In March of this year, the Secretaries of the Natural Resources Agency, Environmental Protection Agency, and Department of Food and Ag tasked the Commission to initiate a thorough and inclusive public dialogue to frame state considerations around shaping well-managed groundwater trading programs.
This task supports action 3.6 of the Water Resilience Portfolio, which calls on the Department of Water Resources, the State Water Resources Control Board, and the Department of Fish and Wildlife to create flexibility for Groundwater Sustainability Agencies (GSAs) to trade water within basins by enabling and incentivizing transactional approaches, including groundwater markets, with rules that safeguard natural resources, small and medium-sized farms and water supply and quality for disadvantaged communities.
“The Commission’s role here is to look at governance, oversight, stakeholder engagement, and really hone in on what those rules or safeguards should look like, and how the state might enable groundwater trading that avoids negative impacts,” said Laura Jensen, Assistant Executive Director. “At the end of this, we will be producing a white paper that will inform the approach of the implementing agencies: the Department of Water Resources, the Department of Fish and Wildlife, and the Water Board.”
Ms. Jensen noted that the current extreme drought the state is experiencing will likely make the conversations around this topic more real and fraught; however, the Commission’s work on groundwater markets will not be completed in time to help with the drought. However, while the Commission’s work is future-looking, it can certainly be informed by what folks are experiencing and bringing to the table this year.
At the June meeting of the California Water Commission, the commissioners heard from a panel of speakers who discussed why groundwater sustainability agencies or GSAs might consider markets, what groundwater trading entails, its opportunities and limitations, and how it is connected to water accounting, allocations, and sustainable groundwater management. The first panelist was Dr. Newsha Ajami, the Director of Urban Water Policy with Stanford University’s Water in the West and an appointed member of the San Francisco Public Utilities Commission. (Other panelists will be covered in subsequent posts).
Dr. Ajami began by noting that California is being impacted by so many different things. California’s water system is quite vulnerable, and the resiliency and future reliability is definitely a challenge. Climate change is impacting water supplies, urbanization and population growth are increasing, and aging infrastructure is top of mind in California and across the US, as well as the need to provide water for the environment.
“The drought this year, and the fact that since the year 2000, we have experienced more dry years than wet years, attests to the fact that we have to be more creative in what we are doing around water and water management,” said Dr. Ajami.
“While you often hear about all the wonderful technologies that are out there that are going to save us from the water limitations we are facing, the reality is we need more innovative management approaches and governance strategies to enable the water sector to make an equitable and climate-resilient transition. And basically, markets are one form of those management approaches.”
The cap and trade model
Water markets have been around for a long time, and water trading in California is nothing new. Temporary trading and water transfers have been happening between agricultural entities with the flexibility to fallow their land and share their water with other landowners or urban areas to alleviate the impacts of the dry years.
However, Dr. Ajami’s presentation focused on a type of trading that utilizes credits and collective action to promote trading without necessarily moving water. She noted it is not a new model; it has been used for cap and trade, renewable energy, and water quality standards, among others.
The concept began in the 1990s when the United States established the world’s first-ever pollution trading system and popularized the terminology ‘cap and trade.’ The government sought a new way to reduce sulfur dioxide and nitrogen dioxide levels that had been accumulating in the air since the Industrial Revolution.
“The idea was very much simple, but actually quite radical: Let people buy and sell the rights to pollute while developing local market-based solutions as a way to clean up the environment,” said Dr. Ajami. “That first cap and trade model was basically aimed at pressing water problems, which is interesting, because of acid rain falling on the earth and causing a lot of water pollution as well. So it worked. What happened was not only the market-based approach sliced about 36% of the emissions in 14 years in different areas, it also happened faster and cheaper than any other solution that was available at the time.”
There is a similar program happening with water quality trading. The EPA has several different water quality trading platforms which operate on a more local scale. The dots on the map show the water quality trading programs happening across the country, especially on the East Coast.
“The idea is to have a cap which means that pollution can happen to a certain level, and then encouraging and allowing people to collaborate within a watershed to come up with solutions to reduce water quality challenges, and allow people to trade,” she said.
Applying the cap and trade model to water supply
Dr. Ajami then gave an example of how this might look when applied to water supply. “Let’s say there is a common source of water, in this case, a groundwater basin. There are so many different stakeholders that depend on the groundwater. Each one of those stakeholders, depending on their capacity, might be able to do certain things. And not everybody has the financial means to do it, but they have the opportunity to do it. Some people have the financial means, but they have done a lot of different things, or they don’t necessarily have a lot of space to do more.”
In this application, the cap would be set as sustainable yield, or how much groundwater can be extracted on an annual basis; that target or goal would be a way to incentivizing a community and a region to work together to achieve the goal, rather than the haphazard efforts of individuals trying to implement projects on their own.
“It’s using regional-scale solutions to create more flexibility, resilience and reliability, and long-term sustainability at the same time,” said Dr. Ajami.
She also noted that the cap needs to be fixed at first and then adjusted lower as time goes on. “That means that as you’re doing more and more and you reach the cap, you need to lower your cap, again, to make sure you can do more to reduce your reliance or environmental impacts.”
An important part of the design is the identification of regional goals. Dr. Ajami noted that the SGMA process is trying to establish specific requirements for basins, but all of these groundwater management plans have identified a safe yield, which is different for each basin. However, that potentially could lead the discussion on setting regional goals.
After the regional goals are set, the next step is to set up regulatory and market incentives. “For example, we have the renewable energy portfolio, which was supposed to be 30% renewables by 2030,” said Dr. Ajami. “We are now in 2021, and we are past that goal. We are actually going to 100% renewable by 2050, so it’s definitely achievable. And a goal that transects regional goals and that everybody can aspire towards is extremely important; then the regulations and market can provide the financial means. That can provide some local coordination and collaboration to make sure that equity is met. It also creates more resiliency.”
Trading credits for diversifying water supply
Dr. Ajami then walked the commissioners through some examples of how this model can be modified and applied to groundwater, much like the acid rain model was used for water quality trading.
So the question is, how could utilities or stakeholders coordinate their efforts and diversify their water supplies? One of the reasons to reduce reliance on a specific water supply source, for example, groundwater supply, is to basically make sure that we can have alternative water supplies, including some of the efforts around conservation efficiency.
The idea is to have a system of tradable credits for the pursuit of a regional water supply diversification goal. There is a common pool of water source, such as a groundwater basin. Many stakeholders depend on that single groundwater basin, so every stakeholder’s action can have a positive or negative reaction in another location.
“It’s really important to focus on this common pool of water as our piggy bank that helps us to exchange credits and resources,” said Dr. Ajami.
In this example, there are two entities: a farm and a community. They are each given a specific water diversification goal, represented on the graphic by three drops of water. On the right side of the graphic, Community A can do many different things, such as conserving more water, building a recycling plant, or doing more stormwater capture. They could do more than their share; they might not have the resources to do it, but they have the capacity. On the left side of the graphic, the farmer might have a chance to recharge groundwater or do more water conservation but might not have as many opportunities.
“So the idea is that the community can generate more than they need to meet the goals; the farmer can only do less,” said Dr. Ajami. “So the community can put that extra water as a credit in the bank, and then the farmer can buy that back as a credit. Because as a region, we have to reach a goal. And that goal needs to be met. So the way to do it is individuals have their own goals, generating these extra drops of water to meet the ultimate goal regionally. The resources that the farmer provides to this bank can then go back and subsidize the cost of the projects [that the community implemented].”
The virtual credit trading model provides a way to invest in local solutions by those who have the capacity to do more but do not have the financial resources.
“This is a very important part because the reality is there are a lot of communities out there who can do more, but they don’t have the resources,” she said. “They are often left behind in this process. So, for example, major stakeholders and beneficiaries in the region can indirectly invest in water reuse sanitation, deepening wells, and other sorts of solutions for underprivileged members of the community while achieving this regional water diversification goal. So, if operated effectively, this can ultimately improve access and equity across the region. Because that also needs to be one of the goals that you’re achieving. And, in this specific case, the common source of groundwater.”
Case study: Sonoma County Water Agency
Dr. Ajami then discussed a case study for the Sonoma County Water Agency. There are nine water utilities and about 600,000 residents. 60% of their water comes from the Russian River, and 40% comes from groundwater. So the region is very much connected in that they depend on the same water source and watershed. So every credit that goes back to the common pool of water either becomes available to another community that doesn’t have the capacity to develop more water; it can also stay in the environment, as the environment can be one stakeholder in this process, she said.
Suppose the region collectively defines the need to diversify the water supply and reduce their reliance on a common source of water, for example, groundwater or the Russian River as a source. How could they coordinate this effort?
“Let’s say the regional target is set for them at 25% diversification goal by 2040,” said Dr. Ajami. “In this case, communities A and B have different options available to them, and not all the utilities or not all the stakeholders have the same capacity in this specific example. We went through all sorts of documents provided to us by Sonoma County Water Agency to look at different communities and their capacity to do things.”
Dr. Ajami presented a graph that illustrates the resources and capacity for each utility; the red line shows the 25% diversification goal is for that specific community. She pointed out that Utility A on the left top has a lot of resources and many projects that they want to do; however, some of those projects are costlier than others. On the other hand, Utility F would have a hard time achieving that 25% diversification goal.
“However, if you put all these things together and assume they’re all part of the same region, and they depend on the same water supply, what you see is all of a sudden, they all can collectively achieve that 25% diversification goal, and with a reduced cost at the same time, so the marginal cost reduces as the basins collaborate,” said Dr. Ajami.
She emphasized that this trading format is rooted in the idea of collaborative governance, which means the stakeholders recognize that they are all in it together and have to work together collectively to invest together in solutions and deal with the problem simultaneously.
For the case study, they tested the market to see how it would function for Sonoma County Water Agency’s water utilities. The first question asked was, can trading help support enhanced water supply diversification efforts? Dr. Ajami said the answer is yes; trading of diversification credits was quite effective, rather than inflexible regulations.
“On the left-hand side, the goal was set at 25%. There wasn’t any trading platform set up for that model, and what you see is collectively, the region does not end up reaching its goal of 25%, and the cost per acre-foot of solutions is about $1500 per acre-foot,” said Dr. Ajami. “When you look at the right side, what you see is, if you allow these communities to work together, collaborate, coordinate, and trade through this common source – remember, we’re not moving water, we’re just leaving water as a credit in our bank, which is the common pool of water – then all of a sudden, what you see here is they do achieve their diversification goal by 2040, they achieve it with a lower cost, about $1350 per acre-foot. So that shows that trading and the governance structure helps a lot more than just having a regulatory goal and letting people depend on different technologies and infrastructure solutions to achieve it.”
The second question they asked was if it mattered if the stakeholders shared information? Does it matter if communities worked together from the beginning to identify options and coordinate actions before trading begins?
The graph shows the response to that question. “On the left side, we did not allow the information sharing within the Sonoma County Water Agency water utilities when we were very giving them the 25% diversification goal, and what you see there is that they sort of barely achieve their 25% diversification goal with a lot higher price,” said Dr. Ajami. “The reason is … if there is an incentive for everybody to diversify the water supply portfolio, and you can sell your credit, and people don’t talk to each other, they may go and develop solutions because they would like to subsidize the costs to them. So what happens is, they may over-invest in solutions that they think they need … and then there are so many sellers, not enough buyers in the market. So then, at the end of the day, the trading doesn’t necessarily happen. So the cost of this diversification increases.”
“On the right-hand side, on the other hand, it’s very similar to what designed a previous slide, they can talk, they coordinate from the beginning, and they achieved the goal and also achieved it cheaper.”
The top graph on the slide shows the cost of achieving the diversification goals. On the left-hand side, the gray bar illustrates that if it was only driven by decisions that economically make sense to different communities, the cost can be high. However, when people can make decisions based on various criteria that they have, the cost might be slightly higher, especially on the right-hand side, but the solutions can fit the needs of different members of the stakeholder group.
“Not everybody wants to do the same thing,” said Dr. Ajami. “It’s important to prioritize what is important to various stakeholders. For one community, it might be a reliable water supply; for another, it might be having a sustainable water source for their crops. So it’s like two different goals achieved two different ways.”
The bottom graph shows that regardless of what kind of decisions people make and the resources they have, the dependence on the common source of water, in this case, the Russian River, was reduced in the end.
“This means that collectively, these groups not only diversify the water supply portfolio but also actually reduce the dependence on the common source of water,” she said. “For this, it was Russian River; for you, it can be the groundwater basin.”
Benefits and key components of trading schemes
There are several expected benefits of trading schemes, including
Financial accessibility for smaller projects and smaller communities that don’t have the means;
Equal access to resources for some of the small service providers who may not necessarily have the capacity or the institutional and financial means to do things. This can provide various opportunities for various groups, such as investing in disadvantaged communities;
Enhancing regional collaboration to implement these solutions through collaborative governance within each groundwater basin; and
Empowering a bottom-up reinvention.
“The state is not telling you how to do it; they only give you a goal; you go work together as a community and figure out what fits you best and make sure you can achieve this over time,” said Dr. Ajami.
However, there are some key things needed for successful implementation:
Set a regional cap: The regional cap needs to be reevaluated periodically, so as people achieve the cap, it is further adjusted. For example, in the beginning, it was 30% renewables by 2030, and it’s 100% by 2050. “We are increasing the cap to make sure people can collaborate and work more and reduce their environmental footprint.”
Limited credits available: The idea is to encourage collaboration and to create flexibility around local solutions. Regional collaboration is key.
Credit banking: The common pool of water brings everybody together; they all depend on our groundwater basin. “They need to understand when they put the water in the bank, they can access it later, or actually, they can access another form of water in a different way. So that common pool creates the exchange opportunity.”
Monitoring: Unless there is an active monitoring system, so it is known how much water is generated, how much is withdrawn, and how much water is left in the bank, it cannot be done effectively. That’s something that the state can provide incentives for to create the information technology and data gathering platforms that are the foundation for the governance structures to work effectively, she said.
Penalties: There needs to be a penalty in place for those who don’t do anything and to make sure that all the beneficiaries are at the table and working together.
COMMISSIONER ANDREW MAKLER: The question of teeth and enforcement: when creating these joint governance structures, is it appropriate to consider it a contractual matter with standing to sue? Or would there be a government entity responsible for enforcement? Second, what is the purpose of the markets? ‘When I think about markets, I’m thinking about sending a price signal that’s going to elicit investment behavior. So is the intention of trading is to create a market to have pricing efficiencies to then have investment decisions?’
“I think your point on having teeth is really, really important,” said Dr. Ajami. “We need to make sure these systems are set up in a way that people would follow the rules and guidelines and everything. And ultimately, whatever goal we have in place, we can accomplish it eventually. And that’s key.”
“About the market, I think you’re absolutely correct,” Dr. Ajami continued. “If you think about this as pure economic markets, then the price is the only signal that drives the movement. People keep paying for bottled water without thinking about how much they’re paying for, but they’re not willing to pay for water infrastructure that brings water to the tap, which is the saddest story of our generation. The way I was trying to frame this is to move away from thinking about these as pure economic markets and help you so think about this as more of a trading platform that has other opportunities in place.”
“The reason I’m emphasizing this is because if you only think about markets as pure economic drivers of what is going on, then the cheapest available resource would be the one that most used. And eventually, that may mean you’re not going to invest in recycling because it’s more expensive than surface water, or you’re not going to invest in stormwater recharge or groundwater recharge.”
“That’s why, in one of my slides, I mentioned that if you think about priorities of different communities, these markets need to actually have social and environmental elements within them, which takes them away from the pure economic market, but makes them more sensitive to the social and economic realities on the ground. For example, with cap and trade and acid rain, it was the same concept; not everybody had the same capacity to invest in the same thing. Maybe some people want to invest in different things; they’re willing to pay for other solutions. So it sort of takes that away … the economic driver still is in there. But it’s not the only driver.”
VICE CHAIR MATTHEW SWANSON commented that the Commission needs to be careful not to create a purely financial model around this whole system. “There are entities, and there are individuals that will come in and buy the whole state water supply, if possible. Okay. So I think that we just need to remember that we have a variety of constituencies. And I think what this plan allows us to do is to, in the end, work together to find solutions; no individual constituency is going to be able to win the whole day and have everything they want.”
COMMENT: Chair Teresa Alvarado: “At the beginning, listening to Dr. Ajami’s presentation, it felt like we were talking about the early days of cap and trade where it felt like folks were being authorized to pollute. And there’s an ethical hurdle to even thinking about trading a precious, and in some minds, a sacred and ancient resource like groundwater. And so there’s that kind of principle to overcome. Then we talk about the human right to water and the concerns and levels of distrust in government and distrust in the industry because of the historical treatment and inequitable treatment of poor people and people of color. So all of those things were in the back of my mind is I heard the presentation.
“But I really appreciate what Dr. Ajami said, which was talking about a trading platform, versus marketing of the basin. That feels more comfortable. It feels more like what we’re talking about, which is we’re trying to within basin change behavior and get to sustainability and resilience. So that feels more comfortable. But what Commissioner Arthur said, really having clear governance structures spelled out and power-sharing models. And I think, as Dr. Ajami said, having very good data and monitoring to ensure and reinforce, through transparency, that we’re managing appropriately. And it is not a free for all trading of water, precious groundwater.”
“One of the postdocs looked at some of these groundwater management plans, and one problem we have with some of these plans is that they use different baselines and different climate projections and so many different kinds of formats, whatever it works to make the basin look good or make it work,” said Dr. Ajami. “If you want to set up something like this, you have to be very honest about your basin and what is possible. It should not be, ‘I do whatever I can to make sure everybody’s pleased with me,’ but actually, collectively sitting down and thinking, we’re running out of water, we need to do something. These are the things that we have to do, and everybody should be at the table.”
“I think we really do not have very good measures in place right now to make sure access to clean water,” continued Dr. Ajami. “We are talking about unintended consequences, but we don’t have any measures that say this is what needs to happen to make sure people have access to water. So some of those have to be as part of this conversation embedded in the way we measure the performance of different basins and different actors within the basins.”