Thoughts on the Current Economic Value of Water in the Central Valley

The past few years has seen unprecedented prices in the sale of water to Central Valley agricultural water users. Pockets of water are being sold annually at prices ranging from $1,100/AF to more than $2,000/AF. How does one reconcile these price levels with the long-term narrative that agricultural water uses are low value uses of water?  There is no mystery.

The Notorious Water Squeeze in the Central Valley

It is no secret that the water supply situation in the Central Valley has been dire. Central Valley Project agricultural water users and the Friant Division contractors have had ­no water allocations the past two years. Even the “senior” Exchange Contractors only received a 65% allocation in 2014 and a 75% allocation in 2015. Sacramento River Settlement Contractors have received 75% allocations. These (lack of) allocations have sent everyone scrambling for water.

Emergency Value of Water

Acreage in annual crops can be fallowed due to lack of water. The economic costs include loss of annual farming income, employment and economic losses sustained by farming related industries and communities. When (or if) water allocations return, fallowed acreage can return to farming. The economics of annual crops is not driving water pricing. Annual crops are on the supply side of the water market.

Permanent crops find themselves in different circumstances. The lack of water not only jeopardizes this year’s income, but also future income. Permanent crops represent significant investment and patience. Depending on the crop, there may be between 3 years (almonds and pomegranates) and 5 years (pistachios) from the first year of planting before trees are generating commercial yields. Lack of water places significant investment at risk.

UC Davis Department of Agricultural & Resource Economics has “tree loss calculators” as a supplement to their long-standing studies of crop budgets (see http://coststudies.ucdavis.edu/en/tree-vine-loss/). While the calculators are based on studies with different dates, they demonstrate two critical points about permanent crops (see value chart):

  • – The economic value of permanent crops is substantial. At the start of commercial production, almonds are worth over $30,000 per acre, pistachios are worth $60,000 per acre and pomegranates are worth $90,000 per acre.
  • – The economic value increases until yields reach maturity and then declines with the age of the tree.

Value Chart
Acquiring water, rather than going without, protects a significant economic investment. There are two components to the economics of acquiring water for current year’s operation.

First, one earns income rather than sustains a loss in the current year. Once orchards reach maturity, the income loss per acre-foot of water use equals $670/AF for almonds, $1,100/AF for pistachios and $1,800/AF for pomegranates throughout the useful life of trees (see income chart). The constant value for tree age reflects underlying assumptions of the UC Davis model­­—constant yields over the commercial life of the orchard once trees mature.

Income Chart_FINAL

Second, acquiring emergency water today keeps the orchard alive for next year. If the water supply situation returns to normal, then the water emergency passes and the economics of orchard operations return to normal. There are no further potential losses (until the next water emergency). However, if the emergency continues, then the operator will find itself in a comparable situation next year as they did in the current year. Unless emergency water is acquired next year, water acquisitions in the current year only defer the losses from lost orchards one year.

In effect, the operator faces a lottery in successive years. The nature of the lottery depends on expectations about the duration of the current water emergency. The table below shows the probability of continuation of a water emergency for different expectations about the expected duration of the current water emergency.

The Water Emergency Lottery Depending on Expected Duration of Current Emergency

Expected Duration
(Years)
Annual Probability of Continuation
4 75.0%
6 83.3%
10 90.0%

The annual value of emergency water in the current year for almonds easily exceeds $1,000/AF for a wide range of expectations about the duration of the current emergency for trees younger than 20 years (see almond chart). These high annual values reflect the fact that there is significant economic value to acquiring water this year so that the trees can live to next year. If the emergency continues next year, the annual value of emergency water will be slightly lower (the trees will be a year older). The annual value of water for 25 year-old trees (the useful life of almonds) converges to the annual value of water in the current year ($670/AF) regardless of the expectation about the duration of the water emergency (there is no “future years” after the useful life of the trees).

Almond Chart_FINAL

The annual value of emergency water for pistachios is even higher than almonds (see pistachios chart). Recall that the peak value of pistachios acreage is twice the peak value of almond acreage. The economic value of keeping the orchard alive for next year keeps the annual value of emergency water for pistachios above $2,000/AF for trees younger than 20 years.

Pistachios Chart_FINAL

Pomegranates have the highest annual value of emergency water (see pomegranate chart). Recall that the peak value of pomegranate acreage is $90,000/acre. The annual value of emergency water for pomegranates is above $3,000/AF for trees younger than 20 years (for expected duration of the water emergency of 4 years and 6 years) and younger than 16 years (for expected duration of the water emergency of 10 years).

Pomegranate Chart_FINAL

Observations on the Marketplace

Spot market water prices are high precisely because there is little water. With the Central Valley Project a “bust,” available water is limited to local groundwater supplies and surface supplies from local rivers. Transportation networks were designed to move “project water.” With no project water to move, trading in available water is understandably geographically fragmented.

The current high price levels may not be sustainable. As the existing stock of trees age, the annual economic value of emergency water declines. Further, investment in new agricultural operations may not be sustainable at long-term water prices at current levels (see table). Look for new investment based on non-CVP water sources that are cheaper and more reliable.

Economic Value of Permanent Crops by Long-Term Water Price ($/Acre)

Water Price Almonds Pistachios Pomegranates
  $250/AF $14,532 $33,527 $65,331
  $500/AF $612 $20,033 $50,856
  $750/AF -$13,307 $6,540 $36,381
$1,000/AF -$27,227 -$6,954 $21,907
$1,250/AF -$41,147 -$20,447 $7,432

 

As in other markets, emergencies generate unexpectedly high prices. The economic circumstances driving current price levels are not sustainable long-term. For further investment in permanent crops, a geographically broader water market must be developed that expands the scope of potential water resources for agricultural development.

 

Written by Rodney T. Smith, Ph.D.