Cooking the Numbers … Or, How to Make a Dam Seem Financially Viable

By Barrie Ridler

Unfortunately, many of those deluged with selective sound bites regarding the Regional Council’s dam proposal have moved on to less stressful pursuits. Others have been convinced of its worth without reading beyond the hype.

For example, prominent farmers have stated publicly that the price of the water to users matters little, and “surprisingly” price can vary between 20 to 30 cents per cubic metre without affecting the economics much. They miss the point that this applies to the NPV of the whole scheme, not to individual farmers, who will be greatly affected if the price moves by this amount.

But the complexity of the proposal makes the “head spin” just thinking about it. This complexity has been minimised by HBRC with a barrage of compellingly simplistic statements. And to ensure any residual doubts are allayed, the certainty of the benefits to the region and the environment are regularly emphasised, which brings to mind this quote:

“At a time when constituents are uneasy and enemies are probing for weaknesses, unflinching confidence has an almost mystical power. It can all but create reality.” (Commentator about George W. Bush.)

But a touch of reality was contained in David Painter’s peer review of the dam proposal:

“There is certain logic of dependency. The irrigated area and land use require certain annual volumes of water; the available water resources need to be able to provide those volumes while recognising ecosystem health; storage is required for a certain reliability of supply; that requires a reservoir and dam; dam and downstream safety require flood management; stored water must be conveyed to the irrigated area.

I am left with a concern that the process comprising:

Unclear choice of rainfall data;
Unstated calibration of rainstorm properties and time profiles;
Unstated loss rate and baseflow techniques; and,
Unexplained irregularities in hyetograph and hydrograph shapes has not made clear either the inherent variability around presented values nor the uncertainty involved in the estimates.”

These fundamental issues of water supply, storage and distribution are still largely to be verified.

However, for this article, we look chiefly at the costs compared to benefits of the scheme for the individual farmer.

Warning: some complexity required

According to the BNZ Advisory Report, 19th September 2013 (the public version, p 4) prepared for the Regional Council:

“Overall, we have found that a water distribution supply price between 20c/m3 and 30c/m3 should be sufficient to compel investment in both off farm (supply) and on farm (demand) infrastructure, provided the public sector participates in the Project with returns that incorporate direct and indirect externalities, as well as a cash return.”

And the same report (p 34):

“Investigation of public sector funding is considered necessary given our initial analysis demonstrated that returns will not be sufficient to attract private equity to the Project at prices that are affordable to a sufficient range of farmers. The Project is expected to realise material environmental and economic externality benefits. As the private sector will not rationally take these benefits into account, there is a viability gap that requires public sector funding.”

This implies that current ‘free’ river flows will be charged to the “public sector” at a price of 25 cents per cubic metre –about $10,000,000 per year and that public money must prop up the “investors” stake to justify investment.

Cost to individual farmer

To irrigate, farmers must pay for distribution to their properties (pipelines will not pass along each boundary), pump and distribute this via pivot irrigation (the most ‘efficient’ form of irrigation if the risks of high wind gusts and evapo-transpiration rates are set aside) and be charged 20-30 cents per cubic metre.

DairyNZ estimates costs of pivot irrigation systems for dairy conversion to
total $6,500 to $7,000/hectare and that borrowing and depreciation costs add up to $1,525 fixed costs per hectare per year to centre pivot.
These costs apply whether water is needed or not
To these fixed costs must be added still more costs:

Power, pumping, charges for water applied ($750 to $1125/ha/yr EVERY YEAR) and capital required for extra stock.
The costs now exceed $2500/ha/year.

This water may grow additional pasture, up to 4500 kilograms dry matter per hectare, BUT only when water deficits occur.
Current prices for additional feed on farms vary from 30 cents to 45 cents. The additional irrigated pasture will cost between 55 cents per kg DM ($2,500 divided by 4500kgDM = $0.55) to as much as $1.00 per kg DM making it uneconomic as an option for most uses in this region.

However, if the cost of borrowing is removed from this figure, it reduces by about a third and appears to be more affordable. This is what the use of EBIT (earnings before interest and tax) disguises when calculating benefits to farmers. However the real farm must pay interest to the bank (and for water) even if the water is unused.

And indeed the water might not be used because:

a) it’s wet enough anyway (a high probability, discussed below);
b) the cost of extra water precludes use due to negative cash flow generated (which the banks will also not tolerate for long).

So, how often then is water likely to be of benefit? Quoting from an HBRC pre-feasibility report:

  • In a ‘normal’ non-drought year all of the Plains appear to enjoy a moisture surplus throughout the growing season, i.e. no irrigation required.
  • In a 10 year drought, the seasonal deficit ranges between zero and about 240mm.
  • In a 20 year drought, the seasonal deficit ranges between zero and about 450mm averaging around 330mm.
  • There is also a significant difference in the average water requirement across zones, for example Zone D in a 20 year drought requires about 240mm, while Zone A requires about 400mm.
  • The western extents of Zones C and D will not require irrigation in most years, and then only a modest amount, even in significant drought events, and this suggests that it will be both uneconomic and unwarranted to irrigate these areas.

The data above show that in most years, irrigation will provide little additional pasture when soil water levels are already adequate and the opposite occurs if too much water is applied. Nitrogen (N) loss also increases markedly with irrigation. N “mitigation” strategies are possible, but are both expensive and of marginal value in reducing N loss. N loss to water will increase by 2 to 3 times if irrigated dairy replaces drystock (Overseer nutrient management program.)

Using the above data, the cost of additional pasture from irrigation over a 10 year period is very expensive compared to other options such as adjusting herd size, improving per cow performance through management and use of summer crop such as turnips to better suit the environment of the area.

The argument that irrigation will allow farms to be fully stocked at all times ignores the fact that this area has slow pasture growth in winter and spring. If the farm is stocked to eat all pasture at peak growth times, large feed gaps appear either side of summer and must be filled by other bought in feed.

Averaging can make any investment ‘profitable’

It is stated that the equity of an existing farm can be used to purchase and convert another block. When the interest charge for the additional land is spread over the whole expanded enterprise (rather than only the new block that generated the cost) it makes any new acquisition look good. Especially if you start with enough initial equity!
When interest only loans are offered it is normally because there is not sufficient money being made to repay debt. That makes the farmer merely an interim manager.

So irrigation can be made to look good by:

  • Averaging across the full enterprise rather than the additional investment.
  • Bundling improvements that do not require irrigation into the benefits of irrigation (e.g., intensification that can be achieved by better managers applies to all land and should not be a part of the benefit that is attributed solely to irrigation NOR to the changes possible on adjoining land).
  • Assuming full water use is required as the only alternative to solve a short term or infrequent shortage, when in fact substitute options will return more profit with less capital and risk. It is only after those options have been analysed that a correct comparison with irrigation can be made. Irrigation is then revealed as an inferior and very expensive substitute.
  • Discussing ‘mitigation strategies’ rather than seriously addressing the problems of greatly increased N loss to water from intensifying cropping and dairy with irrigation.
  • Using input/output models which do not recognise the diminishing returns and increasing costs that apply to increasing production past a certain optimal point.

Simply put, if the extra borrowing and running costs involved with irrigation on pastoral farms are properly compared, use of water will erode equity.

And the perverse fact is, the more additional capital that is required (borrowed), the less ability the business will have to derive any marginal cost/marginal benefit advantage from the existing investment.

Project: How to Make a Dam Seem Financially Viable
Unfortunately, many of those deluged with selective sound bites regarding the Regional Council’s dam proposal have moved on to less stressful pursuits. Others have been convinced of its worth without reading beyond the hype.