Tag Archives: SGMA

Considerations for designing groundwater markets

The California Water Commission staff asked a group of informed stakeholders and experts about “how to shape well-managed groundwater trading programs with appropriate safeguards for communities, ecosystems, and farms.” I submitted the following essay in response to a set of questions.

In general, setting up functioning and fair markets is a more complex process than many proponents envision. Due to the special characteristics of water that make location particularly important, water markets are likely to be even more complex, and this will require more thinking to address in a way that doesn’t stifle the power of markets.

Anticipation of Performance

  1. Market power is a concern in many markets. What opportunities or problems could market power create for overall market performance or for safeguarding? How is it likely to manifest in groundwater trading programs in California?

I was an expert witness on behalf of the California Parties in the FERC Energy Crisis proceeding in 2003 after the collapse of California’s electricity market in 2000-2001. That initial market arrangement failed for several reasons that included both exploitations of traits of internal market functions and limitations on outside transactions that enhanced market power. An important requirement that can mitigate market power is the ability to sign long-term agreements that then reduces the amount of resources that are open to market manipulation. Clear definitions of resource accounting used in transactions is a second important element. And lowering transaction costs and increasing liquidity are a third element. Note that confidentiality has not prevented market gaming in electricity markets.

Groundwater provides a fairly frequent opportunity for exploitation of market power with recurrence of dry and drought conditions. The analogy for electricity is during peak load conditions. Prices in the Texas ERCOT market went up 30,000 fold last February during such a shortage. Droughts in California happen more frequently than freezes in Texas.

The other dimension is that often a GSA has a concentration of a small number of property owners. This small concentration eases the ability to manipulate prices even if buyers and sellers are anonymous. This situation is what led to the crisis in the CAISO market. (I was able beforehand to calculate the minimum generation capacity ownership required to profitably manipulate prices, and it was an amount held by many of the merchant generators in the market.) Those larger owners are also the ones most likely to have the resources to participate in certain types of market designs due to higher transaction costs that act as barriers.

2. Given a configuration of market rules, how well can impacts to communities, the environment, and small farmers be predicted?

The impacts can be fairly well assessed with sufficient modeling with inclusion of three important pieces of information. The first is a completely structured market design that can be tested and modeled. The second is a relatively accurate assessment of the costs of individuals entities to participate in such a market. And the third is modelling the variation in groundwater depth to assess the likelihood of those swings exceeding current well depths for these groups.

Safeguards

3. What rules are needed to safeguard these water users? If not through market mechanisms directly, how could or should these users be protected?

These groups should not participate in shorter term groundwater trading markets such as for annual allocations unless they proactively elect to do so. They are unlikely to have the resources to participate in an usefully informed way. Instead, the GSAs should carve allocations out of the sustainable yields that are then distributed in any number of methods that include bidding for long run allocations as well as direct allowances.

For tenant farmers, restrictions on landlords’ participation in short-term markets should be implemented. This can be specified either through quantity limits, long term contracting requirements or time windows for guaranteed supplies to tenants that match with lease terms.

4. What other kinds of oversight, monitoring, and evaluation of markets are needed to safeguard? Who should perform these functions?

These markets will likely require oversight to prevent market manipulation. Instituting market monitors akin to those who now oversee the CAISO electricity and the CARB GHG Allowance auctions is potential approach. The state would most likely be the appropriate institution to provide this service. The functions for those monitors are well delineated by those other agencies. The single most important requirement for this function is a clear authority and willingness to enforce meaningful actions as a consequence of violations.

5. Groundwater trading programs could impact markets for agricultural commodities, land, labor, or more. To what degree could the safeguards offered by groundwater trading programs be undermined through the programs’ interactions with other markets? How should other markets be considered?

These interactions among different markets are called pecuniary externalities, and economists consider these as intended consequences of using market mechanisms to change behavior and investments across markets. For example, establishing prices for groundwater most likely will change both cropping decisions and irrigation practices, which in turn will impact both equipment and service dealers and labor. Safeguards must be established in ways that do not directly affect these impacts—to do otherwise defeats the very purpose of setting up markets in the first place. People will be required to change from their current practices and choices as a result of instituting these markets.

Mitigation of adverse consequences should account for catastrophic social outcomes to individuals and businesses that are truly outside of their control. SGMA, and associated groundwater markets, are intended to create economic benefits for the larger community. A piece often missing from the social benefit-cost assessment that leads to the adoption of these programs is compensation to those who lose economically from the change. For example, conversion from a labor intensive crop to a less water intensive one could reduce farm labor demand. Those workers should be paid compensation from a public pool of beneficiaries.

6. Should safeguarding take common forms across all of the groundwater trading programs that may form in California? To the degree you think it would help, what level of detail should a common framework specify?

Localities generally do not have either the resources, expertise or sufficient incentives to manage these types of safeguards. Further the safeguards should be relatively uniform across the region to avoid creating inadvertent market manipulation opportunities among different groundwater markets. (That was one of the means of exploiting CAISO market in 2000-01.) The level of detail will depend on other factors that can be identified after potential market structures are developed and a deeper understanding is prepared.

7. Could transactions occurring outside of a basin or sub-basin’s groundwater trading program make it harder to safeguard? If so, what should be done to address this?

The most important consideration is the interconnection with surface water supplies and markets. Varying access to surface water will affect the relative ability to manipulate market supplies and prices. The emergence of the NASDAQ Veles water futures market presents another opportunity to game these markets.

Among the most notorious market manipulation techniques used by Enron during the Energy Crisis was one called “Ricochet” that involved sending a trade out of state and then returning down a different transmission line to create increased “congestion.” Natural gas market prices were also manipulated to impact electricity prices during the period. (Even the SCAQMD RECLAIM market may have been manipulated.) It is possible to imagine a similar series of trades among groundwater and surface water markets. It is not always possible to identify these types of opportunities and prepare mitigation until a full market design is prepared—they are particular to situations and general rules are not easily specified.

Performance Indicators and Adaptive Management

8. Some argue that market rules can be adjusted in response to evidence a market design did not safeguard. What should the rules for changing the rules be?

In general, changing the rules for short term markets, e.g., trading annual allocations, should be relatively easy. Investors should not be allowed to profit from market design flaws no matter how much they have spent. Changes must be carefully considered but they also should not be easily impeded by those who are exploiting those flaws, as was the case in fall of 2000 for California’s electricity market.

The State Water Board needs to act to start Flood MAR pilot projects

I recently presented to CDWR’s Lunch-MAR group the findings for a series of studies we conducted on the universe of benefits from floodwater managed aquifer recharge (MAR) and the related economic and financing issues. I also proposed that an important next step is to run a set of pilots to study the acceptability of on-farm floodwater recharge projects to growers, including how do they respond to incentives and program design, and what are the potential physical consequences.

The key to initiating these pilots is getting a clear declaration from the State Water Resources Control Board that excess floodwaters are surplus and available. Unfortunately, the Water Board has not provided sufficient clarification on how these projects can take “advantage of seasonal or occasional flood waters that overtop the banks of a stream and are then directed into a designated recharge area.” Instead, the Board’s website says that such diverted floodwaters cannot be stored for future beneficial use–which obviates the very purpose of retaining the floodwaters in the first place.

The Board should be at least issuing temporary use permits for floodwaters above certain designated levels as being available for pilot projects on the basis that non-use of those floodwaters constitute a surrender of that right for the year. Then those agencies interested in flood MAR can design projects to experiment with potential configurations.

Moving forward on Flood-MAR with pilots

The progress on implementing floodwater managed aquifer recharge programs (Flood-MAR) reminds me of the economist’s joke, “sure it works in practice, but does it work in theory?” A lot of focus seems to be on trying to refine the technical understanding of recharge, without going with what we already know about aquifer replenishment from decades of applications.

The Department of Water Resources Flood-MAR program recently held a public forum to discuss its research program. I presented a poster (shown above) on the findings of a series of studies we conducted for Sustainable Conservation on the economic and financial considerations for establishing these programs. (I posted about this last February.)

My conclusion from the presentations and the other publications we’ve followed is that the next step is to set up pilots using different institutional set ups and economic incentives. The scientists and engineers can further refine their findings, but we generally know where the soils are better for percolation versus others, and we know that crop productivity won’t fall too much where fields are flooded. The real issues fall into five categories, of which we’ve delved into four in our Floodwater Recharge Memos.

Benefits Diagrams_Page_5

The first is identifying the beneficiaries and the potential magnitude of those benefits. As can be seen in the flow chart above, there many more potential beneficiaries than just the local groundwater users. Some of these benefits require forecast informed reservoir operations (FIRO) to realize those gains through reduced flood control space, increased water supply storage and greater summertime hydropower output. Flood-MAR programs can provide the needed margin of error to lower the risk from FIRO.

FloodMAR Poster - Financing

The second is finding the funding mechanisms to compensate growers or to build dedicated recharge basins. We prepared a list of potential financing mechanisms linked to the potential beneficiaries. (This list grew out of another study that we prepared for the Delta Protection Commission on feasible options for beneficiary-pays financing.)

FloodMAR Poster Incentives

The third is determining what type of market incentive transactions mechanisms would work best at attracting the most preferred operations and acreage. I have explored the issues of establishing unusual new markets for a couple of decades, including for water rights transfer and air quality permit trading. It is not a simple case of “declaring markets exist” and then walking away. Managing institutions have important roles in setting up, running and funding any market, and most particularly for those that manage what were “public goods” that individuals and firms were able to use for free. The table above lists the most important considerations in establishing those markets.

The fourth assessing what type of infrastructure investment will produce the most cost-effective recharge. Construction costs (which we evaluated) is one aspect, and impacts on agricultural operations and financial feasibility are other considerations. The chart at the top summarizes the results from comparing several case studies. These will vary by situation, but remarkably, these options appear to cost substantially less than any surface storage projects currently being proposed.

The final institutional issue to be addressed, but not the least important, is determining the extent of rights over floodwaters and aquifers. California state law and regulations are just beginning to grapple with these issues. Certain areas are beginning to assert protection of their existing rights. This issue probably represents the single biggest impediment to these programs before attracting growers to participate.

All of these issues can be addressed in a range of pilot programs which use different variables to test which are likely to be more successful. Scientists and engineers can use these pilots to test for the impacts of different types of water diversion and application. Statistical regression analysis can provide us much of what we know without having to understand the hydrological dynamics. Legal rights can be assessed by providing temporary permits that might be modified as we learn more from the pilots.

Is it time to move forward with local pilot programs? Do we know enough that we can demonstrate the likely benefits? What other aspects should we explore before moving to widespread adoption and implementation?

Using floods to replenish groundwater

ALMOND  ORCHARD FLOODING

M.Cubed produced four reports for Sustainable Conservation on using floodwaters to recharge aquifers in California’s Central Valley. The first is on expected costs. The next three are a set on the benefits, participation incentives and financing options for using floodwaters in wetter years to replenish groundwater aquifers. We found that costs would range around $100 per acre-foot, and beneficiaries include not only local farmers, but also downstream communities with lower flood control costs, upstream water users with more space for storage instead of flood control, increased hydropower generation, and more streamside habitat. We discussed several different approaches to incentives based on our experience in a range of market-based regulatory settings and the water transfer market.

With the PPIC’s release of Water and the Future of the San Joaquin Valley, which forecasts a loss of 500,000 acres of agricultural production due to reduced groundwater pumping under the State Groundwater Management Act (SGMA), local solutions that mitigate groundwater restrictions should be moving to the fore.

Don Cameron at Terranova Ranch started doing this deliberately earlier this decade, and working with Phil Bachand and UC Davis, more study has shown the effectiveness, and the lack of risk to crops, from this strategy. The Department of Water Resources has implemented the Flood-MAR program to explore this alternative further. The Flood-MAR whitepaper explores many of these issues, but its list of beneficiaries is incomplete, and the program appears to not yet moved on to how to effectively implement these programs integrated with the local SGMA plans. Our white papers could be useful starting points for that discussion.

(Image Source: Chico Enterprise-Record)