Report No FR/CL0005

December 1996

This Manual is intended to provide operational and planning staff within the water industry and associated regulatory agencies with a means to evaluate the benefits arising from improvements in surface water quality. This information will enable a social cost-benefit analysis (CBA) of quality improvement schemes in rivers, estuaries or coastal waters to be undertaken on a consistent basis. Within this overall framework, the Manual provides guidelines for assessing the value of benefits in economic terms. The methodology presented in the Manual identifies which uses (eg. angling, informal recreation etc.) are affected by the proposed changes in water quality for a particular area and then illustrates how the value of the improvement to the users can be estimated. The approach can be applied at the local, sub-catchment and catchment levels.

A structured approach to evaluating benefits is provided. A first. approximate. estimate can be obtained from a Preliminary Assessment (Part 1) using default values listed in the Manual. Most studies will require a Desktop Assessment (Parts 2 and 3). based on available site-specific data, followed by an Overall Appraisal (Part 4). In some instances however, a Field Assessment requiring additional data collection will be necessary (Part 5).

It is important to recognise that the methodology presented in the Manual has been based on existing knowledge and available data. In some cases the understanding of how a particular use will benefit from an improvement in water quality is reasonably well understood. For other uses this is not the case. Similarly the availability of economic data, other than where specific surveys have been carried out as part of the study, is severely lacking or non-existent. The methodology developed for the Manual therefore necessarily reflects these limitations. It is envisaged that experience in the application of the methodology will provide a basis for updating the Manual in due course, particularly in terms of relevant economic data.

The user of the Manual will need to make use of local information wherever possible to help in assessing the quality of the available data. Consultation with individuals or organisations with specialist knowledge is encouraged, as is the need to make visits to the study area in question. Guidance is given in the Manual on appropriate sources of information to support a particular assessment.

European Community legislation, notably the Drinking Water, Bathing Water and Urban Waste Water Treatment Directives, imposed new requirements for water quality improvements. Water charges were set to rise to meet higher standards and, as a result, the Office of Water Services (Ofwat), the industry's economic regulator, issued a paper entitled Paying for Quality: The Political Perspective (Ofwat 1993). This initiated a public debate on the affordability of increased costs for water and on the desirability of the environmental improvements being financed by the consumers.

The Secretaries of State for the Environment and for Wales responded to the Paying for Quality paper by issuing Water Charges - The Quality Framework (DoE/Welsh Office 1993) in which they expressed a commitment to the proper assessment of costs and benefits in setting any Statutory Water Quality Objectives (SWQOs). The considerable cost associated with improving the quality of the water environment has thus put policy-makers under increasing pressure to provide an economic justification for setting environmental standards. These developments have engendered a growing commitment by the water industry and its regulators to the principles of CBA in the belief that it can serve two important functions, namely to help to ensure that:

• new environmental obligations are based on a proper consideration of the balance between costs and benefits; and
• once standards have been set, schemes can be prioritised on economic grounds.

In contrast to the costs of improving the quality of surface water, the monetary value of the resulting benefits is far more difficult to estimate as the benefits do not typically accrue in the form of readily measurable financial flows. Although techniques for valuing environmental resources have been developed by economists they are not widely understood outside the economics profession. In the absence of any formalised methodology there is a possibility that the benefits may be either underestimated or, more likely, simply overlooked and attention focused solely on costs.

To address this problem the Water Companies, Environment Agency (formerly NRA), DoE, FWR, Ofwat, and the Scotland and Northern Ireland Forum for Environmental Research (Sniffer) sponsored a collaborative research project. The objective has been to define appropriate valuation techniques and to make them accessible, together with CBA procedures, to water industry personnel. The project has been managed by FWR with the work contracted to WRc plc, Oxford Economic Research Associates (OXERA), Middlesex University (Flood Hazard Research Centre) and Newcastle University.

The Manual is concerned with valuing benefits and provides no guidance on how to estimate l the capital and operating expenditure for the investment required to achieve the improvements in water quality. Relevant cost information needs to be assembled from other sources in order to complete the CBA.

Guidelines have been prepared. within the Urban Pollution Management Programme (FWR 1994), for estimating the costs of upgrading sewers and wastewater treatment plants to improve the water quality for a particular receiving water.

Improving the quality of a surface water enhances its value to various users of the water. Because different techniques are required to value the benefits of different uses, the Manual considers each of the relevant uses in detail. In most cases the users are active participants (eg. anglers) or derive a benefit indirectly (eg. lower costs for drinking water treatment). In contrast, there is a passive use which reflects an individual's preference for the existence of a clean environment (in this case surface waters) even though the individual may not actually utilise the resource. Better quality waters may have a value to an individual even though he/she may not use them directly for productive or recreational purposes. The corresponding valuation can be explained in terms of existence, bequest or option values: these are usually referred to collectively as non-use values. These three elements of this special category of use are the subject of much debate within the economics profession and are described individually in the Manual.

Table 1 summarises the uses of river water considered in the Manual. The corresponding uses of estuaries and coastal waters are listed in Table 2.

Table 1. Uses of River Water considered in the Manual

Informal Recreation	Agricultural Abstractions
Angling	Property Prices
Drinking water treatment	Canoeing
Boating (motorised)	Non-use
Industrial abstractions

Table 2. Uses of Estuaries and Coastal Waters considered in the Manual

Informal recreation	Water sports
Bathing	Pleasure boating
Commercial fisheries	Shellfisheries
Recreational fisheries	Non-use

The Benefit Assessment Procedure is based at a local level. with short lengths of water reaches forming the basic unit of analysis. It is expected that the Manual will be applied at a sub-catchment level based on the aggregation of the individual reaches of surface water included in the study.

In using the Manual it will become apparent that the co-operation of a number of organisations will be of paramount importance as each organisation will have access to information needed as an input to the study.

The Manual consists of the seven Parts described below and structured as shown in Figure 1.

Each of the Parts begins with statements that identify:

• the actions you should already have taken before commencing the Part;
• the objectives of the Part you are about to start;
• the data you are likely to require;
• the type of information you will generate once you have completed the Part

Each Part, in turn, comprises a number of Sections addressing different aspects of the Benefit Assessment Procedure. Sections contain a number of distinct Tasks that you may have to complete. In order to help you do this, each Task is broken down into a number of separate steps. As you complete these steps the text will refer to worksheets (Part 7) which you should use to show your assumptions and calculations.

The worksheets help to ensure that the Benefit Assessment Procedure is open and amenable to independent scrutiny by providing an audit trail. The existence of an audit trail enables both forwards and backwards checking of the procedure and its results, and allows an evaluation of the consequences, for example, of making alternative assumptions and judgements. The essential rules for maintaining the audit trail are:

• all sources of primary data and information should be referenced;
• all assumptions should be clearly stated and documented;
• the names and positions of individuals who have made assumptions and judgements should be recorded.

Examples of completed worksheets are shown in the Manual and, in addition, throughout the text there are numerous examples which illustrate the application of the Manual.

The Manual is designed to be used to assess the benefits arising from incremental improvements in surface water quality. Consequently all appraisals using the Manual consider the incremental costs and benefits which result from a project against a base scenario of 'do-nothing'. Thus the do-nothing option, which by definition involves no expenditure to improve water quality and generates no additional economic benefit, is implicitly included as the base position within the methodology.

The Manual could play an important role in the water sector at both policy development and project implementation levels, although it is likely to be applied more often at a project level to evaluate options. This role has been reinforced by the Environment Act 1995 with the requirement for both costs and benefits to be taken into account in deciding on the exercise of powers by the Environment Agency. As stated in the Economic Appraisal Manual (NRA 1993), economic analysis at a programme and project level could provide a more consistent approach towards the evaluation of alternative options for setting Statutory Water Quality Objectives, fisheries, recreation and conservation related projects'

The Manual can address three decision contexts:

1. Whether or not to undertake a single project (the one-off case) For example, whether achievement of a particular objective requiring the installation of tertiary wastewater treatment could be justified by CBA.
2. Which of a num6er of mutually exclusive projects to undertake (the either/or case)
   For example, selecting between two alternative projects for improving water quality in a given catchment.
3. Which of a number of mutually compatible revenue competing projects to undertake (the both/and case)
   For example, where there is a need to establish priorities between water quality improvements in different catchments, possibly when capital rationing means that there is limited availability for investment funds in any given year.

The type of decision context will determine the appropriate decision rule for a specific study and have implications for establishing the framework for the appraisal.

The Manual has drawn upon several key published economic guidelines which are described below. They build cumulatively upon each other and move upwards from a general discussion of economic appraisal techniques to more specific guidance on their application in the context of the water environment.

This is the Treasury's "Green Book" which gives guidance on the economic appraisal of expenditure decisions. It contains a general introduction to the concepts of CBA, Cost Effective Analysis (CEA) and financial appraisals. The Green Book recommends that each of these procedures takes into account impacts which cannot be valued. This is extremely relevant to Government Departments as most public service appraisals deal with non-marketed goods and services. The book does not, however, contain detailed guidance on how to evaluate non-marketed goods and services, such as natural resources.

For users of the Benefit Assessment Manual, the Green Book is a useful reference document. It gives a detailed appraisal checklist which establishes best practice for undertaking an appraisal and provides the basis for the other guidance documents.

This DoE publication presents a systematic approach to the treatment of environmental issues within policy analyses in order to increase awareness within government of the need to examine how such decisions affect the environment. The document acknowledges that, in the past, environmental costs and benefits have not been fully integrated into government policy decisions and this will have resulted in the inefficient allocation of resources.

This was written for policy advisers in government, but will also have some relevance for private sector projects. The document provides a simple introduction to the valuation techniques available to decision-makers. It also begins to apply the concepts and ideas identified in the Treasury's Green Book to areas of environmental policy; It therefore provides a useful introduction to the subject.

The 1991 DoE guide helped policy makers understand why they needed to carry out environmental appraisals. This later document (1994) sought to show how that advice had been put into practice through the presentation of a number of case studies.

The NRA's Economic Appraisal Manual concentrates on the provision of more practical and detailed economic guidance on the application of CBA across all the NRA's functional activities. The ideas and techniques included within the DoE guide are more fully described and explained at a practical level in order to meet the more specific objectives of the NRA.

The purposes of the NRA Manual are:

• to establish the basic principles of economic analysis;
• to describe the existing valuation techniques;
• to provide case study examples to illustrate how the techniques are used;
• to form the basis of a CBA training programme within the NRA.

The Benefit Assessment Manual has a narrower focus than the NRA's Economic Appraisal Manual in that it concentrates exclusively on improvements in water quality. In contrast to the other reports, it provides detailed guidance on how to undertake CBA through a series of distinct sections and specific steps. The Benefit Assessment Manual is not meant to be an introduction to economics as such and it frequently refers the user to the above documents as sources cf.s'Jiti3nal information which explain in greater detail the basic underlying economic principles.

The Manual, however, is written with non-economists as the prime audience and contains many examples to illustrate the techniques and concepts presented in the text. Where the use of a technical term is unavoidable, an explanation is included in a Glossary. More detailed explanations of some of the approaches are also included in supporting Technical Annexes.

Department of the Environment (1991) Policy Appraisal and the Environment. HMSO

Department of the Environment (1994) Environmental Appraisal in Government Departments. HMSO

Department of the Environment and Welsh Office (1993) Water Charges - The Quality Framework, DoE/Welsh Office

Foundation for Water Research (1994) Assessing the Costs of River Water Quality Improvements: Cost Guidelines, FWR Report FR 0449

HM Treasury (1991) Economic Appraisal in Central Government, HMSO

National Rivers Authority (1993) Economic Appraisal Manual, NRA

Office of Water Services (1992) The Cost of Quality

Office of Water Services (1993) Paying for Quality - The Political Perspective