Answer

Environmental Valuation Approaches and Contribution to Decisions on Projects

Introduction

Over the past decade, there has been a renewed interest in the topic of sustainability. This particular concept concerns the wiliness of firms to achieve the triple bottom line of balancing the planet, profits, and people (Silvius et al. 2017). As part of pursuing sustainability, the concept of environmental valuation has received increasing attention from both environmentalists and business leaders. As much as sustainability is acknowledged, it is very hard for firms to accurately determine the contribution margin of being a sustainable enterprise. For this reason, there is a need to evaluate environmental valuation approaches to establish the best strategies for valuing sustainability. Bateman and Turner (2015) insist that environmental valuation is a different concept from the environmental evaluation. The former is the strategic process where firms allocate monetary value on environmental services and goods, many of which lack observable or straight forward market prices. Examples of environmental goods and services include biodiversity, scenic views, and mountain vistas. In addition, the term could refer to ecosystem conservation, preservation of genetic materials, carbon sequestration, erosion control, and maintenance of watersheds. To come up with estimated values of these environmental goods and services, finance and economic experts have derived various valuation approaches and techniques.

A broad classification of these approaches includes those based on changes in productivity or production such as changes in forestry, human health, fisheries, and agricultural land over time. Second, some techniques use information and data collected from surveys to estimate values. These techniques are known as contingency valuation methods (CVM) (Mondal, 2020). The third group of approaches is known as revealed preference techniques that value hedonic market using land value methodologies and property value methodologies. The fourth technique is surrogate market approaches; namely, the travel cost method. All these techniques have been improved over the years through continuous application and improvements, making them more robust. Other methods include contingency valuation which is a survey-based technique for environmental valuing that depicts the willingness for consumers to incur an additional cost to obtain an environmental good or services. The additional money paid is believed to be the customer’s contribution to an improved environment. Oerlemans, Chan, and Volschenk (2016) add that the environmental valuation process can be categorized as intrinsic or instrumental. Instrumental value denotes the value derived by the end-user of a product while the intrinsic value is the inherent worth of a good or service. Moreover, environmental valuation often considers indirect and direct use-value. Harrison et al. (2018) define direct use value as the importance or significance of a product experienced through self-consumption of resources, while indirect use-value is the benefit derived by third parties such as ecological benefits realized when using renewable energy sources.

All these approaches are essential in establishing the value of projects and thus helps in guiding decisions on whether they should be pursued or discontinued. It is upon this backdrop that this essay critically reflects on the diverse environmental valuation approaches and the extent to which they contribute to decisions on whether a project should go be pursued. The essay incorporates examples of environmental impacts of new renewable energy projects and railway projects to demonstrate how these approaches can be adopted and how the challenges that come with their adoption can be addressed.

Methods of Environmental Valuation

There are three main approaches to environmental valuation. They include expressed preference methods, revealed preference methods, and preventive expenditure method.

1. Expressed preference approaches

An environmental valuation can be done by measuring the demand for environmental goods and services. The resulting figures show the willingness of consumers to prefer environmental goods compared to other non-environmental goods and services (Mondal, 2020). There are various techniques under the expressed preference approaches. These techniques work by estimating the value attached to environmental goods by individual consumers and households. Furthermore, the expressed preference methods explicitly ask individual consumers questions to establish the extent to which they value environmental goods. For instance, consumers could be asked whether they prefer renewable to non-renewable energy sources. The answers given will help in computing the environmental value they attach to green and sustainable energy sources (Govindan et al, 2015). The main technique under the expressed preference method is the contingent valuation method (CVM), which encapsulates the trade-off game method, costless-choice method, and Delphi method.

The contingent valuation method (CVM) uses analytical survey techniques to apportion monetary values in hypothetical situations involving goods and services. Most survey-based techniques are classified under the CVM. Li, Gong, Zhang, and Koh (2018) explain that contingent valuation often collects information on the willingness to either accept or pay compensation for increases or decreases in non-marketed goods and services. To achieve this goal, CVM asks customers questions about their willingness to pay for environmental resources. It also seeks information from consumers on the cost of compensation they would willingly accept if such resources were to be shortchanged or deprived. A critical analysis of this model shows that it is most effective and productive when respondents are aware and knowledgeable on environmental goods and services. Such knowledge is important in directing the allocation of value to environmental goods and services. Given the significance of this method in environmental valuation, it is essential to expound on each of its constituent techniques.

The trade-off game method relates to contingent valuation techniques. This method relies on creating a hypothetical market for environmental goods and services. The respondents are involved in a single-bid game where they are asked to give single-bids that are equal to their willingness to either accept or pay compensation for the environmental services or goods described (Li et al. 2018). In a repeating or iterative bid game, the respondents are presented with various bids to determine the price point at which they become indifferent to paying/ receiving the bid or losing/ receiving the environment goods or services. Virine and Trumper (2019) explain that the trade-off game method is an improved version of the bidding game which asks respondents to choose between two or more varied bundles of goods. In this case, each bundle could include a mixed sum of money in addition to varying levels of environmental resources. The choice made by the respondent is an indicator of their willingness to make a monetary tradeoff for an increased level of an environmental service or good (Mondal, 2020). Assuming that no money is involved, then the costless-choice method can be adopted.

The costless choice method refers to a contingent valuation technique where individuals select between various hypothetical bundles of services or goods to determine the implicit value of an environmental good. This method does not consider monetary figures, and as a result, it is most useful in instances involving subsistence production and barter trade (Mondal, 2020). The third method under CVM is the Delphi method. This is a variation of the survey-based techniques where experts are interviewed as opposed to individual consumers and households. The experts are asked to allocate value to services and goods through iterative processes where valuable feedback from the experts is documented between each instance of iteration. Egilmez, Gumus, and Kucukvar (2015) explain that the nature of the Delphi method makes it suitable for valuing instances where esoteric resources are involved. This method is lauded for being a specialized survey technique specifically designed to bypass the isolated and speculative nature of expert opinions. This is because it involves a large sample of experts who are each presented with lists of environmental events and asked to attach probabilities. As much as the accuracy of the forecasts by the experts cannot be predicted with certainty, this method helps make realistic environmental valuations (Mondal, 2020). It could also be useful in determining the environmental value of new renewable energy projects where experts are made to determine the probable value of the project as opposed to non-renewable energy sources.

The second environmental valuation approach, after expressed preference methods, is the revealed preference method. The demand and possible value of environmental goods and services can be revealed by either examining or analyzing purchases of similar and related goods across private markets. The comparison might focus on valuing factor inputs or complementary goods according to the household production function. Johnston et al. (2015) note that there are several revealed preference methods namely property value method, hedonic price method, and travel-cost method.

The travel cost method is defined as a surrogate market approach to environmental valuation that uses information on travel costs and time to derive demand curves that are used to make estimations of the value of a particular project (Mondal, 2020). This method is preferred in recreational projects. However, it can also be applied in renewable energy projects and railway projects to estimate the consumer value or surplus of the project to its users. Ruckelshaus et al. (2015) maintain that the travel cost method is preferred when making cost and value estimates derived from public transport systems and recreational projects such as public parks. When used in the railway project, the travel cost method will help to estimate the demand for the services. It does this by determining the number of users within a given period. The figure collected is then used against variables such as the income of the passengers, pricing of the services, and other socio-economic factors (Laird & Venables, 2017). The price of using the railway transport is the travel cost incurred by the user of the service within the period under evaluation.

The information is then used to generate a consumer surplus demand curve. This information provides rough estimates of the possible environmental value of the railway project. Carroll et al. (2019) clarify that for effective application of the travel cost method, the researcher has to introduce a forecasting technique. The Clawson-Knetsch-Hoteling method is classified as one of the most common and effective forecasting techniques. The technique is mostly used to estimate benefits in public transport and recreation sectors using the cost-benefit analysis. Specific to the public railway project, the travel cost method collects information on costs of traveling via trains and all the other means of transport using the railway network. The information is then used to generate a demand curve. According to Pérez, Carrillo, and Montoya-Torres (2015), railway transport tends to satisfy the individual needs of users ranging from psychological, social, and physical needs. It is usually a kind of package that involves anticipation, the actual travel, the experience, and recollection. This computation is summarized in figure 1 below. The image details a scenario that assumes that there is a single railway system in a city, where the travel costs are fixed per visit. Initially, demand for the services is shown using demand curve BDo while levels of environmental quality are shown as Eo.

Figure 1: Demand Curve for Railway Services (Mondal, 2020)

Assuming that the railway system is improved through the introduction of more environmentally friendly and sustainable mediums of transport, then the demand curve will shift upwards as AD1 while the level of environmental quality will shift to E1. The resultant effect will trigger an increase in the number of travels to PK (Mondal, 2020). At this point, the gain, in terms of surplus consumers, is shown using the area PAK. In this case, the net gain in consumer’s surplus after the introduction of sustainable railway services and subsequent improvement in environmental quality is computed using the formula below

PAK – PBC = ABCK.

From this formula, the figure derived at ABCK is the environmental value for the railway project. To this end, it is notable that the travel cost approach analyzes the pattern of use of railway services before and after sustainability measures are introduced (Silvius et al. 2017). As much as this method is useful in computing the environmental value of projects, it has been criticized on various fronts. First, the variation in customer experience, preferences, and tastes could distort the perception of demand. For instance, not everyone who boards a train after the sustainability projects have been introduced is pro-environmental. However, this method assumes that everyone using the train after the introduction of environmental conservation measures is pro-environmental conservation. The second criticism arises from the fact that over demand for the service could force other potential customers to use alternative means of transport (Mondal, 2020). In this case, it becomes elusive to establish the actual value created after the introduction of sustainable railway transport systems.

The second technique under revealed preference methods is the hedonic price technique. This environmental valuation method assumes that the price of a property is equivalent to the stream of anticipated benefits. This method is backed by the hypothesis that the prices charged on services and goods are a reflection of both the non-environmental and environmental characteristics (Mondal, 2020). These implicit prices are, therefore, referred to as hedonic in relation to their environmental attributes. The hedonic price approach seeks to determine the amount of money that the consumers are willing to pay for an improvement in the environmental outcome of a project. This method posits that every good or service creates bundles of attributes or characteristics. Additionally, the method assumes that market goods are intermediate inputs in the production of basic attributes that the customers actually want.

The demand for services such as railway transport is classified as a derived demand since a train offers a means of movement but the process of traveling creates different qualities and quantities of experiences. For instance, a railway passing through beautiful scenery contributes towards the enjoyment of an environmental good. Because of the combined benefits, the price of railway transport is often determined by combining different factors such as the costs incurred in making structural installations of the railway system. Other factors include variable costs such as the cost of energy used to power the train as well as environmental permits and other legal documents and licenses required for operations (Mondal, 2020). In this case, reducing the environmental impact of the railway system could translate into a lower travel cost since sustainable and renewable energy sources are cheaper in the long run.

This explanation is summarized using the hedonic price function below.

Pi = f [S_1i…………S_ki, N_1i ….N_mi, Z_1i………….Z_ni]

Where S denotes structural characteristics of the railway project, for example, the type of trains used, the railway network, and carrying capacity. N refers to the secondary characteristics of the railway project such as accessibility to other mediums of transport, proximity to support services, and the routes selected among others (Mondal, 2020). The function Z assumes that only one environmental variable affects the railway project, and that is air quality. If these attributes correlate linearly, then the function would be summarized as follows.

P_i = [α₀ + α₁S_1i + ….. + α_KS_Ki + β₁N_1i + ……. + β_mN_mi + γ_aZ_a] and y_a > 0.

 Saarikoski et al. (2016) explain that there is a positive relation between air quality (Za) and the price of railway projects or property prices (Rs). As such, an increase in air quality attracts higher project costs. This correlation is evident in figure 2 below.

Figure 2: Air quality v property price (Mondal, 2020)

Figure 3 below justifies that the implicit marginal purchase price of air quality (Za) varies in accordance with the ambient level (Za) before marginal changes.

Figure 3: Implicit marginal purchase price (Mondal, 2020)

The hedonic price method is a well-established approach to environmental valuation. It does this by estimating disaggregated benefits derived from various attributes of goods or services. In the case of the railway project, the attributes are not only structural but also those arising from the experience derived by the service users. Therefore, the hedonic method is preferred when making decisions on railway projects or any project that will have a significant impact on the local ecology and environment (Mondal, 2020). Despite the usefulness of this method, it has been criticized for its inability to value many types of public services and goods, including endangered species, defense, and nation-wise air pollution. Second, the hedonic method is criticized for its ability to compute present value but can hardly give estimates on future improvements made to a project.

The third technique under the revealed preference approach to environmental valuation is the preventive expenditure method. Turra et al. (2017) describe preventive expenditure as a cost-based method of valuing the environment that collects data on actual expenditures made alleviating environmental problems. These include costs arising from mitigation measures taken to repair adversely damaged environments. For instance, if the fossil-fuel-powered trains polluted the air, the preventive expenditure method estimates the cost of cleaning the air to a favorable state. When using this method, Pandeya et al. (2016) explain that finance experts consider the amount of money that individuals are willing to spend to prevent environmental impact or degradation. The mitigating or averting behavior method deduces the monetary value attached to environmental externality by monitoring the costs individuals are prepared to spend to avoid negative environmental effects. For instance, an example is when a person moves to a less polluted location but has to incur additional costs on transportation and spend more time on the road to reach their workplace. Based on this example, the preventive expenditure method assesses the value of non-marketed commodities, namely, cleaner air using the amount of cash an individual is willing to incur for market services and goods to mitigate an adverse environmental externality or avoid a utility loss arising from environmental degradation. The costs could also arise from the anticipated change in behavior to achieve higher environmental quality.

The fourth method of environmental valuation under the revealed preference approach is the property value method. This is a surrogate market approach that allocates monetary values to varying levels of environmental quality (Mondal, 2020). The effectiveness of this approach is determined by the availability of market prices for real estate and the willingness of consumers to incur the cost for improved environmental quality levels.

The third group of environmental valuation approaches is known as cost-based methods. The first of these methods is the opportunity cost method. Bueno, Vassallo, and Cheung (2015) define opportunity cost as the value foregone when a person uses an alternative product or service. This method applies to the railway project since it helps explain how governments make decisions on compensation payments for property and land acquired from private owners for public projects. The opportunity cost method is best used in scenarios where there are difficulties in enumerating the benefits of environmental change. For instance, as opposed to comparing the benefits of alternatives of environmental conservation schemes, financial experts might opt to use the opportunity cost method to enumerate opportunity costs associated with foregone development arising from each of the listed schemes. The experts can then select the option with the lowest possible opportunity cost.

Another method under the cost-based approach is the relocation cost method. This method is adopted to facilitate the estimation of the monetary value resulting from environmental damages. It assesses the potential costs involved in the relocation of a physical facility that could otherwise be damaged by negative changes in environmental quality. This method uses data from potential expenditures. Besides the relocation cost method, there is the replacement cost method which measures potential expenses required to restore or replace productive assets that would, if not be damaged by some project development (Jacobs et al. 2016). These costs are then compared to the total costs incurred in preventing the actual damage from occurring. If the financial expert realizes that it would be less costly to replace an environmental resource after it’s impaired at a future date, then key decisions have to be made. Similarly, the differences in the costs hint at the environmental value of the good or service.

The extent of Contribution to Decision Making on Project Progress

The essence of environmental valuation is to determine the willingness of individuals to pay more to achieve the desired level of services or goods for higher levels of environmental quality. In line with this description of environmental valuation, Meredith, Shafer, and Mantel (2017) note that project managers need to understand the need for such valuations. According to these authors, valuations are important in avoiding environmental litigations. For instance, non-market demand valuation can be used by government officials and project managers to assess the damage caused by a project and thus, assess the amount of compensation to be incurred. The information could equally be used by the government officials in formulating better environmental policies. In the case of project decisions, it is certain that if the environmental litigation costs will be costly to the business, then the project has to be forfeited. On the other hand, if the project has a highly anticipated environmental value, then the project will be commissioned to progress until completion. This is the case with the railway project, whereby if the valuations indicate major damage to the environment, then the project will be foregone, but if the valuation presents a favorable result, the project will progress to completion.

The second need for environmental valuation is to resolve environment-related disputes. Environmental disputes are likely to arise when planning how to lay the railway networks especially when it is meant to pass through conserved regions such as forests, and national parks. Such projects will certainly attract opposition from environmental groups. In such a case, the environmental valuation will help determine whether it is worth pursuing the project as planned. This is because the environmentalists will sue the project managers, and if the costs to be incurred are higher or unmanageable, the project manager will have to discontinue the plan. Additionally, environmental valuation is important in evaluating proposed environmental programs. Jacobs et al. (2016) explain that railway projects have to be accompanied by complementary environmental programs to neutralize the carbon footprint created by the project. In this case, the public cost-benefit framework can be used to assess the value and desirability of the railway project. Some of the measures could be increasing forestation to offset the carbon resulting from the project. Other measures could be proposals to install green sources of energy along the railways to enable the new systems to use renewable energy sources. The findings, made through the environmental valuation, are, therefore, important in making decisions on the continuation of a project. Le Navrud and Pruckner (2017) develop further on this discussion noting that traditionally, environmental valuation serves five primary purposes when making project decisions. These uses are project evaluation, regulatory review, natural resource damage assessment (NRDA), environmental costing, and environmental accounting.

Concerning project valuation, environmental valuation methods enable project managers to estimate the cost of intangibles more consistently and systematically. The progress of the project is thus guided by the findings made during the project evaluation stage. Another area that touches on decisions on whether a project should go ahead is regulatory reviews (Posner, McKenzie & Ricketts, 2016). The environmental valuations using the cost-benefit analysis method weight the costs of regulation and those of environmental conservation. Projects that cause massive environmental damage are more likely to attract strict regulations from the government. In such a case, the findings made when valuing the environment are important when deciding whether to progress or halt a project depending on whether the regulatory costs will be higher. Third, Mayer (2018) notes that natural resource damage assessment (NRDA) could inform financial experts and project managers on the anticipated damage of a project thus guiding decisions on whether or not to progress with a project. Haab, Lewis, and Whitehead (2020) introduce the concept of natural resource damage liability, which focuses on natural assets and how injury on the natural environment influences the environmental value of a project.

Conclusion

This essay identified environmental valuation approaches and explores how they impact decision making by project managers. Three main environmental valuation approaches identified include the expressed preference methods, revealed preference methods, and cost-based methods. Under these approaches, there are various valuation techniques and models. For example, the expressed preference methods have contingent valuation method, trade-off game method, Delphi method, and costless choice method. Under the revealed preference methods, there is the travel cost method, hedonic price method, surrogate markets, property value method, and preventive expenditure method. Cost-based methods include opportunity cost methods, relocation cost method, and replacement cost method. These valuation methods, techniques, and approaches guide decisions on project management by providing information useful in environmental litigation, environmental dispute resolution, environmental regulation, and evaluating environmental programs. Other uses of the valuation information and data include project evaluation, regulatory review, NRDA, environmental costing, and environmental accounting.