Annex D. Natural Resource Damage Assessment (NRDA) using equivalency analysis

This annex provides more details on equivalency analysis that support the NRDA. This process emphasises use of remediation measures following damage to the environment. These measures offset the loss of natural resources and the provided services rather than merely seeking to collect monetary damages from the polluter.

In OECD member countries, where a polluter’s activities have caused damage to the environment, the polluter may be required to: i) remediate the environment; and ii) compensate the public for the natural resources/services lost during the period in which the environment was impaired.

This compensation is resource- or service-based, not monetary. Competent authorities use an approach termed “equivalency analysis” to determine: i) the type and amount of natural resources and services that are lost over time as a result of the damage; and ii) the type and amount of complementary and compensatory remediation actions needed to offset that loss.

Equivalency analysis and the ELD

Annex II of the ELD states that resource-to-resource or service-to-service equivalence approaches should be considered first to determine the scale of complementary and compensatory measures to remediate damaged water or protected species or natural habitats (importantly, not land).1 If their use is not possible, alternative valuation techniques are to be used (e.g. monetary valuation).2 Should monetary valuation techniques be needed, the ELD prefers value-to-value over value-to-cost approaches.3 The competent authorities are permitted to prescribe the method to be used.4 Competent authorities thus have significant discretion to determine the approach.

Key steps in conducting an equivalency analysis

In general, conducting any type of equivalency analysis will entail five fundamental steps (see Figure A D.1).

Figure A D.1. Examples of environmental liabilities and damages

Equivalency analysis: Methods

There are three main methods of equivalency analysis: service-to-service, resource-to-resource and value equivalency. These methods are analysed after the definition of core terms:5

Debit: an expression of the quantity of loss suffered as a result of the environmental damage; it may be multi-dimensional as the damage may have negative effects on a number of different species, habitats, ecosystem functions and human values.
Credit: an expression of the natural resource or service benefit gained through complementary and compensatory remediation.
Metric(s): one or more measurements of loss, usually determined in close consultation with relevant environmental scientists, which serve as indices of keystone natural resources or services subject to damage. The same metric must be used to express the total damage (debit) and the benefit of remediation (credit).
Scaling: the process whereby the expected amount of benefit (i.e. credit) generated from the remediation is made to equal the debit, when quantified in terms of the same metric.6
Discounting: the use of a discount rate (e.g. 3%). This reflects that, holding all other factors constant, losses from damage and gains from remediation accrue over different periods. Furthermore, it also assumes that services gained from future remediation are less valuable to the public than services available today (Chapman and LeJeune, 2007[3]). It permits gains and losses to be reflected in their present day value.

Service-to-service

With this method, also known as Habitat Equivalency Analysis (HEA), losses are expressed in terms of habitat and are offset by remediation of similar habitat (Lipton et al., 2018[4]). It assumes that equivalent habitats will provide equivalent services. In this way, the provision of acres of additional habitat can compensate for years of lost services.7 This particular form of equivalency analysis is intended for use when the service losses arising from the pollution incident are primarily ecological and not direct human use (e.g. recreation) (Desvousges et al., 2018[5]). Services to ecosystems and other ecological resources include habitat for food, shelter, and reproduction; organic carbon and nutrient transfer through the food web; biodiversity and maintenance of the gene pool; and food web and community structure (Chapman and LeJeune, 2007[3]). In HEA, the basic unit of measurement is, typically, a discounted-service-acre-year (DSAY). This represents the value of all of the ecosystem services provided by one acre of the habitat in one year.8 Once calculated, remediation measures are selected that would adequately offset these DSAYs in the form of acres of remediated habitat.9

Resource-to-resource

This method, also known as Resource Equivalency Analysis (REA), is fundamentally the same as HEA. However, crucially, the units of quantification differ with losses being expressed in terms of resource units (e.g. numbers of fish or birds) rather than habitat (Lipton et al., 2018[4]). The method tries to match the actual lost resources with new ones. For this to work, it is essential to determine precisely which organisms are lost from a particular impact and which are gained by remediation (OECD, 2012[6]). The method may be more appropriate than the service-to-service approach where the pollution incident has had a significant effect on particular animals or plant populations (OECD, 2012[6]). Desvouges et al. (2018[5]) observe that, in practice, REA is less frequently used as a scaling technique in damage assessments than HEA.

Value equivalency

As the underlying premise of techniques in this category, damage to natural resources and the services they provide can be measured in monetary terms and compensated through provision of physical resources and services (Lipton et al., 2018[4]). Under the value-to-cost version, the monetary assessment of the damage ensuing from the incident is set as the budget for remediation, the benefits of which are not estimated directly (European Commission, 2013[2]). Under the value-to-value version, both the value of damage and the benefits from remediation are measured in monetary terms (European Commission, 2013[2]). Although compensation may be measured (or scaled) in monetary terms, compensation under the ELD can only be provided in resource-based units, not money (Chapman, Scott and Özdemiroğlu, 2018[7]). This is where the ELD and other frameworks of environmental liability differ from the “indirect” method of assessment in Kazakhstan.

In value equivalency, monetary values are based on individuals’ preferences for given changes in the quality and/or quantity of resources of service (Chapman, Scott and Özdemiroğlu, 2018[7]). There are two means of measuring preference: i) individuals’ willingness to pay money (WTP) to avoid an environmental loss or to secure a gain; or ii) their willingness to accept money as compensation (WTAC) to tolerate an environmental loss or to forgo a gain (Chapman, Scott and Özdemiroğlu, 2018[7]). Environmental values that depend upon people’s actual use of the environment are referred to as use values. Those that derive from people’s contentment from knowing that environmental resources are preserved even if they do not directly use or interact with them, or never will, are referred to as non-use or existence values (Hanley, 2002[8]). Reductions and gains in use and non-use values will be included in the debit and credit estimates in equivalency analysis conducted in relation to environmental damage arising under the ELD (Chapman, Scott and Özdemiroğlu, 2018[7]). As these types of values are often not priced in the market, two broad techniques have emerged that help determine appropriate monetary values for the equivalency analysis:

Revealed preference techniques

These techniques use information about people’s actual behaviour in markets related to the resources of services being valued to estimate value (Chapman, Scott and Özdemiroğlu, 2018[7]). There are two main methods:

Travel cost: this method estimates economic values associated with ecosystems or sites that are used for recreation by assuming the value of the site is reflected in how much people are willing to pay to travel to visit it (OECD, 2012[6]). Such costs include: transport, accommodation, food and drink, and recreational activity (Chapman, Scott and Özdemiroğlu, 2018[7]). This is then used as a proxy for a market price. Thus, for instance, individuals’ WTP to visit the site can be estimated based on the number of trips made at different travel costs.
Hedonic analysis: this method is used to estimate economic values for environmental services that directly affect market prices, such as housing prices (OECD, 2012[6]). This technique reflects the understanding that the value for a good can be divided into component parts (Chapman and LeJeune, 2007[3]). For example, all else held equal, a home near a polluted site will cost less than one far away from it. The difference in housing price reflects an estimate of the loss in value flowing from the pollution (OECD, 2012[6]). This loss in value could then be expressed as the value that a remediation action must create to compensate the public for the pollution (Chapman and LeJeune, 2007[3]).

Stated preference techniques

Stated preference methods use questionnaires to elicit the respondents’ WTP for the provision/conservation of a given environmental asset directly or WTAC for the loss of an environmental asset (OECD, 2012[6]). Hypothetical markets are presented to a representative sample of the population affected by these changes (Martin-Ortega, Brouwer and Aiking, 2011[9]). Answers reflect intentions rather than actual behaviour. There are two main survey-based methods for the valuation of non-market resources (Chapman and LeJeune, 2007[3]):

Contingent valuation method (CVM): individuals are questioned directly about how they value the prevention of a specific environmental damage and the implementation of proposed restoration projects.
Conjoint Analysis: individuals are questioned about how they value the prevention of a specific environmental damage and the implementation of proposed restoration projects but they are given more choices that CVM.

Equivalency methods: Strengths and weaknesses

The following section sets out the strengths and weaknesses associated with different methods of equivalency methods discussed above. Since service-to-service and resource-to-resource approaches are conceptually similar (Lipton et al., 2018[4]), they are analysed to together.

Service-to-service (or HEA)10 and resource-to-resource (or REA) 11

Characteristics

HEA: Habitat equivalency analysis

Losses are expressed in terms of habitat and are offset by remediation of similar habitat. The underlying assumption is that equivalent habitats will provide equivalent services. In this way, the provision of acres of additional habitat can compensate for years of lost service.

REA: Resource equivalency analysis

While fundamentally the same as HEA, the units of quantification differ with losses expressed in terms of resource units (e.g. numbers of fish or birds) rather than habitat.

Strengths

It avoids the need to quantify lost natural resources and services in monetary terms (and the controversy and methodological difficulties associated within this).
It is of greatest use when the service losses are primarily ecological; such losses are difficult to quantify in monetary terms.
It is useful when the services provided by the replacement habitat/resource are ecologically similar to those provided by the natural resources damaged by the pollution incident.
HEA can reflect the variability and complexity of ecosystems in a way in which VEA cannot.
Where the natural resources and services damaged can be identified with ease and remediation through provision of equivalent habitat/resources is possible, HEA/REA is likely to be more effective than VEA in determining with accuracy the appropriate degree of compensatory remediation for service losses.
When a pollution incident has had a significant effect on a particular natural resource (or resources), such as certain animal or plant populations, REA may be best placed among the different equivalency analysis methods to determine appropriate remediation measures.
The risk of a polluter’s liability for remediation costs is derived using HEA/REA is perceived to be easier to absorb for the insurance sector than non-market valuation techniques (e.g. revealed preference). This, it seems, goes to the relative unpredictability of the results produced from revealed preference studies (more on which is said below).

Weaknesses

The methods do not factor in human welfare considerations to the analysis; these may be viewed as important and relevant following damage to the environment from a pollution incident.
The methods assume that the public’s loss of utility can be compensated through provision of equivalent habitat/resources. However, HEA/REA are, arguably, of less value than VEA methods where the service losses are primarily human use/social (e.g. recreational) or such losses comprise a significant portion of total losses.
It may not be appropriate where the services provided by remediation measures are of a different type or quality than those lost following the pollution incident.
It may not be appropriate where the services lost cannot be measured accurately.
It assumes that the public place equal value on the services provided at the site subject to damage and the restored site (where complementary remediation is carried out); this may not be the case owing to certain site-specific considerations (e.g. cultural/ethical).
It cannot capture the fact that social values of a site may be heterogeneous so that particular groups may be perceived to incur higher losses than others.
Neither HEA nor REA allow for changes in preference. They assume the value to society of a given habitat/resource is constant over time. However, there is the argument that increasing development may, for instance, lead to a shortage of certain resources. This, in turn, increases the value of the loss in the future and renders damage more costly today.
It may not be appropriate, where there is difficulty in agreeing to a common metric, to reflect the services damaged by the pollution incident and those gained through remediation.
It is unable to reflect the value of natural resources and services that are irreversibly lost and so non-recoverable following a pollution incident (e.g. endangered species and habitats).
As with all equivalency analysis models, a lack of input data limits the validity of the outputs.

Value equivalency analysis (VEA)

Characteristics

Travel cost and hedonic methods use “revealed preference” information about individuals’ actual behaviour to estimate value.

Contingent valuation method (CVM) and conjoint analysis use “stated preference” methods to estimate value.

Strengths

It provides a means of measuring the monetary value of natural resources that are not traded in economic markets.
It measures the socio-economic value of ecosystem services, something which HEA/REA are unable to do.
It incorporates the social value of the environment into the decision-making process.
Revealed preference techniques are particularly useful where the pollution incident impacts upon recreational activities.
Hedonic pricing is useful for estimating economic values for changes in environmental quality that directly affect market prices e.g. the value of real estate or timber.
Where remediation of the same/similar resources or services is not technically feasible, undesirable or unreasonably expensive, then VEA might provide a better means of scaling remediation than HEA/REA.
Databases can be built to store evidence of economic value that can facilitate quicker and cheaper VEA assessments at a later date. Moreover, they may be considered particularly helpful where primary economic research cannot reasonably be undertaken.
VEA is useful where the scope of environmental damage following a pollution incident is so large that the use of HEA/REA, and important assumptions which underpin their use, are unsupportable.
VEA may be useful where an alternative site benefiting from complementary remediation is located far from the site damaged by the pollution incident.

Weaknesses

VEA reflects an anthropocentric view of nature (i.e. environment possesses value due to its impact on humans), which can be controversial.
The requisite data/level of data may not always be available at a reasonable cost and within a reasonable time.
Services provided by natural resources are extremely difficult to value in monetary terms and, consequently, the results may be controversial and open to legal challenge.
There may be deemed to be a high degree of artificiality in the results produced by VEA given that the method seeks to value goods and services that are not traded in economic markets; they have no objectively verifiable market value.
Results produced by CVM and the travel cost method can be extremely subjective and unpredictable.
Stated preference approaches can be controversial given their foundation on hypothetical intentions rather than actual behaviour.
Relatedly, stated preference approaches are subject to biases and may generate responses which evidence strategic behaviour by the respondents.
VEA does not capture non-anthropocentric values of nature.
VEA cannot capture cultural or ethical values which people attach to the environment. This means that results may not reflect the total value which people place on changes in environmental quality following a pollution incident.
The particular technical choices by the statistician when undertaking estimates of WTP using revealed and stated preference techniques can have significant impacts upon the eventual outcome of the analysis and, consequently, the extent of “compensation” required from the polluter. The fact that different choices may be defensible with no “right” choice may be seen to create a degree of unfairness for polluters.
The level of information provided to survey respondents when using CVM can influence an eventual estimate, leading to important questions as regards the appropriate level of information to be provided.
The production of a robust contingent valuation model takes time (sometimes 12 months) and can be very expensive (USD 1 000 000).
The very idea of WTP and WTAC, when applied ex post to harm that has already been caused to the environment by a pollution incident, may be repugnant to portions of society.
WTP and WTAC measurements for the same pollution incident can differ widely, creating scope for legal argument and the time and cost flowing with this.

Notes

← 1. ELD, Annex II, para 1.2.2

← 2. ELD, Annex II, para 1.2.3.

← 3. ibid.

← 4. ibid.

← 5. The definitions are taken from the ELD Training Handbook, p. 50 (European Commission, 2013[2]).

← 6. Scaling has three broad steps: i) quantification of the total debits caused by the damage; ii) quantification of the credit expected per unit of remediation; and iii) division of the total debit by the unit credit to determine the total amount of credits (i.e. remediation) needed to offset the loss (Lipton et al., 2018[4]).

← 7. U.S. Department of Commerce: National Oceanic and Atmospheric Administration, “Habitat Equivalency Analysis” (Damage Assessment, Remediation, and Restoration Program, undated) https://darrp.noaa.gov/economics/habitat-equivalency-analysis accessed 25 January 2019.

← 8. ibid.

← 9. ibid.

← 10. Also known as Habitat Equivalency Analysis (HEA).

← 11. Also known as Resource Equivalency Analysis (REA).

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