2012 Social Benefit Cost Analysis: Dam Proposal 

A proposal has been made to divert water from a major river and establish a large scale irrigation scheme for agricultural production.

The Proposed Project

Following a prolonged period of dry weather, a State government in Australia proposes to build a dam on a major river primarily for the purpose of irrigating farm land in the near vicinity of the dam. Annual river flows are reliable. An 800 gigalitre (800,000 megalitres) dam is proposed. It will provide 500,000 megalitres of water available for irrigation each year. The balance of 300,000 megalitres is available as 200,000 megalitres for operating the irrigation system and as carryover security when needed, and 100,000 megalitres as permanently retained water.

It will take the water authority responsible for the irrigation scheme three years to construct the dam and the water delivery system, incurring capital costs to construct the dam of $100m in year 1, $100m in year 2 and $50m in year 3 in current dollars. These costs do not include labour costs.

The irrigation project will have a life of 43 years and the irrigation scheme will operate for 40 years from the start of year 4 to the end of year 43.

The dam will enable 50,000 hectares of farm land to be irrigated each year.  Ten megalitres of water are used per hectare of crop each year.

At the end of year 40 the salvage value of the $250m initial capital invested in the dam and water delivery system is expected to be 25% of the value of the initial capital invested, even with annual maintenance expenditures. (Annual maintenance expenditures are included in the annual operating costs of the water authority). The annual operating cost of the water authority that will administer the water supply is expected to be $3m.

To grow 50,000 hectares of irrigated crop each year involves using a crop rotation in which there are three crops grown every four years on a piece of land. Thus around 67,000 hectares of land needs to be developed into irrigation bays with water delivery systems, in order to have 50,000 hectares (75 per cent of 67,000) of land growing irrigated crops each year. The land not used for cropping in any year is rested, with no income or costs associated with it.

It is anticipated that the dam will be constructed and filled by the end of year three. The 67,000 hectares of farmland to be used for irrigation farming (50,000 cropped ha/yr) will be set up for irrigation during year three. 

The 67,000 ha of farm land that is to developed for irrigation will continue to be used for dryland farming as before, during the first two years of dam construction and will earn a net $100/ha/yr. No income will be earned from this land when it is being prepared for irrigation during the whole of year three.

The cost of converting farm land currently used for dryland farming to land levelled for irrigation and the associated on-farm capital costs of changing over to irrigation farming are a total of $1000/ha.

The capital invested in the on-farm irrigation systems will last for around 20 years at which time major renovation will be needed involving new capital investment costing 50% of the original investment cost of the on-farm irrigation system.

In year 43 the on-farm investment in irrigation systems will have a salvage value of 20 per cent of the value of the initial $1000/ha capital invested in the on-farm irrigation system.

On the farms, the irrigated land will be used to grow a crop, in appropriate rotations, and it is expected (expected value, probability weighted value) that crop yields of 4 tonnes per hectare of crop per year will be achieved from irrigated crops each year. Irrigated cropping will commence, and reap the first havest, in year 4.

The irrigated crop yield is expected to return $750/tonne in today’s dollars net at farm gate. This crop price is a subsidized price paid by the national government with a $150 subsidy from general tax revenue. World market prices for this crop have a probability weighted value of $600/tonne in today’s dollars for the past decade, and it is highly likely that this price will apply in the future.

Farm variable and overhead costs for the irrigated cropping each year (including maintenance of the on-farm irrigation system but not including the water charges paid to the irrigation authority) are expected to amount to $700/irrigated hectare/year. This cost includes such variable costs as extra fertilizer, seed, chemicals, fuel, casual labour used by farmers, as well as their overhead costs.

Annual water charges for the farmers are $40/megalitre ($400/irrigated hectare/year) because if the water that is used for irrigation was used in some other way it would have a value to the community of $40/megalitre in its alternative use.

The 200,000 megalitres of water used each year to operate the system also has other uses and has a cost of $40/ML.

The 100,000 ML of water retained permanently in the dam represents a once-off removal, in the year the dam is filled, of 100,000 ML of water from other uses in the economy, at a cost of $40/ML. In subsequent years, this quantity of water would be available as usual to the economy and the environment as it was before the dam was built.

The irrigation farmers involved in the new scheme will pay, in total, an extra $10m in income tax each year from year 4 onwards on their net before tax earnings from their irrigated cropping businesses.

Processors of the extra crop product, who compete to buy the extra crop product that becomes available from the irrigation farmers, will add $400/tonne in value annually to the farmer’s crop product.

Retailers will add a further $100/tonne to the processed crop product annually.

There will be extra fertilizer sales by input suppliers in the irrigation district to the irrigation farmers of an extra 100kg/ha/year at $400/tonne, and extra fuel and chemical sales equal to $5m per year in the irrigation district to produce the extra crop output.

Off Site Salinity Effects
An extra 50,000 hectares of land surrounding the irrigation scheme and used for dryland farming will be indirectly affected by the irrigation scheme through water from the irrigation scheme contributing to the underground water supply and causing water tables to rise, causing increasing salinity in the surrounding 50,000 hectares of land used for dryland farming. Over the 40 years of irrigation of irrigation the surrounding 50,000 hectares of dryland farmland will suffer a decline in annual productivity and profitability, and thus a fall in land value as well. 

Following the commencement of nearby irrigated agriculture, there is expected to be an annual decline in net profit per hectare in these surrounding farming areas from the current $100/hectare to $20/ha by year 43. These losses due to salinity are expected to occur in a linear manner (constant rate) over this time, i.e. each year each hectare is expected to produce $2 less net profit per year than would have been the case of the irrigation scheme had not been set up. The loss of profit in any year is relative to the current $100 profit that would have been earned each year if the dam had not been built. Annual reductions in profit are also equivalent to the total loss in land value that would occur between start and finish of the project as a result of increases in salinity. 

The annual and total magnitude of this salinity effect will not be affected by how much water is used for irrigation or for environmental uses.

Flood damage
Building of the dam is expected to improve flood control downstream. Over the past couple of decades, when the river has not been dammed, there have been major floods downstream every 5 years which have caused around $3m damage in today’s dollars each time there was a flood. With the dam it is expected that such major floods will occur half as frequently as in the recent past, and when a major flood does occur, the damage will be at least 50 per cent less than in the undammed situation. That is, half as many floods (one every 10 years instead of one every 5 years), causing half as much damage when it occurs, as before the dam was built. For the analysis, the last flood was in the year before work commenced on the dam. Flood protection commences when the dam is completed at the end of year 4. Assume the next flood occurs in year 8.

Wetlands
As a result of damming the river there are 5000 ha of Wetlands downstream which have no commercial use and which will experience a marked reduction of water flows. These Wetlands and their associated fauna and flora (which are becoming increasingly rare) will disappear once the dam is filled. This effect could be prevented if an ‘environmental flow’ of 100,000 megalitres of water was released regularly through the year. However, to do this would require that the water available for the irrigated agriculture is reduced from the planned 500,000 megalitres per year to 400,000 megalitres per year. This would involve developing only 54,000 ha for irrigation, and 40,000 ha would be used for cropping in any year. In this scenario in which the wetlands are preserved, apart from the change in cropping area, all the other factors can be assumed to remain the same as with the alternative (no wetlands) 50,000 hectare of crop scenario.

Other crop farmers
The extra irrigated crop produced because of the irrigation scheme will have the effect of causing some producers of the same type of crop produced elsewhere in the country, in areas more distant from the markets, to cease to produce these crops. It is estimated that each year from the start of year 4 $25m p.a. worth of the type of crop now being irrigated, from non-irrigated farms in other areas, will no longer be produced on these farms.

Algal Blooms
A consequence of the high input agriculture that will take place once the Dam is built will be an increase in Algal Blooms occurring in streams and the river in dry seasons. This phenomenon is expected to double in frequency as a consequence, and incur an additional cost to the water authority of $2m every 5 years from the commencement of irrigated agriculture to ameliorate the problem from the beginning of irrigation farming.

Labour
The labour required to build the dam (not included in the construction costs) would cost $5m per year at market wage rates for each of the three years of construction if it was the case that all labour was drawn from those currently fully employed. However, in practice only half of the actual labour force employed will come from employing labour that was already fully employed. The other half of the labour force used will come from people who would otherwise be unemployed over the first three years of the project when the dam is built. Any extra labour employed on farms come from the employed and are accounted for in the farm variable and overhead costs.

The labour force that comes from people drawn from the ranks of currently unemployed are people who receive unemployment benefits. This means that by giving up unemployment and working on the dam this previously unemployed labour is foregoing whatever benefits they received from being unemployed. We can approximate the cost of this labour (previously unemployed-receiving benefits ) (i.e. the cost incurred by giving up unemployment) as being equal to the unemployment benefits they received. That is, the unemployment benefit is 25 per cent of the market wage rate. This is the benefit the previously unemployed currently gain from being unemployed and are now giving up to work on the dam. This is the opportunity cost of the previously unemployed people who will work on building the the dam.

However, there is also a benefit to society from saving the unemployment benefits that previously were being paid.

Fishing and Other Recreation
Downstream from the dam is a popular fishing (non-commercial) and recreation spot. Estimates of the demand for using this fishing and recreation spot have been made and it is estimated that 5000 person-visits per year would be made to use this fishing spot at a cost (willingness to pay) of $50 per user per fishing visit. (This would have been estimated using the Travel Cost Method). The change to the river flows after the dam is filled will mean that this fishing spot will no longer exist.

From the end of year three the new dam is expected to become an attractive place for water sports, fishing and other recreation visits. It has been estimated that the demand for using the new dam for fishing, water sports and recreation each year would be 10,000 users at a willingness to pay of $50 per user for fishing, water sports and recreation visits. This number of visits will occur each year regardless of how much water is in the dam and how much is used for irrigation or environmental uses.

As well, the dam is expected to yield 200,000 kgs of fish each year to commercial fishers, worth $3/kg – regardless of how much water is in the dam and how much is used for irrigation or environmental uses.

Task
Note: A comprehensive Social Benefit Cost Analysis has to be based on a valid With-Without scenario, and take account of all benefits and costs, including opportunity costs, and unpriced benefits and costs, and consider risk.

The merit or otherwise of this investment of public resources in an irrigation project is to be assessed for the typical discount rates used in public project appraisal. 

The option of building the dam and preserving the wetland is also to be considered, i.e. if the decision was made to preserve the wetland, what minimum value is implicitly being placed on the wetland. 

The prices and yields and water volumes in the following details are the expected values (sum of probabilities of values in the whole distribution) levels expected to prevail over the life of the project.

Some assessment of key risks and sensitivities is to be included in the analysis.

Note that a key assumption underlying this BCA is that in the economy resources are currently fully utilized unless otherwise specified.

©Bill Malcolm, Assoc Prof, The university of Melbourne