The Benefits and Costs of the Dam in Australia as per the Current Dollars - Example

Social cost and benefit analysis Student’s Name Instructor’s Name Course Code and Name University Date of Submission Social Cost and Benefit Analysis Agriculture is still largely dependent on the support of the public, especially in Australia. A reform of agricultural policy is required due to both domestic and foreign pressures. Within Australia, the reform is characterized by the desire to curb the negative impacts posed by the prolonged periods of dry weather. This paper provides a cost and benefit evaluation of the Australia’s Federal government proposal of building a dam on a main river, with the primal purpose of irrigating the farm land within the vicinity of the dam (Bradbury 1996, p. 25). Recent research shows that Australia is becoming more vulnerable to the effects of dry seasons particularly being greatly exposed to risks of extreme drought and heat (carbon neutral 2011). The government proposes an 800 gigalitres dam that is expected to provide water quantity of 500,000 megalitres available for irrigation in every year. The Department of water authority anticipates that the project will take three years under construction. This paper estimates the benefits and costs of the proposed dam as per the current dollars. The main estimated costs are construction costs of the dam and water delivery system, labor costs, operating costs and off-site salinity effects. The major benefits will be the creation of employment opportunities, increased flood control, fishing on the downstream of the dam, water sports and other recreation activities. The construction will take three years while in the meantime; the farmland that will be used for irrigation will earn net income$100 per hectares per year for the first two years. The cost of converting the farm used for dry land farming to a leveled land for irrigation, and the associated capital costs of on-farm changing to irrigation farming are $1000 per ha. Cost Benefit analysis A cost-benefit analysis is a technique of economic evaluation (Robinson 1999, 925). It is intended to appraise whether the dam project is worth undertaking, and also establish its optimal size. A feasible project should improve the social welfare of all concerned parties, individually and collectively. The estimated benefits and costs during the period are discounted to values of the present day by use of a range of discounting rates that is 5 and 7 percent (Robinson, R 1999, p. 925). The government of Australia has since tradition favored a rate of discount of around 7% since it is deemed to be an approximate return rate that is available on alternative capital uses (Han, Yoo and Kwak 2008, p. 260). The proposed project is likely to affect the entire population and the government since this water resource project is being undertaken from a national point of view. The set of alternatives that is linked to this project include; the likelihood of the project being delayed to a future date, whether the dam will also be built for purposes of hydroelectricity, and the possibility of the dam being made from several materials like rock-fill. Also, earth-fill or concrete, whether the dam will be built according to different capacities and heights, and also where the dam can be built without or with a fish ladder to lessen negative environmental effects. The major purpose of the dam construction in Australia is irrigation. The positive and negative impacts will be accounted for in the analysis to ensure the project’s economic efficiency. Potential Negative Impacts The project construction costs, which include the water delivery system and the dam, capital costs to be incurred are $100M in the first and second year each, and 50M in the third year. These are valued in the current market prices. On the operation and maintenance cost, the water authority that is to administer the supply of water is projected to be $3M and an extra $10M of income tax every year from the fourth year forward, on their net returns before tax from irrigated cropping businesses. Also, during cropping, there are the overhead and variable costs such as seed, fertilizer, fuel, chemicals, as well as casual labour, which are expected to sum up to $700 per irrigated hectare per year. In addition, it is the conversion cost of the land from the dry land farming to the irrigation farming, which is estimated to an amount totaling to $1000 per hectare. These were as per the current market value. Salinity and waterlogging also have an adverse impact to the surrounding environment. The agricultural production is affected by the rise of ground water brought by surface water (Fitzpatrick and Barnett 1982, p. 28). Fifty thousand hectares of the land adjacent to the irrigation scheme which is used for the dry-land farming will indirectly be affected by the scheme by water from irrigation scheme adding to the supply of underground water, which then causes a rise of water tables in the areas surrounding. In a period of over 40 years estimated for irrigation, this dry farmland will, therefore, suffer a decrease in annual productivity and also in profitability, hence a decline in the value of land, as well. After the commencement of the irrigation, it is expected that the steady decline of annual profit per hectare in the dry farming will fall as of the current $100 to $20 per hectare by the 43 year. These losses are anticipated to occur in a linear manner over time that is, net profit loss of $80 for 40 years where each hectare per year is estimated to produce $2 net profit yearly than it is the case if irrigation scheme is not set up. The profit loss in each year is relative to current profit of $100 that is earned annually if the dam is not built. These estimates are as per the current market prices. Consequently, damming the river, wetlands of 5000 ha in the downstream will be developed, but they have no use commercially and will experience a notable decline of water flows. To hinder this, mitigation costs of reducing the water available for irrigated agriculture is adopted from the intended 500,000 to 400,000 megalitres yearly. This will involve using 54,000 hectares for irrigation and forty thousand hectares utilized for cropping in every year. The risk of the dam failing is attached a probability of 0.5. A sensitivity analysis shall be carried out to examine the possibility. Potential Positive Impacts Irrigation Water Irrigation is a significant constituent in production of agriculture. The actual returns depend on the area irrigated, physical performance of delivery of water, crop patterns, crop intensity and crop yields. The irrigated land shall be used to cultivate a crop in suitable rotations. The expected value of the land is that the crop shall yield four tonnes per hectare per year with the first year of harvest being year 4. The yield of the irrigated crop is estimated to return $650 per tonne. These estimates are as per the economic value since the crop price paid is subsidized by the national government with a subsidy from the general tax revenue of $100. The factor income method is used to obtain estimates. Reduction of flooding The dam will control floods downstream through storing in the reservoir, the rain water and then allowing it out slowly over time. Over the past years, before the damming of the river, there have been flooding every five years that have caused nearly $3M every time they happen (Dobes 2007, p. 16). With the dam, however, it is anticipated that such floods at least happen with a half frequent compared to the recent past with damage of fifty percent less. Recreational and Fishing Benefits from Reservoirs On the downstream of the dam, is the famous fishing and recreational spot (Adams 1998, p. 300). The estimates of the demand for making use of recreational and fishing spot are projected that 10,000 person-visits in every year, will be made at a cost of $100 per fishing visit per user. With the dam, the spot is expected to be more attractive, and demand will rise to 15000 users at a cost of willingness to pay at $150 for each user, for water sports, recreational and fishing visits. The travel cost method assisted in obtaining the estimates of willingness to pay by consumers. This number is expected to constantly remain regardless of the extent of water in the dam. Also, the dam is anticipated to yield quantities amounting to 400,000 kilograms of fish every year to commercial fishers that is worth $4 per kilogram, regardless of the quantity of water in the dam and the much used in environmental and irrigation uses. The factor income approach is used to attain the estimates. Table1. Suitable Valuation Approaches for the Dam Construction Impact Physical impacts Suitable valuation method COSTS 1. Construction, O&M, Mitigation Capital goods, Materials, labor Market price 2. Conversion Property losses, capital goods & materials Market price 3. Salinity and water logging Materials Market price BENEFITS 1. Flooding Property losses Stated Preference 2. Irrigation water Incremental productivity Revealed preferences & market price 3. Recreation and net fishery Net days of visit Revealed preferences and market price In order to compare all costs and benefits, as they occur at different periods, the monetary benefits are discounted by a social discount rate at 7%. All costs apart from capital cost are discounted at a rate of 7% for a period of 40 years. Construction cost, on the other hand, is discounted for three years. All the benefits are discounted for a period of 40 years at a rate of 7%. Economic Evaluation of Costs and Benefits Total Costs $ “000” Construction costs 250 Operating and Maintenance 43 Conversion 67 Renovation costs 125 Variable and overhead costs 1400 Income tax 10 Salinity and waterlogging 4 Algal blooms 16 Labor 200 Total 2115 Total benefits Irrigation water 5200 Processers and Retailer 30 Floods control 6 Employment 50 Recreational 90 Fishing sales 64 Total 5440 A cost-benefit analysis aims at project appraisal. A project is considered worth investing when its benefits exceed its costs (Dobes 2007, p. 24). The projected net benefit of this project will be determined by an approach of net present value, where the project is feasible if it has a NPV greater than one. Also, the Benefit Cost ratio shall be used such that the ratio should be above one for the project to be viable. The third method is Internal Rate of Return that requires the IRR should be bigger than the market rate of return. NPV= Bt-Ct t=0 (1+i)n Where Bt = benefits at time t, Ct = costs at time t, I =discount rate and n = number of years NPV = 5440- 2115 = 222.11 (1 + 0.07)40 The project has a NPV of 222.11 which is positive therefore suggesting that the project is worth investing in. Benefit-Cost Ratio requires the ratio to be greater than 1 for it to be deemed feasible. B/C ratio = B̽t where B̽t is the discounted benefits and C̽t . C̽t B/ C ratio = 363.393 = 2.57 . 141.282 The project has a benefit-cost ratio of 2.57, an indication that it is a viable project that is advisable to invest. The internal rate of return is the highest rate that the project owner will economically pay (Hahn & Tetlock, 2007: 25). It is a discount rate that equates the NPV to zero. When the rate discounts both the benefits and costs, the discounted benefits and costs should equal each other. The IRR of this project is more than 7%, suggesting that this project has a higher rate and hence it is feasible. Sensitivity Analysis It helps to examine the possibility of a project failing (Pannell, 1997: 142). The key variables of this project are; construction, mitigation and operation and maintenance costs which depend largely on geotechnical conditions at the site of the project. Also, dam performance is another variable that constitute the provision of water supply and flood control. In addition, agricultural production has been a variable where the estimates of the outputs were obtained by use of production functions. Discount rate also was taken at 7% as per what the government of Australia recommends. By decreasing the economic benefit with a 25%, the NPV value will change to Npv = 4080 – 2115 = 131.26. . (1+ 0.97)40 Sensitivity indicator = 222.11- 131.26 / 222.11 = 1.63. . 5440 – 4080 / 5440 The sensitivity indicator is not high and hence the risk for the project is not high. Also, the cost-benefit analysis of this project is sound since the sign of net present value has remained positive when the value of key variable has changed. I recommend the construction of the dam since it has an economic value to society. The project has positive NPV as well as the sensitivity analysis has shown a low probability of the project failing. The government should, however, develop ways to help those whose productivity of their land is affected and those who will be relocated. I recommend that the government should let the prices of the products in the market be influenced by the market forces, in order to avoid locking out those other producers of the irrigated crop. List of references Adams, W.M 1998, “The Downstream Impacts of Dam Construction,” Transactions of the Institute of British Geographers, vol. 10, no. 3, p.292-302. Bootman, JL, Rowland, C and Wertheimer, AI 1979, Cost-Benefit Analysis, Evaluation & the Health Professions, vol. 2, no. 2, p.129-154. Bradbury, CE 1996, “Harris Dam Slurry Trench: Design and Construction,” Australian Geomechanics, vol. 19, p. 22-27. Buxton, M 1998, Economic appraisal and prescribing choices. Prescribersʼ Journal vol. 33, p.133-138. Carbon Neutral 2011, Impacts of climate change in Australia. Viewed from http://www.carbonneutral.com.au/climate-change/impacts-on-australia.html Dobes, L 2007, Turning isolation to Advantage in regional cost-benefit Analysis, Economic papers, vol. 26, no. 1, p. 17-28. Dobes, L 2007, A Century of Australian Cost-Benefit Analysis: Lessons From The Past And The Present, Working Paper 2008-01, 1-24. Fitzpatrick, MD and Barnett, RHW 1982, Instrumenting Australiaʼs Cethana Dam, International Water Power & Dam Construction, vol. 34, no. 11, p.26-30. Hahn,W R and Tetlock, CP 2007, Has economic analysis improved regulatory decisisons? Working paper 07-08, 1-31 Han, S.-Y., Yoo, S.-H and Kwak, S.-J 2008, valuing environmental impacts of large dam construction in Australia: An application of choice experiments, Environmental Impact Assessment Review, vol. 28, no. (4-5), p. 256-266. Malcolm, B and Sinnett, A 2006, Investigating conserving native grasslands from the perspective of three farm businesses in the Victorian Volcanic Plains, Working paper, 1- 95. Malcom B n.d, Investigating Net Benefit from Alternative Use of Resources, viewed from http://www.elgaronline.com/view/9781843767558.00009.xml Pannell, D.J 1997, Sensitivity Analysis of Normative Economic Models: Theoretical Framework and Practical Strategies, Agricultural Economics, vol. 16, p. 139-152 Robinson, R 1999, “Cost-benefit analysis,” BMJ (Clinical research ed.), vol. 307, no. 6909, p.924-926. Read More