By Wayne Lusvardi, Guest Blogger
On Feb. 11, 2014, a team of water experts associated with U.C. Davis called for the creation of a “special water market” to generate “revenues that would help support fish and wildlife recovery” to alleviate the California drought.
Their paper, posted at the U.C. Davis Center for Watershed Sciences website, is titled “Why Give Away Fish Flows for Free During a Drought?”
I held the position of chief real estate appraiser for one of the largest water districts in California, which involved the valuation of sales and leases of agricultural land and water. My colleague Charles B. Warren, ASA, and I were the first to have recognized that from 1999 to 2001 Telecom Deregulation had unintentionally created a market price for fiber optic easements and wireless cell sites. Given the typical failure of centralized government to solve a foreseeable drought in California, I welcomed the U.C. Davis group’s call for water markets.
However, after I delved into the U.C. David team’s proposal I had some serious misgivings. Firstly, I question whether it is appropriate to use a public website for an article that could be interpreted as a self-advertisement by a team of water experts offering to structure such a water market?
What Price Environmental Water?
Next, the structure of this new market would not entail the voluntarily purchase of water for fish and wildlife refuges as has been done in the past. Rather, it would create a whole new legal class of senior environmental water rights that could be sold in an artificial market. In such a market the sellers of environmental water would be “free riders” that would not have to buy this water right as would occur in a true market, such as sales of radio spectrum by the Federal Communications Commission.
The U.C. Davis proposal calls for the sale of such green water rights to farmers at “the fair market value of the water made available, the cost of compensatory environmental actions, or a fixed or negotiated fee established by the regulatory agency. “
But for the most part there is no such thing as the “fair market value” of water in California because water is a socialized public good. Water is free. It is the cost to capture, store, convey, and treat water that translates into what is called its price. All public utilities work on a fixed cost system of pricing, not markets.
Only rarely are there water auctions in California. A recent auction of irrigation water in Kern County resulted in “sky high” prices due to drought conditions. Bids came in at around $1,200 per acre-foot of water for 200-acre-feet of water or more. This is about three times the typical going price of $400 an acre-foot cited by the U.C. Davis team in their article. This must bring exhilaration to water economists who define market value as a price set by government to bring about water conservation. But to a real estate appraiser such inflated prices do not reflect Fair Market Value, but a hostage price. Any such valuations by water economists with an agenda to punish farmers for subsidies would be a bias that would disqualify an independent appraiser.
Should water purchased in a drought reflect the price unaffected by the tight supply of water in a drought partly created by government policies and legal decisions? The U.C. Davis proposal doesn’t tell us.
There is a rule in eminent domain appraisal called the “project influence rule.” This rule excludes over or under compensation for “project enhancement” because of the public project for which a property is taken. It is the same principle of not price gouging for bottled water during the Katrina disaster. California has ant-gouging laws but apparently not for environmental water. Buying water at inflated drought prices would defeat the whole purpose of providing water to farmers in a drought that was largely created by an environmental project to restore river salmon runs.
“Cost of Compensatory Legal Actions” or “Fixed, Negotiated Fees?”
The “cost of compensatory legal actions” could be interpreted as an environmental extortion price of the avoided costs of legal actions and environmental clearances. Market Value is not the price that an unwilling buyer can be shaken down for by the threat of legal actions or environmental mitigation costs. Market value is defined in California as where “there is no pressure on either party in a transaction to buy or sell.”
Likewise, a “fixed or negotiated fee established by the regulatory agency” would be so one-sided that, again, this would not reflect market value but a fiat price. A fiat price is a price ordered by the fiat or dictate of government, not a free market.
A better alternative would be to lease Refuge Water to farmers during a drought as they already do in Montana.
Farmers Would Have to Pay Sellers Twice
Moreover, the whole proposal would result in farmers having to buy-back water they already paid for in their water rates. Central Valley farm water rates include a premium for paying off the bonds for the federal Central Valley Project.
Additionally, Central Valley farmers have already paid $180 million into the San Joaquin River Restoration Fund up to 2014 to restore salmon runs through higher water rates. Thus, the proposed price for environmental water would be what is called an environmental surtax (an additional tax on something already taxed) more than it would be a market price.
Another problem I had was the proposal’s reversal of which party would require compensation for the so-called purchase of environmental water. According to the U.C. David proponents:
Creating such a drought environmental water market would help limit the reductions in environmental river flows, while ensuring that such reductions receive some compensation.
But how can farmers be shaken down to pay compensation to environmental agencies and consultants for water that they already paid for? Shouldn’t compensation be the other way around, to farmers, not self-serving environmental bureaucracies?
The U.C. Davis proposal to establish an environmental water market partly induced by environmental regulatory drought does not hold water. And I find pricing environmental water sales by auctions to reflect inflated prices derived from the “project influence” of diverting 58 percent of San Joaquin River water from farmers to the environment in the Central Valley. Nonetheless, I welcome the opportunity to open up a discussion of how markets might alleviate drought hardship on farmers and, wherever possible, on the environment.
 U.C. Davis associated water experts:
- Prof. Jay Lund, Director of Environmental Engineering at the U.C. Davis Center for Watershed Sciences
- Ellen Hanak, PhD, economist for the Public Policy Institute of California
- Barton Buzz Thompson, J.D./MBA, the Robert E. Paradise Professor of Natural Resources Law at the Stanford Law School
- Brian Gray, Professor of Law at Hastings School of Law
- Jeffrey Mount, PhD, and Professor Emeritus of Paleoclimatology at U.C. Davis
- Katrina Jessoe, PhD., Environmental and Natural Resource Economics at U.C. Davis.