Market Plan Can Ease State Water Shortage

The Orange County Register
February 16, 1998

By Terry L. Anderson

The Issue: Our water programs don’t work well because they are predicated
on politics, not market factors.

Just as El Nino rains
are sending rivers over their banks, the Resources Agency of California has released a
draft of the California Water Plan predicting statewide shortages
early in the next century. Doomsday predictions are typical of such reports as are the
calls for bureaucratic planning to correct the problem. Neither the predictions nor more
bureaucracy would be necessary if the plan put more emphasis on water markets.

Here is the essence of the report’s findings. Between today and 2020, population growth
is predicted to increase California’s water shortfall to 2.9 million acre-feet in an
average year. (An acre-foot is approximately the amount used by a typical family each
year. The plan concludes that "Californians cannot afford to sustain future water
shortages of this magnitude." Indeed!

So what is the solution ? More concrete and steel and more bureaucratic controls. David
Kennedy, director of the Department of Water Resources, calls for "water management
options" including new storage and conveyance facilities, water recycling and
conservation, water transfers, local agency surface water and groundwater supply projects
and desalination, to mention a few.

These "management options" suffer from two major problems. First, they lack
any meaningful sense of economic and environmental costs and benefits. Second, they ignore
the obvious solution–water markets–that is catching on around the West and around the

Supply-side solutions including more storage and conveyance facilities, recycling and
desalination are common in state water plans, despite the fact that they seldom pass
economic benefit-cost muster. A classic example of government water economics comes from
Utah. It will cost $300 per acre-foot just to deliver water to farmers from the recently
funded Central Utah Project, never mind the sunk costs of dams already built. The same
acre-foot of water will produce crops worth $30, but cost farmers only $8. Is anyone
surprised that the Utah congressional delegation was able to move this project forward and
is there any question whether California projects will be any different? Water may not run
uphill on its own, but it surely gushes uphill under political pressure.

At costs as high as $2,000 per acre-foot, desalination does not make good economic
sense, and recycling does not look much better with costs as high as $500 per acre-foot.

The second major problem with the plan is that is does not even pay lip service to
water marketing, even though this is the surest way to solve water shortages. A search of
the plans’ summary bulletin revealed not a single reference to water markets or water
prices. Yet markets provide the surest way to encourage water use efficiency and eliminate

If there are water shortages, you can be sure that it is because water prices are too
low. Data from every corner of the world show that a 10 percent price increase reduces
urban water-use by as much as 12 percent and farm water use by 20 percent.

Consider two of the success stories of water marketing.

When the state of California experimented with its Drought Emergency Water Bank in
1991, an offer price of $125 per acre foot yielded offers to supply water in excess of the
500,000 acre-feet that the state was trying to obtain.

In the drought year of 1987-88, water trading between the Australian states of new
South Wales and South Australia involved over 1 million acre-feet and increased farm
incomes by an estimated $17 million by improving water use efficiency.

Trading between California and Arizona for Colorado River water could provide similar
benefits. The Central Arizona Project (CAP) pumps water 3,000 vertical feet from the
Colorado River and delivers it to agricultural users who pay between $17 and $41 per
acre-feet. Even at these subsidized prices Arizona users demand only 55 percent of the 1.5
million acre-feet they are guaranteed by the Colorado River Compact. Moreover, the project
operates at a loss of $24 million per year. Much of the remainder is being captured by
California and Nevada, but the supply is certainly not secure.

Why not encourage some interstate trading between Arizona and California?

A price of $140 per acre-foot would enable CAP to cover its losses. This price is far
below the $150 being paid in California and Nevada for water from irrigation districts and
even farther below the $1,600 for desalinated water. Arizona has expressed interest in
changing the decree that governs water use among the Colorado river states to allow
leasing of unused water. California’s Water Plan ought to jump on this bandwagon.

In 1982 when the Peripheral Canal initiative was defeated by California voters, Thomas
Graff, general counsel for the Environmental Defense Fund raised a prophetic question when
he asked, "Has all future water-project development been choked off by the new
conservationist-conservative alliance?" The California Water Plan suggests not, but
this plan is open for comment. Now is the time for such a
"conservationist-conservative alliance" to make itself heard and put some market
sense into California’s water problems.

Mr. Anderson is a senior fellow
at the Hoover Institution at Stanford University, an economics professor at Montana State
University and co-author of Water Markets: Priming the Invisible – Pump (Cato
Institute, 1997).

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