No. 6 August 10, 1998
Governor Pete Wilson and Interior Secretary Bruce Babbitt recently announced that CALFED, the federal-state task force responsible for developing a water supply plan for the Sacramento-San Joaquin Bay-Delta, will not reach a decision until late 1999, one year later than scheduled. The delay gives policymakers time to get to the heart of the issue: California’s water shortage problem is not one of supply, but one of poor allocation.
Based on existing water policy, which allows the state to determine who needs how much water and at what price, resource agencies have predicted severe water shortages in California’s near future. These predictions have cities, farmers, and environmentalists competing for the state’s limited water supply, as all three groups want to ensure they have enough water to meet their demands.
To address this perceived water crisis, CALFED was created in 1994 as part of the Bay Delta Accord. The task force’s approach thus far, however, does not look at reforming the way California manages its water. It only considers ways to increase the amount available for allocation.
Without the formation of a voluntary water market, the CALFED process — which already bears a $1.5 billion revenue stream and could cost $14 billion more over the next 20 years — will ultimately fail, and needless water shortages will continue.
CALFED’s outdated approach. CALFED has come up with three alternative plans to prevent a water supply shortage and improve the environmental quality of the Bay-Delta, which provides two-thirds of the state’s drinking water; irrigates most of the Central Valley; and supports more than 750 species of fish, animals, and birds, as well as 40,000 acres of wetlands.
The first plan authorizes construction projects for existing pumps, channels, and dams throughout the Delta. The second authorizes additional projects and increases storage facilities. The third includes the projects of the second, and authorizes a new canal much like the proposed Peripheral Canal that was defeated in 1982, connecting the Sacramento River to export facilities of the State Water Project and the Central Valley Project.
All three CALFED plans rely on old-fashioned, costly approaches that postpone, rather than solve, California’s water problems. California does not need more multi-billion dollar water projects to prevent a water shortage. Instead, a market system offers the best solution.
The real issue is poor allocation and management. California’s current water policy fails because it is based on centralized control rather than market incentives. Almost all water is treated as a public good that the state "owns" and leases to users, including both farmers and cities. Arbitrary rules set by state resource agencies govern who gets how much water and at what price, causing prices to vary greatly among users and ensuring that they do not reflect the water’s true value.
Subsidies contribute significantly to the problem as well. For example, the average California household pays $500 per acre-foot for water each year. Yet through federal subsidies, the average agricultural rate is only $50 per acre-foot. Some regions are particularly costly: in San Diego an acre-foot costs the average household 100 times that of the average San Diego farmer.
Artificially low prices for water provide farmers with little incentive to conserve. Furthermore, even if farmers want to sell their water to municipalities, current law rarely allows for such transfers. Agricultural water rights rely on a "use-it-or-lose-it" basis, meaning that if a farmer does not use all the water he is allocated, he will lose his right to that water. All of this leads to misallocation, poor conservation, and numerous environmental and political problems.
Getting the incentives right. A statewide water market would prevent shortages by increasing efficiency and promoting water conservation. Under a market system, water users would own the water rights rather than leasing them from the state. Water rights owners could then trade, lease, or sell their rights to other users for different purposes.
The 1991 California Drought Emergency Water Bank exemplifies how market incentives increase water conservation. Responding to drought in the late 1980s, the state offered farmers $125 per acre-foot for water, which it in turn sold to municipalities. Not surprisingly, farmers eagerly sold more than 500,000 acre-feet once selling water had become profitable. Even during a drought, abundant water could be found once the right incentives were in place.
Such water transfers do not occur under the current system because bureaucratic laws do not allow for such exchanges. Even the Drought Bank was not a true market because the state was the only buyer, and planners, rather than market forces, set the price. But if municipalities and environmentalists could buy water rights from farmers, an ample water supply would arise. For example, shifting just 10 percent of the water currently used for agriculture to municipal use would more than meet California’s urban water needs for the next twenty years.1
Attempted solutions. In October 1992, the U.S. Congress passed the Central Valley Project Improvement Act (CVPIA) in an attempt to use incentive-based policies to encourage water conservation. The Act states that farmers can sell some or all of their rights to qualifying urban districts facing high costs for the development of new water supplies. While the Act takes steps in the right direction, Congress has approved few actual transfers to municipalities since its passage, and has done little more to promote an open-market system.
In April 1998, the San Diego County Water Authority and the Imperial Irrigation District (IDD), a consumer-owned utility that provides water for Southeastern California, signed an agreement that authorizes the transfer of 200,000 acre-feet of agricultural water to municipal use. The transfer is expected to ensure an adequate water supply for San Diego County over the next 45 years and benefit agriculture through a new revenue stream, new incentives for increased water conservation, and more secure water rights. Lloyd Allen, President of the IDD, explains that "farming will remain the cornerstone of our community, and opportunities for future growth in the valley will be secured. Most important, the valley’s water rights will be protected."2
Moving towards an open water market. Water transfers are undoubtedly a good first step, but can also lead to an inconsistent and somewhat ad hoc set of laws. Legislation is necessary, therefore, to make fundamental changes that would create a consistent, statewide water market.
The following outlines how such a system would work:
1. Ownership of water rights would transfer from the state to water users. The initial allocation of these rights needs careful determination and will face political controversy, but the most equitable distribution should rely on current usage. Chile used this approach in 1981 when the country successfully created a market system for water. The Chilean government granted existing water users secure property rights without charge, and sold unallocated rights in an open auction.
However, because such distribution favors users who are currently taking more water than they need, some redistribution should take place to rectify the most blatant misallocations, and any water users who lose rights in the initial allocation process should receive compensation. Individuals and environmental groups that would leave the water instream for fish habitat and water quality should be given ownership of rights allocated for environmental purposes. If any unallocated rights remain, those rights should be sold in an open public auction.
This shift in ownership would also address the problem of subsidies because the government would no longer set the price of water. Rather, market forces would determine the price to reflect the water’s true cost.
2. Rights must be secure and fully transferable. Owners need to be able to sell or lease their rights to willing buyers for any use, including leaving water instream to enhance water quality and habitat. In Oregon this is working well – environmental groups lease water rights from farmers and leave the water instream so salmon are able to spawn.
3. Legislation would need to address water transportation and distribution. The state’s water transport network represents a natural monopoly in which public agencies control the means of water transportation. For a market system to work efficiently, water traders must be able to use the existing infrastructure for transactions. The traders would have to negotiate a transportation rate with the local water districts to use their infrastructure for transport.
For example, in the San Diego transfer, the Metropolitan Water District (MWD) transports the water through the Colorado River Aqueduct. The San Diego County Water Authority, who bought the water from the Imperial Irrigation District, negotiated with the MWD, and decided on a rate to pay the MWD for transporting, or wheeling, the water. Similar statewide negotiations could establish fare and feasible rates.
Supporters of a market system. There is already wide support for a water market system in California. In May 1996, the California Business Roundtable, in conjunction with the California Chamber of Commerce, the California Farm Bureau Federation, and the California Manufacturers Association, released a report entitled A Model Water Transfer Act for California that outlines a clear set of rules for statewide transfers.
The Bay Area Council also favors a market system. In October 1997, the public-private group released The Short Term and Expedited Water Transfer Act of 1998, and sent a letter to legislators urging the development of a water market. The Chief Executive Officers of the California Business Roundtable followed suit, and in May 1998, sent a letter to President Clinton and Governor Wilson urging them to solve the Bay-Delta’s water problem and to establish a fully functioning water market in the state.
Markets must come first for CALFED to succeed. In the case of CALFED, improving the struggling ecosystem of the Bay-Delta and securing a long-term water supply are worthy goals. However, they are going about the process in reverse. The first step is to move to a market system; improving infrastructure should only be considered once that is achieved.
This is crucial because only then can water users determine which water projects are really necessary. As explained by economist Ronald Schmidt, formally with the Federal Reserve Bank of San Francisco, a water market would mean that any decision about a new project "would be based on the financial feasibility of that venture. If an investor thought that added supplies would command a rate of return that would compensate for construction costs, the project would go forth. In this setting, investment in water infrastructure could be handled by the private sector and would not require raising taxes."3
California has always struggled over water. Without appropriate policies to address the problems of centralized control, price setting, and costly subsidies, this struggle will continue, and California’s water supply will continue to fall short. CALFED is not addressing these problems, and their solutions do not treat water as a scarce resource. Market incentives, not more tax dollars, are essential to assure proper allocation of water to farmers, environmentalists, and consumers throughout the state.
1 California Department of Water Resources. Bulletin 160-98: California Water Plan Public Review Draft. (January 1998). Chapter 10: Conclusions. Table 10-1: California Water Budget with Existing Facilities & Programs. Available: http://rubicon.water.ca.gov/b16098pd/ch10pd.html#1021.
2 Business Wire. "Landmark Water Conservation Transfer Agreement Ratified." April 29, 1998.
3 The Bay Area Economic Forum. "Using Water Better: A Market-Based Approach to California’s Water Crisis." October 1991, p. 11.
* Erin Schiller is a Public Policy Fellow at the Pacific Research Institute in San Francisco. For additional information, contact Erin Schiller at (415) 989-0833.
