There is rising concern about “speculators” purchasing water rights in Washington State as we begin the 2020 Legislative session, driven in part by an article this fall in the Seattle Times. Two bills in the current session address the issue, both of which would add hurdles and requirements for water rights transactions. One aims to eliminate intermediaries in water markets. In the face of climate change and increasing water demands between environmental, agricultural and municipal uses, Washington State needs more flexible water management systems. We should be encouraging more water market transactions, and thinking carefully and creatively about addressing the concerns that members of the public have about them.
Most people use the term “speculator” to mean someone doing something that they don’t like, particularly if they are an outsider. So first, a story to help define terms. If I walk into a store and buy a Snickers for $1.50, then walk into the parking lot and sell it to you for $2.00, I have found what economists call an opportunity for arbitrage. It’s a money machine: I make $0.50 for each quick trip into the store. This type of arbitrage by intermediaries might seem objectionable, like selling gasoline from soda bottles for $8 a gallon after a hurricane. We could try to abolish it by banning any intermediaries in Snickers purchases, perhaps requiring that all Snickers buyers eat the candy bar while still in the store. But this misses the key problem: why didn’t you just walk into the store and also pay $1.50? Standing in the parking lot, you perhaps did not know that the price of Snickers was so low and that you could walk in and buy it yourself. Perhaps out of concerns around obesity, the store has a set of questions on diet and exercise that the clerk must ask before allowing the Snickers sale. Like in many water markets, the solution to limiting this arbitrage opportunity is to make it easier for buyers and sellers to find each other (enter the store) and to help buyers know what a fair price is. Computer-aided smart markets or negotiating dry-year option leases in advance can help with the former. Requiring mandatory public price disclosure for all private water market transactions (as in now WA law for mitigation water banks) can help with the latter. It's also worth noting that arbitrage opportunities don't last. I am sure to attract competitors, who are also willing to walk into the store but re-sell it to you for $1.95. I will undercut that competitor at $1.90, and she will undercut me, until we arrive at a price in the parking lot that is just high enough above $1.50 to make it worth our time walking into the store. I am a speculator if I buy the Snickers, store it in my basement, and hope that the manufacturer (Mars) goes bankrupt so I can resell it as a collector’s item for $5.00. But my $1.50 investment in the Snickers had an opportunity cost – I could have put the $1.50 in the bank and earned interest, or invested it in stocks. I’m also taking a risk. Mars will probably NOT go out of business, Snickers bars will NOT become collector’s items, and I’ll have a moldy candy bar in my basement. The big markup from $1.50 to $5.00 is my reward for taking that risk IF things turn out as I hope. What about “speculation” in water markets? Let’s call an investor someone who buys water rights with the intention of selling or leasing them to someone else, and who has no intention of actually putting the water to a beneficial use themselves. Investors will have several motives in their minds, and no one can peer inside and know which one is most important. One motive is pure speculation as defined by our Snickers example above (buy, hold, and sell, expecting the price of the water right to be higher in the future). Another is to generate investment income. I might not expect the price of water rights to increase, but I can hold the asset and lease it out to farmers annually or on longer-term contracts and generate investment income. This is no different than the landlord of an apartment building, who wants to generate annual investment income from rents, but may also expect and hope that the price of his building will increase by the time he retires. Speculation in water markets could be enabled by the state Trust Water Program. The investor “parks” the water in the TWP, waits 10 years, and then sells it at the new, higher price. Is this likely to be a large problem, particularly for public policy? Probably not. First, we shouldn't forget that in each of those 10 years, instream flows improved, serving one of the key purposes of TWP. Second, each year the investor keeps the water right in TWP, he is foregoing the investment income from leasing out the water right to a buyer. If demand for out-of-stream uses increases during the ten years, perhaps because of a boom in hay prices for the Asian export market, that foregone investment income gets larger. The investor is then more likely to pull the water out of TWP and lease it. What if lots of water is parked in TWP? If “too much” water gets parked by speculators, the supply of water rights falls and the lease price should increase, inducing some of the speculators to pull water out of the TWP and lease it. A legitimate concern is that this type of activity might lead to more volatility in prices if large chunks of water are moving in and out of the TWP. Third, note again that this speculator is taking a risk: the value of water rights may go down in the future. If everyone believed the price of rights was going to go up, including sellers, then the speculator would be forced to pay an initial price that built in everyone’s expectations of the price going up. Think of buying a derelict house one block from a planned subway stop in Seattle: everyone knows the land will be very useful in 10 years time for shops and apartments, including the current owner of the derelict building who is demanding a high price! Finally, note that the speculator is providing liquidity to what is a “thin” market with few transactions: a farmer nearing retirement who would like to sell their water right will have an easier time finding a buyer in a market with more investors. The more important public policy concern here is that the buyer might be interested in buying and parking so much water in the TWP that he gains “market power”, meaning he can begin to drive up the price for water rights. In the extreme of only one seller, this would be a monopoly. This could be a possibility in small basins, but is unlikely to be a problem at the scale of the Columbia River Basin. The vast majority of water rights are held by the federal irrigation districts. Furthermore, the experience with the mitigation banks in Kittitas County worked in the way that economics would predict. Very high mitigation prices (which resulted from there being essentially only one seller) induced many more sellers/banks into the market, driving prices back down. Still, the State might have interest in at least monitoring water market transactions for possible market power concerns. To prevent a potential monopolist from hiding behind an opaque network of LLCs, this would require disclosure of beneficial ownership of LLCs that buy or sell water rights in the State. The State could also begin to develop some basic rules and warning posts for how it might assess the potential of any one transaction to harm water users. This could be akin to rules that the Federal government uses to assess possible mergers for antitrust. In the context of state water markets, it might simply trigger increased public comment periods or disclosure requirements. There seem to be two emotional drivers for many of the current concerns raised about water markets in the state. The first is the fear that once water is sold downstream it is gone forever. This is a legitimate concern. Water market transactions that move water upstream receive far more scrutiny and are practically impossible because third parties in between can be harmed (the trade upstream lowers flows in the river) and will object in court. So if the hay grower in Twisp keeps her water right locally, it might be available for mitigating additional domestic use in the Methow in 2050, but if she sells it down the mainstem Columbia it can never return to support those future homes and families, even if the willingness-to-pay in the Methow is extremely high. But there are at least three other solutions to this problem that don’t require a heavy-handed ban on investors. First, it could be solved administratively by legally earmarking a transaction such that any future sale will be allowed back to the same original point of diversion (or nearby river mile). The hay farmer can sell now to Kennewick, but the city of Twisp is guaranteed the legal ability to buy back the right in 2050. (Any third party user who makes use of the additional streamflow between now and 2050 will know their right is interruptible and void the right to block the upstream trade in 2050.) Second, it is also possible that computer-assisted “smart” markets can allow batch processing of transactions such that upstream trades will be allowed when they are bundled with other downstream trades such that the net effect on the river in between is negligible. Third, the state could empower Counties to purchase and hold water rights explicitly for future use. The state could endow a water rights fund, matching County dollars 1:1, to purchase local water rights that might otherwise leave their county or basin. These rights could be stored in the TWP and protected from relinquishment, again benefiting instream flows. The County would have sole discretion on how to manage this portfolio of rights, giving voters in the County a stronger voice in how water rights are managed locally. In summary, if residents in the Methow are more confident that they can, through a functioning market, access those water rights again in the future it may lessen the fears that the valley will be permanently “dried out”. The second emotional driver seems to be about “bigness” and “outsiders”. Given the experience of the financial crisis, we are justifiably wary of “hedge fund” or “Wall Street” people who have no history or connection with our home coming and buying a public resource, particularly one that has important environmental and cultural values. The state has an obligation to manage water rights to balance these values, for example by honoring treaty rights and protecting instream flows. But our system has for 150 years allowed a private right to use water rights for out of stream purposes, and those private rights in our system can be bought and sold. Indeed, they should be bought and sold so that our scarce water resources can be put to the uses that are most important to society, whether those uses are recreational, environmental, agricultural, cultural or municipal. Importantly, water markets allow the pattern of water uses to change as the State changes; they give us flexibility and adaptability. In my view, the fear of “bigness” in water rights can’t be separated from “bigness” in irrigated agriculture. Citizens might be alarmed to learn of an investment fund buying $10 million in water rights, but barely bat an eye to hear the same fund buying a massive irrigated orchard for $100 million. That $100 million orchard would be nearly worthless without water rights, so the hedge fund that buys the orchard is also purchasing/speculating/investing in water rights in a very similar way to our water market investor. Unless there is public appetite for limiting irrigated farm sizes, there will be increasing demand for large chunks of irrigation water supply.
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AuthorI am an Associate Professor in the School of Economics at Washington State University. All opinions and policy statements are, however, my own. ArchivesCategories |