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California Water on the Market: Q&A with Barton “Buzz” Thompson

Felicity Barringer
Mar 3 2021

Three months after the first market trades of California water futures, a conversation about economic forces and an essential material for life.

By Felicity Barringer

Barton “Buzz” Thompson, Faculty Director, Water in the West

Barton “Buzz” Thompson, Faculty Director, Water in the West, Senior Fellow and Founding Perry L. McCarty Director, Stanford Woods Institute for the Environment; Robert E. Paradise Professor in Natural Resources Law.   Water in the West, Stanford University

California water has joined gold, energy and bitcoin as a commodity whose future value can be traded on a financial exchange and the first market trades on water futures took place three months ago. The market, based on values determined by NASDAQ’s Veles Water Market Index, was hailed by some as a useful tool so California farmers can reduce the risk of drought-driven escalation in water costs. It was sharply criticized by others, from a United Nations representative to racial justice groups as potentially limiting access to something essential to life.

Buzz Thompson, a Stanford Law School professor and founding director of the Woods Institute for the Environment, now directs the Water in the West program. He founded the law school’s Environment and Natural Resources program and served as a special master for the United States Supreme Court in Montana v. Wyoming, an interstate water dispute involving the Yellowstone River.


Here are his answers to questions about the development of thinking about water’s value and the possible impacts of this market in water futures.



Water is essential for life, the growth of communities, agriculture, and streams and their fish. California has about 40 million people and an agricultural economy worth $47 billion. How has the value of water fluctuated?

The “value” of water is a contentious issue. In some people’s mind, water cannot even be valued in economic terms because of its importance to human life and health and to the environment. Beyond the ethical questions of valuing water, the economic value of water and its price generally diverge. Water was the subject of Adam Smith’s famous water-diamond paradox. Because we need water to survive, the value of water is the value of life itself. Someone without any water would give everything they have for that water. But despite its high value in use, water typically has a relatively low market price because it is often abundant. Diamonds, by contrast, are luxury goods. Their actual “value” is quite low, but since they are rare, they command very high prices. Water therefore has a higher value in use, but diamonds cost more.

When most people talk about the “value” of water in California, they are asking about its price in the state’s fledgling water markets. How much does a farmer have to pay to get more water for her thirsty crops? How much does a city have to pay to ensure that it has the water needed for its residents. Prices have varied tremendously. From 2012 to 2020, for example, water users paid anywhere from $50 an acre foot for water to $2200 an acre foot. (Water managers in the West generally measure water in terms of acre-feet, which is the amount of water that would flood an acre of land to a depth of one foot. It is roughly equivalent to the amount of water to meet the needs of two households for a year.)


What has determined water’s value in any given situation?

Elk graze the dry bed of the San Luis Reservoir on the eastern slopes of the Diablo Range in Merced County, California in August 2016.  Photo by John Chacon / California Department of Water Resources

Elk graze the dry bed of the San Luis Reservoir on the eastern slopes of the Diablo Range in Merced County, California in August 2016.   John Chacon / California Department of Water Resources

Scarcity has been the principal determinant of water prices. From 2012-2016, severe drought conditions drove some farmers to pay astronomical sums for water to keep permanent crops, like fruit trees or vineyards, from dying. That’s when you saw prices soar over $2,000 per acre foot. Indeed, during the height of the drought, farmers were willing to pay more for water than cities. Anything that leads to water scarcity will increase the price of water. Not only drought, but environmental protections like the Endangered Species Act, which reduce the amount of water that can be withdrawn from the state’s rivers and streams, push up the price.

California’s Sustainable Groundwater Management Act (SGMA), which will require Californians to reduce their pumping of groundwater to sustainable levels, will also lead to higher prices because it will lead to lower supplies. Demand is also a determinant. Because domestic water needs are relatively small, human use does not generally influence the price of water. Permanent crops like fruit trees, nut trees, and vineyards, however, help drive up the price of water during dry periods because farmers do not like to lose their investment in permanent crops.


Which variables have been most important to water’s value?

Two variables have been most important. The first, as just mentioned, is scarcity — whether from weather conditions, droughts, or regulatory measures. Water users are very concerned that a series of regulatory changes (reduced groundwater pumping as a result of SGMA, reduced diversions as a result of an update in the state’s Bay-Delta Water Quality Control Plan) could make water very scarce in the Central Valley, sending water prices there soaring. The second variable has been the hardening of demand. Historically, most farming in California was perennial crops like tomatoes and cotton. In droughts, farmers just planted less. Today, however, more and more acres are planted in permanent crops. Farmers are willing to bid much more for water to keep those crops alive.


Can we have a robust water futures market here, given the widespread lack of quantification or adjudication ensuring clear ownership?

We need to be careful when we talk about “water futures.” Water futures could mean a contract under which someone with a water right agrees to sell that water at a future point in time for a price that’s set today. By this definition, California has long had a limited form of futures market. The Metropolitan Water District of Southern California (MWD), for example, which supplies water to cities in the Southern California coastal plain, has an agreement with the Palo Verde Irrigation District (PVID) under which farmers in PVID agree to sell water during dry years to MWD. In this sense, we have long had a “futures” market in water.

What Price Water? It Depends When You Buy (graphic showing spot price of Nasdaq water index)
Bill Lane Center for the American West
 

What is new in California is a new futures derivative market by which all water users can hedge against increases in water prices. Now any water user who is worried that they might have to buy water at very high prices in the summer, if it doesn’t rain, can hedge against that increase. To do that, the water user buys a future for the price at which the market currently believes water will sell when the water user will need it. When the future expires, the water user gets the current price. If the price has risen, the water user gets more than he or she paid; if it dropped, the water user gets less. Importantly, this is not a future for the water itself. The water user must still find someone on the open market from whom to buy. If the price has gone up, the water user will now have more money to buy it.

The effectiveness of these new water futures depends on how accurately the futures track the real market price. The payout will be based on a composite of prices tracked by a private entity (WestWater Research). So anyone buying a future is betting on the accuracy of their calculations. In addition, remember that the value of water depends on location. The future is based on a composite, so it’s possible that the composite price might not rise as much as the price of water in a particular location — in which case water users who purchase the future will not be fully hedged.


Financial trades based on the future value of a commodity are a longstanding practice with metals, wheat, and energy. Now that California water futures are tradeable, will trades affect water’s value and availability? Will Californians pay more so traders get their cut? Or will trading stabilize their costs?

The fear, of course, is that the new futures market will increase the price of water during shortages by bringing speculators into the market. For decades, politicians and market critics have often blamed futures markets and speculators for run-ups in commodity prices. The evidence from other markets, however, does not support this contention. Supply and demand considerations will continue to determine the price of water on the open market in California, and changes in conditions will continue to lead to often large swings in water prices. The new futures product will simply allow water users to hedge against the risk that the price of water will rise before they need to buy more. While others are free to “bet” on the price of water by buying and selling futures, there is no reason to believe that this speculative trading will affect the actual price of water.


Water is heavy. State and federal governments have spent hundreds of millions of dollars on infrastructure to store, treat and move it. Will access to this infrastructure play a role in these trades?

The John R.Teerink Wheeler Ridge Pumping Plant, part of the state-run California Aqueduct in Kern County.

The John R.Teerink Wheeler Ridge Pumping Plant, part of the state-run California Aqueduct in Kern County.   State Water Resources Control Board

Infrastructure availability does influence water prices. Water is not worth as much if you can’t get it to where the water is needed. So the price of water is highly local. Water in the Sacramento Valley, for example, is relatively more plentiful than water in the San Joaquin Valley. As a result, prices are lower in the Sacramento Valley.

California actually benefits from the large amount of water infrastructure that it has built. It allows water to move around the state as demand changes. In the Central Valley of California, there are two massive water projects (the federal Central Valley Project and the California State Water Project). In most times, their water rights are separate, limiting to some degree the ability to move water from one system to another. During droughts, however, California has often merged the water rights, so that it is easier to move water from one system to another. This has allowed water to flow the most needy areas, reducing the cost of droughts and other water shortages.


A Bloomberg columnist, David Fickling, recently wrote, “A price on low-value public resources is crucial to encouraging less profligate use.” True?

Sprinklers spread water on residential lawns in Bakersfield, California in 2015.  Photo by John Chacon / California Department of Water Resources

Sprinklers spread water on residential lawns in Bakersfield, California in 2015.   John Chacon/California Department of Water Resources

The price of water is frequently lower than its actual value to society. Indeed, water is the only important commodity for which we do not charge people! When you buy water from your local supplier, you are typically paying only for the cost of treating the water and getting the water to you. You do not pay for the water itself, which the state effectively gives away for free. But taking the water out of a river or groundwater aquifer often has a significant opportunity cost to society. For example, extracting water from a river can harm the local ecosystem. Some water suppliers even subsidize the cost of water.

To get people to conserve and to encourage effective water management, we should charge people the true value of the water that they use. This, of course, raises the concern that poorer members of society will not be able to afford it. The answer to is to charge people for water based on how much water they use — what is known as an “inclining block” rate structure. In my ideal world, water supplies do not even charge people for a small amount of water. California has recognized that there is a “human right to water,” and that right should include free access to the amount of water needed for a minimum standard of living.

Once one gets beyond this human right, however, water users should charge people more and more per gallon as they use more. People who are conservative in their water use might pay $X per gallon, but the most profligate users would pay $10X per gallon for their excess use. A large number of water suppliers in California are using these types of rate structures, but they generally do not charge the largest users enough to really make a difference in their calculus. California law, moreover, has made it difficult for other water suppliers to adopt such pricing structures.

Generally arguments revolve around who should pay. Polling has shown that the general public would support a small fee on their water bills to help pay for safe water for all. The water utilities were adamantly against it, seeing it as the “camel’s nose under the tent” for a bigger set of fees like we have in the energy arena, which is understandable but unfortunate. But using general funds for ongoing operations and maintenance is risky. It puts something that must be continually on deck into an annual argument over the general fund, competing with every other human-services need out there out of a pot of money whose size varies considerably, depending upon the economy. No matter the economy, people need clean, safe, and affordable water and sanitation.


Ellen Hanak, a water expert, said that investing in water futures is simply “betting on the weather.” Is she right? What else do traders bet on?

Ellen’s point is an excellent one. Remember that California’s new water futures are really just a financial derivative. They are not a contract for water. Instead, they are a bet on the future cost of water. As a result, anyone who invests in a water future is really “betting on the weather,” which is typically the primary determinant of future water prices. In theory, investors are betting on any factor, including regulatory changes, that might change the future price of water. Because water futures currently focus on relatively short-term changes in price, weather is the major bet.


Which category of water user will be most likely benefit from these trades? Corporate farmers? Small family farmers? Small towns? Who will be hurt?

An almond orchard north of the Sutter Buttes in Calif. on February 24th, 2015. Photo by Kelly M. Grow/ California Department of Water Resources

An almond orchard north of the Sutter Buttes in Calif. on February 24th, 2015.   Kelly M. Grow/ California Department of Water Resources

The major water users who will benefit from water futures are those who can afford to pay for water futures. Remember that futures can go both up and down in value. If you are a small farmer, you might not invest in a water future because you do not want to risk losing the money you paid for the future if it suddenly rains a lot. I therefore expect that the beneficiaries of water futures will tend to be corporate farmers and other large users of water. In my view, the major losers will be those people who “bet” on water futures for speculative purposes and bet wrong. It’s hard to get too upset about them.


What’s your biggest hope for the impact of this market? Your biggest fear?

My biggest hope for the futures market is that they will actually help some water users hedge against changes in water prices and therefore take some of the risk out of their businesses. Futures derivatives are a form of risk insurance, and if they work properly, they can reduce the risk of engaging in societally valuable businesses. Farmers already participate in a variety of futures markets in order to reduce their risk. The new water futures are an addition to this portfolio of risk-reducing derivatives.

My biggest fear is that politicians and other market critics will seize on the new water futures as an indication that water markets are a danger to society and try to shut down or increase controls on such markets. Water futures and water markets are two different things. Water markets existed before the new water futures and are an important way by which society can ensure that water, particularly as it becomes scarcer, is used wisely. Water markets need to be carefully regulated to protect the human right to water and the environment. But with appropriate protections in place, water markets are an exceptionally important and valuable tool.

 

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Reader Comments

Submit your own thoughts and questions by using the form at the bottom of this page. Entries will be reviewed and posted as we get them.

Wayne Lusvardi Rancho Mirage

Responding to California Water on the Market: Q&A with Barton “Buzz” Thompson

Maybe Thompson knows something I don't, but if farmers buy insurance (called hedges) in the euphemistic Derivatives market, the cost of that insurance will be passed on to the ultimate end users, as the traders in the Derivatives Casino are not around to lose money. The question is not whether farmers can stabilize their water costs, but is the additional cost of the hedge worth it in the long run? So, during one Dry Year when water is, say, $2000 acre foot, the farmer saves, say, $1000 per acre foot. But during the four preceding years when water was available, the farmer had to buy the hedge for no additional water. In short, what's the NET bottom line? I'm not sure Thompson or i know, but we might ask a farmer or a private water trader like John Vidovich.

3/4/2021,11:12am

Al B Clarke Blanding, Utah

Responding to California Water on the Market: Q&A with Barton “Buzz” Thompson

Fascinating article. Still reading, but most of this makes sense. Blanding is dry country. We irrigate our lawns and garden, but the house runs on a well. Some years we can't get water and lawn and garden suffer, as the well water is not adequate. I'd feel rotten making a fortune on water future contracts........

3/4/2021, 9:31am

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It’s Not Just Car Tailpipes, It’s Car Tires that pollute the waters of San Francisco Bay. The San Francisco Estuary Institute has measured runoff after cars gather for big events, particularly events held during rainstorms. It estimates half of some 7.2 trillion synthetic particles washing into the bay each year come from tires – which now consist of both rubber and plastic polymers. The institute’s work broadens the focus of environmental damage from cars. Hakai

Federal Plans to Raise Shasta Dam were unveiled by the Bureau of Reclamation. Supporters, particularly those in the agricultural industry centered in California’s Central Valley, strongly support increasing the dam’s storage capacity by 200 billion gallons, or 634,000 acre-feet. The latest press release from the Bureau of Reclamation discusses the findings of its most recent environmental impact statement. Agnet West California Aggie

Colorado’s Air Quality Control Commission Speeding Closures of Coal-Fired Power Plants to meet the state goal of slashing emissions in half by 2030. According to the U.S. Energy Information Administration, from 2011 to the middle of this year, some 95 gigawatts of coal capacity was taken offline another 25 GW is slated to shut down by 2025. Utility Dive

How Much Lithium Under the Salton Sea Can Be Retrieved? The huge lake in the southeastern California desert may sit atop a rich deposit of minerals just waiting to be developed. The hot water trapped beneath the basin's floor contains one of the world’s biggest deposits of lithium. This mineral, which now comes mostly from China, Australia and South America, has growing importance as automakers shift to electric cars powered by lithium-ion batteries. Bloomberg H2O Radio

To Fight Against Climate Change, the Swinomish Use Traditional Knowledge to recover the salmon central to the Indigenous group’s diet and traditions. In recent years, though, the tribe’s harvest, diminished by vanishing habitat and warming waters fueled by climate change, hasn’t been sufficient to feed the hundreds of people who come to pay homage to their ancestors and the fish that sustained them. Their ambitious climate strategy involves not only rebuilding oyster reefs, but, for salmon, restoring tidelands and ancient channels, planting trees along streambeds to cool warming waters and working with farmers to push back setbacks from streams. Some 50 other Native tribes are following the Swinomish lead. Washington Post

In a Tribute to Ansel Adams, a magazine produces a photo essay following in his path. Maptia

Articles Worth Reading: November 24, 2020

Breakthrough Deal Revives Plan for Largest U.S. Dam Demolition along the Oregon-California border. An agreement between the governors of Oregon and California paves the way for the demolition of four hydroelectric dams on the Klamath River, creating the foundation for salmon restoration that would aid tribes in the area. The deal must now be approved by the Federal Energy Regulatory Commission, with California officials optimistic that dam removal could start by 2023.

Associated Press San Francisco Chronicle

Federal Subsidies Accelerate the Draining of the Ogallala Aquifer. For decades, farmers have overdrawn the groundwater from the nation’s largest aquifer, which covers parts of eight states. New research shows that state and federal policies encourage the depletion, which now threatens drinking water supplies. Federal subsidies increased 65% in 2020, partly in payments to cover the pain of losses from trade wars. The subsidies put farmers on a treadmill, creating a vicious cycle of overproduction that requires intensive use of water. The Counter

New Mexico Ranchers Face Historic Drought, forcing some ranchers to sell their animals as there will not be enough grass to support the animals through the winter. The state is facing patches of extreme and exceptional drought, compounded by several summers of record heat and little rainfall. The pandemic is exacerbating the impact of the drought by hurting meat-packing plants and closing restaurants. Albuquerque Journal

Researchers Still Don’t Know Why So Many Birds Died This Fall. Thousands of bird deaths have been recorded across the western U.S. and Mexico. Researchers say the mass die-offs are unusual, finding piles of dead birds in one spot. It is unclear whether these incidents across the country are related or not, and scientists have posited causes ranging from extreme weather events and wildfire smoke to drought. Sierra Club Salt Lake Tribune

Placer County, Calif. Is America’s Riskiest Place for Wildfires. Computer modeling conducted by analytics firm Climate Check shows 17 counties, mostly clustered in the West, face the country’s greatest wildfire risk. Experts say development and population growth in remote areas and on the edge of cities, creating increased growth in the wildland urban interface, is responsible for much of the increased risk. E&E News

Congress Seeks Answers on Alaskan Mine Project. Democrats in the House of Representatives have launched an investigation into the Pebble Mine project, seeking to determine whether the developers misrepresented its plans to Alaskan Natives and the government. House leaders raised concerns that the developers privately planned a much larger and longer project while downplaying the mine to the public. If completed, Pebble Mine would be one of the largest open-pit mines in the world. The New York Times

Articles Worth Reading: November 17, 2020

Hoping to Lock In Drilling Rights on Alaska’s Pristine Coastal Plain, the outgoing Trump administration is asking oil and gas firms to select the places they hope to drill in Alaska’s Arctic National Wildlife Refuge. The idea is to ensure a lease sale in the wilderness area of nearly 1.6 million acres can occur before the inauguration of a longtime opponent, President-Elect Joe Biden. Washington Post

Federal Judge Says Interior Department Ignored Climate Concerns in granting new Wyoming oil and gas leases. The judge blocked the move and called on federal regulators to comply with the National Environmental Policy Act and conduct its environmental analysis and consider possible negative effects on the climate, before drilling on 282 lease parcels on 300,000 acres of federal land could be occur. Casper Star-Tribune

Canadian Environmental Groups Working With Shell Canada and Others to create a national carbon-offset system. The program is something that the government announced last year but has no built-in deadlines to follow. Shell is one of several oil companies pushing the federal government to create a national greenhouse gas offset program. Carbon offsets allow companies and individuals to invest in environmental projects in order to balance out their own greenhouse gas emissions. CBC

The Lights of Growing Communities Attract Deer. Deer Attract Cougars. Research shows that as light pollution grows, it mimics deer’s preferred dusk and dawn grazing times. But there are still enough dark spots for predators to hide and hunt, according to both satellite data and GPS data from 117 cougars and 486 mule deer in the southwest. Salt Lake Tribune

The Head of California’s Clean Air Agency Could Lead EPA under President-Elect Joe Biden. Mary Nichols has kept California focused on efforts to control greenhouse gases. But at the Air Resources Board, disquieting news surfaced about allegations of persistent slighting of Black employee in the agency, which is opening a discussion of the charges with all employees. Bloomberg News Sacramento Bee

Black Cowboys Reclaim Their History in the West Though historians estimate that as many as one-fourth of the cowboys in the late 1800s were Black, many of them have been erased from the history of the “Wild West.” But this history is remembered by men who gather at a ranch in South Phoenix owned by a retired Black trucker from Indiana. High Country News

Graphics & the West

Where California Grows Its Food

See the most detailed survey ever done of crops and land use in California. It covers nine million acres of land devoted to grapes, alfalfa, cotton, plums, you name it – food for people and animals all over the world. View map »

California's Changing Energy Mix

A look at the energy sources California utilities have used gives us insights into the state’s progress in decarbonizing its electricity supply. In 2015, 35% of total electricity generation (in-state generation plus imported electricity) came from zero-greenhouse-gas sources, which include solar, wind, hydropower, and nuclear. View Graphic »

U.S. Conservation Easements

Conservation easements of various kinds cover more than 22 million acres of land in the United States, according to the National Conservation Easement Database, a public-private partnership. Take a look at our interactive map of nearly every conservation easement, with details on over 130,000 sites. View map »

 

Recent Center News

Apr 15 2021 | Center News, Happenings, Research Notes
After partnering to conduct research on policing alternatives last summer, the Lane Center and neighboring cities will conduct follow-up meetings on April 30 to discuss progress, challenges and new research.
Apr 12 2021 | ... & the West Blog, ... & the Best | Stories Recommended by the ‘... & the West’ Blog
Deb Haaland visits Bears Ears; scientists study what makes wildfire smoke toxic; the fight to save old-growth forests in British Columbia; the first urban wildlife refuge in the Southwest; grasshoppers and an opera in Glacier National Park; and other recent news from the West.
Apr 8 2021 | Center News, Happenings, Research Notes
2019 data on public sector debt for pension liabilities, with a focus on California, now available with 'Pension Tracker'