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    Feb 21 2014

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    Guest blogger: Worried about the drought? Let farmers buy and sell water

    Today’s guest blogger is David Zetland of the Aguanomics blog, who wrote this exclusively for Maven’s Notebook:

    Zetland“California is gripped by yet another drought. Citizens are concerned, farmers are desperate and politicians are looking for quick fixes.

    The quickest fix is to allow water trading in markets.

    The drought has reduced supplies. In the past, we would take water from the environment to allow business as usual. It’s gotten harder to take water from the environment, so the agricultural sector — which uses 80 percent of the “developed water” Californians consume — is getting squeezed.*

    Some farmers have responded by calling for relaxed environmental standards, pumping more groundwater from stressed aquifers or fallowing land. Those actions are unsustainable on environmental, economic, and social terms.

    Others farmers are using markets to reallocate scarce water.

    I’ve supported markets for water for about a decade now because they provide so many advantages:

    1. Markets make it easier to move water from those who have to those who need
    2. Markets allocate water based on price, which will maximize the value of water in use
    3. Markets prices to rise and fall according to supply and demand
    4. Market prices help farmers balance among water and other inputs
    5. Markets make it easier to choose conservation or fallowing
    6. Markets help farming communities get by without bailouts
    7. Market prices induce farmers to protect their valuable groundwater

    Markets do not just “pop up.” They work only with property rights, defined quantities of water and a means of transferring water from seller to buyer.A market among farmers in the same irrigation district is far easier to run than a market transferring water from north of the Delta to the south.Markets can take many forms. In many parts of the state, it is possible to establish a market overnight without waiting for outside approval (many are probably functioning right now.)

    Bottom Line: Markets will minimize the harm from the drought by allowing farmers to redistribute water among themselves, reducing pressure on aquifers, buffering rural communities, and turning down the pressure to DO SOMETHING in Sacramento.

    * Cities can buy water from farmers but they have plenty of water, if we take green lawns as a sign of abundance.

    Note from Maven:  You can read more from David Zetland at the Aguanomics blog.  A worthy bookmark!

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      1. Adan Ortega

        While I agree that water transfers have a role, what about efficiency-based transfers everywhere? It seems that the agricultural community is better equipped to follow this path than urban areas. DWR evaluates transfers of water that is conserved in ag by quantifying how much of a conservation practice represents true yield. This already provides a certain amount of flexibility facilitating ag to ag transfers. Urban conservation is all calculated but adds no real flexibility to a water system in terms of incentivizing people to conserve based upon the ability to monetize the true yield by allowing it to be sold to someone else. While this may happen in some adjudicated basins, it’s not available across the whole MWD system, or within the SDCWA system.

      2. dzetland

        Adan — I agree that conservation may “free” water that can then be sold elsewhere, but a miscalculation may lead to false savings that end up harming ground- or surface-water neighbors. My example concerned trades among farmers who share one source of water (e.g., SWP, CVP or any ID). Trades between IDs can work, as long as they are not accompanied by groundwater substitution. (CA needs to get its act together on g/w monitoring and rights.) As usual, I say start with small local trades. Expand by area (out of ID) and definition (conservation) AFTER we get some momentum and experience.

        1. dzetland

          ps/Good post from the LAO on g/w: http://www.aguanomics.com/2009/08/how-should-california-regulate.html

      3. Damian Park

        Nice that Water News picked this up. Did Maven solicit this piece?

        1. Maven

          Yes, I sure did. I thought David Zetland could add an interesting voice to the conversation …

      4. Wayne Lusvardi

        The amount of water has to be quantified first before it can be assigned a property right and then traded. Quantifying water in a state or federal reservoir can be approximated but legal rights probably can not be perfected in such reservoirs. It is water in the public domain and would have to be purchased and then re-sold.

        Once the water is spilled to irrigation districts, urban and industrial, and wildlife refuges then it possibly could be traded but it would be nearly impossible to quantify such downstream water. How much water in the San Joaquin River at any one time is Environmental Water? No hydrologist would probably venture a guess. Even environmental water advocate Peter Gleick has recognized the quantification problem.

        Another huge problem is the freerider problem. How can environmental water be sold by merely claiming a homestead or waterstead right on it without having to buy it first? Environmentalists want to reap a windfall re-selling Federal water allocated to wildlife refuges without first buying that water and paying for the parking rent in a reservoir until the water is sold. And then who pays for the conveyance fees (water wheeling costs)?

        The way the Federal Communications Commission handles this problem with radio spectrum is that it auctions off the spectrum first. Environmentalists would have to stand in line and bid at auction. Or would they claim they have a superior First Right of Refusal at a free price that farmers and cities do not have? Remember, water in nature is free but once in a water hydraulic system it has a cost. Who pays that cost? Right now farmers pay that system cost in their water rates.

        So farmers pay 100% for their water allocation each year to make sure that the costs to operate the system are underwritten. Then they get their 100% paid for water allocation cut to, say, 40%. Then environmentalists claim a right to re-sell the 60% of water diverted to the environment back to farmers that they already paid for.

        It would be like I paid the mortgage payments on my house for 20 years on a 30 year mortgage. And each year I keep making my payments. Then someone comes along and says they claim a 58% interest in my home without having to buy it from me. And they want to re-sell that 58% interest to someone else and reap a profit while I continue to make the full mortgage payment. Capish?

        The reason I use 58% in the above analogy is 58% is the amount of water diverted to the environment in the Central Valley each year since 1990. So farmers are already paying for 100% of the system cost of all the water, but they are only getting, say, 42% each year.

        Remember when sub-prime home loans were “sliced and diced” and re-sold as Mortgaged-Backed Securities? Once a hypothetical market in environmental water is created there would be “Waterbacked Securities” being traded that would be worth only a fraction of their face value because the people selling them never had any “skin in the game” in the first place. Sound familiar? Shades of Phil Angelides and his Laguna West development project.

        Those who are proposing an after-market in environmental water do not seem to have thought through their proposal very deeply. I dub them with the title of Thin Water Experts. Or maybe we should dub them the subprime water rights experts?

        1. dzetland

          Hi Wayne. I’m not talking about ag-enviro water sales. As you note, those are more complex and a later step. Australia’s well developed ag-ag market does not have a very good way to handle enviro-water sales, esp. when the government is the buyer or seller.

      5. Wayne Lusvardi

        I should have added in my prior comment that the creation of a water market has already been accomplished by the much-criticized Westlands Water District since 1996. Westlands has one of the most advanced water metering and pessurized agricultural piping systems in the world. This allows it to deliver water on demand.

        18 years ago Westlands put into place an electronic water marketing system called WaterLink that allows users inside its district to buy, sell, and re-sell water in real time with computers. They post available water for sale, post bids, can find average water prices, and negotiate pricing online. They schedule their own water deliveries.

        Through this e-trade system, they have reduced transaction costs to a minimum (no water auctions, no lengthy and cumbersome bureaucratic water transfers, etc).

        A water bank and the water market in Westlands restricts trading of pumped groundwater as I understand it.

        Westlands has mostly junior water rights that disproportionately affect it during droughts. And the portions of Westlands with the most junior water rights ironically have some of the highest crop yields; those with senior water rights have less productive land. So intra-district water trading works, especially in a drought.

        So it is in the much criticized corporate farms, such as Westlands, that market markets have been established and have resulted in greater water use efficiency. Family farms (less than 160-acres) in the Central Valley are unable to cobble together such a network.

        The proposal for urban water markets mentioned by Adam Ortega would essentially be a cap and trade system, which would be very unwieldy and probably unpopular. Would water customers want to trade something like old S&H Green Stamps, water coupons, or water Bitcoins for the excess water they do not use?

        Let’s imagine a water cap and trade system being set at the retail level between each of the cities in Southern California. Each city can sell excess water it does not use to another city that has a deficit of water. So let’s say Poor City has an excess of water and is running a municipal budget deficit due to unmet obligations in public pensions. So it would be tempted to sell its excess water and reap a windfall that it could, in turn, divert into its General Fund to pay pension costs. But then a 5 year drought hits. Poor City sold its excess water to Rich City and now has no water banked for the drought. Trouble City.

        1. dzetland

          Hi Wayne. Yes, I know of Westland’s market (although I heard that they replaced the BBS system with brokers; not sure of what they’re doing now). Your strawman questions about urban water markets fall apart if cities LEASE rather than sell their water. I’m sure that you will want to take another look at Chapter 7 of my diss on Met (http://ssrn.com/abstract=1129046) to see how I describe a market for urban water in SoCal.

      6. Wayne Lusvardi

        Thanks for the clarification David. I did not mean to insinuate that you advocate for water auctions for environmental water. But high prices set by the fever of water auctions under the duress of a drought and zero water allocations may influence those trying to set prices on environmental water for re-sale. Sort of like saying that subprime loan bubble housing prices affected conventionally financed home sales prices.

        And yes I should have clarified that the Westlands WaterLink system is no longer operating.

        It should be clarified for everyone listening into the conversation that prices resulting from an All-In Water Auction, such as occurred recently in Kern County, at about $1,200 per acre foot for over 200 AF of water, reflects duress sale conditions in a drought transacted by the fever of an auction. Such prices would not meet the requisite legal conditions of Fair Market Value (non duress sale conditions, knowledgeable and willing parties, etc). Any after market for environmental water would probably have to be bound to sell at Fair Market Value, not a water bubble price.

        This poses a huge Goldlilocks problem of what is the price of water that is “not too high” and “not too low” where there are few market transactions to tell us where Fair Market Value might be.

        1. dzetland

          Wayne — I disagree that those are not “fair” values. Bidders are EXTREMELY qualified to appraise the value of scarce water. I think you may want to tell MORE people about those results, as an example of success, instead of wishing for cheap water. Prices will go up with scarcity and down with abundance :)

      7. Wayne Lusvardi

        Bidders who bid $1,200 per acre for 200-acre feet of water due to drought to protect their investments in orchard plantings are duress buyers. Such buyers ARE very knowledgeable buyers but the price can’t be considered for Fair Market Value because market conditions are atypical and compel buyers to buy where they otherwise would not.

        David my expertise is not agricultural appraisal but I did appraise farmland and water rights for MWD as well as hire many well qualified ag appraisers wherein I was the review appraiser. I completed many professional courses on agricultural appraisal from the California Association of Farm Managers and Rural Appraisers.

        I don’t wish low or high values for farmers, just fair values as I stated.

        1. dzetland

          Wayne — you’re right that conditions were tight, but so are conditions for real estate in San Francisco or Beverly Hills. Price rations demand, and $1200/af did its job. The definition of “fair” may vary from buyer to seller, but I’d rather leave that number to a market instead of politicians or bureaucrats.

          You’ve argued — and I agree — that water is misallocated and misvalued as a result of political interference and favoritism. You’ve argued against further distortions (via environmental definitions), and I agree. Don’t throw out the baby of market pricing and allocation with the bathwater of a farmers upset that they can’t get the cheap water they are used to (and we’ve been paying for).

      8. Wayne Lusvardi

        Good enough David. So we should throw out your advocacy of over-priced water to incentivize conservation as a market distortion as well. You can’t have it both ways. If market distortions due to too low water prices are unacceptable then distortions due to overpriced water should also be opposed.

        What I am driving at is that in any re-sale of environmental water it would likely have to be priced at Fair Market Value as codified in existing California law. If not then farmers not only would have to pay double for such water but would have to pay the “environmental premium” that results from reducing the supply of water by 58% in the Central Valley since 1990. If supply is reduced 58% but demand remains roughly the same then prices have to go up. This is called “project influence” in legal terminology.

        For those who dislike insider trading or conversely the Federal Reserve manipulating the purchasing power of the dollar, they should not like environmental water being high priced due to court ordered diversions of water to the environment. This is not a non-compensable regulatory taking of water it is also a public project (The San Joaquin River Restoration Project) of which the farmers are contributing to the costs. So the regulatory order and the public project cannot be easily disentangled.

        Let’s say I am Caltrans and I am extending a freeway ramp through a part of your property which greatly enhances the value of the remainder of the property for retail use (gas stations, fast food, etc.). Should Cal-Trans be forced to pay the higher land value it created? No, says the law. Conversely, neither should farmers be compelled to pay a higher price for water that the seller has created.

        So let’s say the PPIC advocates $1,200 per AF for enviro water based on your advocacy that auctions reflect a market (they don’t). If we price water at that price how many bids do you think will result? Zero, except for buyers being held to buy at hostage prices to protect their investments in their orchards or crops in place. And once again, that is not Fair Market Value. What you and other water economists are advocating is selling water in a negotiated transaction for enviro water or an auction that reflects a hostage price (“take it or leave it”). That is not a market; it is a monopoly value.

        If you hate Big Farming you whoop it up that farmers finally had to pay the so-called real price of water after getting low-priced water and crop subsidies for decades (whoopee!!!!). Call it “environmental justice” or whatever. But once again, I don’t believe as a matter of public policy environmental water can be sold back to farmers at “project influenced” prices loaded with an “environmental premium” due to constrained supply. Neither do I believe that enviro water should be sold by all-in auctions because of the pricing fever of auctions and the desperation of farmers in a drought.

        A malor reason that “SOME” Central Valley water is priced low is that the infrastructure is old, already paid for, or still being paid off at its original cost. If MWD has to rebuild the Colorado River Aqueduct and Parker Dam today (if it could get an approved EIR) the cost of water would be many times what it is today for Southern California. We can call that a subsidy or a price disparity. Political liberals don’t like price disparities unless it is a disparity that sticks a fork in farmers or bankers. To real estate appraisers they are just trying to find Fair Market Value regardless of the politics or price distortions caused by public projects.

        The reason that Westlands had to return to using water brokers is probably the variability of water prices for different uses in differing seasons, etc.

        At $1,200 per AF of water, land values in the Central Valley would collapse overnight. Local governments would suffer a loss in property taxes. But there would be “environmental justice?”

      9. Damian Park

        Regardless of price fairness – keep in mind that the options to the farmers right now are water at $1200 or no water at all. There isn’t a third option of water at a “fair” price.

        1. Wayne Lusvardi

          Damian
          Precisely. But what price should environmentalists sell water back to farmers for? Not the hostage price of $1,200. Nor even $400/AF.

          Legal experts will say that higher ag water prices are due to a non-compensable regulatory taking. But there is a public project involved in this situation — the San Joaquin River Restoration Project – that the farmers have paid $180 million in enviro mitigations. So that would mean that any state sale of enviro allocated water back to farmers could not be for the $1,200/AF by auction or the $400/AF set by some water economist who believed “enviro water is undervalued.”

          As for water markets, they aren’t markets that have loaded in them the public policy premium to encourage conservation. That isn’t a market either. It is a policy price or planner’s price.

          The State LAO is out calling for higher priced water today. That is public policy. Not markets. Higher prices may not even be necessary if there was enough trading allowed.

          The LAO also wants more conservation at the local level — this is a death knell for urban water basins that need homeowners to water their lawns to recharge water basins that make up 30% of Southern California’s water supply.

          More on this in due course.

          We have to thank Maven for creating this venue for an important discussion that isn’t being addressed elsewhere.

          1. dzetland

            Wayne — You need to do a better job listening to people. Damian and I are talking about an Ag-Ag transfer. I put a link in the original post, but here it is again: http://www.aguanomics.com/2014/02/now-thats-market.html. FYI, I am linking to your hydrowonk post on Friday, so yes, we’re listening to you.

            NOW, can we talk about the benefit of fair markets instead of political interference and corruption? If you want to do that, then aggies are going to look WAY worse than enviros…

            1. Wayne Lusvardi

              Truth can’t be found by filibustering and accusing others of not listening.

              I made it EXPLICITLY CLEAR that I have been discussing the specific issue of what the market pricing of ENVIRONMENTAL WATER should be if sold back to FARMERS who had already paid once for that water to keep their annual water allocation without any PROJECT INFLUENCE (if any) of the 58% reduction in water supply from the PUBLIC PROJECT of the San Joaquin River Restoration Settlement of 2006 and Act of 2009. I have written three articles on this for public discussion to a nationwide audience.

              The farmer to farmer pricing of water is not my issue. Never has been, except for those who want to tack a price premium on water for conservation (that’s not me). I don’t think a CONSERVATION PREMIUM is wise but if the state imposes it by fiat then that is FIAT PRICE, not a market price. That is all I have been saying.

              Those who call for markets loaded with distorting CONSERVATION PREMIUMS would not reflect a market pricing. Same goes for under market pricing of water (which is the status quo).

              I also believe that the sale of a puny 12,000 acre feet of water by the Buena Vista Water District in Kern County at $1,200/AF reflects a hostage price to growers who as I understand it needed the water to protect their investment in crops already in the ground and in groves. So in my humble opinion the market of a tiny few growers who are desperate to protect their investments in the ground should not be declared to be “Now That’s a Market!”

              I am injecting the legal concept of Fair Market Value into the discussion: a willing buyer and seller, both acting with full knowledge and without COMPULSION.

              The reason I have injected Fair Market Value into the discussion is that environmental water market advocates are floating prices of $400/AF for Environmental Water which may not (or may be) the Fair Market Value of water. Such environmental water market advocates (not David Zetland) may be influenced by unintentionally misleading third parties to believe that $1,200/AF water prices reflect the market pricing of water.

              A government agency (USBR) would probably have to set the price on any such environmental water and it should not be set by the FEVER PRICES of desperate buyers from all-in auctions; or from prior water transfers where the price has been inflated due to less supply as a result of diversions of water to the environment; or from under market water rates set by USBR.

              My background for my positions comes from actually selling agricultural land by auctions, appraising agricultural land, leases, and water rights, my involvement for a large public water agency in the Palo Verde Irrigation District/MWD voluntary land fallowing program, and experience in eminent domain valuation of property for public utilities and redevelopment agencies.

              Thanks for listening and reading.

              1. dzetland

                Oh, so you’re a thread hijacker? Not cool.

        2. Wayne Lusvardi

          Dream on of $1,200/AF prices as system wide price. 12,000 AF of water auctioned in Kern County is only 0.02% of developed water supply in a dry year.

          Meanwhile Modesto ID is selling water @ $400/AF and water continues to be sold through the CVP and Irrigation Districts at cost (sometimes what? $20/AF?). @$1,200/AF the California ag economy would collapse. Marxist like dreams of killing off the greedy Kulaks.

          Also see
          California’s Cap and Trade Water Proposal – Part 1- A Planner’s Market
          California’s Cap and Trade Water Proposal – Part 2 – Sky High Water Auctions
          @MasterResource.org

          1. dzetland

            Wayne — you, a RE appraiser, of all people should know that prices vary in time and place. The “same” house is worth more in Bev Hills than Compton, just as the price goes up and down with the economy. Check out prices for high (=exch contractors) and low security (=Westlands) water licenses in Australia’s Murray-Darling. They vary by a factor of 2-5.

            You’re not helping people understand how markets work with your exaggerations, and I wonder at your motivations. Are you writing pro-bono (like me) or are you paid by any organization with a stake in these matters? I’m expecting Mike Wade to show up next…

      10. Wayne Lusvardi

        David
        It is UNECONOMIC to farm any crop at $1,200 per AF water. More on this later.

        1. dzetland

          I’ve got 28 farmers who disagree with you:
          Amin Orchard
          Cal Heavy Oil
          Cal Pistachio
          CAPS
          Cawelo Water District
          Chapparel
          Elex Farm
          Grimmway Farms
          Harris Ranch
          Horizon Nut
          John Antongiavanni Jr.
          Kern Westside
          Kern-Tulare Water District
          Munger Bros.
          Paramount Farming
          Primex
          Rainbow Orchards VI
          Rod Stiefvater
          Royal Farming
          Rudy Hernandez
          Sandridge Farms
          Starrh
          Stiefvater Orchards
          Sunnyview
          Virvi Almonds
          Webster Pistachios
          Westchester Group
          Wheeler Ridge Maricopa

          1. Wayne Lusvardi

            David
            I’m not finding it productive to engage you in a discussion. So I will just talk to the readers here.

            Let’s take the cost of farming walnuts with data supplied from U.C. Davis Cooperative Extension (“Sample Costs to Establish a Walnut Orchard and Produce Walnuts,” U.C. Davis 2012).

            Farm Tract: 105 acres
            Income from production per year $3,360/acre
            Total costs per year per acre $2,517
            Total profits above costs $843

            U.C. Davis reports irrigation water cost of $42/AF for groundwater or $138 per land acre per year or 3.3/AF/water/land acre per year

            Now let’s take the $1,200/AF auction water x 3.3/AF= $3,960 land acre/year

            Auction water is 2,045% higher or $3,855/per land acre than groundwater

            Economic Feasibility Test
            Net Profit Above All Costs: $843/acre
            Minus Auction Water Cost:($3,960/acre)
            LOSS: $3,097 per land acre

            Walnut growing at $1,200/AF Auction Water is UNECONOMIC

            However, total planting costs @$4,705/acre x 105 acres = $494,025
            Cost of Auction Water is $1,200/AF x 3.3 x 105 acres = $415,800

            So it is relatively cheaper to buy the $1,200/AF water than replant the orchard but it is still UNECONOMIC because the walnut grower has to take a loss on his $494,025 initial planting cost investment

      11. Wayne Lusvardi

        AND THE 356,250 WATER TRADES SUMMARIZED BELOW DISAGREE WITH YOUR 20 FARMERS

        SNAPSHOT OF WATER SPOT MARKET FROM 2000 TO 2010
        CENTRAL CALIFORNIA – Q1 2011
        METRICS 2000 TO 2010
        Mean Price $160/AF
        Median Price $135/AF
        48-Month Range $25 to $500/AF/Year
        24-Month Range $50 t0 $450/AF/Year
        Volume Traded 403.500 AF
        Average Annual Volume Traded $57,000,000
        Source: West Water Research, Inc.

        1. dzetland

          Wow. You really don’t get it. Amazing.

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