02 March 2015

So why can't California fix its water problems?

PM emails:

"I am/have been involved with the operation of a water spring. Why isn't water derivative trading happening in the US? Australia has their water derivative tied to a dam and is cash based. Why not an actual deliverable contract?

I am in NY. In PA, frackers need on average 3 million gallons of water per well, which they can frack up to 15 times. Fracking has its own problems; nevertheless, the point is, demand. Moreover, the high tech companies building semiconductors need water (demand). The growth of craft breweries and breweries in general, need water (demand). I think it is Budweiser in California that has a problem meeting their water needs for brewing. Contaminated public water sources (happened at couple of times already in the past year in the capital region) increase demand. Farmers need water. You were in California, so you are aware of the water drought facing farmers in California. California has irrigation, New York does not.

So I as a supplier of water, I want to sell water to the demand. No easy market at the moment. However, I see a market as this:

  • Fracker Ltd, has 5 drills operating, wants 5 February water contracts. Oil is not so hot, so they are going to lay off 2 rigs; thus, he gets 2 March water contracts, holds off on the third to see if the price drops.
  • Hard Spirits Inc. can not keep up with demand. Needs water every month, but sees summer months hotter than normal and the price of water going up. He buys June water contracts for his need and speculation.
  • Appleseed Farmer does not expect a hot summer and decides to not hedge crop failure.
  • Oats and Wheat Ltd does not expect a hot summer but wants to hedge crop failure and buys June and July water contracts.
  • Morrill Water & Trading, sells water contracts in the spot market and the future market. I do not think it will be a warm summer and sell June and July Water contracts.
  • River Dry Water is all about a warm summer and holds off on selling contracts until the price gets higher.
These are just some examples of agents hedging, buying, selling, and creating a water spot and future market. Tax payers can stop paying taxes to insurance and assist farmers for drought, since the private sector has provide a hedging tool for drought crop failure. Politicians can sell it to the people as cost cutting and deficit reduction.

Now this is not an all inclusive paper, but just a quick "back-of-the-envelop" speculating. I have seen your comments about the difficulty of moving bulk water -- not to mention its annoying habit of expanding in cold weather (negative 7 degrees F the other day) -- nevertheless, I can see the pipeline running from the spring down into Troy where there is already existing infrastructure for commodity shipment and handling.

Why do I only here about Citi's chief economist talking about water derivatives and infrastructure, Dr. Sander's Environmental Financial Products consulting and talking about water derivatives. Why isn't anyone doing it? Making it happen? Making the idea a reality?"

These are great questions, even if most are rhetorical, and PM answered himself a few days later:

So... I see that Waterfind in Australia is trading water rights and has a forward market. They have gone beyond the water dam level cash payout future that I last heard of. I could see water right trading in USA as a potential problem. However, I did not know that California's agricultural economy is $42.6 billion, while Australia's agricultural economy is $38.2 billion. Nevertheless, they both have very similar water conundrums. Maybe California has something to learn?

Indeed, California has something to learn -- as I've pointed out in many blog posts -- but some people in California do not seem to understand the lesson. Case in point was Friday's op/ed by Peter Gleick, in which he said [my emphasis added]:

"Based on years of research by my organization, the Pacific Institute, here are key water-policy strategies that should be implemented immediately:
  1. The state should create and implement a water bank. It did so previously to great success. Here’s how it would work: Senior water rights holders able to cut use through efficiencies or by changing crops would sell saved water; the bank would resell that water at a higher price to willing buyers; profits would go to buy water for critical fisheries and ecosystems.
  2. Federal and state agencies should provide finance assistance to farmers to help them replace inefficient irrigation systems. This can save both water and the economic health of the farm sector.
  3. California should accelerate implementation of the state’s new groundwater law to eliminate permanent overdraft.
  4. Urban water agencies should greatly expand efforts to inform urban water users how to cut water use and costs. Particular efforts should focus on programs to convert water-guzzling lawns to low-water use landscaping, and efforts to replace inefficient indoor fixtures, identify and fix leaks and modify water-using behaviors.
  5. New management practices are needed to price water so that it encourages efficiency and conservation, protects affordability, cuts overall water bills and protects the financial health of water agencies."
In response, I wrote (and now expand those comments):
  1. Although I agree with some of your suggestions, I'll add that water markets will work much better if farmers are able to profit (as they do in Australia). The government can buy or "grab" water necessary for environmental flows, under public trust powers. It should not expect farmers to cut use or change crops without a profit motive.
  2. Farmers do not need more subsidies (or subsidies at all) when it comes to water efficiency. They will "get efficient" when it pays, as they have in Australia, where they can sell excess water on markets.
  3. Yes!
  4. There's no need to inform users. Raise prices. People will figure out how to save water, whether it's through shorter showers, smaller lawns or low-consumption appliances.
  5. Your recommendation ("New management practices are needed to price water so that it encourages efficiency and conservation, protects affordability, cuts overall water bills and protects the financial health of water agencies") is an oxymoron. Higher prices are unlikely to cut overall water bills, but they will induce conservation. They can be implemented in a way that "protects affordability" using the system of rebates that I describe here.
Bottom Line: Californians (and people other places experiencing "water stress") need to (a) realize that they are living in a "new normal" where water is no longer abundant and (b) implement policy changes that recognize that fact and reward efficiency (punish inefficiency). Market and price signals are the best means of doing that for "economic" water uses (irrigation; water for homes and businesses); social water uses (for the environment) are another matter, but I describe all of these systems and interactions in my free book.

H/T to DS


  1. "There's no need to inform users. Raise prices. People will figure out how to save water..." Well, yes, raise prices. But why not also educate users regarding effective ways to conserve water? Why oblige every person to figure that out independently? Why require constant reinvention of the wheel? Conservation goals will be achieved more easily and quickly if water consumers are educated about effective methods to achieve those goals.

    1. Why not educate users on how to use less energy? gasoline? beer? @Anon -- your point implies that water is "special" when it's really just an economic good that people will use (or waste) in accordance with their tastes AND the price/cost of use. There's endless data on the connections between cheapr water and extra use.


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