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CHAPTER I

INTRODUCTION

1.1 PURPOSE AND SCOPE

This report describes the results of our first year of work on the project entitled "An Analysis of Contemporary and Historical Economics Associated with Water Development Projects in Wyoming."¹ The motivation for the project is the need for a better understanding of the economic ramifications of projects proposed for construction under Wyoming's Water Development Program. This need is summarized aptly in the Request for Proposals issued by the WWRC in May, 1988.

In more rapidly growing and more populous states in the western United States conflicts among users for limited water supplies are creating the need for far reaching additional water development projects as well as innovative legal means of transferring the water and its rights from one use to another. As Wyoming looks to its future and the potential need for water development, it is critical that a clear understanding of all the economic ramifications of water development projects be understood. This may require that Wyoming not only look at its own water supply and demand picture (both present and the future), but that this picture be couched in a broader context of the water supply and demand activities ongoing in surrounding western states to determine what effect they may have on Wyoming water development. While the research conducted must approach the issues from the perspective of Wyoming, it should serve to elevate and articulate reasoned concerns applicable to many western states. (P. 1)

The objective of our first year's research effort was to formulate a preliminary set of economic methods and criteria for evaluating Wyoming water projects. These methods were developed in the context of water needs in surrounding states and the desert southwest that may affect Wyoming's water development possibilities in the future. The methods also attempt to take into consideration the legal framework within which water rights are couched and the institutional framework in which water development decisions are made in the western United States.

Our economic methodology is preliminary in the sense that it has not yet been used to evaluate any specific water projects. The second year of this research project would, however, involve a comparison of traditional benefit-cost approaches with our new methods in the evaluation of historical water projects in Wyoming and surrounding states. Based upon that analysis, refinements would be made to the new methods before they were finalized for use by Wyoming water planners.

1.2 WYOMING'S WATER DEVELOPMENT PROGRAM

The Wyoming Water Development Program was established by the 1975 Legislature in W.S. 41-2-112 (a), which provides in part:

The program shall encourage development of water facilities for irrigation, for reduction of flood damage, for abatement of pollution, for preservation and development of fish and wildlife resources [and] for protection and improvement of public lands and shall help make available the waters of this state for all beneficial uses, including but not limited to municipal, domestic, agricultural, industrial, instream flows, hydroelectric power, and recreational purposes, conservation of land resources and protection of the health, safety and general welfare of the people of the state of Wyoming.

Wyoming's Water Development Program received no significant funding until 1982, however, when the legislature appropriated over $100 million in general funds for the program and established two mineral severance taxes as ongoing sources- of program revenue. The 1982 Legislature also established the Wyoming Water Development Commission (WWDC) to oversee the program.

Since 1982, the WWDC and its staff have implemented three programs in support of water development in Wyoming:

1. The New Development Program.
2. The Rehabilitation Program.
3. The Water Resource Planning Program.

The purpose of the New Development Program is to develop presently unused and/or unappropriated waters in Wyoming. This program is funded by Water Development Account No. 1, which to date has received $117,600,000 of General Fund appropriations and revenues from a 1.5 percent excise tax on Wyoming's coal production. New development projects can be proposed by local sponsors such as municipalities and irrigation districts. For a local entity to sponsor a new development project, it must be capable of assuming all of the project's operations and maintenance (0&M) costs and repaying a portion of the project's capital costs. Alternatively, new development projects can be sponsored by the state, with no local commitment for repayment. State projects are typically multipurpose in nature and are often intended to generate a surplus of water above current needs to provide for future economic growth.

The Rehabilitation Program provides funding assistance for improving water projects that were completed and in use prior to 1970. Rehabilitation projects are usually proposed by local sponsors. The Rehabilitation Program is funded by Water Development Account No. 2, which receives revenues from a 0.167 percent severance tax on Wyoming's oil and gas production.

The Water Resource Planning Program involves developing basin wide water plans for the state's major drainages, providing planning assistance to municipalities, and doing research in the areas of instream flows and groundwater availability. Legislative approval must be obtained before funds can be allocated for the study or construction of either new development or rehabilitation projects. The WWDC is charged with evaluating both sponsored projects and state projects in making recommendations to the legislature with respect to funding. The WWDC currently follows a five-step process in evaluating new development and rehabilitation projects. A brief synopsis of that process is given below: ²

1. Application Review - The WWDC reviews applications from potential sponsors to insure that the proposed project is consistent with the program's statutory goals and objectives, that the WWDC is the most appropriate source of funds for the project, and that there are no apparent economic, legal, or environmental problems that would prevent project development. If this review is favorable, the WWDC requests funding from the legislature for a Level I study as described below.

2. Level I - Level I studies typically involve an analysis of development options, the identification of project beneficiaries, and a description of the physical, legal, technical, economic, and environmental constraints that may affect project development. Projects are typically recommended for a more detailed. Level II, study if there are no constraints that would prevent project development.

3. Level II, Phase I - Level II, Phase 1 studies involve a detailed engineering analysis of the project; detailed estimates of project construction, operation, and maintenance costs; estimates of direct project benefits; and an analysis of the project sponsor's ability to pay. A determination is made of the project's technical, economic, and legal feasibility at the end of this phase. If a project is deemed to be feasible, and the project sponsor has the willingness and ability to participate in project financing, the project proceeds to Level II, Phase 2, as described below.

4. Level II, Phase 2 - Level II, Phase 2 investigations include the final technical design work for the project, identifying all necessary state and federal permits required for the project, conducting an environmental analysis, identifying land acquisition needs, and performing a complete economic analysis of the final design including estimates of both direct and secondary benefits. If a project is still deemed feasible at the end of this phase, it is recommended to the legislature for construction funding.

5. Level III - Level III is the construction phase of the WWDC Water Development Program. During this phase, construction permits and land are acquired, and construction plans and bidding documents are prepared. Level III activities terminate when construction is completed and the project is operational.

Although the five-step evaluation procedure described above includes economic feasibility considerations, no formal economic evaluation criteria or procedures have been promulgated by the WWDC. Instead, the WWDC typically specifies the scope of the economic analysis appropriate for each level of study, but leaves the choice of economic evaluation procedures to the discretion of prospective contractors. The lack of formal economic criteria has been a subject of criticism with respect to the Water Development Program (for example, see Jacobs and Taylor [1989]). One of the primary purposes of this study is to fill that void.

1.3 A FRAMEWORK FOR ECONOMIC EVALUATIONS

There is a dichotomy in the economics profession concerning the appropriate framework for evaluating water projects. Some economists believe that benefit-cost measures alone are the appropriate evaluation tool for water projects, and that projects should not be constructed unless it can be convincingly demonstrated that project benefits will exceed project costs. This view has been argued by Freeman and Haveman [1970] and more recently by Jacobs and Taylor [1989].

Other economists believe that it is often difficult to capture all of the appropriate "pros" and "cons" of a given project in a traditional benefit-cost framework (for example, see Howe [1987]). As a result, benefit-cost measures usually ignore certain project characteristics that may be of interest at the state level. To illustrate this point it is useful to refer to Howe's depletion of the factors influencing water decisions as illustrated in Figure 1.1. The lower left-hand circle, entitled economic efficiency, is the issue addressed by traditional benefit-cost studies. Other economic issues such as equity considerations, social stability, environmental impacts, and regional impacts are traditionally ignored in benefit-cost studies, as are certain special interest considerations.

Howe's argument is that rational decision making with respect to water projects can take place only when all of the factors involved in the decision making process have been identified and the appropriate ones incorporated into project evaluation. Otherwise, the project evaluation process will be subverted or ignored by those with agendas other than economic efficiency. The authors of this report agree with that view.

With respect to the Wyoming Water Development Program, there are several economic issues that are difficult to capture in an economic efficiency framework such as benefit- cost analysis. We have identified some of those issues in previous work undertaken for the WWDC (see, for example, Watts, Brookshire and Cummings [1989]). Among them are:

1. Wyoming's status as a surplus water state in a region where water resources are becoming increasingly scarce and valuable.
   

2. The changing role of the federal government with respect to water resources development and management, including increasingly stringent permitting procedures for new projects.

3. Emerging legal trends that add an element of uncertainty to Wyoming's interstate decree and compact water entitlements.

4. The role of water transfers in making water available for new uses in the western United States.

Because economic implications of these factors are difficult to capture in a benefit-cost framework, we believe that the economic criterion used for evaluating Wyoming water projects must extend beyond traditional efficiency considerations. Otherwise, there will be a tendency for the economic evaluation criterion to be subverted or ignored.

With that thought in mind, our goal during the first year of this study has been to:

1. specify how efficiency considerations should be addressed at state levels;

2. identify those non-efficiency considerations of importance to Wyoming's citizens; and

3. incorporate both efficiency and non-efficiency criterion into a meaningful decision making framework.

1.4 RESEARCH APPROACH

The literature addressing the appropriateness of project evaluation procedures is voluminous both in the government "gray literature" as well as in the academic journals.³ Our research approach was to attempt to stand back from the plethora of writings and attempt to identify a set of central issues that would guide our inquiry. To that end we asked the following three questions:

1. What are the forces and considerations that potentially are and/or will "drive" Wyoming's water development program?

Candidate forces include the legal environment, the interface between the relative abundance of Wyoming ' s water relative to downstream scarcity and/or the possibilities for water transfer schemes. Given these forces, there might be an argument for evaluating Wyoming's water development program utilizing a different framework.

2. What is the appropriateness, for Wyoming's water development program, of traditional project evaluation procedures that were principally developed for Federal water projects?

This is a perspective that might well be termed a "Wyoming eyes" perspective. We are asking whether a Wyoming eyes perspective should be different from the federal or other states perspectives. More specifically, given that federal programs "attempt" to choose only efficient projects, should efficiency be the only choice criteria for Wyoming.

3. What do the citizens of the state of Wyoming desire? What perspectives do they have regarding what is "important" in designing a set of water project evaluation criteria?

Thus we were interested in asking the residents of the state whether a pure efficiency criterion is important to them and if there are other non-efficiency considerations that are of importance.

4. Finally, how does one, given the above inquiries, incorporate all of the perspectives and considerations into a meaningful decision making framework?

To this end let us be clear on our goal. We intended to look beyond traditional benefit-cost analysis as it is voluminously detailed in the literature. This is not to say we are disregarding the traditional efficiency framework. We are not. We simply are asking whether the framework for project evaluation should be guided by other considerations than those of strict efficiency tests as well as those that do not fit neatly into the traditional framework.

Chapter 2 of this report presents a discussion of efficiency and non-efficiency considerations with respect to Wyoming's water development program. Benefit-cost measures appropriate for Wyoming water projects are presented in Chapter 3. Chapter 4 presents the results of a survey of Wyoming households concerning the relative importance of various efficiency and non-efficiency criteria. Our methodological framework greatly hinges on the results of this survey. Chapter 5 presents a preliminary method of integrating efficiency and non-efficiency criteria, and Chapter 6 details plans for additional research. A series of appendices provide much of the background material that was instrumental in designing the preliminary methodology presented in this report.

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