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The Rise of American Water Markets and Investments

“You know,” said Trump. “You could build a pipe, and you would never have a problem in Los Angeles and Southern California again.”

“It would have to be a big pipe.”

“Wouldn’t have to be that big. A lot of water would come down, I can tell you that. They have nothing but water.”

— A conversation between Donald Trump and David Burn from 2015 transcribed in Where the Water Goes: Life and Death Along The Colorado River

A Western Water Crisis

Long before anyone took Donald Trump seriously as a presidential candidate, he had a plan for water: build a pipe from a water rich northern region (Minnesota and Alaska are the usual targets) and ship it to water thirsty southern regions like Los Angeles. Who knows? Maybe Canada would even pay for it. Compared to some of the other ideas floating around (zapping clouds with silver iodide, “toilet-to-tap” schemes, lugging icebergs from the arctic, etc.), building a 2,000-mile underground piping system isn’t the craziest. The fact is, people are desperate for a solution. After a century of sustaining desert cities, desert agriculture, and desert politics, the abused Colorado River has reached the end of its stream.

Since 2000, Colorado river flows have dropped 16% below their 20th-century average levels. Climate change will withdraw another ten to thirty percent by 2050. That’s a big problem, considering it provides water to 1 in 8 Americans, sustains foliage cover across 7 major cities, and supports 15% of the nation’s farmland. Why is one of the most developed nations on earth facing water shortages? There is no single scapegoat we can blame. A combination of cultural practices, dietary preferences, rigid water rights laws, climate change, and outright waste have led to the current crisis at hand.

But at the heart of all these underlying issues lies one central problem: the true value of water remains unrecognized and underpriced. As long as the demand side — whether it’s growing urban centers, industrial farms, or your neighbor’s sprawling lawn — continues to use water with little effect on price, expectations for sustainable reforms and conservative use are largely delusional.

The Complexity of Reducing Agricultural Demand

It’s impossible to discuss water shortages without discussing agriculture. Agriculture remains the biggest drain on water resources by far. Worldwide, it accounts for 71% of global water withdrawals. That number holds true for the US, and in the Colorado River Basin it’s even higher: 80% of the river flow is used to irrigate 6 million acres of cropland across the arid west. While farmers have made significant efficiency gains since the 1980s, demand is hardening thanks to the rise of tree nuts which require constant watering each year. Farmers have heard it all. Water hogs. Ag sponges. Water guzzlers. Imperial Valley — a stretch of arid desert in Southern California that serves up 80% of the nation’s winter vegetables — has priority rights to a fifth of the Colorado River. In many places, the temperatures are so high that significant water loss occurs simply by evaporating into hot air. Climate change research predicts that evapotranspiration will increase by 7% in the immediate future thanks to rising temperatures. One obvious question is why we decided to situate our agricultural heartland in the middle of giant desert? It turns out, there are a lot of good reasons for doing so. For one thing, there’s no surprises. It’s hot all day, every day. No need to worry about frost or hail. Very few rainstorms! Desert land provides a controlled growing environment that allows farmers to make consistent predictions for crop yields and income.

Why Do We Grow So Many Water Intensive Crops?

Then there’s the question of why we grow certain crops. Almonds are the poster child for heartless water-sucking crops that many people would like to ban. A much-cited figure is that to produce one almond requires one gallon of water. While it’s true that almonds use a lot of water, they’re also highly nutritious and more lucrative than your standard salad garnishes. When compared to beef — which uses 2,500 gallons of water per pound — their water efficiency per calorie is much higher. Things get thornier when the food we’re growing isn’t for humans. Alfalfa — a close cousin of hay — is California’s biggest crop, and it’s the food item of choice for cows. It’s an incredible water guzzler, consuming 2 trillion gallons a year. But even then, alfalfa, while not a high-value crop in it of itself, feeds directly into the much- prized dairy market. It’s essentially the bottom feeder of the food chain that leads directly to ice cream, pizza, yogurt, and milk. Critics of the crop don’t really have two feet to stand on unless they’re devoted vegans. There’s also the complaint that much of this isn’t even feeding our own cows: it’s feeding China’s. But even then, there’s a good justification. Alfalfa is one of the few American products that other countries still want from us (they don’t have the water resources to grow it either). Our trade deficit is so steep that in many cases it’s much cheaper to ship alfalfa back to China in ‘empties’ rather than to transport it across country by truck.

So until Americans make a radical diet change and decide that they’re all going to fast on Fridays (just one meatless day a week would conserve the equivalent of the Colorado River’s entire flow each year), or until we come up with a higher value product to offset our trade deficit other than hay, it may be difficult to reduce agriculture’s water use simply through self-righteous media campaigns.

Reimagining the Price of Water

One way to redirect water resources is to actually start charging for it. Farmers (and consumers) may not respond to shame and blame campaigns, but they would likely respond to higher price signals. If food items actually reflected the cost of water involved in their production, many Americans might rethink buying that quarter-pounder. With the right price, maybe they’d even reconsider the culinary appeal of crickets (crickets are a wonderful combination of a high-protein, relatively low-water food source. Unfortunately, they still look disgusting). In other commodity markets, price responds to supply levels. As the price increases, people who need less of it scale back their purchases. This is not the case for water. Water is treated and priced as if we’re all floating by on Noah’s ark. Prices are kept laughably cheap: even during extreme shortages, senior water right holders are entitled to their full allotment basically for free. In some western states, 1,000 gallons of agricultural water can cost as little as a few pennies. Consumers are no different. Most water bills don’t even cover the cost of delivery, and the most extravagant users come from wealthy neighborhoods feeding their manicured lawns or in-ground pools. Where else would this be acceptable? It might explain why outdoor landscaping still accounts for over half of all urban water use, and how Americans manage to use 3x more water per capita than China. Water markets would eliminate frivolous lawn displays (or cost you dearly for it) simply by raising the sticker price. By pricing water beyond the cost to transport it, water consumption could be directed towards more high value uses than bringing palm groves to death valley.

The Growth of US Water Markets

Water cannot be priced correctly without the growth of water markets. Water markets are increasingly drawing the attention of private investors, but many are daunted by their complex and fragmented nature. Water itself is divided into different asset classes (the most common is surface water) that each have their own trading rules depending on the source.

US water markets are in their infancy years. Water trading is highly regionalized due to physical and political trading barriers across geographic lines. There are over 25 different regional water markets in western states alone.

California dominates both in terms of volume and value, but even then water trades only account for 2% of its total supply. In the past decade, approximately $3.9 billion dollars of water were exchanged. This consisted of trading water rights, or, in recent years, temporarily leasing them. Temporary leases respond to market scarcity by redistributing water to where it’s needed most. Popular examples include “dry year option” contracts which allow cities to lease water rights from farms (for a premium) during times of drought. The majority of water rights holders, and therefore, sellers, are farmers. Farmers hold 4x more water rights than municipalities. Demand comes primarily from Western cities, which are projected to grow by 10 million residents by 2050. One interesting source of new demand comes from environmentalists looking to replenish natural water resources and rescue endangered species of fish. They represented 25% of the total volume traded in the last decade. Other interested buyers include investment firms, oil and gas companies, and Native American reservations. Even college endowments have hopped on board. Harvard spent ten years buying up $100 million worth of vineyards to secure their water rights. Sadly, they don’t have a Harvard branded wine label. While the overall investment resulted in some negative headlines (Harvard allegedly destroyed several ancient burial grounds and diverted water resources from native populations), ag investments remain of interest to endowment funds thanks to their stable rent income and long-term appreciation.

Decreased Regulation Needed for a More Mature Market

Willem Buiter, former Chief Economist at Citigroup, predicts that there will be a “globally integrated market for freshwater within 25 to 30 years” that will outsize all other commodities markets. If western states can gather enough political approval to facilitate more frequent trades, that timeline may be much shorter for the US. The current trend supports greater leasing opportunities, which allow for more frequent, cheaper transactions without stiffing farmers or urban centers. Only when the market is nimble enough to respond to sudden water crises will it be able to reallocate water resources in a meaningful manner. The Australian Murray-Darling River Basin may provide the best blueprint for a fully developed water market. There, water pumps are consistently measured, monitored, and traded via an online market system that operates much likes a stock market. Instead of personally soliciting the next distressed rancher (as they often do in the US), buyers and sellers are able to exchange resources in a matter of minutes. During dry years, the value of water climbs so high that crops such as cotton and rice are temporarily pulled from the fields since their selling price can’t justify their water usage. If we’re lucky enough, California may learn to scale back its apocalyptic water usage, and we may soon see the same prudence applied to almonds and alfalfa.

Investing in and Lending on Water Assets

In 2010, Michael Burry, who formerly came to fame by shorting the housing market, shocked Bloomberg News when he revealed his latest investment strategy: buying up farmlands. He was an early advocate for the hidden value of water rights, stating, “I believe that productive agriculture land with water on site will be very valuable in the future… I’m a value guy, so I want the raw land. That’s the way to get it cheapest.” Other avenues for investment, while not necessarily very sexy, present legitimate opportunities. These include water infrastructure, water quality and measurement, wastewater treatment, and new technologies for water efficiency, etc. The Organization for Economic Cooperation and Growth (OECD) estimates that global infrastructure investment in water will top $1 trillion by 2025, with much of the capital coming from private investors. One investor, Disque Deane Jr., built a hedge fund exclusively devoted to buying and selling water related assets. His company, Water Asset Management, looks for undervalued investments like distressed farms with valuable water rights that are situated near growing municipalities. However, he warns against oblivious investors jumping on opportunities without conducting proper due diligence within local communities first. As water scarcity increases in many California farming areas, water rights are playing an increasingly important role in farm valuation and access to better loan terms. Farms with surface water rights have an advantage when it comes to bartering with cities, who will pay hefty fees in exchange for rotational fallowing. Outlooks are less cheery for farms without those rights. Many traditional banks have scaled back their willingness to extend credit, particularly to small farmers unable to provide sufficient collateral. In 2015, during the height of the California drought, lenders were urged to increase their due diligence in regards to borrowers’ water access to mitigate their risk exposure. Deane estimates that in California alone, there are at least two to three hundred thousand acres of permanent crops that were planted without access to reliable water resources. Many farmers unwittingly built their livelihoods in areas where they anticipated being able to tap underwater resources. However, with California’s new Sustainable Groundwater Management Act, new drillings face great restrictions. Farms without surface water priority rights may have to sell or seek new markets for water access. Here, too, Deane points to Australia for guidance. If one of the driest countries on earth still has water availability for agriculture, the Southwestern US should be able to figure out a cost-efficient plan that allows for both food production and the preservation of rural communities.


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