule obtained, after aggregation across income levels, and smoothing by linear regression, are presented below, together with the relevant aggregated cost curve. It can be seen that at current usage of 25 Mm3 the value of water is higher than the costs, as is the case in other water use sectors. This is to be expected, as some water is still provided at sub-economic costs. However, it is found that municipal water tariffs are much closer to their economic values, despite the fact that some users are subject to a tariff clearing prices than is the case in other sectors.