Tag Archives: water transfers

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.

California’s water futures market slow to rise as it may not be meeting the real need

I wrote about potential problems with the NASDAQ Veles California Water Index futures market. The market is facing more headwinds as farmers are wary of participating in the cash-only markets that does not deliver physical water.

Their reluctance illustrates a deeper problem with the belief in and advocacy for relying on short-run markets to finance capital intensive industries. The same issue is arising in electricity where a quarter-century experiment has been running on whether hourly energy-only markets can deliver the price signals to maintain reliability and generate clean energy. The problem is making investment decisions and financing those investments rely on a relatively stable stream of costs and revenues. Some of that can be fixed through third-party contracts and other financial instruments but the structures of the short term markets are such that entering or exiting can influence the price and erode profits.

In the case of California Water Index futures market, the pricing fails to recognize an important different between physical and financial settlement of water contracts: water applied this year also keeps crops, particularly permanent ones such as orchards and vineyards, viable for next year and into the future. In other words, physical water delivers multi-year benefits while a financial transaction only addresses this year’s cashflow problem. The farmer still faces the problem of how to get the orchard to the next year.

Whether a financial cash-settlement only futures market will work is still an open question, but farmers are likely looking for a more direct solution to keeping their farming operations viable in the face of greater volatility in water supplies.

Is the NASDAQ water futures market transparent enough?

Futures markets are settled either physically with actual delivery of the contracted product, or via cash based on the difference in the futures contract price and the actual purchase price. The NASDAQ Veles California Water Index future market is a cash settled market. In this case, the “actual” price is constructed by a consulting firm based on a survey of water transactions. Unfortunately this method may not be full reflective of the true market prices and, as we found in the natural gas markets 20 years ago, these can be easily manipulated.

Most commodity futures markets, such at the crude oil or pork bellies, have a specific delivery point, such as Brent North Sea Crude or West Texas Intermediate at Cushing, Oklahoma or Chicago for some livestock products. There is also an agreed upon set of standards for the commodities such as quality and delivery conditions. The problem with the California Water Index is that these various attributes are opaque or even unknown.

Two decades ago I compiled the most extensive water transfer database to date in the state. I understand the difficulty of collecting this information and properly classifying it. The bottom line is that there is not a simple way to clearly identify what is the “water transfer price” at any given time.

Water supplied for agricultural and urban water uses in California has many different attributes. First is where the water is delivered and how it is conveyed. While water pumped from the Delta gets the most attention, surface water comes from many other sources in the Sacramento and San Joaquin Valleys, as well as from the Colorado River. The cost to move this water greatly varies by location ranging from gravity fed to a 4,000 foot lift over the Tehachapis.

Second is the reliability and timing of availability. California has the most complex set of water rights in the U.S. and most watersheds are oversubscribed. A water with a senior right delivered during the summer is more valuable than a junior right delivered in the winter.

Third is the quality of the water. Urban districts will compete for higher quality sources, and certain agricultural users can use higher salinity sources than others.

A fourth dimension is that water transfers are signed for different periods and delivery conditions as well as other terms that directly impact prices.

All of these factors lead to a spread in prices that are not well represented by a single price “index”. This becomes even more problematic when a single entity such as the Metropolitan Water District enters the market and purchases one type of water which they skews the “average.” Bart Thompson at Stanford has asked whether this index will reflect local variations sufficiently.

Finally, many of these transactions are private deals between public agencies who do not reveal key attributes these transfers, particularly price, because there is not an open market reporting requirement. A subsequent study of the market by the Public Policy Institute of California required explicit cooperation from these agencies and months of research. Whether a “real time” index is feasible in this setting is a key question.

The index managers have not been transparent about how the index is constructed. The delivery points are not identified, nor are the sources. Whether transfers are segmented by water right and term is not listed. Whether certain short term transfers such as the State Water Project Turnback Pool are included is not listed. Without this information, it is difficult to measure the veracity of the reported index, and equally difficult to forecast the direction of the index.

The housing market has many of these same attributes, which is one reason why you can’t buy a house from a central auction house or from a dealer. There are just too many different dimensions to be considered. There is housing futures market, but housing has one key difference from the water transfer market–the price and terms are publicly reported to a government agency (usually a county assessor). Companies such as CoreLogic collect and publish this data (that is distributed by Zillow and Redfin.)

In 2000, natural gas prices into California were summarized in a price index reported by Natural Gas Intelligence. The index was based a phone survey that did not require verification of actual terms. As part of the electricity crisis that broke that summer, gas traders found that they could manipulate gas prices for sales to electricity generators higher by simply misreporting those prices or by making multiple sequential deals that ratcheted up the price. The Federal Energy Regulatory Commission and Commodity Futures Trading Commission were forced to step in and establish standards for price reporting.

The NASDAQ Veles index has many of the same attributes as the gas market had then but perhaps with even less regulatory protections. It is not clear how a federal agency could compel public agencies, including the U.S. Bureau of Reclamation, to report and document prices. Oversight of transactions by water districts is widely dispersed and usually assigned to the local governing board.

Trying to introduce a useful mechanism to this market sounds like an attractive option, but the barriers that have impeded other market innovations may be too much.

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?

Repost: Learn Liberty | Blame outdated rights for California’s water woes.

A good explanation of how regulation differs from litigation, and how California’s water rights differ from other systems.

Source: Learn Liberty | Blame outdated rights for California’s water woes.

Maven’s Notebook: Fishing groups win lawsuit to overturn Delta water delivery contracts

This could have far reaching implications about how CVP contracts are renewed.

From the law offices of Stephan C. Volker: On July 25, 2016 the Ninth Circuit Court of Appeals ruled in favor of the Pacific Coast Federation of Fishermen’s Associations (“PCFFA”) and the San Fra…

Source: MAVEN’S NOTEBOOK – Water news

Cataloging calls for “water markets”

It’s trendy now to propose water transfers between regions and agriculture to urban uses as the primary solution to California’s drought. While this may not be the “silver bullet” that the proponents believe, I’m starting to catalog the articles I find making these proposals. I’ll hold my commentary until later.

Here’s a San Diego Union-Tribune piece from Erik Telford at the Franklin Institute.

Here’s a Sacramento Bee article from Christopher Thornberg at Beacon Economics.

Here’s another Bee article by Jay Lund, Ellen Hanak and Buzz Thompson at PPIC. And another post by Jay Lund on the many uses.

More from the Bee by Lawrence J. McQuillan and Aaron L. White at the Independent Institute.

A proposal by EDF with five recommendations.

Let me know about others.

 

 

Why ag “savings” might not be the solution to urban water woes

Over the last couple of years, I’ve come across several examples of how increased agricultural irrigation efficiency hasn’t led to water savings. When interviewing a farmer in San Joaquin County about managing agricultural pumping loads, he described how he had invested $2,000/acre in a microdrip system for his tomato and melon fields. To avoid his subterranean systems, his farm has a GPS repeater that guides his tractors within a few inches. Another consultant described how they couldn’t find any flood irrigated tomato fields, a standard method in 2007, for a comparison survey for drip effectiveness. Fresno County tomato yields increased more than 25% from 2007 to 2012, and individual field yields have increased 50%.

The result is that growers are using the water they have to increase productivity. They also have moved into more permanent crops which deliver higher revenues per acre-foot. For example, almond acreage has more than doubled since 1995. And little additional water has been freed up for urban or environmental uses.

With the increased value of water to agriculture, urban agencies have lost much of their competitive edge in pursuing water transfers. In 2014, Westlands Water District paid Placer County Water Agency an unheard of $325/AF, and there were reports of some transfers costing several thousand dollars per AF to protect orchard investments. The urban agencies use to largely have this playing field to themselves, but that era looks to be ending.

The evolution of California’s water transfer market (albeit a bit dated)

Eric Cutter and I wrote a paper in 2002 that extended my dissertation chapter exploring how the state’s agricultural water management institutions, i.e., special districts like irrigation and California water districts, affected water transfer participation. We had built the first extensive transfer database in 2000 (On-Tap) for USBR and CDWR, using secondary sources, and used that analysis for the paper. Ellen Hanak of PPIC reconstructed a data set from primary sources a couple of years later, and updated it in 2012, so this data has been superseded. (Her 2012 coauthor Liz Stryjewski is now a consulting associate with M.Cubed.)

The paper discusses two important aspects not often touched upon: 1) the search and transaction settlement mechanisms are important to market success, and 2) the nature of the institutions managing agricultural water can affect willingness to participate. Another important aspect is that California already has about 10 MAF in long-term permanent water transfers embedded in the CVP and SWP contracts. The 2 MAF in short-term and more recent long-term transfers are on top of those already occurring. So California has already has a viable market contrary to ill-informed observations by others; the question is whether that market can and should be expanded further.

UCLA professor’s comments not helping California’s drought problem

An environmental horticulturalist for UC Cooperative Extension in Los Angeles, Don Hodel, has been getting a lot of press recently criticizing the State Water Board’s urban water restrictions. He advises that the Water Board should have advised targeting changes in watering practices rather than limiting supplies, and claims that urban restrictions were unneeded, implying that agriculture should bear the entire brunt. Unfortunately, he’s made at least two grievous errors in his assessment.

First, Hodel fails to understand that the actual implementation of the reductions is to be done by the local water utilities, not the Water Board. The Board only provided the targets, and the stick if the targets aren’t met. Hodel needs to complain to the utilities if he thinks they aren’t doing their job.

But of course, he’s equally naive about the huge problem of communicating about changing irrigation practices to millions of urban customers across hundreds (yes) of distinct water utilities. Of course, these utilities have been trying to get their customers to improve outdoor watering, but just getting their attention is a big enough problem.

Second, his real agenda is to imply that urban horticulture is more valuable the state’s agricultural industry. Urban agencies have only so much contractual and physical access to water supplies. To not cutback deliveries would require transferring water from farmers. But there’s at least two problems with that, the first being that agricultural water is much more valuable than Hodel imagines and second is that it’s not easy getting the water from northern to southern California.

It turns out that those farmers have been doing an exceptional job at improving their irrigation practices; the problem is that they’ve used that efficiency to increase output rather than to save water. The original proponents of agricultural water efficiency didn’t anticipate this response and the surplus didn’t materialize for urban users or the environment.

And even so, moving water from farm areas and treating it for domestic uses adds substantially to the cost of water. It’s the primary reason why urban water costs well in excess of $2,000 per acre-foot while agricultural water is much less than $500 per acre-foot. Water isn’t a particularly fungible good, and proponents of water transfers as the “solution” ignore this issue (along with the problems of market design and function.)

These types of moments are when I wished that journalists were better informed and able to filter out the uninformed “experts.”