Analysis of Sectoral Water Demands and Optimal Water Allocation in the Middle Olifants Sub-Basin of South Africa: The Case of Mining and Irrigation

This study aims to investigate optimal water allocations and possible benefit gains from water trade and to identify respective efficient water prices. As South Africa is one of the many countries in the world experiencing water shortages, this research focuses on an extremely water scarce region in the north east of the country; the Middle Olifants sub-basin. The research area is characterized by inelastic water supply, increasing competition between users for scarce water resources and a poor water demand management, leading to an imbalance of water supply and demand. The South African government tries to overcome the problem and to increase social welfare by developing an integrated water resources management and improving water use efficiencies. This requires knowledge on current water demands and water values, price elasticities of water demand, possible impacts of different market allocation mechanisms as well as necessary economic instruments and institutional and political conditions. Accordingly, this study seeks to estimate water demands of the two production sectors irrigating agriculture and mining. Primary data on quantities and expenditures of production factors and information on yields are used to model water demands. Water demand in the mining sector is estimated with econometric methods using time series data. A seemingly unrelated regression (SUR) procedure is applied to estimate cost functions for the five mines analyzed and water price elasticities and water demand functions are calculated. Calculated water own price elasticities vary from -0.77 to -0.95 and together with cross price elasticities they show, that there is potential to influence water use patterns. Using the estimated cost functions, water demands can be derived by varying the water price holding all other inputs and output constant. In the agricultural sector water price/quantity schedules are simulated with an optimization model in GAMS, maximizing farm profits with varying water prices. Demand functions are obtained by fitting regression equations and point water price elasticities are calculated. At current water prices of 0.07 Rand/m3 elasticities are with around -0.2 far below unity implying that, in the agricultural sector rather institutional measurements than water pricing must be applied as a solution to water scarcity. The determined inverse water demand functions of the two sectors together with water supply figures represent the basic elements in the water allocation model, where benefits from water use are maximized. Three different scenarios are compared under two political settings. The first setting allows water use to remain with current quantities, and to exceed its sustainable use, whereas the second setting considers basic human as well as ecological needs to be given priority, which decreases available water supply for mines and farmers. The three scenarios modeled include (1) the status quo situation, (2) intraregional trade and (3) interregional trade. In the status quo situation water demands are fixed to current consumption levels and according benefits from water use are determined. In the second scenario, where trade between agriculture and mining is only allowed within catchments but not within the whole study area, new water use quantities with new equilibrium prices arise. By allocating water from low-value uses to high-value uses benefits are maximized and efficiencies of water use are improved. In the third scenario trade is allowed between all catchments in the study area, leading to one equilibrium price in the whole region of 0.084 and 1.819 respectively depending on water supply levels, dictated by the respective political condition. Compared to the second scenario where only intraregional trade is allowed, benefits from water use are further increasing through reallocation of water to the optimal allocation levels. Model results give necessary insights to sectoral water demands and economic aspects in the study area, and they can be of support in the decision-making of appropriate policies.