Water resource managers, planners, investors and other interested parties must make decisions in the face of uncertainty about a variety of factors.  How many times has a professional been in a meeting where a critical future factor was unknown and the discussion was basically an exchange of unsubstantiated opinion?  Would a credible quantification of the likelihood and consequence of the impact of future events facilitate better, faster and cheaper planning and decision-making?

This post discusses the potential for prediction markets to assist planning and decision-making in the water industry.  The next post in this series will provide more background on how effectively they have worked in the public and private sector.

Prediction markets involve the trading of contracts about the risk and consequences of future events.  They can provide a useful tool to improve planning and decision-making.

Consider a sample of questions for which properly designed and executed prediction markets could provide quantitative answers:

Public Policy Questions

• Will a governor place a major ballot initiative on a special ballot in 2013?
• Will the initiative pass if placed on the ballot?
• Will a recently proposed project generate litigation in 2013 and on what major issues?
• Will a proposed project be successful in changing state law in the 2013 legislative session?
• Did the prospect of passage of a bill improve or decline after a recent hearing before a State Senate Committee?
• Will the Legislature fund the state’s water plan in the 2013 session and at what level?
• Will a minute to an international treaty be signed by December 31, 2014?
• Will the minute include provisions facilitating the cross-border exchange of water?

Projects and Agreements

• Will a bundle of long-term agreements terminate in 2013?
• What impact did a recent newspaper article critical of a water project have on the likely success of a project?
• Will purchases of water by member agencies of a regional wholesaler increase next year, be unchanged, decline up to 5%, or decline by more than 5%?
• In response to a Request for Bid for new water supplies for a municipal water agency, will the lowest annual price bid for delivered water be less than $800 per acre foot, higher than $800 and less than or equal to $1000 per acre foot, or greater than $1,000 per acre foot.

Hydrologic Risk Assessment

• Will the elevation of a reservoir fall below a threshold level that triggers changes in reservoir operations by December 31, 2013?
• Will the elevation of a key well in an aquifer decline to the level where production cutbacks are implemented?
• What will be the initial yield declaration for a surface water project?

Litigation

• Will a state Supreme Court affirm the rule of capture for groundwater?
• Which party in litigation over water transportation policy will prevail at the trial court level?
• Will local agencies be able to negotiate a settlement of a specified lawsuit with the Environmental Protection Agency in 2013?
• What would the court award be in a proposed condemnation proceeding?

The Potential Questions are Limitless

The circumstances of a community, region, state or the United States (on federal issues) will yield many issues and questions that are (i) in the future, (ii) unknown today, and (iii) have a critical impact on the water industry.   Quantitative assessment of the probability and consequences of future events will improve planning and decision-making.

A well-functioning prediction market provides information on a continuous-time basis.  In other words, pricing provides information about the issue as of the day of trading, and pricing evolves in the future in response to new information regarding the issues addressed by prediction markets.

The pricing generated from prediction markets provide real-time data that can be incorporated into water industry planning and decision-making.  Suppose that a water agency is considering alternative projects whose relative attractiveness depends on the outcome of legislative activity.  The probability of success identified in the pricing of a prediction market can be considered in the assessment of alternative project opportunities.  For organizations engaged in the political process, how legislative initiatives impact pricing in a prediction market provides feedback on whether their efforts had any impact on the probability of the bill becoming law.  Information about what is successful or a failure can be used to adapt political strategies.  Similar questions can address the effectiveness of public outreach programs.

Water users dependent on the yield from a specific project need to know what the project yield will be next year as they plan their activities for next year (for agricultural users, planting decisions; for municipal users potential need to engage in short-term transfers or plan to withdraw water from storage).  While project operators often provide estimates of available water, the timing often lags behind when water users need information.  A prediction market can provide information ahead of the project operator’s initial or subsequent estimates.  The pricing in the prediction market can provide “updated” assessments after the release of the initial estimate providing information about the anticipated water availability later in the year.

Pricing from prediction markets generates information about issues relevant to decision-making, and how prices move generates feedback on the impact of events about what is traded in the market. The experience of prediction markets in other settings in the public sector and private sector outside the water industry provides optimism about the potential usefulness of prediction markets.  Like any tool, whether prediction markets will be successful in the water industry depends on execution.

Next Post in this series: What are Prediction Markets and Why Do They Work?