Big Water Arbitrage in California

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Big Water Arbitrage in California
 
By Henry Bonner 
“Water law in California began in earnest in the early part of the 20^th century,” Rick Rule recently wrote for the Bonner Family Office, “when interests in Los Angeles bought up most of the available water rights in Owens Valley of Eastern California.

“This took the rights from ranchers – who had enjoyed them for free – and allowed the new owners to ship that water to Los Angeles, where it fueled the growth of the city.”

But agricultural interests, the dominant political force at the time, were unsettled by these events.
“Farmers disliked fair markets for water,” says Rick. “They wanted to protect their water from being bought up by urban interests who could afford to pay more for it. So they changed the rules for water distribution.
“Water that flowed through agricultural land was reserved for agricultural use unless an exemption was provided for urban use. Farmers who wanted to sell their water to urban users were prohibited from doing so.”

A hundred years later, that system is still in place.

Because agricultural water is protected from being bought up for urban use, agricultural water has remained relatively cheap and water for human consumption has skyrocketed.
The gap between the two is immense…

In San Diego County, untreated water now costs upwards of $1,000 per acre-foot¹ (about 326,000 gallons, or enough to supply three households for a year²). Water used for growing almonds in the San Joachin Valley, meanwhile, only costs around $40 per acre-foot.³

Today, a lot of farmers would make more from selling their water than from growing crops. But the law says they have to use it to farm or give it up.

As a result, agriculture uses 85% of the water that is not reserved for environmental purposes⁴, whereas farming only represents 0.4 percent of gross total regional product.⁵
But with population booming and water supplies dwindling because of the drought, we could see necessity force authorities to loosen the rules that bind water use in California.

If affluent coastal communities in Los Angeles, San Francisco, or San Diego begin to feel the effects of water shortages, will it matter to them that farmers should have a ‘right’ to grow their water-intensive rice paddies or other crops in the arid Central or Imperial Valleys?

We could see California follow the example of southeastern Australia. After a decade of drought, the authorities allowed a kind of market for water rights to occur. As a consequence, agricultural usage became much more efficient – switching water-intensive rice paddies for higher-value crops like citrus fruits and wine grapes.

If agricultural water could be bought and sold more freely, this might allow the $40 water to be sold to people in San Diego, for instance, who are willing to pay 25 times more for the same water. Rick believes some investors could gain from participating in this substantial water price arbitrage.
In particular, he explains, we should look for ways to own those water rights still trapped by the old rules -- and wait until circumstances allow us to sell those rights to a higher bidder.

Rick Rule has devoted over 35 years to natural resource investing.  His involvement in the sector is as broad as it is long; his background includes mineral exploration, oil & gas exploration and production, water, agriculture, and hydro-electric and geothermal energy. Mr. Rule is a sought-after speaker at industry conferences, and a frequent contributor to numerous media outlets including CNBC, Fox Business News, and BNN. He founded Global Resource Investments in 1993 and is now a Director of Sprott, Inc., a Toronto-based investment manager with over $7 billion in assets under management, and CEO and President of Sprott US Holdings, Inc., where he leads a team of skilled earth science and finance professionals who enjoy a worldwide reputation for resource investing.

¹ http://www.sdcwa.org/san-diego-county-water-authority-adopts-rates-and-charges-2013
² http://www.epa.gov/WaterSense/pubs/indoor.html
³ University of California Cooperative Extension, 2011. Sample Costs to Establish an Orchard and Produce Almonds
⁴ http://www.californiawater.org/cwi/docs/CIT_AWU_REPORT_v2.pdf
⁵ http://aic.ucdavis.edu/publications/socal.pdf