Groundwater problems and prospects, part 8: Economic issues and challenges of groundwater resources

Howitt SliderboxDr. Richard Howitt says in the Central Valley, groundwater is all about economics

This year’s California Water Policy Seminar Series, presented by the UC Davis School of Law and the Center for Watershed Sciences, focused its attention on the issues and challenges surrounding implementation of the new Sustainable Groundwater Management Act. The legislation, signed by Governor Brown last fall, set in slow motion a process to regulate most of the state’s groundwater basins.  In this lecture, the last in the series, Dr. Richard Howitt, Professor Emeritus of Agricultural and Resource Economics at UC Davis, discusses the economic implications of groundwater management in the Central Valley.

Dr. Richard Howitt

Groundwater is a capital asset,” began Dr. Howitt. A capital asset in economic terms is a type of asset that has a role in contributing to the business’s ability generate a profit; it is generally expected that benefits from a capital asset will extend for a long period of time. “If you’re using it too much, you’re depreciating your asset faster than it can stabilize, so anytime your pumping on average, over a ten-year average, more than the natural recharge, and that’s partially comes off the mountains and partially from the irrigated land overlying, your depleting this asset,” he said.

There are several reasons to stabilize groundwater levels, such as to prevent or mitigate the environmental impacts, to prevent subsidence and infrastructure damage, to protect water quality, and to preserve the water as a reserve stock, he said. “It’s also about intergenerational equity,” he said. “You are depleting the ability of the next generation to farm they way they want to; it’s cashing in the inheritance that you have to give. But even if you look at it from a cold hearted capitalistic viewpoint, the value of the farm as a business will be lower if the groundwater is less available and of poorer quality.”

The other thing to be considered are the pumping costs, but all of it gets it to economics in the Central Valley, so my argument is we should be looking at the economics,” Dr. Howitt said.

Howitt_Page_04He noted that nearly all basins designated as “high priority” have over 60 foot drawdown, and that the direct environmental impacts of further drawdown are negligible. “Opposition to SGMA comes largely from concern about the economic cost of stabilization, so for most of the Central Valley, it’s all about the economics,” Dr. Howitt said.

Current groundwater correlative rights are an example of the tragedy of the commons. He explained that he owns property with a well, and there are absolutely no limits to what he can pump. “I pump what I want to pump. I pay the electricity charges and that’s it. Now my neighbor has a large farm and he has decided to put in a new orchard in the back run by a new well. My well is about 300 feet deep, and his deepest well is 1500 foot deep. So we’ll see how that works out,” he said.

The law defining and enforcing western resource property rights has evolved as resource scarcity justifies increasing complexity of rights, he said. “The LA Basin never used to price air, now they price clean air. We’re thinking about pricing water, and the cost of doing that are really important,” he noted.

One of the problems is measuring groundwater and the costs of doing so, both political and financial, he said. “But it’s done in every other state, and it’s been done in some places in California, of most note are Orange County and Santa Clara County where they’ve been forced for various reasons – natural forces to deal with this problem some time ago. One was salt water intrusion in Orange County and one was flooding of high value tech plants in Santa Clara, and so they have both run a groundwater management program for some time, Orange County for over 30 years now, very successfully.”

Dr. Howitt explained that in Orange County, they don’t restrict how much their groundwater pumpers can pump, but they do measure how much is pumped. “You’re free to pump what you like, but the minute you go over your safe yield, we will charge you whatever it costs us to put the water back,” he said. “It’s a very simple system, to me, blindingly fair, and has run for over 30 years through three major droughts now. Each time they’ve drawn their asset down, which is the correct financial thing to do, and then built it back up. And so my point is, don’t get too fussed about it, just drive to Orange County and asked them how they do it.”

Howitt_Page_05So it can be done, and it is being done in a few places, and it’s not that hard, but you do have to measure the wells or the pumping or you have to estimate it from the crops,” he said.

Dr. Howitt also noted there is a distribution of capital in wells. “When you put a well down, you plan that the actual well will last for about 50 years, depending on the casing and depending on who drilled it. You replace the pump every ten to twelve years, depending on the sand content.”

In terms of groundwater and economics, there are a lot of questions, he said. “What level should you try and stabilize the water at and given the target depth, how fast should you stabilize? Everyone is pumping and at what depth shall we stabilize it, because if it’s it too high, you’re wasting an asset. There’s a certain depth you can pump it down to and then after that, it becomes costly in the long run; in the short run, it looks good, particularly if you’re not paying your bills – you’re not paying for the capital cost of the asset, you’re mining.”

Howitt_Page_14Groundwater is a capital asset sitting there, and as long as its more profitable to pump that out and turn it into wheat or almonds or corn, then the cost of pumping the water from that deep of depth is brought back in both security and discount rate, then you should utilize that capital asset, but there’s a point where we should stabilize,” he said.

He defined marginal private benefit of pumping is the marginal product of the least valuable crop grown with groundwater. “This is the value of wheat or perhaps it could be cotton, and it’s going to be somewhere around $17 to $18 an acre-foot, current prices and costs,” he said. “It is the least valuable you give up first and that’s the private benefit.”

There is a cost to society which are the pumping costs plus the asset costs plus the cost of subsidence and water quality degradation,” explained Dr. Howitt. “There are two other costs which the farmers get. There’s the cost of stranded pump capital when the level drops below the pumps, and then there’s the cost of not having the reserve for your perennial crops when you need it, so we call that the buffer costs and the stranded capital costs. We can calculate what the marginal cost is, and we put it into those economic formulas.”

If I’m the person with the deepest well here, and I pump like crazy and I lower the water and extract one acre-foot from under my property … and the water in the soil falls approximately three or four feet, that creates a depression and so the water from my neighbors flows in and equalizes over time,” he said. “I only pay if I’ve got neighbors and the cost that I’m imposing is not on myself. I’m doing what the correlative rights says you shouldn’t do, I’m imposing an externality on my neighbor’s pumping. So if I do that to my neighbors, what are my neighbors going to do to me? The same. And so everybody overpumps … That is the tragedy of the commons.”

Dr. Howitt explained that the marginal social cost of pumping is the present value of pumping from a deeper depth; the marginal cost depends on the storativity of the aquifer, the average rate of extraction you can do in perpetuity, and the discount rate. “And so we have marginal private benefit, marginal social cost, and we should equate those if possible. The optimal depth is where the marginal net benefit is equal to marginal social costs. And there is in every basin, and every overlying urban or agricultural economy utilizing that groundwater at optimal expected depth of stabilization.”

Howitt_Page_16There is also the capital costs of the wells to be considered; with about 1 million wells in the Central Valley, that’s about $40-$50 billion in installed capital – about three times the cost of high speed rail, Dr. Howitt said. “If you have an average expected life of 50 years, at 10%, it’s $4 billion,” he said. “The critical thing is not how deep the well is, it’s how deep the most shallow screen going into the well is. If groundwater depth is falling faster than envisaged when the well was drilled then wells will go dry in drought years, and it often means a permanent loss of sunk capital … and short term drought crop losses can be very costly.”

Howitt_Page_17He then presented a graph of the well depth distribution, noting that this came from well logs which provide data on where the screens are and other data. “This is the cumulative probability distribution of the depth above the baseline of the wells, and fundamentally it says a 50 foot drop in groundwater can strand 10% of the wells in the area. Remember the picture of the groundwater drops between 2013 and 2014? We had about a 40-foot drop. We are going to get that this year. And this is a significant cost. It’s the capital cost of groundwater dropping faster than the expected rate.

Howitt_Page_18Dr. Howitt then presented an example of three different crops: almonds, tomatoes, and wheat; the revenue per acre-foot at this year’s prices was $1700 for almonds, $500 for tomatoes, and $135 for wheat prices. He noted that the higher yielding crops are the more risky ones, so much like a retirement account, a farmer should have a portfolio of crops that balances riskiness against expected returns. “The probabilities of having wet and normal years and dry years and drought years are such that on the average we will pump 2.75 acre-feet, but actually adding together recharge at the 2.01, so we have a groundwater overdraft expected at .3 million,” he said. “So what can we do that to utilize this concept of a buffer value, and keep our perennial crops there.”

Howitt_Page_19He presented the results of the portfolio ran under different years and under different policies. He noted that if you have no management and just let thing go, you get a certain amount of overdraft and profit; if you have a fixed pumping cap, there is a much higher income loss and drop in acres; or with a buffer stock, you have a much lower income loss, but you have stabilized the water and you have most of the land in production.

My preferable way is to take the Orange County solution and allow farmers or cities to trade water over time, because that’s the time we live in,” he said. “We live in a Mediterranean climate – there’s wet years and dry years and everything in between, so farmers retain their unused groundwater or buy it from their neighbors such that they have a buffer stock and they can keep full production of both their almonds and their tomatoes, but they have to give up their wheat in the wet years to allow that water to recharge.”

This goes back to the concept that nobody in the valley wants to hear, and that is that we have to reduce the net evapotranspiration use of water to stabilize the system,” he said. “Here we can do by switching water over time if we have the property rights and the ability to do it.”

We want to avoid if possible adjudication costs,” he said. “We want to have it possible local management because groundwater basins are different. We must have a system that’s perceived as equitable amongst overlying users, if possible avoid punitive fees and taxes, and by punitive fees and taxes I mean taxes and fees which are over the expected costs, and we have two really nice working examples, the Orange County Water District and Santa Clara Valley.”

Orange County had to address groundwater issues back in the 1950s due to sea water intrusion. “They had lots of money, they had the Santa Ana River which they turned into a recharge system, and they said we won’t adjudicate, we won’t regulate, we will measure and assign people a pro rata safe yield of the basin, and if they pump more, go ahead, but we’re going to charge the expected average cost of recharging that water in the future and this is what they call a replenishment charge,” he said. “We define the values and the average safe yields, we then pro rate the safe yield by overlying area, measure everything, and say pump as much as you like, but if you pump more than your social share, that’s alright, but you have to put it back, and this is what it’s going to cost you. The beauty about this is that there are no restrictions on individual pumping so it allows you to utilize this drought after drought, there’s no regulation except there’s measurement and enforcement, and it’s equitable.”

Howitt_Page_22And it has worked for over 30 years,” he said, presenting a graph of groundwater levels in Orange County, noting that during the severe drought in 1977 and in 1991, they drew the basin down but then they put it back. “The point is that Orange County manages groundwater without adjudication, with minimal regulation for over 30 years in a difficult situation.

One solution for measuring groundwater use is to use remote sensing, Dr. Howitt said. “We can essentially measure the evapotranspiration net water use from a 40 meter by 40 meter pixel every 14 days from outer space for a few cents per pixel, and so we can measure water, theoretically,” he said. “If we know what the surface water is, we can net out groundwater.” He noted there are many advantages: it’s uniform, it has low transaction costs, it’s easily understood, accepted by the courts, and it has errors, but they are the same for everybody.”

Howitt_Page_24He then presented a slide showing a test of the system in the Delta. “Fundamentally, it was really accurate,” he said. “What we could do to actually measure not only the total water use by field, but we could actually measure the variation within the fields.”

Dr. Howitt then gave his conclusions:

  • Economic benefits from management are: Power, Capital and Buffer stock costs
  • For many basins it is in the economic interest of agriculture to define property rights and stabilize groundwater.
  • Basin stabilization must enable flexible pumping for the drought buffer role.
  • Orange County WD pricing system is simple, equitable, and has been shown to work well.
  • Remote sensing methods hold promise for low cost consistent water measurement.

That’s my take on groundwater management,” he concluded.

During the discussion period, Dr. Howitt was asked to give his thoughts about the groundwater legislation as a resource economist/agricultural economist and as to the likelihood that it will succeed in accomplishing its legislative objectives, or not.

It’s really iffy,” said Dr. Howitt. “I am also from a narrow discipline point of view, but where’s the economics in this … for most of these basins, it’s all about money. It’s really about, ‘I don’t want to give up my pumping’ … what do I think about the Act? I think it’s an extraordinarily good idea, more so, I think it’s absolutely essential to the long-term well being of California. … What I was trying to do with the appraisers in Modesto was to convince them that it’s in their self-interest. Not immediately, but yes you’re going to have to bite the bullet and cutback and take some costs, but you will stabilize your system. You cannot expand these high value crops any more without coping with the groundwater because the groundwater is the critical buffer value resource. Frankly I think this buffer value and capital value of the wells is probably going to be politically more important than the actual pumping costs; the pumping costs you can throw the money at. The wells are like the unemployment statistics; if you’ve got a bunch of farmers saying you rotten people, you’ve made my well level dry and I’m destitute, that has some political resonance because it is patently and clearly inequitable, and so my job as I see it, is to try and convince the people I talk to, both urban and agriculture, that it’s really in their self-interest.”

The interesting thing is about two or three years ago, Jay and I were writing a book, we had some off-the-record meetings in the valley and we got a group of big, big capitalistic pumpers who came to talk to us, and without exception, they all said, you’ve got to have some sort of groundwater management,” Dr. Howitt said. “But now we’ve got it, thank goodness. I personally can make what is an essentially bullet proof case that it’s in their self interest in the long run, and what do I mean by the long run? We’ve run a few models out, about the first 15 to 20 years, you will actually have lower net revenues, but from then on, you’ll be making more money.”

For more information …
For more from the California Water Policy Seminar Series …

This is the third year that Maven’s Notebook is covering the lecture series at UC Davis.  Previous speakers have included John Laird, Mark Cowin, Felicia Marcus, Tim Quinn, Jay Ziegler, Ellen Hanak, Michael Lauffer, Ronald Robie, Harrison ‘Hap’ Dunning, Michael Rosenzweig and many more.  You can access all coverage from all years in the archive here:  California Water Policy Seminar Series Archive

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