“The most obvious function that people overlook when criticizing speculators is their ability to head off shortages”
— Andrew Beattie, “Market Speculators: More Help Than Harm,” Investopedia.com
Imagine a recessionary market for housing or land where no one is selling, a periodic event here in California. At such times, a group of speculators is always ready, willing, and able to buy in this thin or virtually nonexistent market.
The situation is similar during water droughts (which occur in four of five years on average), when few if any farmers or cities want to sell water at wholesale.
Nonetheless, economist Matthew Fienup of California Lutheran University proclaims that the first so-called groundwater “market” has been established in the agricultural groundwater basin of the Oxnard Plain in Ventura County (“How California Got Its First Groundwater Market,” Water Deeply, June 27, 2017). This so-called water market would work only if a farmer has a surplus of water and can trade it—a situation unlikely to occur in a “drought.”
Gov. Brown’s Water Mandate
This Ventura groundwater market comes in response to Gov. Jerry Brown’s mandate for the adoption of “sustainable groundwater management plans” in 515 groundwater basins in California by June 30, 2017, even though California experienced a “snow drought,” not groundwater drought, from mid-2012 to mid-2016.
The Sustainable Groundwater Management Act allows markets to be used to re-allocate water within a groundwater basin. This is a “cap and trade” policy that puts a cap on the amount of water that can be traded—but only within a specific water basin (intra-basin trades).
This new groundwater market won’t do much to alleviate water shortages that are caused by the curtailment of inter-regional (inter-basin) water allocations during a time of drought by the State Water Project or federal Central Valley Project. So groundwater markets are a beggar-thy-neighbor policy whereby a farmer or city has to beg neighbors to sell them water. The first phase of the Ventura market includes only farm irrigators, but the plan is to include cities eventually.
Previous “Market” Attempts (Speculative Transactions Missing)
Previous attempts at water markets have not been successful in alleviating inter-regional water shortages. The state of California went into the water market business from 1991 to 1992. But this did not lessen the structural water deficiency of from 1.6 million acre-feet of water in wet years and 5.1 million acre-feet in compounded dry years, as noted in 2001 by Norris Hundley in his book The Great Thirst: Californians and Water (enough water for 3.2 to 10.2 million households or 533,000 to 1.7 million acres of cropland).
An inter-basin water market using home computers was tried in the agricultural Westlands Water District but predictably failed due to non-use in 2007, coincidentally when a judicial drought occurred due to court ordered curtailments of farm water deliveries to protect fish from 2007 to 2010 (National Resources Defense Council v. Secretary Dirk Kempthorne, U.S. Dept. of Interior).
A major logjam for a speculative water market in California is the state Water Code, which provides that sellers must be “rights holders” and the water they sell must be “wet,” not “paper water.” Moreover, water not used for over five years can be lost under the “use it or lose it” doctrine in the Code.
And water bought and banked in a government reservoir by a farmer can be spilled to the sea if the reservoir is filled to capacity in a wet year. In 2017, farmer Joe Del Bosque lost $1 million worth of water he stored in the San Luis Reservoir because the reservoir was at full capacity. But in the recent 2016–17 wet water year about 70 percent of all system water still flowed to the sea.
Diverting only about 1 percent of that escaped water on a compounded basis that could be purchased by a speculative tier of the water market might be enough to make a difference in critical dry years. Structural water deficiencies can only be made up right now by resorting to statewide water conservation and water policing measures.
Another major impediment to a speculative water market is whether it would have perceived legitimacy, given the stigmatization of speculators as hoarders, arbitrageurs, and profiteers of water that otherwise is considered a “public good” and not a commodity.
Golf courses in Palm Springs are seen as illegitimate even if they use recycled water, but curtailing lawn watering that depletes urban water basins by 15 percent per year is seen as sustainable and justified. In California, it is legitimately perceived water that “runs uphill towards money.”
Protecting farmers from high water prices in bottom dry years compared to low prices during peak wet years is not price gouging. Ironically, many of those who demonize farmers as accepting crop and water subsidies also feel the same farmers need to be protected from speculative water prices with anti-speculation laws and policies.
Australia already has a working water futures market, but it is also based only on selling surplus water available after government water allocations, although it also allows trading for paper gains.
The Shanghai Gold Exchange (SGE) could serve as a model for a speculative California water market because it delivers only actual physical gold, not debt contracts to game the system for investment purposes such as the New York and London gold markets. It is ironic that a Communist regime runs a better market model for a speculative water market than a literal army of academics and think tanks proposing to construct water markets in California.
The New York Stock Exchange designates nominated advisors, called Nomads, to ensure firms are legitimate before getting a stamp of approval by being listed on the exchange. This process could similarly legitimatize a speculative water market (the horror: speculators selling water for fish or to an urban water replenishment district spreading ground in a wet year).
Currently, California has over-committed the amount of allocated water that can be delivered partly because of the volatility of water flows in wet/dry years and court-ordered diversions of water for fish. Government, or an Initial Public Offering of speculators, would have to buy out water rights and contracts to create a speculative water market. Or maybe a farmer will eventually buy enough land with water rights to create his own “spec” water market, which is what savvy water-rights investor John Vidovich may eventually pull off in the Central Valley.
Red Tape Water Trading
Current water trading in California is a bureaucratic process that can take up to two years. By then a drought could be over. Andrew Beattie said: “The most obvious function that people overlook when criticizing speculators is their ability to head off shortages.”
California continues to run deficits in its state budget, pension funds, road and school funds, water infrastructure (Oroville) funding, and its water allocations. A speculative market could plug the shortfall in water. But don’t look for such a needed “spec” market to emerge as long as the intellectual and political classes stigmatize it as illegitimate for political and career gains.
A “spec” tier of the water market also has implications for California’s Cap and Trade air pollution market. Polluters buy “allowances” to emit pollution above their pollution cap. This policy assumes polluters will buy and sell allowances during boom business cycles and thus pollution will not exceed the cap. But sellers are likely to hoard allowances for their own use during a rapidly expanding business cycle. So a pollution cap and trade market is yet another fake market that merely serves as a taxation scheme.
Boone Pickens once wrote: “When you look at a commodities market you need hedgers and speculators. If you don’t have [them], you don’t have a market. That’s how it works”.
Water, power, or pollution markets without a speculative tier are not markets.
Wayne Lusvardi worked for California’s largest urban water agency for 20 years and is an independent public utility, water rights, and land appraiser in Rancho Mirage. His previous posts at MasterResource are here.