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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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To Save Snake River Salmon, A Republican Congressman Wants to Breach Four Dams. Rep. Mike Simpson of Eastern Idaho has proposed a massive, federally-funded dam removal effort beginning in 2030. Many stakeholders are uncertain about the future of the $33 billion proposal, which would replace the hydroelectricity from the dams and provide alternatives to barging crops downriver. Simpson hopes this will preserve endangered salmon and support local economies. Idaho Statesman

Coachella Mandates Hazard Pay for Farmworkers under its jurisdiction in southeastern California. About 8,000 farmworkers live in Coachella Valley, with 30 percent of these in the city itself. Farms have been a common site of Covid-19 outbreaks. Workers often struggle to find protective gear and many occupy shared housing. As of mid-February, at least 12,787 farm workers have tested positive for Covid-19, and 43 have died, according to the Food & Environment Reporting Network’s outbreak tracker. The Counter

To Win State Control of Federal Lands in Utah, Suits Claimed Thousands of Wilderness “Roads” Existed. Their existence has been in dispute since suits were first filed in 2012, and a recent judicial ruling, saying wilderness advocates were improperly cut out of the certification process, may mean years more litigation. Some in state government are asking if the effort is worth it. Salt Lake Tribune

Environmentalists Fighting Tejon Valley Ranch Development Invoke Native Claims that the California condor qualifies as a cultural resource. In an appeal of a federal court ruling that allowed nearly 9,000 acres to be developed with homes and a golf course, the Center for Biological Diversity and local tribes argue the development in condor habitat would harm the bird. A dozen years ago, a landmark agreement between the ranch and major environmental organizations protected 240,000 acres of the ranch’s land and allowed development on the remaining 30,000 acres, including the land now in dispute. The Center was not a party to the agreement. Mynewsla High Country News

Montana’s National Bison Range Now Under Native Control. After 25 years of and on-again, off-again federal effort to transfer management of the range located on the Flathead Indian Reservation from the Interior Department to the Confederated Salish-Kootenai tribe, the final legal agreement was reached in December and earlier this year the transfer took place. Charkoosta

California Legislators Consider Vast Expansion of Offshore Wind. A new bill would require California to set a target of constructing 3,000 megawatts of offshore wind by 2030. Fishermen and environmentalists are still somewhat wary of offshore wind, but the bill has attracted support from labor leaders across the state. San Jose Mercury-News

Articles Worth Reading: Feb 2, 2021

On U.S. Public Lands, Can Biden Undo What Trump Has Wrought? President Biden’s ambitious agenda for public lands includes bans on oil and gas drilling and restored protections for key areas. Reversing the Trump administration’s policies, however, may be made difficult by conservative courts and rules changes. Yale Environment 360

Why Utah’s Wild Mink COVID-19 Cases Matter: In Utah, which faces similar problems to those encountered by the Netherlands last year, thousands of farmed minks have died of Covid-19. The affected sites have been forced into quarantine, and a wild mink tested positive for coronavirus last month -- the first wild animal to have naturally been infected with the virus. High Country News spoke with Dr. Anna Fagre, a virologist and veterinarian at Colorado State University, to help put the recent COVID-19 outbreak among wild minks in context. High Country News

Timber Tax Cuts Cost Oregon Towns Billions. Then Polluted Water Drove Up the Price. In rural Oregon, logging-related water contamination has threatened their access to clean, safe drinking water, forcing small towns to spend millions on new water infrastructure. The future of logging regulations remains murky for the nation’s top lumber producer. For decades, Oregon has allowed logging companies to leave fewer trees behind than in other states. Propublica/Oregonian

The Interior Department Effort to Relocate Jobs to Colorado Prompted a Mass Exodus; some 41 of 328 employes slated to move to Grand Junction, Colorado actually made the move; the rest left the agency. The Bureau of Land Management’s loss of so many longtime career employes – only 60 jobs were left in place in the Washington office -- is an example of the Trump Administration’s success the federal government. Washington Post

An Exploration of the Reasons to Cherish Microbiotic Soils. Fungi, lichen, cyanobacteria, algae, and other tiny organisms live in just the top few millimeters of soil; these crusts are critical to the health of the desert, and can be damaged repeated trampling by people, cattle, or off-road vehicles. Sierra Club

Some Ecological Damage from Trump’s Rushed Border Wall Could Be Repaired; conservationists are urging the Biden administration to remove sections of the barrier that cut across critical habitats, block migration corridors, and damage watersheds. The coalition opposing the wall has identified specific problematic sections to be potentially removed. Scientific American

Tens of Millions of Birds Pass Through Two Corridors in the West: California’s Central Valley and the Colorado River Delta. New research finds that more than 82 million birds pass through these regions during spring migration, with tree swallows concentrating in the Colorado delta and Anna’s hummingbirds in the Central Valley. This data helps define critical habitats for western birds, with up to 80 percent of some species’ populations passing through the two areas. Yale Environment 360

The Navajo Generating Station, a Major Employer and a Major Polluter on Navajo Land, has Been Demolished after Navajo and Hopi community members fought for years to close the facility. Now, Navajo and Hopi community members are outlining steps for community restoration, such as securing electricity and clean water access for residents, as well as job training. Center For Health, Environment And Justice

Articles Worth Reading: January 19, 2020

A Forever Drought Takes Hold in the West. The U.S. Drought Monitor — the nation’s official tally — shows Utah, Arizona, Colorado and New Mexico mired in “exceptional drought.” This type of drought is only supposed to happen every 50 years, but it’s now a regular occurrence. Even if rain and snow arrive in the coming months, parched soil will slurp it up, leaving less for riverbeds. Axios

“We’re Bound by That River,” one water expert said of the Colorado River, which supplies water to 40 million people. “All of us, regardless of our legal rights, regardless of what’s on paper, we need to consider how we can use less water. And we need to take action immediately.” The Colorado Basin and its water managers must juggle the laws that are decades old, new agreements and persistent aridity. The huge reservoirs of Lake Powell and Lake Mead have shrunk dramatically. Some observers say the rules governing distribution of the Colorado’s waters need to be fundamentally reimagined. Arizona Republic

Unlikely Coalitions Form to Block New Port Facilities to export fossil fuels. Teaming with Native Americans, ranchers and sportsmen, environmentalists have worked to block nearly every effort to export coal, oil and liquified natural gas from the West Coast. They just claimed another major victory this month – the latest of more than two dozen -- when a proposed coal-export terminal in Washington state was called off. Associated Press

“Fossil” Groundwater Is Being Depleted in California, and its users can’t rely on it being replenished any century soon, according to new study. If the water tucked underground for 100 centuries is used for the crops and pools of the 21st century, the fossil water stores will disappear for good. “It’s just like taking gold out of the ground, out of a mountain,” said Menso de Jong, the study’s lead author. “The gold is not going to grow back.” San Jose Mercury News

Apaches Sue to Stop First Step in Approval of Copper Mine Near Sacred Site. If an environmental study’s publication is blocked, the process of approving the mine planned by Resolution Copper might be derailed. A podcast interview with the reporter covering the controversy, Debra Utacia Krol of The Arizona Republic. KSUT

To Help Rural Economies, One-Third of Spotted Owl Habitat in Oregon Was Excluded from Protection. The size of the protected acreage has yo-yoed from one administration to the next, but this cut in protected areas is one of the biggest on record. The amount of habitat protected in the Obama administration was more than 9 million acres; the Trump administration in its final days cut that by more than 3 million acres. E&E News

Rural Coloradans Seek to Contain Light Pollution. NASA photos of Colorado from space show a widening urban white-out reaching into rural areas. The dark-sky zones that southwestern Colorado leaders are proposing in areas like the San Luis Valley would, all combined, cover more than 3,800 square miles — the largest official area protected from artificial light on the planet. Denver Post

Wildlife Take Stock of Photographers Taking Stock of Wildlife. “Animals interrupting wildlife photographers,” a thread by the Catalan journalist Joaquim Campa. Twitter

Articles Worth Reading: December 7, 2020

New Data Shows Lethal Damage to Coho Salmon Is From Tire Residue, as researchers double-down on the findings about tires’ environmental damage. One chemical, 6PPD-quinone, interacts with ozone and becomes highly toxic to Puget Sound salmon, taking out 40 to 80 percent of returning salmon before the spawn. The problem extends from Washington state, where scientists have been studying the issue, to California; tires are the largest source of microplastics in San Francisco Bay. The Seattle Times Los Angeles Times

With Legal Barriers Gone, More Westerners Are Harvesting Rain to supplement the disappearing water in the Colorado River and the Ogallala Aquifer. Rainwater harvesting—a cheap, low-barrier, low-energy method—may provide one piece of the long-term solution to water shortages in a region where climate change is intensifying droughts. Today, rainwater capture is legal in every state, though many have restrictions. A few, like Colorado, didn’t legalize it until 2016 and still restrict the total amount harvested. The Counter

A Navajo-Majority County Commission in Utah Calls for Restoring the Bears’ Ears Monument to its original size. The Trump Administration dramatically reduced the monument from 1.35 million acres to two separate areas totaling 200,000 acres. The San Juan County Commission voted 2-to-1 to make the request, with its two Navajo members in the majority. Associated Press

In the Wake of Fierce Fires, A Sudden Burst of Logging in Colorado. State foresters are overseeing wholesale mechanized tree-cutting, as tractors dig holes up to 140 acres in size are appearing among the lodgepole pines. A hot national wood-products market snaps up the lumber created in Colorado, which has never traditionally been a logging state. Across western Colorado, insect attacks on old and drought-enfeebled trees over the past decade have left 5 million acres of skeletal trees in a region climate change has made susceptible to wildfire. This year, 700,000 acres burned. Denver Post

As Insurers Blanch at Newly Calculated Wildfire Losses — $24 Billion in the U.S. in 2018, they continue to flee fire prone areas. In California alone in 20219, insurers pulled coverage from more than 230,000 homes — about 31 percent more than the year before. California regulators want to keep private insurers from fleeing the state, but know that climate change is changing everyone’s risk calculation. Bloomberg

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 »

 

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