Water subsidies are the focus of much controversy in California, with farmers commonly bearing much of the blame. The waters can be cleared a little by examining two positions held by David Zetland, a well-known water economist, currently at Leiden University in Holland. Among other things, he previously was an instructor at the University of California, Berkeley, teaching Environmental Economics and Policy.

1.The mirage of water subsidies

In an interview, Zetland said:

“Consider these facts:

“Farmers pay $20 per acre/foot of water (that’s an acre of land covered a foot deep in water).

“A single person consumes 1/8 of an acre/foot per year.

“A single person pays $1000 per acre/foot of water.

“Farmers own 75% of the nation’s water supply.

“Moving water from agriculture would increase water supplies for urban dwellers, at a market-appropriate price. Some farmers, for example, can make more money selling water than farming low-value crops like alfalfa, hay, or cotton. The water they own would be put on the market, and consumers, other farmers, industries, businesses, etc. would compete for that water in an auction. Of course, a bidding war for water is likely to increase prices – and higher prices will signal that water should be treated as a precious resource….

“The food supply would shift to higher value crops (less alfalfa and more broccoli). Food prices would go up, but they would reflect the true cost of growing food, not the subsidized cost from unsustainable practices.

But how are such alleged subsidies calculated?  They are calculated as the difference between the cost to maintain the water system and the spot market price for water by auctions in summer months during droughts.

However, in California 95 percent of water is purchased by long-term water contracts and 5 percent by water auctions and water transfers.  If all water were exposed to the spot market daily, or even monthly, the agricultural economy would collapse and social unrest would result.  This is because farming requires large expenditures to purchase or lease land and equipment, to buy seed, fertilizers and prepare the ground in advance of growing a crop.  Additionally, the municipal bond market would collapse if the huge costs to build dams, reservoirs and aqueducts had to be paid for from water sales in the spot market instead of long-term contracts.  Modern water systems would cease to exist.

The solution to such situations where huge upfront costs need to be spread out and paid back over long periods of time is a water contract.  There is an active, mature market in water contracts in California.  Water contracts make the water supply reliable and affordable.

The low locked-in price in a 25-year-old water contract compared with the high price for water at drought auctions is not a subsidy.  This would be like saying the difference between the high value of a home with a 30-year mortgage at a low 4 percent interest rate and value in an all-cash sale with no mortgage today is a subsidy.  If all homebuyers had to pay all cash for homes, the real estate market would collapse.  This is what happened to home values in the 1930’s Depression as loan financing became unavailable.  The same is true for water.

2. The facts about All-In-Auctions for water.

Another popularized concept bandied around about pricing water for droughts is called an “all-in” or “all-pay” auction. According to Investopedia’s definition it is:

“An economic and game theory concept in which participants place silent bids on a particular item. Unlike a standard auction, all-pay auction has everybody pay for their bid, regardless of whether they win the item being sold. Of course, in a standard auction, the highest bid wins the item.”

In all-in auctions, overbidding typically occurs and sellers can expect to get more than fair market value. (Zetland himself provides a good description of the concept in this video.)

In Nov. 2012, Zetland published a paper, “All-in-Auctions for Water.” The abstract:

“This paper proposes a novel mechanism for reallocating temporary water flows or permanent water rights. The All-in-Auction (AiA) increases efficiency and social welfare by reallocating water without harming water rights holders. AiAs can be used to allocate variable or diminished flows among traditional or new uses. AiAs are appropriate for use within larger organizations that distribute water among members, e.g., irrigation districts or wholesale water agencies. Members would decide when and how to use AiAs, i.e., when transaction costs are high, environmental constraints are binding, or allocation to outsiders is desired. Experimental sessions show that an AiA reallocates more units with no less efficiency that traditional two-sided auctions.”

However, such a system recklessly would collapse agricultural markets and create water anarchy. The entire food chain to everyone’s dinner table would be interrupted.  If they have to buy water in a spot auction market each month or year, farmers would not be able to borrow money to buy or rent land; to buy farming equipment, seed and fertilizer; and to pay upfront labor costs for land cultivation

In such a system, the volatile price of water would interrupt repayments by farmers to the U.S. Bureau of Reclamation for the capital costs to construct the federal Central Valley Project.  Moreover, farmers and cities both would have to pay for water they might not receive in an all-in auction.

All-in agricultural water auctions would squeeze out lower-valued uses of water, as for growing feedstocks such as alfalfa, low-value crops such as melons and tomatoes, and wildlife refuges.  How could dairies produce milk products, cattle ranches produce protein, or biomass power plants produce electricity if there was no water for feedstock, cattle or corn ethanol production?

Markets

However, regular markets (not All-in-Auctions) are an essential drought management tool that could expanded from the 5 percent of the water market they now serve. Doing so would help redistribute water from the haves to the have-nots during a drought.

Bottom line: newfangled auctions are not necessary. With reasonable modifications, current markets and contractual markets are adequate.

Calls now are going out to raise water prices even higher to spur conservation. Instead of fining people for watering their lawns, numerous economists are recommending just tacking a punitive surcharge onto water rates until use drops.

But there’s a problem with this drought fix: It would violate Proposition 218, which voters passed in 1996. It requires voter approval for any tax increase. And higher rates for using more water effectively are a tax on usage.

CalWatchDog.com brought up the matter with Jon Coupal, president the Howard Jarvis Taxpayers Association, a major backer of Prop. 218 and defender in court of voter consent for taxes, especially punitive or luxury taxes.

“Some of these tiered rates are probably illegal,” Coupal said. “To be fully compliant with Prop 218, a [water] district would probably have to characterize the higher tiered rate as a penalty or fine.” 

So voters would have to approve any higher water rates for “drought pricing,” “tiered drought water rates” or “water conservation rates.”

The matter also has been litigated in a case settled by the California Supreme Court in 2006, Bighorn-Desert Water Agency vs. Verjil.  That case concerned whether the public initiative process under Prop. 218 could repeal water-rate increases. The court established that water-rate increases or decreases are “property-related fees” subject to Prop. 218.

So do all water rates have to be approved by voters? No. Prop. 218 only stipulated any rate increase “shall not exceed the funds required to provide the service.” That allowed rate increases for higher operating costs or inflation. But it did not allow rate increases for anything above such costs, such as for water conservation, unless a majority of voters gave their approval.

Water Experts 

“Drought prices” are being advocated by some water economists from both sides of the political spectrum:

• Kathryn Shelton and Richard B. McKenizie of American’s Future Foundation;
• Benjamin Powell, director of the Free Market Institute at Texas Tech University;
• Former U.C. Davis water economist David P. Zetland, writing on the libertarian website Reason.com;
• Ellen Hanak and Caitrin Chappelle of the Public Policy Institute of California;
• Jay Lund of U.C. Davis;
• Stephanie Pincetl of the UCLA California Center for Sustainable Communities;
• Peter Gleick of the Pacific Water Institute in Oakland.

These advocates call it a “market solution.” Yet 95 percent of system water in California is a monopoly controlled by the government, with only 5 percent sold on the spot market.  When purchasing a car, a computer or a hamburger, if one is dissatisfied with a high price or low quality, one simply switches to a competitor. But with water, one cannot do that except by moving into a new water district — something hardly practical for most people or businesses.

So even a “market solution” really is political, meaning it falls under the rubrics of state law, including Prop. 218.

Tiered usage

Many water districts already use a tiered structure for water usage, where those who use more pay more, to encourage conservation even in times and places where there is no drought. Such tiers can be structured around the water source or service (potable, recycled, construction, fire), and do not trigger Prop. 218.

But if the tiers are based on usage, then the tiers trigger Prop. 218 approval by voters.

Finally, long-term studies show tiered usage does not discourage use. See the study from July by the Centre for Energy Policy and Economics Department of Management, Technology, and Economics in Zurich, “Urban Water Demand and Water Rate Structures Over Decades.” It found:

“Using primary pricing data from 125 Texas communities spanning more than two decades (1981 – 2003)…. The adoption of water pricing structures alleged to promote water conservation (e.g. increasing block rates) does not lead to expected results as in our sample (13447 observations) consumption increased by 5-6 % … after the change occurred.”

In Part 2, we will further explore the notion of drought-pricing water. 

Wayne Lusvardi worked for one of California’s largest water agencies for 20 years in valuing land with water rights, agricultural land leases, and land fallowing contracts for water conservation.

By Wayne Lusvardi

In California, water wars are fought not merely over water but over water ideology that justifies the creation of commercial or public sector jobs that flow from the water.

The latest water war involves Rep. Tom McClintock, R-Elk Grove., who delivered an address on water last month in Washington, D.C.; and former Unviersity of California, Davis water professor David Zetland, now senior water economist at Wageningen University in the Netherlands.

McClintock delivered his address, “Self Evident Water Truths,” at the annual meeting of the Association of California Water Agencies on Feb. 27.   Zetland responded to McClintock on his water blog aguanomics.com on March 21, calling McClintock’s truths “Self Evident Water Delusions.” He wrote, “Bottom Line: It’s self evident that Congressman McClintock has no idea of how water is misdirected and mismanaged in California. He needs to think more than one election/donation cycle into the future.”

McClintock

McClintock is a congressman for the 4th District in California, located along the vital watershed of the Sierra-Nevada mountain chain.  He serves as chairman of the powerful Water and Power Subcommittee of the Natural Resources Committee.  McClintock is an outspoken advocate for Central Valley farmers, whose water was shut down from 2007 to 2010 by a lawsuit to protect the Delta smelt fish.

McClintock opposes the proposed removal of dams on the Klamath River. And he wants clean hydropower expanded, more fish hatcheries and the restoration of the “beneficiary pays” principle that produced the great water projects in the United States.

Zetland

Zetland is a water economist with a Ph.D. in Agricultural and Resource Economics from U.C. Davis.  Zetland’s Ph.D. thesis was a critique of the bureaucratic structure of the Metropolitan Water District of Southern California.

Zetland is the author of the book, “The End of Abundance: Economic Solutions to Water Quality.” Zetland’s book proposes a single solution to water scarcity: end water subsidies to farmers and raise water rates so high that farmers have to pay a “market” price based on water’s highest and best use by urban households. Zetland is an environmentalist who proposes that water for ecosystems must come first.

Zetland believes that water storage is not the problem in California. Rather, he says demand exceeds supply.  But isn’t the reason that demand exceeds supply in dry years because California has built no substantial water capture storage reservoirs in the last 50 years?

Zetland perpetuates the myth that California agriculture uses 70 to 80 percent of the water, when the California Department of Water Resources says it is about 40 percent in an average year; and 28 percent in a wet year.  He advocates water markets, but only those that can be regulated with high prices to force up agricultural water prices so that farmers will conserve.  But markets are social mechanisms to produce the cheapest good or service, not the costliest.

Modern versus de-modernized water ideologies

What really separates McClintock’s and Zetland’s views of the perpetual California water crisis are two powerful sociological and cultural worldviews.

McClintock’s modernization ideology reflects the ideas of growth, urban and agricultural development and change through technological advancements. This follows the last 100 years of the expansion of the regional water storage and conveyance system that has brought urban civilization and corporate farming to the Southwestern United States. McClintock’s modernization ideology emanates from industry, bureaucratic water agencies and engineering schools.

McClintock’s ideology is expressed in the following four truths from his address:

1. More water is better than less water.
2. Cheaper water is better than more expensive water.
3. Water is unevenly distributed over both time and distance.
4. We don’t need to build dams, aqueducts and reservoirs if our goal is to let water run to the ocean. 

Conversely, Zetland’s views reflect de-modernization, which means to reverse, remove and de-legitimate modernization.  This occupational ideology is sociologically located in the youth counter culture, academia, media and California’s liberal political culture.  De-modernization ideology is reflected by anti-industrialization, anti-capitalism and an anti-bureaucratic ideology.

If we could summarize Zetland’s de-modernization ideology of California’s water crisis expressed on his blog on March 21, it would be the reverse of the above four “truths” expressed by McClintock:

1. Less water for corporate agriculture and cities is better than more water.
2. More expensive water is better than cheaper water.
3. Water is unevenly geographically distributed but should be socially redistributed.
4. Conservation should replace building more dams, aqueducts and reservoirs because the environment takes first claim to raw water.  

Which Ideology for California? 

California’s water world is divided today into two ideological camps.

The water ideology of modernization, based on the notion of growth, has brought about unprecedented productivity and a standard of living that far outweigh the costs to the environment.  If we removed all dams and aqueducts, there would be an enormous loss of fish and wildlife habitat including downstream urban wildlife habitat.

The ideology of de-modernization in California has mostly brought about water conservation policies resulting in self-serving higher water rates for water agencies, bonus taxes for stressed city budgets, overblown species extinctions, adjudicated agricultural water shutdowns and highly symbolic river restorations programs that have served as cover for massive jobs programs.

The adherents of the de-modernization ideology dominate the social lens of the media, academia and environmental agencies through which each ideology is portrayed.

Many environmental water projects are ideological covers for special interests such as commercial fishing, tourism, lodging, lake view home development and political patronage for environmental research and monitoring jobs. Such special interests want to use the political and judiciary process to get water rights without having to pay for them.  Ideologists in the de-modernization camp don’t seem bothered when such green special interests get subsidized water but only when farmers get subsidized water.

De-modernization ideology mainly justifies taking low-skilled jobs from corporate farming and transferring them to green tech and academic jobs for the professional class. De-modernization ideology must be weighed by the severe human costs and taxes that it imposes especially on working class communities.

Mikhail Gorbachev, the last leader of the Soviet Communist Party, once said that “water, like religion and ideology, has the power to move millions of people.”  Water has the power to move people into jobs.  Thus, powerful cultural ideologies have developed to legitimate job creation in the public sector over the commercial sector.  This is how California water policy has deteriorated to the point where it is better to let water flow to the sea and scapegoat farmers for wasting water as long as public sector jobs are preserved.

If California is going to overcome the threat of slow growth, it will need to return to the modernization ideology of water resource development that brought about the state’s famous prosperity.

By Wayne Lusvardi

How did a 1996 Federal Environmental Protection Agency “mandate” to clean up smog result in the California Energy Crisis of 2001 and the “wet drought” from 2007 to 2010?

This is a question that California water experts never seem to ask. But it is a question worth answering if California is going to understand how the cost to improve air quality conditions in California’s urban air basins got loaded into the price of water.  Neither can we understand what California’s new Green Power mandate and Cap and Trade Pollution Emission Trading Program are without first understanding what happened during the Energy Crisis of 2001.

The End of Abundant Water?

G. Tracy Mehan III, a former U.S. EPA official and professor at George Mason University School of Law, in the July 16 issue of the Weekly Standard reviews water economist David Zetland’s “The End of Abundance: Economic Solutions to Water Scarcity (Aguanomics.com Press, $24). Zetland holds a PhD in economics from the University of California, Davis, is very knowledgeable about state water issues and blogs at Aguanomics.com.

Mehan agrees with Zetland that it would be better to price water based on its market scarcity than its socialized cost, as is currently done.  I also advocate water markets.  But this does very little to help voters or policy makers understand how water is really priced in California. Mostly ideology substitutes for a real world understanding of the Byzantine-like California water pricing system.

I spent 20-years handling water, energy, land use and valuation issues for one of California’s largest water agencies.  I disappointingly found both  Zetland’s book and Mehan’s review of it to reflect the view of outsiders who don’t seem to understand how a welfare-economics water system works.

Allow me first to say I am a fan of Zetland’s market approach to water and his blog Aguanomics.com.  When Zetland solicited for informal peer reviewers for his book, I responded.  I don’t come near the qualifications of either the book’s author or its reviewer.  But I have been swimming inside the fish tank of California water and energy issues for some time.  Others have been pressing their nose up to the glass of California water system aquarium to study it from the outside.  As sociologists say: “What you see is from where you sit.”

To Understand Water Pricing, You Need to Understand 2001 Energy Crisis

To understand water pricing and the court-ordered “drought” in California that lasted from 2007 to 2010, you must first go back to the state Energy Crisis of 2001.  This is because, loaded into the cost of wholesale water is the cost to improve air quality conditions in California’s urban air basins.

The original cause of the California Energy Crisis was not Enron, deregulation or cost-based water pricing.  It was the 1996 Environmental Protection Agency’s mandate to clean up urban smog by 2001 or face a cut off of federal highway and education funds. The only way to comply with this federal “mandate” was to shut down old polluting fossil fuel power plants along the California coast owned by Pacific Gas and Electric, San Diego Gas and Electric, and Southern California Edison.  These obsolescent power plants were subsequently divested to private operators and converted to cleaner natural gas fuel power plants.  By the summer of 2002, the San Gabriel Mountains northeast of Los Angeles were not hidden in plain sight anymore behind a curtain of smog.

California was not running out of energy in 2001; it was running out of clear sky.  The real crisis was not energy, but how to pay off the unpaid corporate bonds –- called “stranded assets — on the mothballed power plants. Everybody wanted smog eliminated, but no one wanted to pay for it.  Federal environmental policy became “clean air at any price.” It ended up as energy and water and air pollution credits at nearly any price.

The initial solution to the energy crisis in 2001 was to give a quasi-monopoly to natural gas suppliers, mainly in Texas. The unstated idea was to try to pay off the bonds on the old power plants by loading the extra cost into electricity rates. This policy was erroneously called “deregulation.” It failed. The plug was pulled on deregulation when a Democratic Legislature and governor came into power and replaced it with a system of energy price caps. Energy caps have never worked for very long wherever they have been tried.

Retail electricity prices were eventually capped, resulting in an induced energy pricing fever in wholesale power rates. This bubble in energy prices was intentionally created in an attempt to pay off the unpaid bonds on the mothballed power plants.  But price caps also failed miserably and even resulted in some fatalities due to rolling blackouts.

Finally, some $42 billion in unpaid corporate bonds were rolled into price premiums loaded into long-term energy contracts, mainly to run the pumps for the California State Water Project.  Smog reduction was indirectly paid for by inflated water rates. Not the Public Utilities Commission, the California Energy Commission, nor the Independent System Operator, but the California Department of Water Resources was tasked with these long-term water contracts to pay off the $42 billion bond.

How 2001 Energy Crisis Created a “Drought”

By 2007, a man-made drought resulted from an environmental lawsuit to protect the purportedly endangered Delta Smelt fish in the Sacramento Delta. In 2010, an appeals court ruled that the allegation that the Smelt was endangered was bogus.

By manufacturing a drought, California not only protected a bubble in water rates that securitized the payoff of long-term bonds to reduce smog. They also brought about even higher regional and local water rates. These higher local water rates have not been repealed anywhere in California after the court-ordered drought was ended in 2010.

Loading the cost to clean up the air into water contracts avoided having to go to the California Public Utilities Commission for an electric rate increase, to the state Legislature for a tax increase, or to the voters for approval of a tax increase as required under Proposition 13.  It was a “California Dream come true” for politicians: “Taxation without representation and without limitation.”

Coincidentally, long-term water contracts expire in 2013, when AB 32, the California Global Warming Solutions Act of 2006 kicks in.  In other words, in 2013 California will no longer pay premiums loaded into the price of water to pay off the cost to reduce smog. But a replacement premium will instead be added to electricity rates to pay for the mandatory shift to expensive clean Green Power.

The California Energy Crisis of 2001 ended up loading the huge cost to reduce smog into premiums in water rates.  That, in turn, resulted in the necessity of an artificial drought.  Instead of building more dams, reservoirs and pipelines, the only way left to manage water supplies was by conservation. California had to protect its water-rate bubble, and thus had to squelch any new water development or competitive water markets for more than a decade.

It needed a “sustainability” ideology to legitimate its conservation policy. And it needed an “endangered fish” in the Delta to protect the “water pricing bubble” and hike water rates even higher at the onset of the managed Depression of 2008 and ongoing.

Cities all over California use Utility Users’ Taxes to overcharge for retail water. Anywhere from 5 to 10 percent of these so-called “user fees” are then siphoned into the operating budgets of cities that were imperiled by the Mortgage Meltdown and Bank Panic of 2008.  The bogus Delta Smelt case infused cities across California with taxes during the onset of the national managed Depression.

But neither a “sustainability” nor a “market” ideology has much explanatory power when it comes to understanding real world water and energy pricing in California, where “public goods” are paid for by obscure means.  Public goods such as clean air, water, energy, and artificial jobs programs for water engineers often have to be paid for by muddied-up means because everybody wants them, but nobody wants to pay for them.

California may finally put an $11 billion water bond on the election ballot in 2014, not coincidentally right after the bonds on the California Energy Crisis of 2001 are paid off and California’s Green Power mandate and Cap and Trade laws kick in.

The above interpretation of water pricing in California does not reflect a conspiracy theory.  It reflects that policy makers are often ignorant, or cast a blind eye to the unintended consequences of their actions.  Government often works by “muddling through” problems and jumbling up the price of water, energy and other public goods.

California paid $42 billion to clean the air. It will also be paying about a $5 billion or more annual premium to keep the air clean via Green Power, starting in 2013.  The $6 to $12 billion annual Cap and Trade pollution emissions trading program is mostly a tax to mitigate for lost jobs caused by Green Power.  But Cap and Trade taxes will not go to those most affected: heavy industry, public and regulated utilities, or energy-intensive businesses.  Instead, Cap and Trade will be meted out as a redistribution program to low-income communities to buy votes for political purposes.

This is to be justified on the fictional grounds that low-income communities are disproportionately affected by poor air quality.  But bad air doesn’t honor political boundaries.  By some strange logic, Oxnard is said to have more air pollution than, say, Claremont; or National City more than Carlsbad. Smoggy Visalia, Merced and Fresno would be taxed and the taxes transferred to clean-air coastal low income communities such as Oakland and Richmond. Of course, such a policy will be soundly backed by “science.”

A Water Shortage Problem or a Water Storage Problem?

California doesn’t have a water shortage problem; it has a water storage problem.  One reason is the wide dissemination of a part truth by many of the highest qualified water experts in California. They continue to assert that agriculture uses 75 to 80 percent of the state’s water.

And they are right. But they never disclose that this is only true in a dry year and when water reservoir levels are low.  The State Department of Water Resources states that agriculture uses 42 percent of all system water on average.  In a wet year, agriculture only uses about 28 percent of all system water.  And if total precipitation is considered in a wet year, agriculture only uses about 8 percent of all potential water.

And the only reason that agriculture uses 75 percent or more of all system water during consecutive dry years is that California shifted from big water infrastructure projects to water conservation, partly as a way to pay off the huge cost of cleaning up air basins for the past 10 years, as described above. U.S. Bureau of Reclamation water consultant Bob Johnson states that California only has about half a year of water storage in both the federal and state water systems, combined, even during a wet year.

California is considered a state in perpetual drought. But in 1998 — a wet year — rainfall and imports totaled 335 million acre-feet of water, or enough water for 670 million urban households or about 1.675 billion people; or 335 million acres of farming. And 64 percent of this water went to the environment, not farms, not industry not cities or suburbs.

And agriculture and industry, not urban cities, conserved 6.65 million acre-feet of water, or enough for 13.3 million urban households or 6.65 million acres of farming. In a dry year in California, such as 2001, there was “only” 145 million acre-feet of rainfall and imports, or enough for 290 million urban households or 145 million acres of farming (source: Cal State University Stanislaus). The problem is capture, storage and treatment — not drought, waste, the amount of water used by agriculture, global warming, or even population growth.

There is a lack of “abundant water” in California. But it isn’t due to a shortfall of water, but a diversion of water pricing to pay for cleaning up smoggy air basins, massive artificial jobs programs and political patronage.  Water has been “energized,” “smogified,” “fishified,” “siphonaged,” and “politicized” in California.  In California, water keeps the welfare state liquid.