Cost-benefit analysis. Is the nitrate program effective?

Cost-benefit analysis (CBA) is an analytical tool used to assess the impact of a particular project, plan or program on social welfare. The nitrate program, currently in effect in agricultural areas, also underwent such an evaluation at the development stage. Did the cost-benefit analysis show anything of interest? How were both measured?

Nitrate program

The nitrate program implements the objectives of the Nitrates Directive, which aims to reduce water pollution caused by fertilization of agricultural land with natural products containing nitrogen compounds and to prevent further pollution of this kind. The most important activities that the Nitrate Program specifies are:

• conditions for the agricultural use of nitrogen fertilizers near water, on areas with steep slopes, and on frozen, flooded or snow-covered soils;
• The dates when agricultural use of fertilizers is allowed;
• conditions for storing natural fertilizers and handling leachate;
• How to calculate the annual dose of natural fertilizers;
• Principles of planning nitrogen fertilization of individual plants.

The program was adopted by Decree of the Council of Ministers on January 31, 2023. (Journal of Laws 2023, item 244), and its provisions came into effect on February 8 this year.

What is a cost-benefit analysis?

Cost-benefit analysis (CBA) is an analytical tool to assess the impact of project implementation on social welfare. The effects of a project, unlike a typical financial analysis, are considered from the point of view of the interests of society as a whole and the impact on the socioeconomic environment.

The rules for performing CBAs have been unified at the level of EU institutions. Base textbooks, used among others. For the purpose of analysis to obtain funding are:

• “Guide to Cost-Benefit Analysis of Investment Projects; Economic appraisal tool for Cohesion Policy 2014-2020,” issued in December 2014. by the European Commission (hereinafter: “CBA Guide”);
• “Economic Appraisal Vademecum 2021-2027; General Principles and Sector Applications,” released in 2021. by the European Commission (hereinafter: “CBA Vademecum”).

These studies present methodologies and assumptions to be made for analysis, as well as practical case studies. In addition, at the national level, there are guidelines and industry manuals that set out specific rules to be used in performing CBA.

Cost-benefit analysis – key steps

The basic steps of cost-benefit analysis are:

• A description of the socioeconomic, institutional and political context;
• goal setting;
• project identification;
• Technical feasibility and environmental sustainability (including, but not limited to, demand analysis and alternatives);
• Financial analysis (determination of cash flow in terms of project costs and revenues, sources of financing, financial sustainability of the project, calculation of typical indicators for evaluating the efficiency of investment projects, such as NPV or IRR);
• economic analysis;
• Risk assessment (including sensitivity analysis).

A comprehensive cost-benefit analysis includes both financial and economic analysis, the principles of which will be discussed below. Economic analysis is the focus of this article, as environmental programs are not usually implemented to generate monetary income. Economic analysis – relative to financial analysis – differs, among other things. taking into account fiscal adjustments, the transformation of market prices into hidden prices, the evaluation of non-market impacts, and its purpose is to determine the economic rather than financial profitability of the project.

Economic analysis

The economic analysis includes the following steps:

• identification of investment and operating costs (incurred by all parties involved in the project and those affected by the project);
• making fiscal adjustments (since taxes and subsidies are transfer payments that only transfer control of resources from one segment of society to another) and adjustments for hidden prices (in practice, conversion factors are applied to investment costs and selected operating cost items);
• Identification of socio-economic benefits for society, for example, environmental externalities (reduction of greenhouse gas emissions, noise, air, soil, water pollution, etc.);
• comparing benefits and costs, discounting the results with a social discount rate and determining economic indicators, such as ENPV (economic net present value, i.e., the difference between discounted total benefits and social costs), ERR (economic rate of return, i.e., the rate that gives a zero value for ENPV), BCR (B/C ratio, i.e., the ratio of discounted economic benefits to costs).

The purpose of the economic analysis is to demonstrate that the planned project is justified from a social point of view, even though it may not be financially viable. If the ENPV is greater than zero, the public is considered to need the project.

Nitrate program – calculation of economic efficiency

Among the costs of the Nitrate Program that were evaluated, they identified:

• expenditures on retrofitting farms with liquid fertilizer tanks and manure slabs;
• Costs of controlling compliance with the provisions of the Program and monitoring (including sample analysis);
• The cost of preparing nitrogen fertilization plans and documentation.

The remaining costs were analyzed qualitatively (due to the lack of a reliable basis for estimating them).

Data held by public entities were used to determine the level of identified costs, in particular: the amount and value of investments in manure pads and liquid fertilizer tanks financed by support instruments (data from the Ministry of Agriculture and Rural Development), the costs of soil and water control and monitoring incurred by the National Chemical and Agricultural Station and its regional branches, reports on the implementation of the directive, CSO data (including the 2020 Census of Agriculture). The total cost of implementing the Program in 2022-2024 (in terms of quantifiable costs) was estimated at PLN 3.2 billion. In the following steps of the analysis, a conversion factor was applied to net capital expenditures, which reflects an adjustment for hidden prices.

The advantages of implementing the Nitrate Program relate primarily to environmental benefits (in particular, reducing eutrophication of the Baltic Sea) and, to a lesser extent, reducing farm expenses on mineral fertilizers.

The valuation of the agricultural nitrogen load entering the Baltic Sea can be treated as an opportunity cost, i.e. They can be classified as a kind of waste. Increasing the efficiency of nitrogen fertilization would translate into lower mineral fertilizer purchase costs. The benefits of reducing the cost of acquiring mineral fertilizers were estimated at PLN 83 million per year.

Nitrogen and phosphorus compounds flowing with river waters into the Baltic Sea are the main causes of eutrophication. The Nitrogen Program’s activities should result in a reduction of nitrogen from agricultural sources polluting the Baltic Sea by water by about 7,700. t per year. The unit benefits of reducing the eutrophication effect in monetary terms were assumed according to Helcom studies (see bibliography). The target benefits, related to reducing the eutrophication effect of the Baltic Sea, after the completion of the Program were estimated at 910 million zloty per year.

To calculate economic efficiency, the socioeconomic benefits and costs discussed above were compared. Cash flows were discounted at a social discount rate of 3 percent. No residual value was determined due to the fact that the projections covered the entire life of the asset (the recommended approach).

The economic efficiency indicators for the Program are ENPV: PLN 13 billion, ERR 46.6 percent. and BCR: 4.8. The economic analysis performed and the positive economic viability indicators confirmed the legitimacy of the Program.

Applications

A cost-benefit analysis of the implementation of the Nitrate Program shows that while the initial financial outlay may be significant, the long-term economic, social and environmental benefits outweigh this. With the numerical results of the analysis, reasoned decisions can be made that yield positive results for both the environment and the community.

Comment: in 2022, a review and draft update of the “Program of measures to reduce water pollution by nitrates from agricultural sources and prevent further pollution” was commissioned by the Ministry of Infrastructure. One of the integral elements of the study was a cost-benefit analysis performed by the company’s experts Actia Forum Sp. z o.o. based in Gdynia.

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Source:

“Guide to Cost-Benefit Analysis of Investment Projects; Economic appraisal tool for Cohesion Policy 2014-2020,” issued in December 2014. by the European Commission (“CBA Guide”)

“Economic Appraisal Vademecum 2021-2027; General Principles and Sector Applications,” released in 2021. by the European Commission (“Vademecum CBA”)

“Baltic Sea Action Plan (BSAP). 2021 update”, Helcom, 10.2021 and “Worth it: Benefits outweigh costs in reducing eutrophication in the Baltic; BalticSTERN Summary Report for HELCOM 2013 Ministerial Meeting”, K. Hyytiäinen, B. Hasler, S. Ericsdotter, M. Nekoro, K. Blyh, J. Artell, L. Ahlvik, H. Ahtiainen (“Helcom study”).