The Colorado River remains in disarray as parties search for ways to meet the Bureau of Reclamation’s announced goal of reducing use of Colorado River water by 2 million acre-feet to 4 million acre-feet annually perhaps through the year 2026 (https://hydrowonk.com/blog/2022/08/19/the-colorado-river-in-disarray/). Hydrowonk hears rumors that parties are struggling in negotiations to secure voluntary conservation to meet the Bureau’s objectives, as well as provide conserved water to offset curtailments junior priorities incur under the 2019 Drought Contingency Plan.
Differences in price opinions between buyers and sellers are as natural as the sun rising in the East. Buyers, especially those who had not been pro-active in addressing the inevitable shortages on the Colorado River, are prisoners of their expectations from the 20th Century. Sellers understandably see economic opportunity in today’s circumstances. Visions of the price of desalinated seawater or the $1,500+ per acre-foot current prices in the Central Valley undoubtedly shape their opinions of value.
Both sides need to distinguish between “wishes” and economic reality. For buyers, consider the economic costs of water shortages avoided by successful transactions when deciding the price they are willing to pay. For sellers, a correct valuation of desalinated seawater must factor in the transfer of ownership for $1 after thirty years where desalination plants, with suitable maintenance and renewals, will continue to provide water into the indefinite future. (HINT: The price paid today is substantially above the long-term cost of desalinated seawater). Water prices in the Central Valley are driven by the economics of protecting permanent crops against water shortages. Is the economic cost of water shortages for permanent crops higher, lower or the same as the economic cost of water shortages for municipal water users?
Based on Hydrowonk’s experience representing the Imperial Irrigation District in negotiations of the San Diego agreement, the Quantification Settlement Agreement, and related agreements, we do not have the luxury of time to engage in months, if not years, needed to bridge the valuation gap.
A short-cut would be to look for transactions between willing buyers and sellers for Colorado River water. How about the 1998 Imperial-San Diego water conservation and transfer agreement. Neglecting a myriad of renegotiations over the years, the price San Diego paid Imperial in 2021 was $688 per acre-foot. The agreement also includes a 25% shortage premium when the Secretary of the Interior declares there is less than 7.5 million acre-feet available in the Lower Basin (true today?). Let’s not get distracted by the renegotiated side deals that suspended the shortage premium until 2035, the 1998 agreement provides an indication of a mutually agreed valuation of how much more valuable Colorado River water is in times of shortage.
Hydrowonk’s opinion is the current price of Colorado River water in 2021 is $860 per acre-foot ($688 x 1.25). Adjusting for the current rate of inflation (8.2%), the price for 2022 is $931 per acre-foot increasing to $1,275 per acre-foot by the year 2026 (see table)
Hydrowonk Opinion Adjusted for 8.3% Inflation
Note: Hydrowonk would not recommend “hard-wiring” an assumed inflation rate into pricing (that is why price adjustment clauses exist). Depending on the content of the price adjustments, the price in future years may differ from the prices in the table even if inflation remains at 8.2%.
Hydrowonk does not know the existing negotiation position of any party. If buyers are bidding $350 per acre-foot, the $931 per acre-foot price is “Split the Difference” Settlement if sellers are asking $1,511 per acre-foot (see table). The higher the buyer’s bid price, the lower the seller’s ask price that yields a $931 per acre-foot “Split the Difference” Settlement.
Bid and Ask Prices Yielding a “Split the Difference” Settlement
Price of $931 per Acre-Foot
Will a $931 price per acre-foot hunt? Beats Hydrowonk. There are two ways to find out. Continue negotiations in back rooms jawboning and see when, if ever, parties move off initial positions and reach a mutually agreeable price.
Alternatively, the Bureau could run a double-sided auction and let water interests set the price through buyers bids and sellers offers (for more detail, see https://hydrowonk.com/blog/2022/08/19/the-colorado-river-in-disarray). At the close of the auction, buyers who bid too low prices will suffer the economic cost of water shortages because they did not acquire new water. Sellers who asked for too high prices will lose the opportunity to secure an economic gain.
An auction makes potential buyers and potential sellers think hard about their price bids and price asks. Responsible buyers will think hard about the economic costs of water shortages. Responsible sellers will think hard about what price it makes sense to conserve water.
In effect, the auction will discover “who is in and who is out” of addressing the challenges on the Colorado River. To the extent the Bureau is using the funds from the Inflation Reduction Act to address the drought in the west, the Bureau could submit bids for acquiring conserved water to increase storage on the Colorado River in a competitive marketplace. As discussed in my earlier post, the Bureau should oversee the development of the rules and procedures of the auction, but a third party should operate the auction. Sellers need assurance that the Bureau addresses its conflict of interest of being a buyer of water (who understandably dreams of low prices) while maintaining that water right owners should reduce their use of water for the benefit of all.