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. F 1D 30SCpF. 1996
DISCUSSION PAPER
Cost Benefit Analysisof Private Sector
Environmental InvestmentsA Case Study of the Kunda
Cement Factory
Yannis Karmokolias
INTERNATIONALFINANCE
CORPORATION
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IFC Discussion Papers
No. I Private Business in Developing Countries: Improved Prospects. Guy P. Pfeffermnann
No. 2 Debt-Equity Swaps an(d Foreign Direct Investment in Latin America. Joel Bergsmanand Wayne Edisis
No. 3 Prospects for the Business Sector in7 Developing Countries. Economilics Departimient, IFC
No. 4 Strengtheninig Healtlh Services in Developing Con ntries through the Private Sector.Charles C. Griffin
No. 5 The Development Conthi bution of IFC Operationis. Ecolnolmlics Departilmelit, IFC
No. 6 Trena's in Private Investment in Thirty Developing Countries. Guy P. Pfeffermannand Andrea Madarassv
No. 7 Automotive Industry Trends anid Prospects for Investment in Developing Countries.Yannis Karmokolias
No. 8 Exparting to Industrial (Countries: Prospects far Businesses in Developinlg Countries.Economics Departmenit, IFC
No. 9 African E ntrepreneuris-Pioneers of Development. Keith Marsden
No. 10 Privatizing Telecommunicationis Systems: Business Oppartunities in Developinzg Countries.William W. Ambrose, Paul R. Heninemeyei-, andjeani-Paul Chapon
No. 11 Trends in Private Inv7yestment inz Develaping Countries, 1990-91 edition. Guy P. Pfeffermannand Andrea Madarassv
No. 12 Financin,g Corporate Growth in the Developing World. Economics Departmiienit, IFC
No. 13 Vlenture Ctpital: Lessonsfrom the Developed Warldfir the Developing Markets. Silvia B. Sagariwvith Gabriela Guiicotti
No. 14 Trends in Private Investment in Developing Countries, 1992 edition. Guy P. Pfeffermannand Andreat Madar-assv
No. 15 Private Sectar Electricity in Developing Countries: Supply anid Demand. Jack D. Glen
No. 16 Trends in Private IntVestment in Developing Countries 1993: Statistics far 1970-91.Guy P. Pfefferimianini and Andci-ea Madarassy
No. 17 Howv Fi-ins in Develoiping Countries Manage Risk. Jack D. Glen
No. 18 Coping With Capitalism: TheANew Polish Enti'preneurs. Bohdan Wyznikiewicz, Brian Pinto,and Maciej Grabowski
No. 19 Intellectual Propert Pr-oteCtion, Foreignt Direct Investment, and Technolog Transfer.Edwin Mansfield
No. 20 Trends in Private Investment in Developing Countries 1994: Statistics far 1970-92. Robert Millerand Mari-isz Sumlinski
(Conttinuted on the inzside back cover.)
INTERNATIONALFINANCECORPORATION
DISCUSSION PAPER NUMBER 30
Cost Benefit Analysis of PrivateSector Environmental
Investments
A Case Study of the Kunda Cement Factory
Yannis Karmokolias
The World BankWashington, D.C.
Copyright ) 1996The World Bank and
International Finance Corporation1818 H Street, N.W.Washington, D.C. 20433, U.S.A.
All rights reservedManufactured in the United States of AmericaFirst printing September 1996
The International Finance Corporation (IFC), an affiliate of the World Bank, promotes the economicdevelopment of its member countries through investment in the private sector. It is the world's largestmultilateral organization providing financial assistance directly in the form of loan and equity to privateenterprises in developing countries.
To present the results of research with the least possible delay, the typescript of this paper has not beenprepared in accordance with the procedures appropriate to formal printed texts, and the IFC and the WorldBank accept no responsibility for errors. The findings, interpretations, and conclusions expressed in thispaper are entirely those of the author and should not be attributed in any manner to the IFC or the WorldBank or to members of their Board of Executive Directors or the countries they represent. The World Bankdoes not guarantee the accuracy of the data included in this publication and accepts no responsibilitywhatsoever for any consequence of their use. Some sources cited in this paper may be informal documentsthat are not readily available.
The material in this publication is copyrighted. Requests for permission to reproduce portions of it should besent to the Office of the Publisher, at the address shown in the copyright notice above. The World Bankencourages dissemination of its work and will normally give permission promptly and, when the reproductionis for noncommercial purposes, without asking a fee. Permission to copy portions for classroom use is grantedthrough the Copyright Clearance Center, Inc., Suite 910, 222 Rosewood Drive, Danvers, Massachusetts 01923,U.S.A.
The complete backlist of publications from the World Bank, including those of the IFC, is shown in theannual Index of Pul1ications, which contains an alphabetical title list (with full ordering information) andindexes of subjects, authors, and countries and regions. The latest edition is available free of charge from theDistribution Unit, Office of the Publisher, The World Bank, 1818 H Street, N.W., Washington, D.C. 20433,U.S.A., or from Publications, The World Bank, 66, avenue d'lena, 75116 Paris, France.
ISSN (IFC Discussion Papers): 1012-8069ISBN 0-8213-3738-6
Yaannis Karmokolias is a senior economist in the Economics Department of IFC.
Library of Congress Cataloging-in-Publication Data
Karmokolias, Yannis, 1946-Cost benefit analysis of private sector environmental investments
a case study of the Kunda Cement Factory / Yannis Karmokolias.p. cm. - (IFC discussion paper / no. 30)
ISBN 0-8213-3738-61. Kunda Nordic Tsement, AS. 2. Cement industry-Waste disposal-
Estonia-Kunda-Cost effectiveness-Case studies. 3. Cementindustry-Capital investments-Estonia-Kunda-Cost effectiveness-Case studies. 4. Environmental policy-Estonia-Costeffectiveness. 5. Air pollution-Economic aspects-Estonia.1. Title. II. Series: Discussion paper (International FinanceCorporation) ; no. 30.HD9622.E754K865 1996363.72'88-dc2O 96-34236
CIP
Contents I
Abbreviations ............................................ iv
Foreword ............................................ v
Acknowledgments ............................................ vii
I. Executive Summary .............................................. 1
II. Introduction .............................................. 3
Statement of the Problem ...... 3......................................3Objectives of the Study ............................................ 4Methodology ............................................. 4
III. Description of the Region and of the Kunda Cement Plant ............................................. 8
Characteristics of the Region ............................................. 8Plant Description and Process ....... 8.....................................8Pollution from the Kunda Plant ....... 8.....................................8
IV. Investment Program ............................................ 11
New Company Environmental Policy ............................................ 11Environmental Investment Program .............................................. 11
V. Impacts of the Environmental Investments ............................................ 13
Description of Impacts ............................................ 13Quantifiable and Non-Quantifiable Impacts ............................................. 14
VI. Economic Quantification of Environmental Impacts ............................................ 16
Raw Materials and Operating Benefits and Costs ............................................ 16Soiling and Material Effects ............................................ 17Real Estate ............................................ 18Health ............................................ 18Forestry ............................................ 20Agriculture .............................. 21Tourism and Recreation ........................... 21S02 and NOx Reduction Impacts.22., , .................................... 22
VII. Cost-Benefit Analysis ................................ 25
Return on Investment..................................,,,,,,,,,,,,,,,,,,,,,,,,,,,,, 25Beneficiaries ........................................................... 27
VIII. Major Findings .......................................................................... ,.,................................... 29
Bibliography ............................................................................................................................... 31
iii
Abbreviations
CIF Cost, insurance, freightCOI Cost of illnessCVM Contingent valuation methodEEK Estonian kroonERR Economic rate of returnESP Electrostatic precipitatorFIM Finnish markFOB Free on boardIFC International Finance CorporationIRR Intemal rate of returnKNC Kunda Nordic Cement CorporationNEFCO Nordic Environment Finance CorporationNO, Nitrogen Oxides; mainly NO2
NPV Net present valuePM10 Particulate matter below 10 microns in diameterPV Present valueSO2 Sulfur dioxideTSP Total suspended particles (concentration in ambient air)US$ United States dollarsWTP Willingness to pay
Note: Exchange rates used in this study (prevailing in 1993): US$1 =FIM5,2= EEK13
iv
Foreword
This Discussion Paper breaks new ground for IFC. It considers the case of a cementplant in Estonia and tries to answer the question: how do the (private) costs of curbingpollution compare to the (social) benefits to the population? While it is often easy to estimatecosts, it is exceedingly difficult to capture the benefits, especially in developing and transitioncountries. This pioneering empirical study concludes that in the case of Kunda Cement, thesocial benefits exceed private costs by a margin wide enough to justify the environmentalinvestment in economic terms.
Guy PfeffermannDirector, Economics Department
& Economic Adviser of the Corporation
v
Acknowledgments
The study was made possible thanks to the generous financial support provided by theInternational Finance Corporation (IFC) - Government of Finland Trust Fund. Additionalfunds were contributed by the Nordic Environment Finance Corporation (NEFCO); FinnFund;the Kunda Nordic Cement Corp. (KNC); and IFC.
Yannis Karmokolias of IFC developed the conceptual framework for the study andmanaged its implementation. Field work and preliminary analysis were carried out by Soil andWater Ltd., under Fjalar Kommonen, while work pertaining to the health impact wasperformed by Pekka Roto of the Tampere Regional Institute of Occupational Health. Thesupport and participation of Harro Pitkanen of NEFCO is gratefully acknowledged.
Important contributors also include the staff of the health centers of KNC, KundaTown, Rakvere Meat Factory and Rakvere Town; The Estonian Academy of Sciences; MalleMandre of the Institute of Ecology; Aada Teedumae, Toomas Metslang and Anto Raukas ofthe Estonian Institute of Geology; Angelos Pagoulatos of the University of Kentucky; andPekka Laippala of Turku University.
The project team obtained important data and comments from KNC; the NatureProtection Office of West-Viru county; the Ministry of Environment in Estonia; and theMinistry of Environment in Finland.
vii
I. Executive Summary
Project economic analysis is based on estimating and comparing costs and benefitsduring the economic life of the project. Analysis is usually limited to those costs and benefitsinternal to the project. Occasionally, external costs and benefits of public sector projectsdealing with natural resources have been valuated and included in the analysis but this is rarelythe case for private sector projects.
An increase in environmental awareness in recent years, has led IFC, and otherinstitutions, to ensure that projects it finances are environmentally sound. This means that,when necessary, borrowers must undertake capital and operating costs to ensure compliancewith World Bank/IFC's environmental guidelines. In practice, these "environmental"investment costs are included in a project's economic analysis but corresponding benefits,generally, are not. As a result, the economic analysis is incomplete and its findings can bemisleading.
Inclusion of environmental benefits and costs would improve significantly the reliabilityof the economic analysis and its value to private sector managers and public policy makers.More comprehensive environmental cost-benefit analysis would: Improve the estimate of aproject's development impact; provide information to managers on the benefits associated withspecific environmental investments; and enlarge the information base available to public policymakers by estimating the benefit and identifying the beneficiaries of environmentalinvestments.
This study entails an environmental cost-benefit analysis of a private sector project,using the Kunda cement factory in Estonia as a case study. Kunda was chosen because theexisting factory, which had been recently privatized, was a heavy polluter. The Kunda NordicCement Corp. (KNC) had embarked on a US$31 million renovation, including US$8.7 millionof environmental investments to meet World Bank/IFC environmental guidelines. Thus, it waspossible to compare the "before and after" situation in pollution and related impacts. Kundawas the only source of pollution in the area so that there was no risk of mixing up pollutionsources and impacts. Together with the advantages, Kunda also entailed some difficulties forthe analysis. Data was generally scarce, particularly on market prices, as the transition from acommunist to a market economy had just gotten underway. It was, therefore, necessary tocomplement data collected in Estonia with findings of studies conducted elsewhere.
The study identified all impacts related to Kunda's air pollution but valuated only thosewhich had economic significance and for which data was available. These impacts included:Soiling and material damage; real estate values; health; forestry and agriculture; tourism; rawmaterials and personnel turnover at the cement company; and global effects of SO2 and NO,emissions. The rate of return for the environmental investments was estimated at about 25percent over fifteen years. Sensitivity analysis showed that even if benefits are drasticallyreduced, the rate of return remains acceptable at over 16 percent.
Most benefits take place in the vicinity of the factory. Significantly, important benefitsalso accrue to residents throughout Estonia and of nearby countries. This clearlydemonstrates that environmental policies should be approached from a broad internationalperspective.
2
H. Introduction
Major changes have taken place in recent years in the way the environment is regardedby policy makers and implementing agencies in governments, multilateral institutions andprivate companies. Multilateral institutions understand that environmental protection is anintegral part of the development process and have adopted measures to put this into practice.IFC has taken concrete steps to ensure that environmental issues are addressed when potentialIFC investments are appraised. Specifically, IFC has sought to arrest environmental damageby on-going projects in which IFC invests and to minimize any such damage in new projects.
Statement of the Problem
Projects are eligible for IFC financing if they meet four criteria. Appraisal of theproject must conclude that it: is in the private sector and financially profitable; makes apositive contribution to the country's national economy; is technically feasible; and isenvironmentally sound.
Under current IFC practice, environmental analysis consists of ensuring that theproject's construction and operation, including that of existing facilities, do not violate therespective country's and World Bank/IFC's environmental policies and guidelines. Otherwise,IFC will not invest in the project. It is important to highlight that IFC's environmentalanalysis, as practiced currently, is based on technical considerations. For example, in the caseof an air polluting project, the analysis ascertains whether maximum emissions permitted underthe guidelines are exceeded, and if they are, what must be done to lower emissions below themaximum limit. Compliance invariably requires additional investment outlays by thesponsors. The environmental analysis does not address the economic aspects of environmentalimpacts such as their respective values, whether they are costs or benefits, and who bears thecosts or enjoys the benefits.
Correspondingly, economic analysis of projects does not, as a matter of course,quantify environmental factors. In general terms, economic analysis estimates incrementalcosts and benefits directly related to the investment during the economic life of the project andcalculates the economic rate of return (ERR). The analysis includes only costs and benefitsinternal to the project, adjusted, if necessary, for distortions because of, for example,subsidies, tariffs, or exchange rate discrepancies. Ordinarily, environmental externalities arenot included in the economic analysis.
Omission of substantial environmental impacts from a project's economic analysis mayresult in a significantly distorted picture of its effect on the national economy. Often, theiromission also distorts the estimate of a project's profitability. For example, pollution couldaffect workers' health and productivity, health related company expenses, or corporate productmarketability.
3
There are good reasons for estimating the costs and benefits of major environmentalimpacts and including them in a project's economic analysis. Such analysis would result in:
* More accurate estimates of a project's development impact;* Broader information base for investment decision making;* Development of a management tool for company executives;* Better information for environmental policy makers.
There are, as may be expected, valid reasons why this is not being done:
* It requires additional expenses;* Relevant data is scarce;* Findings may support claims for retroactive compensation.
Objectives of the Study
The main objective of the study was to investigate the feasibility of developing apractical method to calculate, in economic terms, the major impacts of environmentalinvestment undertaken by the private sector. The Kunda cement factory in Estonia wasselected as a case study. The study also aimed to answer the following:
* What are the major environmental impacts of the investment?* Which of these impacts can be quantified? Why are other impacts not quantifiable?* Which are the investment costs and benefits, both internal and external to the project,
associated with the Kunda investment?* What is the ERR of these investments?* Who bears the costs and who are the beneficiaries of the environmental investments and
related impacts?
Methodology
Cost-benefit analysis, including externalities, has been used to evaluate some publicsector investment projects since the 1930s, although the practice became more prevalent in the1960s (Marglin, 1967; McKean, 1967). This has rarely been the case for private sector projects,where cost-benefit analysis has been confined to direct, or internal, costs and benefits. Thiswas due, in part, to scarcity of relevant data and to the limited time and other resourcesavailable but also due to the comparatively little emphasis placed on extemal effects,particularly the environment.
Extemal effects of a project are usually defined as income or income-equivalent welfarechanges for individuals or groups not directly affiliated with the project. A project generatingextemal effects neither receives nor makes a full financial payment to these individuals or
4
groups. In economic analysis, all environmental effects, both costs and benefits, should beidentified and, where possible, quantified. Environmental effects can be quantified bymeasuring the change in output that these effects cause in the economy. It is recognized,however, that some environmental effects, because of their nature, do not readily lendthemselves to quantification.
The Kunda cement plant in Kunda, Estonia was selected as the case study. KNC usedto be fully-owned by the Government. At the time of the study, it had been partiallyprivatized, a substantial share had been bought by a consortium of private companies, andmanagement had been taken over by one of the Finnish sponsors. The new owners plannedmajor renovation of the factory, including pollution control. Part of the financing for therenovation was provided by IFC, the Nordic Environmental Finance Company (NEFCO),FinnFund, and EBRD.
The factory was the only major source of pollution in the area, which facilitated theidentification of impacts. The pollution was of major concern to all those involved infinancing and operating the plant, to the Government and, most of all, to the area residentswho had expressed their concerns quite clearly and forcefully. The environmental impactsidentified in the study were measured as the differences between the following two scenarios:
Scenario A: The Kunda cement factory continues to operate without making investments forenvironmental improvements.
Scenario B: Environmental investments are implemented as planned and cement productioncontinues accordingly.
Differences in the environmental impacts projected in the "with" and "without"scenarios represent incremental costs and benefits quantified and monetized in this study.Costs were defined as the investment and operating costs of new equipment to reduce pollutionto the level prescribed by World Bank/IFC guidelines. In project economic analysis, inputsand outputs should be valued at their contribution to the national economy; i.e. the alternativeproduction foregone or the cost of alternative supplies. Because domestic market prices do notalways represent these opportunity cost values, alternative methods of valuation have beendeveloped. The most common methods are briefly described in Box 1.
Of these methods, the market-valued direct cost approach was used whenever possiblein this study, as well as damage cost valuation and, to a lesser degree, hedonic pricing. Theresources available did not allow for generation of data that would have required a long time,e.g. data for health and tourism related benefits. In these cases, findings of other relevantstudies were used to complement or compare data collected in the course of this study.Willingness to pay (WTP) field work to establish social cost valuations was not undertaken.WTP reliability, questionable in many situations, would have had especially limited value inEstonia, where a centrally planned economic system could have made responses devoid of amarket price context. A consequence of this approach is that the benefits are probablyunderestimated, because non-quantifiable positive impacts have been omitted from the
5
calculations. Tradable goods were priced at border parity prices but because of datalimitations in Estonia, parity prices were, at times, substituted with those of nearby Finland(Curry and Weiss, 1993; Pagoulatos, 1992).
Box 1 Social Cost Valuation Methods
For welfare losses that cannot be directly calculated from market prices, several techniqueshave been developed to approximate social welfare losses from pollution. Commonly usedvaluation techniques are briefly presented below.
Damage Cost ValuationReduction in income based on product market prices, increase of medical costs and indirectcosts from illness. Dose-response functions relate the responses to pollutant concentrations,[and the concentrations are calculated from emission amounts and dispersion studies. Example:SO2 and NO, particle emissions which affect health, crop yield, forest growth, materialdamage and others.
Replacement Cost ValuationCosts of emission reduction or costs of shadow projects (shadow projects are alternativemeasures to reduce emissions to the same recipient). Example: National or regionalevaluations of total and marginal costs to meet internationally agreed pollution reduction goals.
Avertive ExpendituresExpenditures for substitutes or complements to compensate for effects of pollution on "victims"of pollution. Example: Noise abatement using insulation, cost to farmers of more land orextra fertilizer to compensate for reduced crop yield.
Travel Cost MethodTravel expenditures to reach a recreational site indicate its value to society.
J Hedonic Pricing MethodsPrices of marketed goods, e.g. housing, influenced by the presence of non-marketed goods,e.g. pollution. In such cases, valuation can be based on the effect of the state of theenvironment on property prices.
Experimental MethodsField studies of society's willingness to pay (WTP) for environmental improvement, orwillingness to accept (WTA) compensation for environmental damage. Examples: WTP toavoid chronic or acute illness, WTP to preserve endangered species.
Legal LiabilityDamage penalties paid according to law enforcement can give indications of the value tosociety of environmental quality.
6
Costs and benefits were compared using standard cost-benefit analysis, includingconversion of money flows to net present value (NPV) at a real discount rate of 10 percent.The "profitability" was assessed in terms of the rate of return on the environmentalinvestments (Little and Mirrlees, 1974; Ray, 1984) by calculating the corresponding ERR. Localprices were converted to US$ at the 1993 exchange rate of 13 Estonian Kroon (EEK) per US$.For the time series involved in NPV and IRR calculations, all values are expressed in 1993constant prices.
The analysis followed the phases described below:
1. Identification of all impacts caused by pollution generated by the Kunda cement plant;2. Selection of impacts to be quantified and valuated, on the basis of economic significance
and availability of data;3. Description of non-quantifiable impacts;4. Valuation of selected impacts;5. Evaluation of the profitability of the proposed environmental investment on the basis of
NPVs and ERRs.
7
M. Description of the Region and of the Kunda Cement Plant
Characteristics of the Region
The KNC cement plant is situated in the town of Kunda, West-Viru county, about100 km east of Tallinn, Estonia's capital. Kunda has a population of about 5,000. The plantwas located there because of the proximity to raw materials. Limestone and clay deposits areavailable in Kunda and oil shale in Kivioli, about 45 km southeast.
The surrounding area is mostly covered with forest. There are also a number of farmsfor crop production and dairying. The town has a small scenic fishing harbor that was recentlyexpanded for bulk shipping cement. At a distance of 3 to 7 km from the factory are beachesand other recreational areas, where about 2,000 persons spend summer vacations. There arealso some archaeological sites dating to medieval times.
Plant Descniption and Process
KNC is the main employer in the Kunda area where the factory has been producingcement for several decades. The four kilns operating at present are quite old, having beeninstalled between 1961 and 1972. While Estonia was part of the Soviet Union, most cementwas marketed within the Union, mainly in the St. Petersburg area. When Estonia becameindependent, former markets in the former Soviet Union were no longer available. Theresulting drop in demand caused production to decline from nearly full capacity of 900,000tons in 1991 to 500,000 tons in 1994. Since privatization, the objective has been to modernizethe plant, restore production to 900,000 tons by 1998, and develop new export markets,mainly in northern Europe.
Kunda cement is produced using the standard wet process. Oil shale is used instead ofcoal or fuel oil because it is locally available, its oil content is high and the oil shale ash isused as raw material in cement production.
Pollution from the Kunda Plant
Prior to the environmental investment program, the Kunda plant generated air andwater pollution from its production processes and from solid waste mismanagement. Mostsignificant , by far, was air pollution, predominantly in the form of flue gases from the cementkilns. At full production of 900,000 tons of cement, dust emissions amounted to a staggering129,000 tons per year. In addition, there were substantial SO2 and NO, emissions, as well asdust emissions from oil shale preparation and grinding, transport of raw materials, and cementbagging operations.
8
Water pollution, although minuscule in comparison to the air pollution problem, relatedto inefficient use of water and to possible contamination of water supplies from occasionalspills in the fuel and lubricating oil storage areas. Waste from the plant was dumped at alandfill which did not meet Estonian and World Bank/IFC guidelines.
Air pollution has earned Kunda the dubious distinction of "The Gray Town of Estonia."Area residents have been actively protesting the pollution problem. They have taken their caseto the national and local government authorities, to the media, and to KNC. They haveorganized petitions, seminars, demonstrations and have had frequent meetings with KNC.They managed to get the Kunda Town Council to discuss the possibility of closing the plantuntil pollution controls were in place. The motion was not approved, in view of the plant'simportance to the regional and national economy, but the pollution issue remains very muchalive for Kunda's residents.
To establish the spatial extent of the problem, a dispersion survey was carried out aspart of this study, to find out where the dust settled. The survey estimated particle
2concentrations and depositions in an area of 100 km around the plant. Dust dispersionmeasurements were made at 356 receptors, placed at distances of 250 m to 1 km betweenreceptor points. The survey results, presented in Table 1, show that particulate emissions fromthe unrenovated factory caused very high levels of one-day dust concentrations.
Table 1
One-Day Dust Concentration Around Kunda Cement Factory
Distance From Plant Dust concentrations
(km) (jig/m3)
1-2 18003-5 500
6-10 300
Note: One-day concentration value is a daily value exceeded less than 2 percent of the time.
The annual concentration maximum was also extremely high at 263 Pg/m3, comparedto 60 pg/M3 allowed in nearby Finland and 80 Pg/M3 under World Bank/IFC guidelines. TheFinnish standard was exceeded throughout an area of 28 km2 around the plant.
The dispersion of PM10 (particulate matter below 10 microns in diameter) was alsoestimated. PM10 makes up 25 percent of cement dust emissions and is considered moreharmful to humans than larger particles. The survey showed that PM1O dispersion patterns aresimilar to those of total suspended particles in the air (TSP) and that when TSP emissions arereduced, those of PM1O are reduced proportionally.
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If the calculated particle concentrations are compared to Finnish and recentlyestablished Estonian air quality guidelines, one-day values exceeded the limit by 1,200 percentin the vicinity of the plant and by more than 100 percent in the total dispersion area.Maximum annual average concentrations were 3.3 times higher than the World Bank guidelineand 4.4 times the Finnish guideline. After the modernization, the highest daily values wouldbe dramatically reduced to about 10 percent of the air quality guidelines and the highest annualaverage concentrations would be about 4 percent of the guideline.
10
IV. Investment Program
New Company Environmental Policy
After privatization, the new management adopted a new environmental policy with thefollowing objectives:
1. To meet Estonian environmental requirements as soon as possible;2. to meet all World Bank/IFC requirements within 3 years; and3. to be the best environmentally managed industrial company in Estonia within 5
years.
To meet these objectives, management embarked on a three-part strategy: First, itassigned responsibility for environmental matters to the general manager; second, it gave toppriority to investing in new equipment and modifying the production process, aiming to meetWorld Bank guidelines by end-1997; third, to give all KNC personnel basic environmentaltraining to increase their awareness and responsibility in environmental matters.
Environmental Investment Program
KNC gave priority to reducing dust emissions by installing new ESP flue gas filters andmodifring the kilns. By end-1996, all operating kilns would have an emission level of 50mg/m according to World Bank/IFC guidelines. Total annual dust emissions, at fullproduction of 900,000 tons, would be reduced from almost 130,000 tons to below 10,000tons.
Oil shale preparation, mainly grinding, would be improved by replacing existingequipment to reduce emissions from 4,000 mg/m3 to about 50 mg/mr3.
Mills would be equipped with new ventilation and cooling systems, including new bagfilters. Emissions would be reduced from 4,200 mg/rm3 to below 20 mg/m3 . The fly ashreceiving silo would be equipped with a fabric cassette filter, bringing emissions down to 20mglm3 .
Fabric filters would be installed at the cement bulk loading, where at present no de-dusting takes place. The cement packing plant and its silo would be renovated and the existingbag filters would be made operational.
Additional investments would be made to safeguard against water pollution andimprove waste management.
11
The total investment for the plant's modernization was estimated at US$30.9 million,of which US$8.7 million would be allocated for environmental improvements.
KNC's investment program is summarized in Table 2.
Table 2
KNC Investment Program, 1993-1996
Environmental Other Total
(Thousands/US$)
Basic engineering 50 140 190Engineering of new cement plant 150 150Storage hall cranes -- 170 170Slurry preparation -- 125 125Oil shale preparation improvements 2135 670 2805Kiln improvements 4810 4035 8845Clinker conveying 310 90 400Grinding improvements 534 1850 2384Bulk loading and storage improvements 300 450 750Electrification 35 130 165Process control and instrumentation 210 835 1045Laboratory equipment -- 525 525Buildings and infrastructure restoration -- 800 800Finish grinding in closed circuit 150 2510 2660Palletizing line for cement bags -- 700 700Cement bag storage -- 350 350Port facilities 8000 8000Contingency 165 661 826
Total 8699 22191 30890Percent of Total Investment 28.2 71.8 100
Source: KNC
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V. Impacts of the Enviromnental Investments
Description of Impacts
Actions taken by KNC, their effects on pollution and the corresponding impacts on theenvironment are summarized in Table 3.
Table 3
Environmental hnpacts of KNC Actions to Reduce Pollution
KNC Action Effect on Plant Pollution Environmental Impact
Improve kilns; install ESPs; Dramatic reduction in dust Workers' and residents'improve oil shale and cement emissions health; tree and plant growth;grinding, bagging and livestock health andtransport operations productivity; soiling of
buildings, streets andhouseholds; town image; realestate values; tourism; factoryoperating costs
Energy saving in slurry Lower SO2 /NO, emissions Health; corrosion; plant andpreparation tree growth; soiling
Oil spill prevention or Less water contamination Health; fish population;containment; sewer under ground and in Kunda salmon spawningrenovation; new waste landfill riversite
Some of the environmental impacts are confined locally but others occur over a muchlarger area. For example, the survey of dust dispersion showed that its effects are felt at thelocal and regional level but SO2 and NO, emissions, which are airborne over very longdistances, affect the environment beyond Estonia's borders. A geographical classification ofKunda's environmental impacts is shown in Table 4.
13
Table 4
Geographical Significance of the Environmental Impacts
Type of Pollution Geographical Area AffectedControl and Related Impact Local Regional National International
Dust emission- tree growth x x-- crop production x x
E-tourism x x- health x-soiling x- real estate x-operating costs x-livestock x- fish population x- salmon spawning x x x x- town image x x x
So2 and NOx emission- tree growth x x x x- crop production x x x x- health x x x x
Ground water x x
River pollution x x
Qualiaifiable and Non-Quantifiable Impacts
Environmental impacts were classified, with respect to economic valuation, intoquantifiable and non-quantifiable. Among the former are: Health; forestry; agriculture;soiling; tourism and recreation; real estate value; SO2 and NO, impacts; and operating costs.
Non-quantifiable impacts, for the purposes of this study, are those for which valuejudgments would be required, e.g. regarding Kunda's image, or for which data is unavailableor their economic significance is minor or are practically the same in both scenarios. Non-quantifiable impacts are briefly described in the following paragraphs.
There are indications that water pollution decreases fish catches and reduces the qualityof fish in the Kunda river. However, there has been no scientific work to verify that pollutionfrom the factory actually impacts on the fish and to what degree. The river is used only byrecreational fishermen, and even if there is an impact from reduced pollution, the incrementalcatch would be very small (Raukas and others, 1993). A more significant impact could occur
14
on the population of salmon in the Gulf of Finland, given that the Kunda river is one of thefew remaining spawning sites in the area.
Changing the image of Kunda from "the gray town of Estonia" into a clean andprosperous place to live is very important. Part of this has been quantified in other impactssuch as real estate values and the cost to KNC of personnel turnover. It is certainly importantto those who have organized protests against Kunda pollution, as well as to the passivemembers of the community. No attempt was made in this study to valuate these sentiments.
There have been reports of cement dust affecting the milk production and fertility ofdairy cows. Reliable studies establishing a cause and effect relationship between Kundapollution and livestock health or dairy production have not been carried out. Also, there arecomplaints that cement dust has reduced the supply of berries, mushrooms and otherhorticultural produce in the forests. However, the affected forest area is limited and so is themarket value of the goods involved. The study did not attempt to calculate the WTP for theseproducts by affected individuals.
In some areas, a negative effect of reduced dust deposition may be the result ofdecreased neutralization of acid rain. This effect, however, is not so important in Estoniabecause of the relatively high buffer capacity of the soil.
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VI. Economic Quantification of Environmental Impacts
Raw Materials and Operatng Benefits and Costs
The plant's operating costs would be affected by the environmental investments inseveral ways. It would be possible to return about 2/3 of the dust collected from ESPs to theproduction process, thus saving limestone raw material. However, remaining dust would bedisposed in the new industrial waste dump at an annual cost of EEK600,000 at the currentproduction level of 600,000 tons/year or EEK900,000 at full capacity. The change in benefitsand costs associated with ESPs is shown in Table 5.
Table 5
Impact of ESP Operation on Kunda's Operating Costs
Savings EEK/year US$/yearRaw material savings 8,351,850 642,450
Cost
ESP Operating costs 5,204,550 400,350Dust removal 900,000 69,231
Net savings 2,247,000 172,846
Source: KNC
At full production of 900,000 t/year, net benefits from ESPs on operating costs wouldbe US$173,000/year. Full benefits would be gradually realized over a period of six years withUS$120,000 in year 1 and US$173,000 in year 6.
Pollution abatement would affect recruitment costs as more qualified people would bewilling to work at Kunda, while fewer would be leaving. KNC's 20 percent yearly personneltumover, at present, is double that at the Rakvere meat packing plant yearly. The cost ofrecruitment and training of a new employee averages EEK4,000 per person. If the turnover isreduced to 10 percent or 60 employees annually, the corresponding savings would beEEK240,000/year or US$18,500/year.
With respect to compensation, the company did not anticipate that salaries and wageswould be reduced as more persons sought to work at KNC.
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Soiling and Material Effects
Soiling of the town of Kunda from the thousands of tons of cement dust that have beenfalling on the town impose a dual burden on its residents. First, surfaces become dirty morequickly than they would in the absence of dust, so that streets, sidewalks, and floors have to beswept or dusted more frequently, and clothing must also be washed more frequently.Secondly, the dust, which is alkaline, damages painted surfaces such as walls, doors andautomobiles. No damage has been reported to stone and brick surfaces.
Most studies of the impact of air pollution on buildings and materials have beenconcerned with acid pollutants like SO2 and NO,, and acid corrosion. In Kunda, the mainpollutant is alkaline cement dust, not known to cause corrosion but, in combination withmoisture, is damaging to painted surfaces. The cost of surface cleaning and painting in Kunda
2~~~~~~~~~~~was estimated at about EEK25O/m . There are 160 individual houses in Kunda and thewooden painted surface of an average house is estimated at 70 m2 . (The remaining populationlive in cinder-block apartment buildings). Interviews with Kunda residents revealed that theaverage period between house painting of 8 years has been shortened by half because of thecement dust. Savings from less frequent painting were estimated at EEK750,000/year orUS$577,000/year. Cars also needed more frequent repainting because of the dust. Therewere about 250 cars in Kunda, half of which were not kept in garages. On an annual basis,the incremental cost of car painting in Kunda because of the cement dust was estimated atEEK330/car for a total of about EEK58,000/year or about $4,800/year. These estimates donot include the cost of sweeping dust from the streets or buildings nor the cost of washingclothes.
Earlier studies have pointed out that actual expenses for cleaning, repair andmaintenance, do not reflect the total value of household cleanliness (Watson and Jaksch, 1982;Freeman, 1982). Findings from these studies indicate that households do not always increasethe frequency and cost of cleaning as the level of pollution rises. Nevertheless, total welfareloss is greater, because households experience reduced utility from having to live in a dirtyenvironment. Also, if repairs and maintenance are not kept up, the result would be morecostly repairs later or reduced property values. Comprehensive studies of the cost of soiling inthe US have found that the benefit of reduced soiling from lower TSP corresponded toUS$1.0 - US$1.5 per inhabitant for 1.0 pg/m3 reduction. Partial findings in Kunda pointed toa slightly greater benefit but the data was too limited to be sufficiently reliable. Applying themore conservative findings of earlier studies to the 50 pig/m 3 TSP decrease in Kunda results ina total economic benefit from reduced soiling of: 4,700 inhabitants * 50 Pg/M3 *
US$1.5 = US$350,000/year. About 20 percent of this amount represented the cost ofunskilled labor, a non-tradable, and the remaining 80 percent the cost of paint, brushes,brooms and other supplies, all tradable. Unskilled labor in Kunda was valued at the localwage level for a total of US$7,000. Costs for tradable items were valued at import parity
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prices for a total of US$280,000 (Soil and Water Ltd., 1995). Thus, the total economic benefitfrom reduced soiling at Kunda was estimated at US$287,000 per year.
Real Estate
In January 1994 the Government assigned property values for the purpose ofdetermining taxes and fees for use of state-owned land. The values were EEK12/m2
(US$0.9/mr) inside Kunda town limits and EEK6,200/ha (US$0.05/M2 ) beyond town limits(Teedunae, 1994). No other data exist and, in the absence of a real estate market in Estonia, itis not known whether these assigned prices represent actual values. These prices were about1/20 to 1/10 of those for similar land in Finland.
Earlier studies have used hedonic pricing techniques to assess the impact of pollution onproperty values. They have concluded that, a one percent increase in TSP decreases propertyvalues by 0.05 percent to 0.14 percent (Pearce and Markandya, 1989). Typically, thisrelationship is not linear, especially when pollution levels increase substantially. Based on thisinformation, it could conservatively be assumed that in Kunda, where TSP reduction would beclose to 80 percent, real estate values would increase by at least 5 percent.
The total town area of Kunda is 1,001 ha (Raukas and others, 1993) of which about 66percent is buildings and the remaining vacant lots and fields. In economic valuation, land andunskilled labor, as non-tradable, should be shadow-priced, while construction materials andskilled labor should be valued at the apropriate border price. In the absence of data forEstonia, the average value of US$19.2/m for buildings in Finnish towns similar to Kunda wasapplied as a border parity price (Finnish National Board of Survey, 1994).
Thus the increase in economic value of buildings in Kunda from the reduction inpollution was estimated at 1,001 ha x 0.66 x 0.005 x US$192,000 = US$6.3 million. Thevalue of undeveloped land is about 10 percent that of buildings and the correspondingeconomic impact from reduced pollution would be 1,001 ha x 0.34 x 0.10 x 0.05 x$US192,000 = US$0.33 million, for a total real estate benefit of US$6.6 million. In view ofthe time it will take for pollution to be reduced and for the realization of a cleaner Kunda to bereflected in real estate values, the real estate benefit was spread over five years, starting withthe second year of the project.
Health
During the planning stages of the study, discussions with Estonian government officialsand with Viru County and KNC health personnel indicated that the plant's pollution causedsignificant health problems, related primarily to respiratory and dermatological illnesses. Inview of the apparent importance of the health issues involved, the Finnish Institute ofOccupational Health joined the study team to assess the health impact of Kunda's air pollution.It became evident very quickly that this would be a complex and time consuming task.
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Possible impacts related to both chronic and acute respiratory problems that could best bestudied with a time-series methodology spanning many years. This approach was not possiblein this study because of time and budget limitations. Furthermore, many of the plant's long-time workers were ethnic Russians who had left the company, and possibly Estonia, after thecountry gained its independence from the Soviet Union.
Faced with these constraints, the study team decided to tackle the issue as follows:First, regarding chronic health problems, to rely on an on-going study by Orebro MedicalCenter Hospital of Sweden and the Estonian Institute of Experimental and Clinical Medicinewhich was scheduled to be completed prior to this study. Secondly, regarding acute healthproblems, to carry out a cross-section investigation comparing Kunda workers and Kundaresidents to a control group of workers in a meat packing plant in Rakvere, about 30 km fromKunda. Rakvere has no heavy industry and the meat packing plant had been constructedrecently according to Finnish environmental and occupational safety standards.
The results of the epidemiological cross-section study did not indicate statisticallysignificant differences in relevant symptoms or diseases between the groups tested (Roto andothers, 1995). This contradicted the perception of the participants in the health study, withKunda workers and town residents reporting significantly more air pollution related healthproblems than the Rakvere workers. Furthermore, three peer reviewers of the healthinvestigation gave differing opinions on the validity of the results but all suggested a time-series approach which would require a number of years to complete. In the meantime, thecompletion of the Swedish-Estonian study of chronic effects had been delayed. It was,therefore, decided to rely on existing studies that had dealt with the health impact ofconstruction materials dust, including cement (Ostro, 1994). Dose-response relationshipsestablished on this basis are shown in Table 6.
Table 6
Morbidity Effects from a 10 ug/m3 Change in PM1O Concentration
Morbidity Low Estimate Central Estimate High EstimateRHA/100,000 6.57 12.0 15.6ERV/100,000 128.3 235.4 342.5RAD/person 0.404 0.575 0.903LRI/child 0.008 0.0169 0.0238Asthma attacks/asthmatic 0.163 0.326 2.73Respiratory symptoms/person 0.91 1.83 2.74Chronic Bronchitis/100,000 30.6 61.2 91.8
Notes: PM1O concentration is the annual average concentration in ambient air TSP below 10microns in diameter; RHA is Respiratory Hospital Admissions; ERV is Emergency RoomVisits; RAD is Restricted Activity Days; LRI is Lower Respiratory Illness of children.
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These general morbidity coefficients were monetized applying the findings of recentlycompleted studies (US Department of Energy, 1994) to the average change in PM1Oconcentration in Kunda of 20 jug/m3. The change in PM1O had been established by the dustdispersion survey undertaken in the course of this study. The results are shown in Table 7.
Table 7
Kunda Town: Benefits from a 20 ytg/m3 Reduction in PM1OAnnual Concentration
Number of Annual Average Total AnnualAffected Morbidity Morbidity Cost MorbidityPersons (# of Incidents) (US$/Incident) Cost (US$)
Hospital Admittance 4700 1.13 6306 7126Emergency room visits 4700 22.13 178 3939Symptom days 4400 16104.00 6 96624Restricted activity days 4400 5060.00 51 258060Children's LRI 300 10.14 132 1338Asthma incidents* 235 153.22 30 4597Total 371684
The number of asthmatic persons is assumed to be 5 percent of the population.
Thus the total health benefit from reduced pollution at Kunda, including the cost oftreatment (medical facilities, medical personnel, medicine) as well as the cost of days lost fromwork, was estimated at US$372,000/year. This estimate does not include WTP measurementsfor being healthy. Nor does it include the effect on the productivity of employees normallyworking with the person absent nor the effect on productivity of employees who work eventhough they are sick.
Forestry
About 46 percent of the affected area is covered by commercially exploited forest.The total volume of the forest stands was estimated at nearly 700,000 m3, comprised ofdeciduous trees (51 percent), pine (38 percent) and spruce (11 percent). It has been establishedthat cement dust from the plant retarded tree growth by obstructing photosynthesis or bynegatively affecting soil composition. Preliminary findings showed that 70 percent of the yieldreduction was caused by inadequate photosynthesis of leaves and needles and 30 percent fromchanges in the soil. However, the latter effect occurred very slowly, so the impact on treegrowth would not be significant during the 15-year time period covered by this study (Mandre,1994). The average growth deficit in the affected area (up to 5 km west and 10 km east of theplant) compared to non-affected areas is 12 percent for pine and 20 percent for spruce. Thesepercentages correspond to volumes of 1,000 m3 for pine and 420 m3 for spruce each year.
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The fob-Tallinn price for pine and spruce timber averaged $50/m3. Processing andtransport costs from Kunda to Tallinn were estimated at $15/m , which was subtracted fromthe fob price, giving an export parity price of $35/m3. Thus, the benefits from increasedtimber production once the pollution decreases were estimated at $34,790 per year.
Agniculture
Cement dust fallout affects about 1,850 ha of agricultural land. Crops mainly consistof barley, wheat, oats and potatoes. Earlier research had found that, depending on the species,growth is 23 percent to 33 percent lower in heavily polluted areas within one km from thefactory, compared to a control area. The impact is lower, as dust fallout decreases, averaging ayield reduction of 10 percent over the affected area of 1,850 ha of farmland (Mandre, 1994).The reduction in rate of growth is strongly dependent upon climatic factors. Dust effects aresmallest in cold and rainy seasons and largest when the growing season has been warm andsunny. Crop quality is also affected by dust downfall, based on experiments which show thatcrops exposed to cement dust have lower contents of beta-carotene and essential amino acids(Mandre, 1994).
The average price of crops in the affected area was estimated at US$780/ha cif-Tallinnequivalent. Handling and transport costs from Kunda were added, making the farm gate valueat import parity prices US$830/ha. With the reduction of dust fallout, yields would increaseby 10 percent. The impact on quality is not quantified because of lack of data. Because thequantity affected by the plant's pollution is small, prices of the various crops will not beaffected from the increase in supply. Thus, the total agricultural benefit from increased cropproduction in the affected area after pollution has been reduced, would be 1,850 ha x O.lxUS$830/ha = US$101,000/year.
Tourism and Recreation
The area around Kunda is very scenic, especially along the coast. Yet, recreational andtourism activity is noticeably less than just beyond the dust dispersion area. Even where thereis no dust deposition, the visible dust cloud rising from the factory and Kunda's bad reputationalso act as deterrents to would-be visitors. It is obvious that should air pollution besubstantially reduced, tourism activity would rise. The question remains, however, how muchtourism and how much related spending would take place in the absence of pollution. Toanswer this question would required extensive field research which was not possible within theconstraints of this study. Consequently, this part of the analysis relies on secondaryinformation about tourist activity and spending in other parts of Estonia and neighboringcountries.
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Most tourists in Viru County are Estonian nationals. An estimated 2,000 Estonians and300 foreigners spend their summer vacations at the fringe of the dust dispersion area.Practically all are Viru County natives who now live in Tallinn or in neighboring countries. Itis assumed that with the reduction of pollution, the number of vacationers in this area wouldincrease by 1,000 Estonians and by 150 foreigners, (Case A). If the pollution continuesunabated, the numbers would decrease by 1,000 and 150 persons, respectively, (Case B).Thus, the difference in tourism volume between the two scenarios after 15 years would be2,000 domestic tourists and 300 foreign tourists.
Based on 1992 data, expenditures by foreign tourists amounted to EEK207/day with anaverage stay of 2.5 days. Domestic tourists spent EEK36/day, averaging 14 days per stay(Estonian Statistical Yearbook, 1993). In 1993 prices, total annual tourist expenditures would be:
Domestic tourists 2000 x 14 x 79 = EEK2212000Foreign tourists 300 x 2.5 x 449 = EEK336750Total = EEK2548750 or
US$196,000 per year
Because of the difficulty in calculating border prices for goods and services consumedby tourists, tourist expenditures in Finland were used as a proxy. In 1993 they averaged US$96/day for foreigners (Finnish Tourist Board, 1994a), and US$ 46/ day for local tourists (FinnishTourist Board, 1994b; Finnish Tourist Board, 1994c) or 5.5 times higher than in Estonia. It wasestimated that 50 percent of tourist expenditures related to tradable, e.g. food, drinks,supplies, which should be valued at border parity prices and 50 percent to non-tradable, suchas labor and utilities.
Accordingly, the annual tourism benefit for tradable would be US$0.5 * 196 * 5.5 =US$539,000 and for non-tradable US$0.5 * US$196,000 = US$98,000, or a total ofUS$637,000. Since independence, tourism has been increasing rapidly in Estonia. Tallinn isthe main destination but the coast has also been attracting visitors leading to the construction oftwo new hotels in Viru county. It is difficult to project how tourism will develop over time.Adopting a conservative approach, it was assumed that tourism benefits would increaselinearly over 15 years, from about US$43,000 in year 1 to US$637,000 in year 15 of theproject. Although these estimates are based on plausible assumptions, they are probablyconservative because in the absence of pollution the average stay would probably be greater.Also, recent tourism activity in the area, particularly of visitors from Germany and Sweden,suggests that tourism receipts would rise faster than assumed in this study.
SO2 and NO. Reduction Impacts
Energy savings achieved through process improvements in the factory have beencalculated by KNC to be 20 percent of existing energy consumption. This would, in turn,result in lowering SO2 emissions by 1,200 tons/year and NOx emissions by 200 tons/year.Because SO2 and NOx are transported over long distances, those originating in Kunda would
22
affect areas far beyond Estonia's boundaries. A recent study found that 71 percent of SO2 and87 percent of NO. emissions originating in Finland were deposited several hundred kilometersfrom the source of emission, mostly in other countries (Tuovinen, 1994; Otterstrom and Koski,1994). Other studies have reached similar findings (Markandya and Rhodes, 1992; Pearce, Bann,and Georgiou, 1992; Finnish Ministry of the Environment, 1989). The Finnish study is especiallyrelevant to Kunda because it analyzed emissions originating in an area 50 km to 200 km fromKunda, a short distance in comparison to the transboundary character of SO2/NOX impacts. Itconcluded that the most significant impacts from SO2 and NO, emissions are:
Morbidity: A dose-response function was established between SO2 concentration in the airand cough-days for children and of chest discomfort for adults. Values based on WTP toavoid these symptoms were estimated. NO, also caused morbidity, directly and via ozoneformation, but its significance was small.Material impact: Dose-response functions were established between the SO2 concentration inair and deterioration of structural materials like zinc-plated steel, painted steel, aluminum,concrete and wood. Damages were valued for structures in Finnish urban areas.Forest growth: Forest damages due to acidification have been estimated in several studies ofcritical acidification loads in Finland. SO2 deposition was found responsible for 60 percent ofthe total acidification, NO, for 30 percent and ammonia for the rest. The potentially importantdamages on forests (mainly due to NO, concentration) have not been reliably valuated.Crop production: The combination of NO, and volatile organic substances in the airproduce ozone, part of which is from pollution imported from other countries. Results fromseveral published dose-response functions were applied to estimate relevant damage to crops.Water pollution: Water pollution damages were estimated from acidification of groundwater, which causes corrosion in water pipes and from the reduction in fish populations.
The findings of the Finnish study regarding SO2/NO, emissions are summarized inTable 8.
Table 8
Costs of SO2 and NOx Emissions from Energy Production in Finland
Costs
Impact Cost per kg of SO_ emitted Cost per kg of No, emitted(US$) (US$)
Morbidity 0.77Material Damage 2.43Tree Growth 0.21 0.16Crop Production - 0.61Water Pollution 0.03 0.05Total 0.56 0.69
Source: Otterstrom and Koski 1994.
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The values shown in Table 8 are lower than those estimated in the other studies but aremore relevant to Kunda because of Southern Finland's proximity to the plant. These estimateswere, therefore, adopted in this study, giving annual benefits of US $672,000 for a 1,200 tonreduction of SO2 and US$138,000 for a 200 ton reduction in NOR.
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VII. Cost-Benefit Analysis
Return on Investment
The cost of the environmental investments to reduce air pollution below the maximumallowed under World Bank/IFC guidelines consists of the capital and operating costs of thepollution control equipment and of other improvements in the factory. Benefits consist of lessraw material and personnel recruitment costs, less soiling, higher real estate values, lowerhealth costs, increased forestry and agricultural production, higher tourism receipts and lowerSO2/NO, impacts (Figure 1).
Figure 1 Present Value of Envirommental ImpactsImpacts
SO2/NOx Impacts
Real EstateValues w 3
Health
Soiling/MaterialDamage
Tourism
KNC Net OperatingBenefits
Forestry andAgriculture -
0 1 2 3 4 5 6 7
PV in Million USS
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Quantified incremental costs and benefits related to the environmental investments arepresented in Table 9. The table does not include benefits that were not quantified.
Table 9
Total Discounted Incremental Costs and Benerits
Costs/Benefits Present Value*(US$ million)
CostsCapital 8.00Operating 3.55Total Costs 11.55
BenefitsRaw Materials 4.86Personnel Turnover 0.17Soiling Reduction 2.42Real Estate Values 5.50Health Improvement 3.09Agriculture and Forestry 1.17Tourism Receipts 2.22SO2/NO, Reduction 6.78Total Benefits 26.21
Economic Rate of Return (ERR) 24.7%
* 10 percent rate of interest
The reduction of dust concentration gives benefits that are more than twice the capitaland operating costs. The largest benefit is derived from the reduction of SO2/NO, emissions,the impact of which extends over an area substantially larger than Estonia. The second largestbenefit relates to increased real estate values in the town of Kunda. However, given the stilluncertain situation with respect to transfer of ownership and the real estate market, theincreased values may not fully translate into tangible benefits for their owners. Cost savings inraw materials and energy are substantial and more than offset the operating and maintenancecosts of the pollution control equipment. Health benefits are also substantial, and may beunderestimated because intangible factors such as the value of well-being were not included.Tourism receipts are not as sizable as most other benefits but are also the least reliable, bothwith respect to magnitude and as to the year in which they might materialize. There are plansfor the construction of the Baltic Highway to connect Finland and the Baltic countries toCentral Europe and to develop Kunda's port into a marina for Finnish yachts. Should theseplans materialize benefits from tourism would be much larger than estimated in this study.
The economic rate of return has been calculated at 24.7 percent which certainlyjustifies the investment. Estimates of the benefits tended to be on the conservative side and the
26
return on investment could well be higher. At the same time, it is recognized that scarcity ofdata and the absence of market transactions for some factors, necessitated the use of relevantfindings from other studies which may not be fully applicable to Kunda, even though pollutionin Kunda was many times higher than that in most parts of the world. There is no doubt thatthe environmental investment has significantly high returns. Even if the three most uncertainbenefits are reduced by 50 percent (tourism, health, and real estate) the ERR would still be19.7 percent, and with the additional halving of SO2/NO, related benefits the ERR would beover 16 percent, which demonstrates that the investment in air pollution control results insignificant benefits.
Beneficiaries
An important aspect of the cost-benefit assessment was to identify the groups of personsbenefitting from the environmental investments at Kunda. Beneficiaries include residents ofEstonia and of other countries in the region, as shown in Table 10.
Table 10
Present Value and Benericiaries of Environmental Investments(US$ million)
Impact PV Beneficiaries
Forestry and agriculture 1.17 Forest owners and farmers within 5 km radius
Raw materials/ Employee 1.48 KNCturnover*
Increased tourism 2.22 Enterprises and employees in Kunda region
Reduced soiling and material 2.42 Kunda residentsdamages
Reduced health care costs 3.09 KNC workers and Kunda residents
Real estate values 5.50 Real estate owners in Kunda
Less damage from SO2 , NO, 6.78 Inhabitants of European countries near Estoniaemissions
Of the total benefits of US$22.66 million (discounted to year 1 of the project andhaving subtracted ESP operating costs) about US$16 million accrue to residents of the Kundaregion and nearly US$7 million to residents of a wide area encompassing all of Estonia, Latviaand Lithuania and parts of Finland, Sweden, Norway, Russia, Belarus and Poland. If non-quantified benefits are considered, e.g. water pollution and salmon spawning, welfareincreases in Estonia and neighboring countries would be even greater. Some of theenvironmental impacts which affect the Kunda area directly, also affect the whole countryindirectly. For example, improved health or increased tourism activity in the Kunda region
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generates national benefits in the form of foreign exchange or in terms of budget allocationsfor public health. It is significant that an investment concentrated in a single factory hassubstantial environmental and socioeconomic impacts not only for the local community butalso for Estonia and for neighboring countries.
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VIII. Major Findings
Investments to reduce air pollution at Kunda cement factory would, once fullyimplemented, result in significant net economic benefits. The ERR has been calculated at 24.7percent and sensitivity analysis confirmed that even if benefits are significantly reduced, theERR is over 16 percent.
The most important environmental benefits identified are: Reduced global effects ofSO2 and NO. emissions, better health and less health-related costs, reduced soiling andmaterial damage, increased tourism income, greater real estate values, and increased forestryand agricultural yields. Additional benefits were identified but were not valuated because oflimited data.
It is important to highlight that benefits occur over a wide geographical area. Althoughmost would take place in the vicinity of the factory, important benefits also accrue to Balticcountries and to parts of Russia, Belarus, Finland, Sweden, Norway and Poland.
This type of research requires an inter-disciplinary team approach. In this study,environmental impacts ranged across several disciplines including agriculture, forestry,fisheries, livestock, chemistry, real estate, health, engineering, business and economics.
Data limitations, of both technical and economic data, made the study period longerthan had been anticipated and necessitated the use of findings from other parts of the world,which may have resulted in underestimating some impacts and overestimating others. Thesensitivity analysis indicated that, for this study, these over/under-estimates do not materiallyaffect the conclusions of the study.
Findings of this type of study have many applications in the private sector, including:
* Improved project investment analysis;* Clearer demonstration of the development impact of environmental investments;* Help in developing investment plans, by estimating the returns to specific environmental
investments;* Improved corporate image and public relations;* Higher environmental awareness.
Environmental cost-benefit analysis can also help public policy makers with respect to:
* Funding investments;* Providing incentives;* Justifying environmental regulations;* Establishing penalties for non-compliance of regulations.
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The research initiated in this study should be continued through subsequent case studiesto establish the degree of validity and replicability of the findings in other locations and acrossdifferent economic activities.
30
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Watson W., and J. Jaksch. 1982. "Air Pollution: Household Soiling and Consumer WelfareLosses," Journal of Environmental Economics and Management 9:248-262.
32
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IFC Discussion Papers (continued)
No. 21 Radical Rform in the Automotive Industry: Policies in Emerging lMarkets. Peter O'Brienand Yannis Karmokolias
No. 22 Debt or Equity? How Firms in Developing Countries Choose. Jack Glen and Brian Pinto
No. 23 Financing Private Infrastructure Projects: Emerging Trends from IFC's Experience. Gaiy Bondand Laurence Carter
No. 24 An Introduction to the Microstructure of Emerging Markets. Jack Glen
No. 25 Trends in PrivateInvestment in DevelopingCountries 1995: Statisticsfor 1980-93.Jack D. Glenand Mariusz A. Sumlinski
No. 26 Dividend Polity and Behavior in Emterginig Markets: To Pay or- Not to Pay. Jack D. Glen,Yannis Karmokolias, Robert R. Miller, and Sanjay Shah
No. 27 Intellectual Property Protection, Direct Investment, and Technology TransJfr: Germany, Japan,and the LUnited States. Edwin Mansfield
No. 28 Trends in Private Investment in Developing Countries: Statisticsfar 1970-94. Frederick Z.Jaspersen, Anthony H. Aylward, and Mariusz A. Sumllliinski
No. 29 InternationalJoint Ventures in Developing Countries: Happy Alarriages? Robert R. Miller,Jack D. Glen, Frederick Z.Jaspersen, and Yannis Karmonkolias
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