Steve Maxwell has 30 years of experience in the water and environmental industries. I spoke with him about the California drought and what it means for investors.
Bloomberg reports California is in one of the worst droughts since records began in the 1850s’.1
Reservoirs are at 60 percent of their average volume, while mountain snowpack is at about 12 percent of normal for this time of year.
In 2013, Los Angeles received 4 inches of rainfall compared to an average of 15 inches, and San Francisco got 6, which is far below its expected 22 inches in normal times.
Will this drought affect water as an investment?
Steve Maxwell, who has worked in various consultancy roles in the water industry for 30 years, says that water stress in the western states will increasingly open up opportunities in this sector for investors.
Water ownership is based on a system of historical legal claims to supply. Users such as individuals, corporations, and municipalities acquired an early right to water resources based upon putting the water to ‘beneficial use’ such as for agriculture or human consumption. That claim to water is called a ‘water right.’
In the April 2010 American Water Works Association Journal, Steve asserted that water rights will become increasingly valuable going forward. Market forces will cause prices to gradually rise, and thus help reduce the amount of fresh water that is misused or wasted. In turn, many new opportunities will become available to private investors.
In fact, we have already seen this occur elsewhere in the world – specifically in the Murray Darling Basin of southeastern Australia. In 1990, after a decade of severe water shortage, authorities created a limited trading market for water rights – almost like our “over-the-counter” market.
A 2011 report from the Australian National Water Commission says this was critical in resolving the region’s water problems.2
Between 2005-06 and 2008-09 the amount of water used for irrigation agriculture dropped by 53%, but the output from these crops fell only 29%.
Farmers who grew rice, a water-intensive crop, planted more in times when water was cheap. Conversely, they planted less when water was scarce and more expensive.
While rice production fell, land devoted to the almond industry in the Basin increased six-fold from 2000 to 2010. Wine grape production also developed rapidly in the 2000’s. The report plainly states that “The horticulture industry could not have developed in the [Murray Darling Basin] over the past decade without water markets.” In short, water was more wisely and efficiently allocated.
As competition for water arose, the price of water rights also increased. The following chart from Steve’s report in the AWWA Journal shows average prices of water rights in southeastern Australia from 1998 to 2009:
According this report, the price of raw water supplies rose an annualized 12-14% over this period.
What about the western United States?
Does it make any more sense to grow cotton and alfalfa, which are water-intensive, in the deserts of Arizona?
Steve says that water is often underpriced in the western United States, because access to water has been subsidized by the Federal government for so long.
“In the western United States, most of the water was initially used by the agriculture and mining industries, and water rights were staked in the same way as mining rights during the 19th century.
“Although these rights can be traded, there are numerous economic, legal and cultural obstacles that impede the full-cost pricing of water.”
In California, regulations prohibit water that originates on farmland from being used for any other purpose except agriculture unless there is a specific exemption. This keeps prices low for farming at the expense of urban users.
Farmers in Imperial County, which holds the biggest claim to water from the Colorado River, can sell their water rights to Southern California residential areas. But the Imperial Irrigation District decides how many famers get to sell in any given year and sets the duration and price of the contracts.3
“Water is being misused, misallocated, or wasted because it is not properly valued,” says Steve, “in part because of the vast network of subsidies and historical rules that affect the way we price water.
“A lot of the water in the western United States was originally developed via huge federal spending projects like the Hoover Dam and the other federally operated dams. These dams were set up in the first half of the 20th century to encourage economic expansion in the West. They provide water that is sometimes underpriced, and that does not reflect the real expense of bringing it to market.
“Eventually, we should see water prices rise, and we will increasingly see water go toward those applications where it is the most useful or valuable.
“We saw the success of this type of model in southeastern Australia, where users became much more efficient after a market for water rights was created.”
Steve reckons there really are no viable new supply sources to help solve the water crisis in California other than improved conservation, and better allocation – because the western United States has little remaining and unused or unallocated water.
Many of the upstream states, such as Colorado, already believe that California receives more than its fair share of the Colorado River water that flows through these States.
If there is a move to a market-priced water system, investors may have more opportunities to enter the sector.
“Proposed desalination plants and water tunnels are also too expensive and fraught with political difficulties. So there is no easy way out of the water squeeze.”
As Steve puts it, “California has to become more efficient in using and allocating its existing water reserves – and make do with what it’s got.”
Steve Maxwell has been involved in the water industry for 30 years and is the founder and Editor of the Water Market Review, and the author of The Business of Water and The Future of Water. He is Managing Director of TechKNOWLEDGEy Strategic Group, in Boulder, Colorado. He is also a contributing editor to American Water Works Association Journal, the Environmental Business Journal, American Water Intelligence, Water Underground Infrastructure Management, and the Environmental Lab Report.