World Water Day 2021

Why are we valuing water

The leaderette: The theme of this year’s World Water Day is “Valuing Water”. The 2021 World Water Development Report also features this theme. As to why are we valuing water, Prof. Guiliang Tian shares with us his ideas in this article.

Water is the source of life, necessity of production, and base of ecosystems. The importance and preciousness of water resources is self-evident, but why is water still wasted extensively? To answer the question in a simplest way, the scarcity of water resources is not valued as it should be, and water is undervalued. These are the crucial reasons for the extensive waste and pollution of water. 

I. Relative abundance and absolute scarcity

People might argue, we are not in short of water in the south, and therefore its scarcity does not have to be valued. Indeed, the heterogeneity of water in spatial and temporal distribution is one of the most important characteristics of water. The reality that water is abundant in the south China and scarcity in the north forms this illusion that it’s only necessary to talk about its scarcity where water is in shortage. Therefore, in water-rich areas, people have a low awareness of water shortage. However, in face of people’s infinite demand for water for life and production, water is in scarcity in an absolute term. Even though water may be relatively abundant locally, the capacity of aquatic ecosystems is always limited, and more consumption means more sewage discharge, which is also an important reason that south China is in no water shortage, but lacks quality water. Therefore, water-rich areas must give up the false idea that water is inexhaustible, and raise their awareness that water is a scarce resource of natural, economic and social values, with which we could sustain the “three red lines” in water quantity, quality and consumption efficiency.

In drier areas, water is of course more precious. Water availability often becomes the missing crucial piece of the puzzle for many high-quality industrial projects. Meanwhile, the shortage of high-quality water sources also threatens drinking water safety of the local communities, and the sustainability of ecosystems in arid areas. Since water is indispensable, water may even be more precious than “diamond” under certain circumstances. Compared to costs for residential, industrial and other water uses, the scarcity of water in water-deficient areas is greatly underestimated under most circumstances. 

II. Value discovery via the market

Accurate valuation of water might be the most difficult task compared to other natural resources. This is because water has the most complicated natural, economic and social attributes. Water sustains life. While the value of life is immeasurable, water is priceless in this regard. Water is of different quality, usage, and locations, which leads to different values, like mineral water versus tap water. Water in another form, flood for example, could even have negative values. Therefore, there is still no ideal model to value such a complicated resource. 

Market is known as the invisible hand, which is good at discovering the real value of goods. As a form of market mechanism, auctions often conclude the transaction of goods at a price closest to their intrinsic value. So, can market mechanism be applied to the realisation of water value? Water agencies and researchers of the country have been actively exploring the reform in this field. Around 2000, Wang Shucheng, former Minister of Water Resources, proposed the development water right market in China. His efforts successfully promoted water right transfers in the Yellow River Basin. Irrigated farms got the incentive to save water and transfer the saved water intake to industrial enterprises, which not only made the farms a considerable economic return, but more importantly, solved the urgent needs of industrial enterprises. Because of different rates of return, the same resource produced greater economic benefits after water was transferred to sectors with higher rates of return, which improved the overall well-being of the society. 

The Third Plenary Session of the 18th CPC Central Committee decided to “allow the market a decisive role in allocating resources”, which gave a new boost to water market. The establishment of the water market was marked by three landmark events. First, piloting of water right was launched in 7 provinces nationwide. Second, China Water Exchange was established. Third, the Interim Regulations for the Administration of Water Right Transactions was put into effect, which is the first special administrative regulations for water right trading. Under the market mechanism, sellers and buyers decide prices on a voluntary basis through negotiation under the regulatory framework. Through market competition, water realizes its true value. 

However, some people are afraid of the market. They believe that the marketisation of water as a crucial resource risks malicious hoarding and price jacking. Therefore, some concerns remained about the use of market as a means in China’s water governance. But we must point out that, water market does not mean that the market is in charge completely, and instead, China’s unique institution can effectively make up the inherent defects and avoid market failures. The establishment of a trading market of water rights, with China’s unique characteristics of “active government” and “effective market”, is the must-go road for practicing the idea of “allowing both roles of the government and market in water governance” in the future. 

III. Valuation as the premise of water market

Water market helps set up water price, but markets fail. Marxist political economy holds that the price fluctuates around its value. So, effective valuation of water is crucial to the healthy and prosperous development of water markets, and valuation is the premise and foundation of the pricing of tradable water rights. As Parker (2006) and Claydon et al (2009) argue, pricing of tradable water rights need to ensure that parties involved in the trade are economically incentivised to do so. That is to say, water right prices shall at least reflect its value. These transactions are divided by Eyal Brill (1997) into “active trades” and “passive trades”, and the average costs determine prices. Therefore, costs are the most important aspect of valuation. 

At present, the most used valuation methods include: full costing, shadow pricing, and marginal utility approach, etc. Wherein, full costing is to determine the value of water right finally by calculating various cost inputs and compensations of transactions. The costs involved in general transactions mainly include the cost of resources consumed, the cost of project, the cost of risk compensation, the cost of ecological compensation, and the cost of economic compensation. The advantage of this method is that, it considers all the costs of water right transaction, the scarcity of water resources, and also the costs of water right transferor, and meanwhile, it interiorizes the cost of ecological environment damage, so it is a relatively complete pricing model. It also has a remarkable disadvantage, that is, the content and method involved in the calculation of various costs are different, so the fairness of value assessment is affected. 

Shadow pricing reflects the scarcity of water, and its theoretical basis is marginal utility. The marginal benefit of each incremental unit of water is its shadow price. This reflects the relationship between the scarcity and value of water. Positive shadow price indicates scarcity. The greater the scarcity is, the higher the shadow price will be. Zero shadow price indicates surplus of the resource, and the increase in its supply will not bring about economic benefits. The advantage of shadow pricing is that it reflects the relationship between supply and demand in the market and the scarcity degree of the resource. Its disadvantages are that this method requires a large amount of data, and it is difficult to set the model parameters. 

The theory of marginal utility believes that the value of water rights lies in two parts. First, water rights are in scarcity. In a local area, water availability is limited, while the demand for water keeps increasing. When the actual exploitation exceeds the renewal of local water resources, shortage or depletion of water resources will occur. Because of the scarcity of water, water rights are tradeable. Second, water rights create utility. Water is a basic natural resource which is indispensable from life, economy and the environment. Water has many functions, including water supply, irrigation, power generation, shipping, aquaculture, and tourism. Therefore, the right to use water, that is, the water right, forms utilities. Water rights have different marginal utilities, namely values, among different sectors or water users, and this drives the transaction of water right. The scarcity and utility of water therefore meet the conditions for the realization of value. This method, for its compressive consideration of scarcity and utility, is advantageous since it is in line with traditional economic principles. However, since different water right trading has different utilities, it is very difficult to be adapted for universal assessment of water value. 

To sum up, the existing methods for assessment of water value aim to consider and discuss the value of water comprehensively and objectively from different dimensions and perspectives, and reflect the value of water to a certain extent. However, because of the uniqueness of water as a resource, the above-mentioned methods all have their own disadvantages and limitations, among which the greatest common disadvantage lies in that they only assess the current value of water resources, which is the existing value of water for life, production and ecology. Due to the uncertainty of water availability, the uncertainties in its value out of future fluctuations are not sufficiently considered. For example, because of climatic changes and human activities, possible future risk of water shortage could raise the value of water. Therefore, it’s necessary to treat the uncertainty in values of water from a financial perspective.

IV. Financialization as leverage to value enhancement

Financialization is the advanced form of the market. Financing is no stranger to us all, and various financial products are around us, including banking, insurance, funds, and securities. But do you know that water can also be financialized?

Yes, the natural scarcity and uncertainty of water resources make it possible to capitalize and financialize water resources. Generally speaking, water finance refers to various financial transactions and institutional arrangements related to water resources transactions, including the trading of water rights, the development, utilization, protection and financing of water resources, the investment and financing of water conservancy projects, and other relevant financial intermediary activities. At present, the uneven spatial and temporal distribution of water resources, the frequent occurrence of floods, droughts and water shortage, the serious waste of water, and other water problems in China have severely hindered the high-quality development of Chinese economy and society. Whether it is possible to find a way which can effectively realize the cross-regional and cross-temporal allocation of water resources using financing tools has gradually become a frontier issue attracting greater attention from the green financing field. Since traditional measures for management of water resources can no longer adapt to the present chain problems in flood and drought, agricultural production, energy structure, ecological health and water ecosystem safety, etc., water banks, water bonds, water futures, water options etc. are becoming bright spots in green financing of the field. 

Water bank are enterprise-like entities similar to commercial banks. They are established under the macro-control of the national administration in charge of water, and take water as its service. It mainly refers to a mechanism which promotes the legal transfer and market transaction of the right to surface water, groundwater, and water stored in other forms. Through deposit and loan business like a commercial bank, the water loans and deposits by the water bank can be regarded as assets and liabilities respectively, and therefore a balance sheet can be drawn. Through the water deposits, water loans and water interests, farmers, factories, water service companies with water right can sell surplus water to the water bank. Acquiring parties that need water for production, life and ecology can obtain water right by payments, so that water could be transferred from water-rich areas to water-scarce ones, or from high-availability seasons to low-availabilityseasons. Meanwhile, water interests, divided into current or fixed rates, short-term or long-term rates, could also adapt to and regulate the demand-supply relation between water deposits and loans. 

Similarly, various financing instruments with investment value, transaction demand and fluidity, such as water right mortgage, water right pledge, water right bond, water right repurchase, water right option, water right futures, water right insurance, water right “insurance + futures” and other diverse forms of investments, play important roles in the optimal allocation of water resources. For example, in 2005, a bank loan of RMB48.8 billion was obtained from 7 banks including the China Development Bank, the Industrial and Commercial Bank of China with a  collateral of the water charges from the east and middle routes of the South-to-North Water Transfer Project; in 2012, Glacier Water Investment Co., Ltd. obtained a general fixed asset investment loan of RMB200 million specially for reservoir construction from Agricultural Bank of China with the right to operate water resources; in 2018, Ezhou Water Group Co., Ltd., with the right of reservoir irrigation as pledge, obtained a loan of RMB20 million from China Development Bank Hubei Branch. The above cases not only sufficiently prove the financial attributes of water resources, but also build a bridge between water resources market and capital market, and realize the transformation of water rights from commodity to finances.

With the implementation of water financial transactions, more people are re-thinking about their understandings of water, and start to consider means of saving water resources as well, so as to make the most out of this limited resource for local economy and society. Promoting the development of water finance and developing the asset based securitization of tradable water rights can sufficiently explore the inherent value of water, effectively activate such assets, lower the costs of search and information in transactions, optimize the structure of water allocation, and transfer water from low efficiency sectors to higher ones, and realize the full value of water. Meanwhile, the price discovery, risk management, financing adjustment, and other functions of the market can also effectively measure and manage risks of fluctuation, guide reasonable flows of fund, so as to further serve and support the high-quality development of the water market.

— And the realization of all these depends on our better understanding and valuation of water.

References

  • Claydon, G. K. &Onta, P. S. (2009) Smart water planning in Queensland, Australia, paper presented at OzWater’09 Conference, Melbourne, Australia, 16–18 March 2009.

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World Water Day 2021: Valuing water

Credit: UN Water