GROUNDWATER MARKETS: A case study of the Fox Canyon Groundwater Market

The Nature Conservancy’s Sarah Heard goes through the mechanics of the market, the first to be formed since the passage of SGMA

A water market is much like a stock market for water​, but instead of ​trading stocks and bonds, sellers in water markets offer short- or long-term ​transfers of water.  Water ​trading can be an effective tool for water managers to provide flexibility in the allocation and use of water by moving water to where it is needed most, especially during times of drought. Water transfers can also help accommodate shifts in water demand over the long-term.  However, water markets must be carefully designed so they function effectively while avoiding adverse impacts to other water users or unreasonable impacts on the environment.

Sarah Heard is Director of Conservation Economics & Finance with the California chapter of The Nature Conservancy where she does market-based work on strategies to support the biodiversity of the lands, waters, and oceans by incorporating economic and financial tools.  At the Groundwater Resources Association’s Western Groundwater Congress, Ms. Heard gave this presentation on the Fox Canyon Groundwater Market, the first groundwater market since the passage of the Sustainable Groundwater Management Act.

The Nature Conservancy has been working in Ventura County for almost two decades; the last threee years, they have been working on developing a groundwater market with Fox Canyon Groundwater Management Agency.

Ventura County has the last free flowing river in Southern California, the Santa Clara River, and some of the last best wetland habitat in the region,” she said.  “We feel very strongly that agriculture is compatible with our conservation goals, and so we have acquired over 4000 acres of agricultural lands.  Those lands come groundwater allocations, so we have been very involved in the creation of a Groundwater Sustainability Plan for Fox Canyon, and we really feel that the GSP is the most important way to ensure basin resilience.”

The Fox Canyon Groundwater Management Agency is in Ventura County in Southern California and is one of the most productive agricultural areas, not just in California but in the country.  The 55,000 acres of prime farmland is used to grow high-value crops such as berries, avocados, lemons, and many others.  It’s also an area that’s highly dependent on groundwater.  The area has been managed by the Fox Canyon Groundwater Management Agency, a special act district that was formed in 1982 to address seawater intrusion.

There are 500 agricultural wells that have been metered since 1987 and there have been groundwater allocations since the 1990s.  Despite these efforts, two of its basins, the Oxnard and Pleasant Valley basins, are critically overdrafted, so they are working to meet the deadline on January 31st.

WHAT IS A GROUNDWATER MARKET?

A groundwater market is a tool to implement the groundwater sustainability plan (GSP).  Simply put, it’s a cap and trade scheme where the cap is represented by the sustainable yield or the total amount of pumping that can be allowed in the basin, and the trading happens at the allocation level between individual water users, she said.

We see this as a more alternative approach to just command and control,” said Ms. Heard.  “Everybody gets an allocation, and it you go over that allocation, you are required to pay surcharges.  It also provides an alternative source of revenue.  If you have more water than you need, you can sell it, and that can compensate you for forgoing planting.”

She presented a diagram to illustrate the concept.  Everyone gets an allocation, and if a grower exceeds their allocation, they would then pay a surcharge.  With a market, if a grower needs more water, he/she can buy water from another grower and change their allocation legally so they don’t have to pay the surcharge.

ENABLING CONDITIONS

The Fox Canyon groundwater market is the first under SGMA.  The market came about through grass-roots efforts by the growers in the basin who had been struggling with groundwater levels for decades.  They knew that under SGMA, they would likely have to cut around 40% of their water use over the next two decades and they recognized the potential for flexibility in a groundwater market.

With a cap-and-trade style market, having fixed allocations is key.  There needs to be a clearly delineated unit of trade.  This is something that Fox Canyon has committed to as part of their GSP, but it’s not something that is required under SGMA, Ms. Heard noted.  While there are other approaches to managing the groundwater resources such as pump taxes or fees, those wouldn’t support a cap-and-trade style market, she said.

Technical expertise is important for developing an effective market.  California Lutheran University, The Nature Conservancy, and Matthew Feinup who led the stakeholder group provided expertise in market design and economics and were essential to creating a market that would function well.  Funding and capacity were critical, especially considering that the GMA is also preparing a GSP at the same time.  The funding in part came from a conservation innovation grant from Natural Resource Conservation Service, which helped to pay for some critical infrastructure and staff time which was important for capacity.

ELEMENTS OF FOX CANYON’S GROUNDWATER MARKET

There are a number of essential elements to a groundwater market.  Some of them are really important and transferable to other places, and some of them tailored to the way things are done in Fox Canyon, Ms. Heard said.

Stakeholder involvement:  This was a grower-led effort that started with an open group of over 50 folks who were mostly growers but also included environmental interests and municipal interests.  They first learned about the benefits of markets and how markets work; they then worked to develop the market, from the goals and rules as well as making recommendations to the GMA.  Ultimately it was this group of farmers that made the recommendations that were ultimately adopted by the agency.

Goals and rules: The goals and rules are the outline for how the entire market will function, who can trade, where can they trade, for how long, and other details that are important to get right up front.

Measurement: Measuring groundwater is necessary, not just for the market, but for managing the resource in general.  Although Fox Canyon has had meters since the 80s, they’ve had semi-annual self-reporting, which hasn’t been working.  So at the recommendation of growers, they moved to Advanced Metering Infrastructure (AMI) or telemetric, real-time data collection that includes a data portal where growers can access the data, as well as the GMA and the Market Administrator.

Administrator: A market needs an administrator who rolls out the rules and conducts the trades.  “In this case, the growers really wanted a neutral third party,” she said.  “They did not want the GMA to be administering it.  They wanted someone who didn’t have a stake in the health of the basin, just as a neutral operator, and that is done by Cal Lutheran because of their involvement in the early design of the market.”

Electronic exchange:  They also developed an electronic exchange.  “Not all markets have this but we feel like this is a way to make trades most efficient,” she said.  “It was very important to growers that trades be anonymous.  There was a lot of concern about data privacy and identity with respect to other people knowing who is trading and who is not and being able to influence that behavior, so we have a web-based platform, and we have something called blind algorithmic matching.”

Pilot testing: It’s important to test the markets; they are complex, and no matter how much time is spent designing it, it’s probably going to go differently it’s rolled out.  “We’ve learned an enormous amount from testing it,” she said.  “We’ve had two different rounds and it allows us to evaluate what’s working, what’s not working and to adapt and improve it.”

FOX CANYON GROUNDWATER MARKET GOALS AND RULES

The goals for this market revolve around flexibility and incentivizing water conservation and developed in the spirit of starting small and simply and building over time.

In the beginning, this groundwater market was limited to growers only, so no municipal interests could trade, and you must be growing in the basins,” Ms. Heard said.  “A third party can’t trade, but The Nature Conservancy can trade because we are a grower, not because we are an environmental interest. Temporary trades only are allowed, and that’s because if you allow for permanent trades, there is a decent risk of conversion from agriculture to development because of a certainty of supply, so the growers and TNC were very supportive of doing annual trades.”

There are two special management areas in the basin.  There are issues related to salt water intrusion and cones of depression from overpumping, so each of the special management areas have rules that are called ‘directional trading’.

Ms. Heard explained the concept.  “You can trade within your special management area and you can sell your pumping allocation outside so that you’re retiring that pumping and pumping less, but you can’t buy in – you can’t pump more.  The goal there is that the total allocation within each management area is not allowed to increase, and that’s to help solve some of the problems that they are dealing with in these areas.”

Every farmer has access to a data portal where they can log in and manage their data.  The market administrator also has access, but they cannot see the same level of data – only what they need to see to manage the transactions.  The portal is also the entry point for trading on the market.  The electronic exchange, hosted by Cal Lutheran which right now, is rather basic; the goal was that it would have just the basics needed for the initial tests and it can be made more sophisticated and reviewable over time, she said.

BLIND ALGORITHM FOR MATCHING TRADES

The growers use the electronic exchange to buy and sell with the actual matching happening through a blind algorithm.  Ms. Heard said that this is a way to make it more efficient.

In many markets, there are ‘over the counter’ or ‘coffee-shop trades’ where two people who know each other might get together and negotiate a trade.

We’re not allowing that in our pilots and that’s because we feel like this reduces transaction costs and takes all the work out of it,” she said.  “By the time you get to the point of trading, everything should be pre-cleared and pre-approved and the matching happens and takes all that work and extra time out of it.”

The reason it is a blind match in part arises from privacy concerns; the growers did not want it to be revealed who is buying and selling, particularly because there is some sensitivity around the influence of packers and shippers, as the packers and shippers who source from multiple growers in the area might want to control who is buying and selling water and at what price so they can source their crops as cheaply as possible.

The blind matching algorithm also minimizes strategic bidding.  It’s intended to get people to reveal their true preferences.  “The way it works is that everybody enters their bids and offers,” explained Ms. Heard.  “It matches the highest bid with the lowest offer and splits the difference in the midpoint. So if you go in there and you’re willing to pay a whole lot and willing to accept a little, it balances out and all the other trades fall around that midpoint.  So one of the things it does is minimizes the price volatility so you don’t have wildly different match prices, and then it’s trying to incentivize revealing your true preference, so you’re not low-balling and won’t make a match.”

PILOT STUDIES

They have conducted two pilot studies so far.  The first was a small, short-term pilot lasting about four months to test the setup of the market.  The first AMI units were installed, and they tested the eligibility of those who opted in.  It was a voluntary market with 47 wells that opted in, and after checking the meter calibration and compliance with all of the GMA’s regulations, it screened out a number of them.

The pilot was really helpful in identifying what needs to happen if folks want to actually trade and how do they get up to speed,” said Ms. Heard.

At the time of the presentation, they were still conducting the second pilot test, which has over 100 wells that have opted in.  AMI has been installed on all of the 500 active wells in the GMA’s jurisdiction.

That’s broader than the market, but there’s the recognition that everybody need to be measuring their groundwater much more tightly than before and because ultimately this will be the type of market that people can opt-in and out of as they like, they all need to be on the same system,” she said.

An incentive program was implemented to motivate people to implement AMI early.  Although it was required by the GMA, rebates were provided so the sooner people signed up, they received more of the subsidy.

Test trades were conducted a few months ago.  Because The Nature Conservancy has several different landholdings in the basin, they traded amongst their different properties to test the interface as well as to try and game the system.

We basically had a set of trades mapped out where we were trying to break all the different rules, such as could we buy more water into a special management area and pump more where there’s saltwater intrusion?” she said.  “We learned a lot and this is what we are going to be doing for the rest of this pilot.  The goal is to trade for the better part of the year and really kind of maximize that activity and learning.”

LESSONS LEARNED

Ms. Heard then gave the lessons learned.

It’s important to create the GSP with a market in mind.  Ms. Heard acknowledged it’s a huge lift to create the GSP and market at the same time; if you stagger it, it’s possible to create a GSP that might enable a market.

Develop the market through a public and transparent process.  This was a heavily stakeholder-led process, which was important.  “You just can’t create a market in a vacuum and then roll it out on the people who are going to use it, because they probably aren’t going to use it,” she said.

Allocations are controversial, but must be compatible with a market. The process of allocating water to different groundwater users and what they are going to get over the next 20 years has been extremely controversial as you would expect, and it has slowed down our progress on the market,” she said.  “The way we have managed to get going is to create pilot allocations.  So for this pilot, everybody in the pilot is going to have an allocation that is based on this year’s data, and so that has let us keep going and not get all wound up in the allocations which are still not determined.”

Accurate water use data is essential for the GSP and for market compliance.  “This is not just about the market,” she said.  “This is about the broader GSP and we really feel like AMI or telemetric data is the most precise and enables us to measure water use the best.”

Tailor the goals and the rules of the market to the specific basin and the users within it. We really hope the Fox Canyon groundwater market is a model for others who are interested,” she said.  “We think there are some components that need to be in a well-designed market, but what works for us probably isn’t going to work in another basin.  We have our own specific conditions and it’s very important to make sure that’s driving the market so it can be designed to really function for the basin and the users.”

Test the market and get the ‘bugs’ out. There were a lot of bugs and there will be more bugs, so making sure that you really know how the rules working, how’s the infrastructure working, how’s your administrator working, and how do the exchanges function,” she said.  “There are so many things to get right and it’s really important to take the time that you need to see how it’s going before you go full-scale with the market.”

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