Last month we learned about economic instruments for conservation, specifically payments for ecosystems services (PES). This post is going to take an in-depth look at one payment for ecosystems services program currently being implemented throughout the globe to protect watersheds: the Nature Conservancy’s water funds.
The water funds, referred to by the Nature Conservancy’s CEO Mark Tercek as a ‘triple win’, are a classic PES program wherein downstream water users, often public utilities or beverage companies, pay for the maintenance of healthy ecosystems upstream. By paying for better land-use practices upstream to prevent water quality degradation and erosion, companies are able to avoid the costs associated with treating sediment and contaminant laden water. In Tercek’s words, “Companies save money by preempting the need for more costly water treatment activities. Water resources are kept healthy and flowing for local communities. And natural systems are protected to provide good livelihoods for local communities, habitat for wildlife and to deliver clean water.”
The first project was launched in 2000 in Quito, Ecuador. Investors like breweries, soft drink companies, and water utilities invested in upstream conservation, successfully negating the need for an expensive water treatment plant. Since then, the Nature Conservancy (TNC) has successfully developed 28 water funds globally and has 40 more in development, all working to provide better water quality or water availability to users within their watershed by funding activities such as riparian restoration, reforestation, land management best practices, and wetlands restoration.
To get a better understanding of this innovative approach to watershed conservation, I sat down with Hugo Contreras, TNC’s Water Security Director for Latin America, to discuss water funds and the ramifications of their success for water management in Latin America.
First of all, can you introduce yourself?
Contreras: My name is Hugo Contreras, and I’m Water Security Director for the Nature Conservancy in Latin America. I have a background in water, I’ve been working in water for more than 15 years at a private company called Bal Ondeo which is part of Suez Group, and I’m an economist by training, with a Masters in Environmental and Natural Resource Economics. I also worked for the government and private consultants before my tenure at TNC.
As Water Security Director for Latin America, what is your role with the Nature Conservancy’s water funds?
Contreras: Our strategy for water security in the Nature Conservancy is really focused on protecting cities – to protect their water source and watersheds with nature-based solutions. We’re exploring opportunities to use nature-based solutions to protect groundwater, aquifers and the like. And more and more we’re working to try to bring nature-based solutions into the urban areas: parks, buffers, bringing more green into the city. The hypothesis behind the program is that a combination of green and grey-based infrastructure is going to be superior to only applying nature-based or grey independently. The vehicle that we've designed to implement these programs are the water funds. They are these governance and financial instruments that allow water users to put resources towards nature-based solutions and increase the capacity to influence policy design through the use of science.
We’ve focused on this strategy now, and with the support of the Inter-American Development Bank [IDB] and the FEMSA Foundation, we created a platform called the Water Funds Partnership. The Partnership has the objective of identifying, creating and strengthening water funds throughout Latin America. So far we have more than 20 funds that have been created in different phases of development.
Can you explain the basic finance model for a water fund? I know it probably varies from project to project and numbers of investors?
Contreras: The financial rationale behind the water fund is similar to a start-up enterprise. First, you identify the challenge. You invest some resources to investigate if that challenge is worth looking at and if we have something to say through nature-based solutions. That [feasibility study] is funded through The Partnership.
We then develop a basis for a case, which we present to local stakeholders, whose vision is very linked to water security. It does certainly bring in private stakeholders, but many times its public stakeholders. With that support we develop a strategic plan for the long run.
You have an initial investment for the feasibility study, then you grow and you invest more or less 5 times what you invested in the feasibility study for the design phase. With that business case you start convincing investors to invest maybe 10 times what you invested in the design phase, and you start operating.
And there comes the acid test of water funds, because you may have the resources or the feasibility to do the design and run some pilot projects, but the question is, how are you going to be sustainable over the long run? The fundamental hypothesis behind [the funds] is that private resources are going to leverage public resources – we’re going to make a policy case and business case that investing public resources into these funds is a good investment for the cities.
So the investors get the benefit of the cleaner water, etc. but they also get a dividend every so often? They also get paid out?
Contreras: No, so far it has not been an investment, it’s not, say, a cash investment in terms of the return. You put cash in but you don’t get cash out. You get the quality. Why is that important? How can that be monetized?
Take, for example, if you were a utility, for example Empresas Publicas de Medellin in Medellin. They’re very concerned about the quality of the water they intake from their reservoirs. And the quality is being effected by agricultural practices surrounding the reservoirs. The more sediments arrive into their reservoir the higher the costs are going to be for the utility. So they invest in preventing the sediments from arriving. So they don’t get cash back, but they don’t need to spend money to remove sediments anymore, so for them it’s very direct.
For private companies who don’t use the water like a utility, like a beverage company or a cement company, they get different things: one, they are investing in making sure they will have water in the long run; two, they are investing in their reputation, and there’s a social license to operate, certainly. They want to become good citizens, in a way that aligns clearly with their business.
It’s an interesting question and challenge because, in the long run, we do believe there is an opportunity to make returns. There is a neat example in Oregon. There’s a commercial company, a pulp and paper company, and they’ve created a couple of investment funds to buy plantations. Their business is to improve the efficiency of the plantations, that’s their goal. They’re competitive at that and they get competitive returns by doing that. But then they realized that they provide additional benefits by doing good management of their plantations, so they commercialized their benefits.
What benefits did they commercialize? Their sediment retention. The U.S. has a program that actually pays companies to provide sediment retention, so they get access to public funds for retaining the sediments. They also went to the city of Portland and said, “Look, you get a lot of ash when wildfires occur, and that increases your cost of water treatment. What if you didn’t get that ash because we control the fires in this area?” They make good money on their core business, but they make extraordinary profits by adding some additional benefits to their model through sustainable management.
So, the structure of these water funds varies from place to place. Because you have a different population that’s being served, different investors, in the upper watershed [you have] different land use and land ownership regimes. Can you talk a little bit about how these different variables facilitate or hurt the success of a project?
Contreras: As you know, we’ve been trying to operate and create water funds since the experience in Quito early in 2000. My take is, between 2001 and 2011 when we started the partnership, were trying to understand the model and see how we could replicate it. We were creating funds that were very different. We only thought we need to protect the sources of water and that’s the end goal, so we were not very good at understanding the structure that the fund would have to have.
When we started The Partnership in 2011, we grew the number of funds, because we had a high capacity to invest. But again, we were creating funds that were not systematic in their approach, they were similar but not systematically similar. We understood that if we wanted to scale the solution to many cities in Latin America and the world, we needed to have a more systematic approach.
We’ve been working on refining the methodology, what we call now the ‘desired state’, which is the methodology of five phases of the water funds, but with a franchise-model mind-set in defining the processes. As you say, all cities have different issues, they face different challenges, or a mix of different challenges, but they analytical framework we use to approach the challenges and find the solutions is now very, very similar. Eventually we want to see funds that you immediately identify and say, yes, that’s a fund, and it’s a fund generated by The Partnership, because that’s a fund that follows certain guidelines – that produces results, that produces reports, that generates information, and that can be, in a way, easily accountable for the results.
Do you ever run into resistance from private landowners when implementing a water fund, [resistance to] implementing those best practices? Or are they usually pretty cooperative?
Contreras: No, you always find, if not resistance as such (in some places there might be), but hesitancy, skepticism. Because payments for ecosystem services programs only work and only generate an impact if they’re carried over the long-run because you’re acting in the margin. And your benefits are higher than the benefits to the landowners. So for them it’s relatively cheap to just withdraw from the program if you fail to fulfill your commitment.
The question in the communities is, ‘Are you going to be here in five years or is this just one shot. Am I going to do all this and you’re going to leave in two years?’ And I think that’s the biggest challenge. How do we ensure that we’re going to be there for the long run, that the big investments are made upfront but the families get a return that is quantifiable and that they value? I think that’s a big challenge in all payment for ecosystem services programs.
So how do you determine what that amount is [that you pay to landowners]?
Contreras: I don’t think we have a systematic approach to that. I would like to say that we do, that we have a very nice econometric model that accounts for all these values. But its experience and competition, and competition in the sense of, what is the trade-off for the land owner and what is the trade-off for the investors. We could come up with quantities that are marginal – we don’t want to overpay, we don’t want to underpay. It’s more of an art, a craft, than an analysis. But it would be fantastic if we were to understand more systematically what those values are.
I want to move to Mexico specifically now. The biggest water fund in Mexico is in Monterrey, an industrial city that has a lot of flood risk and drought susceptibility. The fund has been in the monitoring stage for 4 years now. Have you seen positive results coming out of Monterrey or is it still too early to tell?
Contreras: I think it’s still too early to tell. You’re right, the fund was created about four years ago. It’s had a very nice reception from the investors, and for now they have enough money. In the last 18 months they’ve been investing in projects on the ground. They bought a piece of land, I think a 2,000 hectare piece of land, and they’ve been doing conservation projects – I would say on the order of 3 million dollars – so it’s picking up momentum. They have a plan. If they continue with the plan, they will have an impact.
It’s early to tell because it hasn’t really gone to scale, and then you need to test it. Hopefully you have enough time to build your capacities, your natural assets before you need to test it. That means when the hurricane comes. Then that poses another challenge – how do you communicate the value when it’s like an insurance policy? You invest in nature, it looks very nice, people are happy, they like to plant trees, that’s fantastic. Now, why should I continue investing? What am I buying?
We also should underscore the relevance of the fund as a governance instrument. Now the fund has become an important stakeholder in water management in the state. The way I like to put it is, we are trying to sit at the table of the guys discussing big water issues. And we come from the back door of nature-based solutions – the big discussion is not at our table, it’s not at the environmental table. It’s at the water management table and the finance table, and that’s a table we’re slowly moving into. The water fund in Monterrey has proven to be particularly successful at moving into that space, so they’ve been asked and mandated by the government to produce a long term management plan for the state. Which is something very nice. I mean, it’s not just nature-based solutions, it will be a small part of their portfolio of activities, but the important thing is that it will be there. If you were to think of the IDB water portfolio, there’s about a billion dollars per year in loans just for the water sector. If we could only tap 10 percent of that and direct it towards nature-based solutions combined with a big portfolio, it would have a significant impact.
We have to talk to the water agency and convince them and the water stakeholders that using nature-based solutions is a good thing, so that when they draw up their big plans they say, ‘Ok, these are my dams, these are my conservation areas, these are my buffers, these are my wetlands,’ and that’s part of the plan. Then they go to IDB and say I need 100 million dollars to finance this package. That’s a game changer.
There’s also a water fund currently in development for the Central Valley, can you talk a little bit about what that’s going to look like, what protections it will provide, who’s contributing, who’s receiving those payments?
Contreras: The Mexico City Water Fund, Por El Agua it’s called, was officially and legally created several months ago. It has gathered a nice set of initial investors which have put important amounts of money into the fund. They’ve done the feasibility and they're doing the strategic plan. One of the things they are focusing on is that they believe that the fund should contribute to the following things:
Narrow information gaps. The city and the citizens perhaps don’t have enough quality information and analysis of that information to make decisions. So they believe the fund has a role to play in reducing those information gaps.
A second is raising awareness about the problem. Whenever there’s a rainy year, we complain about the rain and we don’t worry about the water. And we generally don’t worry unless you don’t get water in your house, but that’s about 10 percent of the population.
Another important part is protecting the sources of water. The fund is focusing initially in the southern mountain range of Mexico City because 50% of the water that rains and eventually infiltrates into the aquifer, actually rains up there. So it’s critical that we manage to preserve that area and manage to preserve the ecosystem functions that it produces.
The last is improving governance. What happens in this city is that there’s no accountability. Nobody is really accountable to anyone. The relevant stakeholders at the state level are accountable to different principals and those principals don’t talk to each other. So the national water commission [CONAGUA] which is responsible for the Cutzamala system, is accountable to the president but not to the mayor, nor to any of the governors of the four states that are in the valley. And the general manager of the water utility in Mexico City is accountable to the Mayor, but not to CONAGUA or to the mayors of the other municipalities surrounding the city, so there’s no accountability and there are no checks and balances. There’s also no regulatory system, so no one is actually regulating – not the water utility of Mexico City or any of the other 50 utilities that operate in the valley. It’s an institutional design failure, so the fund thinks it has an opportunity there.
Lastly, we know that climate change is likely to cause more intense storm events and more severe droughts in Mexico. What role do you anticipate water funds playing to mitigate these water management challenges? Do you think they can become ubiquitous, everyone can have a water fund?
Contreras: When the water fund approached the resilience office in Mexico City, they immediately adopted the fund as one of the pillars in the resiliency strategy of Mexico City. So it’s already there. People are receptive because we are, more and more, understanding that nature is one of the most important investments to mitigate and adapt to what’s coming with climate change. Take Monterrey. If we do things right and we use nature and we understand that climate change is going to bring perhaps less frequent hurricanes but stronger hurricanes, then we need to buy an insurance policy. Nature is an insurance policy. If you think that Mexico City is going to have droughts, longer droughts, but at the same time it’s going to concentrate all its rain in a couple of weeks, then you need a way to absorb that water, not take it out of the city. And nature again, it’s your insurance policy. Take Central America, one of the reasons why Central America is often so devastated by hurricanes is that they have very bad land degradation. That is why damages are so bad – they don’t have anything to defend them from these heavy rains.
How much will [water funds] contribute? I think that remains to be seen. We certainly believe that nature has a positive contribution. If we’re living in a perfect world where authorities were doing their jobs and institutions and regulatory frameworks were well designed, you wouldn’t need water funds. Because water funds are filling a policy and regulatory gap. Take for example in France, you have the water basin authorities. They do their job fine, they don’t need a water fund. But we do in Latin American and many parts of the developing world.
Has there been any movement to development a program at CONAGUA using water funds?
Contreras: I think they’re more open now to include nature-based solutions and actually, I talked to the general manager of the Organismo de Cuenca which is the basin organization for Cutzamala, and one of their strategy pillars is protecting nature. He doesn’t have a clear idea of how he’ll do it, but it’s there. Perhaps our opportunity, our task, is to convey the value with business cases showing that there’s value there.
This interview has been edited for brevity and clarity.