Water and Payment of Environmental Services in Costa Rica

Ricardo O. Russo
EARTH University, Costa Rica
Presented at 21st Century Watershed Technology: Improving Water Quality and Environment.
International Conference organized by ASABE (American Society of Agricultural and Biological
Engineers) and EARTH University (Gucimo, Limn, Costa Rica) focusing on water quality.
21-24 February, 2010, Gucimo, Costa Rica

Abstract. Costa Rica has been a leader among Latin American countries in the design of and
development of a system of payment for environmental services (ES) to preserve its forests. Since 1997, a
program locally called Pagos de Servicios AMBIENTALES (known as PSA in Spanish, or Payments for
Environmental Services, PES in English), has been providing payments to farmers and forest owners for
reforestation, forest conservation, and sustainable forest management activities. Costa Rica's Forest
Law 7575 recognizes four ES provided by the forest ecosystems: i) Carbon sequestration and storage
(mitigation of GHG emissions); ii) Watershed protection (hydrological services); iii) Biodiversity
protection (conservation); and iv) Landscape beauty (for recreation and ecotourism). Furthermore, this
PES program has been an instrument of wealth redistribution that comes to fortify the family economies
in rural areas.

Keywords:Payment for Environmental Services, environmental services, watershed

protection, hydrological services, Costa Rica.

Introduction

In Costa Rica, there has been a shift toward more sustainable and integrated forms of water
resources management jointly with a noteworthy spread of ecosystem based financial instruments
as mechanisms of support for conservation activities. Payment for environmental services is one of
these initiatives. Since 1997, a program locally called Pagos de Servicios Ambientales (known as
PSA in Spanish, or Payments for Environmental Services, PES in English), has been providing
payments to more than 4,400 farmers and forest owners for reforestation, forest conservation,
sustainable forest management and agroforestry activities. This program has been recognized for
helping the country to achieve deforestation control and increasing forest cover since the early
2000s. Forest Law No.7575, enacted in 1996, explicitly recognized four environmental services
provided by forest ecosystems: (i) mitigation of greenhouse gas emissions; (ii) hydrological
services, including provision of water for human consumption, irrigation, and energy production;
(iii) biodiversity conservation; and (iv) provision of scenic beauty for recreation and ecotourism.
The law provides the regulatory basis to contract landowners for the services provided by their
lands, and establishes the National Fund for Forest Financing (Fondo Nacional de Financiamento
Forestal, FONAFIFO). The PSA Program is managed by FONAFIFO, a semi-autonomous agency
with independent legal status. FONAFIFOs governing board is composed of three representatives
of the public sector (one each from the Ministry of Environment, Energy and Telecommunications,
the Ministry of Agriculture, and the National Banking System) and two representatives from the
private forest sector (appointed by the board of directors of the National Forestry Office).
This paper emphasizes the experience of Costa Ricas PSA program in relation to hydrological
services, including provision of water for human consumption, irrigation, and energy production.

What Environmental Services Means

Traditionally, environmental services (ES) have been understood and defined quite narrowly in
terms of facilities that provide water and waste-treatment services, often by the public sector.
However, there is a need of moving beyond this stage, and to consider ES holistically.
Therefore, ES can be defined as a set of benefits generated for society by the existence and
dynamic development of natural resources or ecosystems, in this case with a particular interest
on tropical forests. Also, ES can be seen as a set of regulatory functions (on stocks and flows
of matter and energy) of the natural ecosystems and some agro-ecosystems that help to
maintain or improve the environment and peoples life quality (Odum and Odum, 2000; NRC,
2004). De Groot et al. (2002) define ecosystem functions as the capacity of natural processes
and components to provide goods and services that satisfy human needs, directly or indirectly
and additionally, these authors identified 23 ecosystem functions that provide goods and
services, making a contribution to the ecological understanding on ecosystem services and a
proposal for valuing them.
Although a wide range of ecosystem functions and their associated goods and services have
been referred to in the literature, De Groot et al., (2002) suggest that it is convenient to group
ecosystem functions into four primary categories: (1). Regulation functions: This group
relates to the capacity of natural and semi-natural ecosystems to regulate essential ecological
processes and life support systems through bio-geochemical cycles and other biospheric
processes; (2). Habitat functions: Natural ecosystems provide refuge and reproduction habitat
to wild plants and animals and thereby contribute to in situ conservation of biological and
genetic diversity and evolutionary processes; (3). Production functions: Photosynthesis and
nutrient uptake by autotrophs convert energy, carbon dioxide, water and nutrients into a wide
variety of carbohydrate structures which are then used by secondary producers to create an
even larger variety of living biomass; and (4). Information functions: Because natural
ecosystems provide an essential reference function and contribute to the maintenance of
human health by providing opportunities for reflection, spiritual enrichment, cognitive
development, recreation and aesthetic experience. Water and hydrological services are linked
to the four main ecosystem functions.
In the case of forests, they produce oxygen and remove carbon dioxide from the atmosphere,
regulate the surface and underground flow of water, smooth out peaks and troughs in water
availability, and provide very effective filtration systems for higher water quality
(FAO/REDLACH, 2004). Additionally, forests support a diversity of native flora and fauna,
and provide valuable goods and services, ranging from timber through scenic beauty.

Millennium Development Goals and Water Quality

In 2000, the United Nations established eight Millennium Development Goals (MDGs) with
the aim of speeding up poverty alleviation and socio-economic development by 2015: 1.
Eradicate extreme hunger and poverty; 2. Achieve universal primary education; 3. Promote
gender equality and empower women; 4. Reduce child mortality; 5. Improve maternal health;
6.Combat HIV/AIDS, malaria and other diseases; 7. Ensure environmental sustainability; and
8. Develop a global partnership for development. Water quality management contributes both
directly and indirectly to achieving all eight MDGs, but it is most closely tied to the targets of
Goal 7: a) Integrate the principles of sustainable development into country policies and
programs and reverse the loss of environmental resources; b) Halve by 2015 the proportion of
people without sustainable access to safe drinking water and basic sanitation; c) Significantly
reduce biodiversity loss by 2010; and d) Achieve significant improvements in the lives of at
least 100 million slum dwellers, by 2020 (UN, 2009). One of the key considerations in meeting
the MDGs is that water quality must be improved at all levels. A manner of avoiding the
degradation of water resources, and achieving MDGs, is the model of payment to providers of
ecosystem services from beneficiaries of those services as a way of reducing negative
externalities and protecting the resources. This concept of payments has received much
attention in various Latin American countries as an innovative tool for the financing of
sustainable management of land and water resources. FAO and other organizations have
promoted discussion and exchange of experiences on this issue by organizing specific events
such as the Regional Forum on Payment Schemes for Environmental Services at the Third
Latin American Congress on Watershed Management, held in Arequipa, Peru, 2003 (FAO,
2004). A complete description of the goals, targets, and indicators can be found at the
Millennium Development Goals website of the World Bank or of the UN Statistics Division
(http://www.developmentgoals.org/About_the_goals.htm ) (http://millenniumindicators.un.org/unsd/).

Valuation of Environmental Services

Environmental services valuation can be a difficult and controversial task. In conventional
economics it is generally accepted that measures of economic value should be based on what
people want or the amount of one thing a person is willing to pay. At present, the valuation of
ES in agriculture, forestry and natural resources, and also in relation to ecosystem services is in
a shaping state (Gutman, 2003; Lewandrowski et al., 2004), probably because of the term
valuing ES is often used as attaching economic values to ecosystem services which are treated
as public goods and therefore have no market value. Therefore, attempting to assign values to
ES presents several challenges because of the environment provides several services
simultaneously, and different types of value are measured by different methodologies and
expressed in different units, which involves subjective judgments (Fausold and Lilieholm,
1996). Although this review does not attempt to enter in a discussion on valuation, it is
important to say that people are not familiar with purchasing such services if they are not
specific stakeholders, then their willingness to pay may not to be clearly defined. However,
this does not mean that ecosystems or their services have no value, or cannot be valued in
dollar terms. Among most used methods for valuing ecosystem services are stated-
preference techniques (used to measure the value people place on a particular environmental
item. Examples include how much people would pay annually to obtain drinkable freshwater,
or to protect). These methods include contingent valuation and choice experiments. The
contingent method differs fundamentally from other conservation approaches because instead
of presupposing win-win solutions, this approach explicitly recognizes hard trade-offs in
landscapes with mounting land-use pressures, and seeks to reconcile conflicting interests
through compensation (Wunder, 2005). Additionally, there is a large body of literature about
valuation of ecosystems and environmental services (Costanza et al., 1997; ONeill, 1997;
Pearce, 1997; Daily et al., 2000; De Groot et al., 2002; Pagiola et al., 2002; NRC, 2004).
Perhaps the most important choice in any ecosystem valuation study is how the initial question
is framed. In some cases, water quality may be the key issue; in others, policymakers make the
critical decision to value all the services of the watershed. However, uncertainty can arise at
many steps in an analysis. For ecosystem valuation, one of the biggest sources of uncertainty is
the lack of probabilistic information about the likely magnitudes of some variables; economic
factors can introduce uncertainty as well (NRC, 2004).

The Program of Payments for Environmental Services in Costa Rica

The Program of Payments for Environmental Services (PSA) implemented in Costa Rica has
been an alternative approach to halt environmental degradation derived from deforestation
(Castro et al., 2000; Castro et al., 2001; Ortiz, 2002). Land and forest owners are paid for the
environmental services they produce when they adopt land use and forest management
activities that preserve the forest and biodiversity and maintain people's life quality. The PES
program of environmental services aims to protect primary forest, allow secondary forest
recovering, and promote reforestation of abandoned pasture and degraded lands (Rodrguez
Ziga, 2003). These goals are met by contracts of payments for environmental services with
individual farmers. The program functions like a funds transfer system from those who are
benefited of the environmental services toward those that produce such environmental services
(Mejas and Segura, 2002). It was designed as a financial mechanism to promote the
conservation of the forest resources of the country. It is a program where forest and plantation
owners are financially and legally acknowledged for the environmental services that their
forests provide to the community.
In all cases, participants must present a forest management plan certified by a licensed forester,
as well as carry out conservation, reforestation, or sustainable forest management activities
(depending on the type of contract) throughout the life of individual contracts (Camacho Soto
et al., 2002; Ortiz, 2002). The program was established in 1996, building upon previous
experiences in Costa Rica as well as an institutional framework dating back to 1979. The legal
basis for the program is Costa Rica's Forest Law 7575, which recognizes four above mentioned
ES provided by the forest ecosystems: i) Carbon sequestration and storage (mitigation of GHG
emissions); ii) Watershed protection (hydrological services); iii) Biodiversity protection
(conservation); and iv) Landscape beauty (for recreation and ecotourism). In addition, it has
also been proposed that the PSA be an instrument of wealth redistribution that comes to fortify
the family economies in rural areas (FONAFIFO, 2005).
An overview of how the program works has been presented by Landell-Mills and Porras
(2002). Briefly, the Ministry of Environment (MINAE), through FONAFIFO, is charged with
channeling government payments to private forestry owners and protected areas. Payments
vary according to the type of activity undertaken: reforestation (US$ 450/ha), forest
preservation (US$200/ha) and agroforestry systems (US$ 0.75/tree). Payments are made over a
five-year period. In return landholders cede their environmental service rights to FONAFIFO
for this period. When the contracts expire, landowners are free to renegotiate prices, or sell the
rights to other parties. They are, however, committed to managing or protecting their
contracted forest for 20 years (or 15 in the case of reforestation). Their obligation is recorded
in the public land register and applies to future purchasers of the land.

Water service payments

Forest Law No.7575 clearly acknowledged the role of forests in providing hydrological
services. Payments from hydropower producers and other water users were always seen as one
of the ways on which the PES program would stand; however, the Law does not compel
beneficiaries to pay for services. Any payments must be negotiated with potential service
buyers. FONAFIFO has dedicated substantial efforts to negotiating with water users for them
to pay for the water services they receive and has reached a number of agreements (Pagiola,
2006; Table 1).

Although Costa Rica does not normally face water quantity shortages, there exist water quality
and distribution problems that challenge to Costa Ricas communities and local governments
(Ortega-Pacheco, 2007). Water quality scarcity has also been attributed to uneven water
service distribution and deficient water treatment (Calvo 1990). For example, in 2008 only
83.4% of the Costa Rican population had access to a drinking water supply system and
approximately 26% of the water provided by Costa Rican municipalities and communities
failed to fully meet international standards of quality (Astorga 2009).
A first agreement, with hydropower producer Energa Global, was reached in late 1997 with
the assistance of FUNDECOR, an environmental NGO. Under this agreement, Energa Global
contributes to payments made to participating land users in the watersheds above the
companys two run-of-the-river powerplants. Similar agreements were reached a year later
with other hydropower producers, including state power producer Compaia Nacional de
Fuerza y Luz (CNFL). After a slow start, the number of financing agreements with water users
rose sharply, helped by the development of a streamlined process based on environmental
services certificates (Certificados de Servicios Ambientales, CSA) which are standardized
instruments that pay for the conservation of one hectare of forest in a specified area (Pagiola,
2006). Rather than negotiating each agreement on an ad hoc basis, FONAFIFO can sell
interested water users the appropriate number of certificates. Recent agreements include
bottlers, municipal water supply systems, irrigation water users, and hotels. The amounts paid
have also risen: early agreements saw water users paying for a quarter of conservation costs
(based on the notion that water services are one of four services that the law said forests
provide), while recent agreements involve water users paying the entire cost of conservation,
as well as covering FONAFIFOs administrative costs. Agreements with water users are
typically for five years.

Table 1: Contracts for provision of water services in Costa Ricas PSA program

Company Type of user Watershed / Area Area covered Contribution Contribution to Comments
by contract to payment to FONAFIFO
(ha) participating administrative
land usersa,b costs
(US$/ha/yr)
Energa Global Hydropower Ro Volcn Ro San 2,493 12 0 Signed 1997,
producer Fernando 1,818 10 renewed 2002
Platanar S.A. Hydropower Ro Platanar 1,800 15 5% of payment Signed 1999, renewed 2004;
producer 30 addendum on non-titled land users
signed 2000 for 10 yrs
CNFL Hydropower Ro Aranjuez 5,000 42 $13/ha yr 1 Umbrella agreement signed 2000,
producer Ro Balsa 6,000 42 $7/ha yrs 2-5 with addendums covering specific
Ro Laguna Cote 900 42 watersheds
Florida Ice & Farm Bottler Ro Segundo 1,000 45d $29/ha yr 1 Signed 2001, later modified to use
22d $4/ha yr 1 CSA
Heredia ESPH Municipal Ro Segundo Signed 2002 using CSA
water supply
Azucarera El Viejo Agribusiness Acufero 550 45 7% Signed 2004 using CSA
(irrigated) El Tempisque
La Costea SA Agribusiness Acufero de 100 45 7% Signed 2004 using CSA
(irrigated) Guanacaste
Olefinas Agricultural Acufero de 40 45 7% Signed 2004 using CSA
supplies Guanacaste
Exporpac Agribusiness Acufero de 100 45 7% Signed 2005 using CSA
(irrigated) Guanacaste
Hidroelctrica AguasHydropower Ro Aguas Zarcas 1,666 30 7% Signed 2005 using CSA
Zarcas producer
Desarrollos HotelerosTourism Acufero de 925 45 7% Signed 2005 using CSA
Guanacaste Guanacaste
La Manguera S.A. Hydropower La Esperanza 3,000 10 n.a n.a.
producer

Sources: After Pagiola, 2006; FONAFIFO website

In 2005, Costa Rica expanded the use of water payments by revising its water tariff (which
previously charged water users near-zero nominal fees) and introducing a conservation fee
earmarked for watershed conservation (Fallas, 2006).

The town of Heredia has established an environmentally adjusted water tariff, the proceeds of
which are used to pay landholders to maintain and reforest watershed areas (Castro and
Cordero, 2001; 2003). In a separate initiative, hydropower producer La Manguera SA is paying
the Monteverde Conservation League to maintain under forest cover the watershed from which
its plant draws its water (Rojas and Aylward, 2002).

At local, Ortega-Pacheco (2007) examined the institutional impact of watershed-based,

collective, and locally-financed PES programs, through the lens of the institutional economics
Situation, Structure and Performance [SSP] Framework, The study was focused on six
communities in Siquirres , Limn Province, in the Caribbean region of Costa Rica, that
operate their own collective rural aqueduct systems. Local administration and financing of
such drinking water systems is common in rural Costa Rica. The author found that
participatory and ecosystem-based management approaches might lead to more effective
protection of global water supplies; and also that every income segment of the local population
of water-users exhibited significant demand and willingness to finance the PES program to
protect local water quality (Ortega-Pacheco et al. 2009).
 Final Considerations

Payment for Environmental Services (PES) is rising as an inventive financial instrument with
both theoretical and practical opportunities for bringing positive change to environmental
management, preservation and conservation of water resources, as well as contributing to
sustainable development and alleviation of poverty at all levels

Proper management of watersheds is necessary for the protection of water resources and
ecosystems; in addition, quantifying ecological impacts of management activities, where
possible beyond a simple listing and qualitative description of affected ecosystem services is
also essential.

PES tools and spaces of discussion, including economic, social, environmental, gender, micro-
financing, market access and infrastructure should be developed and applied appropriately.
These tools would guarantee effective valuation of the natural resources, and enhance wider
participation of stakeholders including donors and recipients from public and private sectors as
well as local community members and private individuals.

Capacity building should be promoted. This may include arrangements for exchanging
initiatives to become trained at PES based on living examples in other communities, countries
and regions. Furthermore, teaching and learning processes for understanding the relationship
between PES and water resources in academic environments should be promoted.

References
Blackman, A. and R.T. Woodward. 2009. User Financing in a National Payments for Environmental Services
Program: Costa Rican Hydropower. Discussion paper 09-04. Resources for the Future. Washington, DC. 36 p.
http://ssrn.com/abstract=1345932
Astorga, Y. 2009. Situacin del recurso hdrico. Dcimoquinto Informe sobre el Estado de la Nacin en Desarrollo
Humano Sostenible. Informe Final. Programa Estado de la Nacin (PEN), San Jos, Costa Rica.
Calvo, J.C. 1990. Water resources development in Costa Rica 1970-2000." Hydrological Sciences Journal,
35(2):185-196.
Castro, R. and S. Cordero. 2001. Tropical forest and the emerging CO2 market. Investigacin Agraria Sistemas y
Recursos Forestales (Fuera de Serie No. 1):185-204.
Castro, R. and S. Cordero. 2003. Global trade for local benefit: Financing energy for all in Costa Rica. In Providing
Global Public Goods: Managing Globalization. Kaul, I.; Conceicao, P.; Le Goulven K.; Mendoza, R.U. (Eds.).
Oxford University Press. New York, US. p. 516-531.
Costanza, R., R. dArge,, R.S. De Groot, S. Farber, M. Grasso, B. Hannon, K. Limburg, S. Naeem, R.V. ONeill, J.
Paruelo, R.G. Raskin, P. Sutton, and M. Van Den Belt.1997. The value of the worlds ecosystem services and
natural capital. Nature 387:253-260.
Daily, G.C.; Sderqvist, T.; Aniyar, S.; Arrow, K.; Dasgupta, P.; Ehrlich, P.R.; Folke, C.; Jansson, A.M.; Jansson,
B.O.; Kautsky, N.; Levin, S.; Lubchenco, J., Mler, K.G., Simpson, D.; Starrett, D.; Tilman, D.; Walker, B.
2000. The value of nature and the nature of value. Science 289:395-396.
De Groot, R.S., M.A. Wilson and R. Boumans. 2002. A typology for the classification, description and valuation
of ecosystem functions, goods and services. Ecological Economics (Special Issue) 41:393-408.
Fallas, J. 2006. Identificacin de zonas de importancia hdrica y estimacin de ingresos por canon deaguas para cada
zona. FONAFIFO, San Jos.
FAO (Food and Agriculture Organization of the United Nations, IT)/REDLACH (Latin American Network for
Technical Cooperation in Watershed Management, PE). 2004. Electronic forum on payment schemes for
environmental services in watersheds (on line). 12 April - 21 May 2004. Final Report. FAO Regional Office for
Latin America and the Caribbean, CL. Available at http://www.rlc.fao.org/foro/psa/pdf/report.pdf
Fausold, C.J., and R.J. Lilieholm. 1996. The economic value of open space: A review and synthesis. Lincoln
Institute of Land Policy Research Paper. Land Lines Newsletter. September 1996. Volume 8, Number 5.
FONAFIFO (Fondo Nacional de Financiamiento Forestal, CR). 2005. FONAFIFO: Ms de una dcada de accin.
Fondo Nacional de Financiamiento Forestal de Costa Rica (FONAFIFO). San Jos, CR. 70 p.
Gutman, P. (Ed.). 2003. From Goodwill to Payments for Environmental Services: A Survey of Financing Options
for Sustainable Natural Resource Management in Developing Countries. Macroeconomics for Sustainable
Development Program Office. World Wildlife Fund (WWF) Washington, DC. 148 p.
NRC (National Research Council). 2004. Valuing Ecosystem Services: Toward Better Environmental Decision-
Making. The National Academies Press. Washington, D.C. 290 p.
http://books.nap.edu/openbook.php?record_id=11139&page
Lewandrowski, J., M. Peters, C. Jones, R. House, M. Sperow, M. Eve, and K. Paustian. 2004. Economics of
Sequestering Carbon in the U.S. Agricultural Sector. Economic Research Service (ERS), U.S. Department of
Agriculture. Wasthingon, D.C. Technical Bulletin No. (TB1909). 69 p.
Odum, H.T. and E.P. Odum. 2000. The energetic basis for valuation of ecosystem services. Ecosystems 3(1):21-23.
Ortega-Pacheco, D.V. 2007. Payment for Environmental Services in Eastern Costa Rican Watersheds: Institutions,
Public Participation and Demand. Master Thesis, Michigan State University, East Lansing. 151 p.
Ortega-Pacheco, D.V., F. Lupi and M.D. Kaplowitz. 2009. Payment for environmental services: estimating demand
within a tropical watershed. Journal of Natural Resources Policy Research 1( 2): 189202.
Pagiola, S., J. Bishop, N. Landell-Mills (Eds.). 2002. Selling Forest Environmental Services: Market Mechanisms
for Conservation and Development. Earthscan. London, GB. 336 p.
Pagiola, S. 2006. Payments for Environmental Services in Costa Rica. MPRA Paper No. 2010, Muenchen. 22 p.
http://mpra.ub.uni-muenchen.de/2010/
Rojas, M., and B. Aylward. 2003. What are we learning from experiences with markets for environmental services
in Costa Rica? A review and critique of the literature. Markets for Environmental Services. International
Institute for Environment and Development (IIED). London, GB. 100 p.
UN (United Nations). 2009. The Millennium Development Goals Report 2009. UN, New York. 56 p.
http://www.un.org/millenniumgoals/pdf/MDG_Report_2009_ENG.pdf