Incorporating Environmental Impacts into Investment Analysis Randall Kramer Professor of Environmental Economics kramer

1. Incorporating Environmental Impacts into Investment Analysis Randall Kramer Professor of Environmental Economics kramer@duke.edu

2. Methods for Valuation of Environmental Impacts 1. Travel Cost Method  (recreational benefits only) 2. Contingent Valuation Method  (most widely applicable, but controversial) 3. Hedonic Property Value Method  (appealing because relies on property characteristics) 4. Productivity Analysis  (useful where biological resources affected by pollution) • Opportunity Cost Analysis (can be applied when there is a clear substitute)

3. CV Method – Example 1 Water Quality CV (Kramer and Eisen-Hecht, 2002) Now, assume a vote is being held today to approve or reject this management plan. Your payment for this plan would be collected through an increase in your usual state income taxes. All residents in counties within the Catawba River basin would make identical payments. This money would only be used for implementing this management plan for the Catawba River basin. If a majority of Catawba basin county residents vote in favor of this management plan, it will go into effect. Before you answer the following question, please consider your current income, as well as your expenses. Suppose that this management plan would cost you $____ (5, 10, 25, 50, 100, 150, 200, 250)eachyear for the next five years in increased state income taxes. Would you vote in favor of the management plan? 1 Yes 2 No D Don’t know (do not offer, record only) R No response

4. Estimates of the lower-bound mean willingness to pay (WTP) Mean WTP for all respondents $139 Comparison of mean WTP based on state of residence Mean WTP for North Carolina respondents $135 Mean WTP for South Carolina respondents $150 R.A. Kramer and J.I. Eisen-Hecht, “Estimating the Economic Value of Water Quality in the Catawba River Basin,” Water Resources Research 38 (2002): 1-10.

5. CV Example 2 – Global Ecosystem Benefits of Protected Areas • Mail survey of random sample of U.S. residents with questions on knowledge and attitudes on rainforest conservation, socioeconomics and willingness to pay (WTP) • Used contingent valuation method to gauge WTP for a Save the Rainforest Fund to double the amount of national parks and nature reserves in tropical countries

6. Key Results on Global Rainforest Services • 91% of respondents familiar with tropical rainforest issues • 67% believed industrial nations should share the cost of tropical rainforest protection. • Willingness to Pay by U.S. Residents for protection: R. Kramer and E. Mercer, “Valuing a Global Environmental Good: U.S. Residents’ Willingness to Pay to Protect Tropical Rain Forests,” Land Economics, 73 (1997): 196-210.

7. Hedonic Example - Water Quality in Chesapeake Bay • Leggett and Bockstael’s investigated water quality effects on residential property values along the Chesapeake Bay. • Used data from waterfront property sales from 1993 to 1997 in Anne Arundel County, Maryland. • Used fecal coliform data from samples collected at 104 sites along the county’s coastline and constructed a water quality measure based on the distance of each property from the nearest monitoring station. Leggett, C.G., and N.E. Bockstael. 2000. “Evidence of the Effects of Water Quality on Residential Land Prices.” Journal of Environmental Economics and Management 39: 121-144.

8. Hedonic Model Water Quality Results • Results showed that coliform levels had a significant and negative impact on property values. • Modest reductions in fecal coliform counts in the middle and upper reaches of the inlet increased property values by 2 percent. • Potential gains across all properties in the county could amount to more than $12 million if water quality was improved by a similar amount elsewhere.

9. Opportunity Cost Example - Land Set Aside for National Park in Madagascar • Opportunity cost to villagers of losing access to the land set aside for the Mantadia National Park based on data from survey of 351 households. • Cash-flow models constructed for each village group to estimate income from agricultural and forestry activities. Lost access to forest land estimated from aerial photos. • The mean annual extent of these losses was estimated to be $91 per household. • Assuming a 3-percent rate of population growth and 10-percent discount rate, we estimated an NPV of the opportunity costs over 20 years to be $566,000. P. Shyamsundar and R.A. Kramer, “Biodiversity Conservation - At What Cost? A Study of Households in the Vicinity of Madagascar’s Mantadia National Park,” Ambio 26(1997): 180-184.

10. What if there are insufficient funds or time to do an original non-market valuation study of ecosystem services?

11. Benefit Transfer • In benefit transfer, benefit estimates from one site are transferred to another site. Study site => policy site • Avoids the cost of another survey based study. • Benefit transfer is increasingly used by regulatory agencies such as USEPA and the European Commission • Research to date shows some success as long as there is a careful matching of site characteristics. • Benefits transfer website: www.evri.ca

13. Benefit Transfer Example:Drinking Water Provision as an Ecosystem Service • An important ecosystem service is water purification • Water treatment plants process raw water to produce drinking water • Treatment costs are higher when raw water quality is lower: • Turbidity (from sediment) • Other pollutants Y. Kraus Elsin, R.A. Kramer, W.A. Jenkins, ‘Water Quality Benefits for Drinking Water Treatment in the Neuse Basin: A Benefit Transfer Approach,” Working paper, Nicholas School of the Environment and Earth Sciences, Duke University, December 2007

14. Avoided water treatment costs • Avoided water treatment costs is a way to value water purification ecosystem service • Connected to upstream land use

15. Drinking Water Benefit Transfer • Found 4 studies estimated water treatment costs as relate to quality of raw water input • Each use different set of variables • Turbidity (from sediment) – key WQ variable in common • Study areas: • Great Lakes, OH, TX, Nat’l

16. Drinking Water Benefit Transfer • Two BT methods applied: • Point transfer • Function transfer • Data from 9 of the 10 largest water treatment plants in Neuse River Basin • Avg turbidity, avg amount of water processed (MGD), annual O&M costs, annual chemical costs

17. Results - Drinking Water Benefits • For a 5% decrease in turbidity, NPV of cost savings in the Neuse Basin ranged from $0.4 to $2.7 million • For a 30% change, NPV of cost savings ranged from $2.6 to $16.5 million

18. Conclusions • Ecosystem valuation is challenging due to uncertainties, interdependence among services, and varying geographic scope • Valuation of ecosystem services can help: • inform environmental policy decision making intended to balance human activity and conservation • develop mechanisms to enable landowners to capture ecosystem benefits, e.g. nutrient trading • target conservation efforts.

19. Further Reading: G. Stavros, D. Whittington, D. Pearce and D. Moran, Economic Values and the Environment in the Developing World, 1997. J. Dixon, et al., Economic Analysis of the Environmental Impacts of Development Projects, 1988. OECD, Environmental Policy Benefits: Monetary Evaluation, 1989. C.D. Kolstad, Environmental Economics, 2000. http//:www.ecosystemvaluation.org http:// www.evri.ca