Full Transcript

Ellen Hanak:
So, this is one of those topics that has just lit the media up over the last couple few months. When people talk about water futures, you’re going to get news stories that will talk about how Wall Street is getting involved in California’s water management. What has happened is…the trading exchange for commodity futures, frozen orange juice, pork bellies, corn wheat, they have now launched a water futures market. And this is based on California’s water market…and basically there’re contracts for buying and selling water on this market.

(INTRO)

Jay Famiglietti:
Welcome back to another episode of Let’s Talk About Water. If you’re a filmmaker, activist, or just someone with a camera, you want to stay tuned to learn how you can win 10,000 US dollars. Speaking of money, we’ll be chatting with experts about what happens when we monetize or add value to our water resources. If you’ve seen the movie, The Big Short or The Wolf of Wall Street, or if you’ve heard about the GameStop stock controversy making headlines, you might’ve realized that sometimes the most unexpected stocks can have the biggest impact on the stock market.

Jay Famiglietti:
Now, we won’t be talking about trading and buying shares in video game stores or in the mortgage market, but we are talking about something much more valuable, our freshwater resources. We’re more specifically the rising popularity of buying and selling shares in water markets and water futures. And while physical water has been traded for decades, the buying and selling of water futures is a whole new ball game.

Jay Famiglietti:
We’re going to dig into that in this week’s episode. We’re going to learn about what these new water management tools have to offer by asking questions like how are water markets investing in the future of water an important strategy to help manage water along with more traditional government infrastructure and policy tools? What does the commodification of our future water mean, and why would we want to do that? And what will it be into the environment and to, well, we the people?

Jay Famiglietti:
To explore the dynamics of water markets when they can be beneficial and when they may crumble, we have two experts joining us today, James Eklund and Ellen Hanak.

(Part 1)

Jay Famiglietti:
Ellen Hanak is the vice president and director of the Public Policy Institute of California’s Water Policy Center, where she holds a chair in water policy, which is actually named after her, the Ellen Hanak chair. Nicely done. She’s an author of many reports, articles, and books regarding water policy, climate change, and infrastructure finance. And she is a leader in planning for a more resilient future for California. Ellen, thanks for joining us on, Let’s Talk About Water.

Ellen Hanak:
Thanks for having me.

Jay Famiglietti:
Okay. So we’re talking about the future of water. I have to admit that I really don’t understand what water futures are. Can you explain what they are and are they, in your opinion, an important piece of the water management puzzle?

Ellen Hanak:
So, this is one of those topics that has just lit the media up over the last couple few months. When people talk about water futures, you’re going to get news stories that will talk about how Wall Street is getting involved in California’s water management. What has happened is the CME, which used to be called the Chicago Mercantile Exchange, training exchange for commodity futures, frozen orange juice, pork bellies, corn wheat, they have now launched a water futures market. And this is based on California’s water market. And you can, as an investor, or just as a water user, you can get in there and basically there’re contracts for buying and selling water on this market.

Ellen Hanak:
Basically, you can use it if you’re a water user. If you’re a farmer in California’s Central Valley, you can use it to kind of lock in the price that you’d be willing to pay for water if you expect that you’re going to have to buy water as part of your irrigation water supply. So it’s based on the actual price of water in California. There’s a firm that kind of tracks those prices. And so they’ve developed kind of an average price for water. So it’s tied to California’s water market. You not actually getting water delivered. It’s just a financial risk management tool, kind of like insurance for how much you might pay for water.

Ellen Hanak:
So, it’s been big, big, big hype in the media because anytime people talk about trading water, that can get scary. There’s an element of water that’s really a basic need. We all need water to live. But there’s also a big element of water in the Western US, that is just as a business input, especially to agriculture. So our agriculture in California uses about 80% of the water that people use. Cities using kind of the other 20%. So it’s an input to agriculture in the same way that labor is, in the same way that seeds are, in the same way that fertilizers are. And it’s an important cost item for farmers when they’re thinking about and the economics of their business decisions. So in principle, this could be helpful for them. The water market itself, the underlying water market, has been around in some form ever since water rights were established back in the late 19th century. But it’s been very active, I would say, and become a really modern water management tool over the last few decades.

Jay Famiglietti:
But I think when people hear the term water market, maybe they’re thinking a little bit about some of this water future stuff that we were just talking about. Sometimes they’re fearful because you don’t understand it. You hear what are market, and you think, oh my gosh, my water price is somehow going to be going up and I’m going to be in rough shape. So are those fears warranted? It seems like there should be safeguards in place, right? So are there?

Ellen Hanak:
In California, there are a lot of safeguards. Most of our water trading so far has been with our surface water. We also have a lot of ground water. So in order to trade water, you have to get various approvals. And those are approvals around making sure that you’re not harming the environment, making sure that you’re selling your water and not somebody else’s water, making sure that you’re not jumping the queue, that you’re not causing injury to anybody else. And sometimes we talk about these as third party effects. That if you and I make the deal, we’re happy with the deal. We’re the parties to the transaction. But there are these other parties, these third parties that they’re not getting any benefit from this deal necessarily, and they could be impacted. So the safeguards are to kind of look at that.

Ellen Hanak:
And what people do is they go through, they do the analyses, what can work. And sometimes that’ll include setting up a mitigation to make sure that somebody is kept whole, these third parties. And that can take some time. And in the actual water market, a lot of the work around this is making those rules more predictable and kind of setting things up so that it’s not hampering trades that would be beneficial for the economy at the same time that it’s providing those protections.

Jay Famiglietti:
So I want to flip back now talk a little bit about water futures. And again, I’m often afraid of what I don’t understand, especially in water. So now I understand a little bit more about buying and selling of water rights. But when I hear the water futures, the CME exchange getting involved in this, I get fearful that some high rolling speculators are going to come in and drive up the price of water. And suddenly, you and I are going to be paying more money for water. Is that a possibility, or am I just paranoid? Which well, I am paranoid.

Ellen Hanak:
But in this case, actually it’s one of the misperceptions. This futures market is not a market for physical water. It’s really just a financial risk management tool. It’s just about allowing you to kind of make a bet on what the future price of water is going to be at any moment in time. I think that the actual water users who get involved in this market, it’s probably mainly going to be agriculture and they’re mainly going to be doing it as a kind of an insurance for the price that they’ll have to pay for the water that they buy on the market.

Ellen Hanak:
The actual price depends on the actual supply and demand of water. So if it’s dry, the price will be high. If it’s wet, the price will be lower. And there’s nothing about this futures market that’s going to change those fundamental supply and demand conditions. Nobody’s getting delivery of contracts in actual water. And that’s where it’s different from some of the commodity futures markets where you could actually end up owning a bunch of grain, right? This is not that. There’s no delivery of water. And so yes, the market will not work unless there are people involved in it who are what the business calls market makers, sort of financial investors who are just doing it as part of their portfolios. Otherwise there’s not going to be enough liquidity in this market. But every given deal, somebody’s going to make money and somebody’s going to lose money. And farmers probably have a better idea of what to expect on the ground than the speculators do. So I don’t think farmers are going to buy insurance that’s way too expensive for them.

Jay Famiglietti:
So, I want to finish up trying to get a handle on how do we know if you’re using the market, applying market forces, how do we know if things are working better? What does your checklist look like?

Ellen Hanak:
Well, one of them is the economics of it. You never have the exact counterfactual happening because you do it or you don’t, and you can kind of observe what happens. But to know what would have happened, you kind of need to look at economic modeling, but economists are pretty good at that. And so there’ve been some really helpful studies showing, for example, we had a major drought from 2012 to 2016. Studies that have looked at, okay, well, what happened? What was the value of water trading during that drought in terms of what it did for the agricultural economy and for jobs?

Ellen Hanak:
And you can kind of see that those numbers are significant. California is in the process now of really trying to get a handle on ground water management and becoming more sustainable with its ground water. If you do that in areas that have to basically go on a water diet, because they’ve been pumping too much ground water, if you do that in a really inflexible way and just make across the board cut backs, that will cost a region like the San Joaquin Valley, much, much more in terms of lost jobs and lost economy than if you allow trading.

Ellen Hanak:
The numbers are so stark and so striking that it’s really about how do we make it work and make sure that there are the protections in place so that people are not being injured, and they’re being made whole. There’s enough difference in value in uses of water that it really makes a very compelling sense in California to do that. And I think that’s true to some degree in a lot of other Western states too. But again, you have to remember if everybody’s just growing alfalfa, then it’s really just going to come down to is your neighbor more interested in staying in the business if you have to all go on a water diet?

Jay Famiglietti:
Ellen, thanks so much for coming on our podcast and keep making waves in California water policy. Ellen Hanak is a senior fellow with the Public Policy Institute of California. And she is the vice president and director of the PPIC Water Policy Center. It was great chatting with you today.

Ellen Hanak:
Lovely to visit with you, Jay. Stay warm.

Jay Famiglietti:
We will try.

(Part 2)

James Eklund is a water lawyer, a water policy expert, and the former director of the Colorado Water Conservation Board. In his role as Colorado’s lead water official, he was responsible for the state’s first strategic water plan, which was also the first water plant by a state in the American West. James also helped frame the Colorado River drought contingency plan. He now leads his own law firm, Eklund Hanlon, LLC, which focuses on water and infrastructure in the Western United States. James is a true leader in water policy and water diplomacy. Bringing together multiple states, agencies, and stakeholders across the Western United States and Mexico to craft collaborative. And he’s also my friend and colleague. James, great to have you on Let’s Talk About Water.

James Eklund:
Jay, it’s awesome to be with you, and thanks for having me.

Jay Famiglietti:
So, James, I was reading the New York Times just after the new year. And as I was scrolling through, I came across this picture of you, looking of course dapper as usual. And it was in an article about water markets. And actually the title of the article was Wall Street Eyes Billions in the Colorado’s Water. My first thought was, oh my gosh, looks like James is gone off to the dark side. Then a little bit more rationally, I thought, let’s get him on the podcast so he can educate us. Here’s a quote from the article talking about you. “He believes that the last best hope against the drought is a market-based solution. One that allows private investors seeking a profit a significant hand in redrawing the map of water distribution in the West.” Where do you go from there? So yeah, that might alarm some people. Can you elaborate on that for us?

James Eklund:
Absolutely, Jay. And there’s been a lot of activity after that article, as you can imagine, including from members of my own family. I got asked in in much more blunt terms using some colorful language from members of my own crew from the western slope of Colorado, what that was all about.

Jay Famiglietti:
More like WTF?

James Eklund:
Yeah, it was definitely a spirited couple of phone calls right off the bat. The article had a objective of making sure that the issue was covered in the business section of the Times. I’m an avid New York Times reader. On Sundays, I get the paper in a hard copy here at my front door. And so I think that the goal was to really get the full story out there. Well, the reporter that was working on that story when he contacted me in the fall of last year for an interview, reached out to me, and said, “Hey, I’m looking at this issue. I’ve never done a water article before, much less a western water article. And so, maybe you can give me some background. Kind of unpack this issue for me.” And so I did that.

James Eklund:
I gave him quite a bit of time on background to understand exactly what water in the West is, all this political stuff, economic stuff, environmental stuff, and social justice stuff too. And he wrote an article that had a bunch of the flavor for kind of painting a portrait of me and who I am and where I’m from in there. And then he lost his editor at the paper and had to basically shop the article again. And the good news was that the new editor said, “Yes, I think this is still worth publishing.” The bad news is he had to cut 1,000 words at the drop of a hat to get the thing done. And a lot of what came out were the kind of personal details that really explained that I would never do anything to harm agriculture in Colorado, much less Western Slope Colorado agriculture.

James Eklund:
I’ve been approached, as you can imagine, before the article, after the article, by folks from all stripes of investment firms. Everything from purely speculative, kind of Big Short, you mentioned in the intro type of, we want to short water, or we want the opportunity to kind of do what we do with other commodities. One end of the spectrum, I had calls from people in that business. And on the other end of the investment spectrum were very patient capital that was more of the kind of, you’d almost call it impact investing. Where it was not purely philanthropic. They were looking for a rate of return for sure, but it’s more of the type of investment that doesn’t need to see a quick hour by hour, or day by day type of gain. It can be in it for the longer term and draw comfort. And there’s a benefit, kind of a non-monetary hard to quantify benefit out of investing in something that you believe in and that you want managed well.

James Eklund:
Where I intended to go was to really recognize the system we’ve created in the Western UDS, and specifically in Colorado, with the doctrine of prior appropriation and this class of private property rights that we have come up with. Now, not everybody’s done it that way. When white people came and settled the United States from England, they brought the common law with them, the British common law. And that was the riparian doctrine. And it just meant if you’re on the river, you own land on the river, you can put your straw or your shovel in the river, and you can do what you need to do. As long as you don’t injure the river, you’re good. And with rivers on the East, that’s perfectly fine. That works. And there’s enough to go around, and they don’t need this kind of administrative system that we’ve developed here in the West.

James Eklund:
So, what we did is we had all these miners really, and some irrigation people, but it started with miners coming out here to mine in the Rocky Mountains. And they didn’t have any land. They didn’t own land by the river. And they needed to put the water into some sort of conveyance structure to get it to their operations so that they could run the sluice box or do whatever the process is that they were doing to mine and use the water. So, it wasn’t conducive to buying a bunch of property on the hope that you found the right spot at the right time. And so to encourage the development of Colorado, we developed in this state something that a lot of the other Western States called the Colorado Doctrine, because it started here, and that was the doctrine of prior appropriation, which is basically first in time, first in right. If I put my shovel in the river in 1888, and then you come along, Jay, and in 1898-

Jay Famiglietti:
I’m not that old.

James Eklund:
But yes, 1988, when you were just-

Jay Famiglietti:
When I was 28.

James Eklund:
…a small child. Yes, when you were a very small child, you would be junior to my water right. My water right would be senior to you. And even if you were upstream of me, you would have to let your water go past your head gate to get to mine before you get to take a drop. And then if there was enough water in the river for you, then you got to take water too. Then that right to use the water is a private property right in Colorado. Just to be clear, the molecule of water, and I think this is true in most, if not all Western states, the molecule of water in the river belongs to the people of the sovereign, the state.

James Eklund:
But if you want your water right, your ability to put that water to a use, a beneficial use in Colorado is required, it’s best if you go to water court. We’re the last state in the Union with water court, and you get your water right put on paper. Well, those pieces of paper, those water rights, have a value. And the value that they’ve grown up with as time has gone on has depended on how much water is reliably in a system. That was what I was trying to elude to in my interview with the New York Times was that fact that we have this system that recognizes private property rights.

James Eklund:
And for that to work, there is already a market in place. It’s not traded on a stock exchange. It’s not in a futures market. It’s a market in the more generic sense of the term market. There’re buyers and sellers. Those buyers and sellers can be in it for all sorts of reasons. But because we have an anti-speculation doctrine in our state, you can’t speculate with the water. You have to have a beneficial use that you put the water to. You can’t just come in here and buy it, hold onto it, and wait for it to get valuable, and then flip it.

Jay Famiglietti:
Okay. So, let me see if I understand. So, if you live in Colorado and you own a water right, and you’ve got a piece of paper that proves it legally, you can sell that water right. They have value based on how old they are, right? Which are the earliest ones are the most valuable. You can sell that. So that’s the market that you were talking about, the market for buying and selling water rights.

James Eklund:
Correct.

Jay Famiglietti:
So, let’s just focus on that. So yes, you said it has to be for beneficial uses. Can you give us an example of positive and negative applications of this market for water rights?

James Eklund:
You bet. Yeah. So, positives with a market like this is you’re trying to find the most efficient distribution and allocation of capital. That’s why we have stock markets. That’s why we have markets at all. If you go back to your Adam Smith kind of invisible hand economics 101. The reason we have markets is because there’s a belief in capitalism that it will find the equilibrium point where the price of a good or a service matches up with the true value of that service or good.

James Eklund:
As you know better than anybody, Jay, we have not done that in water in the West. We keep the value of water artificially low because everybody has to have it. Without it, we can last three days, and then we’re done. What economists called the diamond water paradox, where you’ve got a substance like water that everybody has to have valued very low. It’s cheap compared to diamonds, which really, ornamental diamonds, you don’t have to have. But there’s a huge value assigned to those. Something you don’t need is valued way up here. And the thing you absolutely have to have is valued clear down here. That’s a paradox.

James Eklund:
So anyway, the good things that can come from a market are that if I’m a farmer or rancher, or any water user, and I need to total up my assets and my liabilities like businesses do and tell a banker I need alone. And here are my assets. Here are my liabilities. Tell me how much money I can borrow and what the terms are going to be of that loan. If I have a valuable water right, then I can borrow more than if I were able to just say, “I don’t have a value associated with my water right. It’s the value of the land that I have. And I’m borrowing against that.” The free flow of capital in the marketplace is lubricated or encouraged by markets that have few barriers and transaction costs are low. Positive externalities, I guess come out of those transactions for individuals and for communities that have water of a certain value.

James Eklund:
You asked about the negative examples of water markets. Well, the New York Times article, I think did a good job of pointing to Enron, right? I mean, if you have any commodity, whether it’s energy, or water, or pork bellies, or whatever, and an entity essentially fabricates an artificial market that doesn’t really exist, and people invest in that, and then the whole house of cards crumbles in on itself, that’s a negative example of having markets in this space that nobody would like. Not me, not anybody wants to see that happen. So there needs to be regulation in place just like with any market that it can’t just be a complete free for all Wild West approach to doing this.

James Eklund:
But to ignore the reality that we have private water rights in the West, I think misses the boat because it’s not going to make good policy to just ignore the reality of how water works out here. The game has changed. The facts have changed. And if we don’t change with those facts, that’s a real problem. So, demand management is a way of saying, listen, we’ve got to try and control our descent. How we hit the ground is up to us. We can crash into it at 200 miles an hour and splatter all over the place in a really disgusting display. And we will do that by the way, if we just keep doing what we’re doing.

James Eklund:
I think that’s the good analogy is a parachute. We’re jumping out of the airplane and we’re going to crash into the ground, but we have this parachute on our back called demand management. And it’s perfectly capable of slowing our descent and controlling our landing if we use it. But we in the state of Colorado right now are arguing about the color of the parachute. No, I want it to be a red parachute. No, I want it to be a blue parachute, and I want it to have these amenities with it. And that’s all fine. And there’s a place for that. As the water plan demonstrated, there’s no substitute for grassroots conversations that bubble up and produce good policy.

Jay Famiglietti:
Thanks so much, James. I really appreciated the opportunity to learn about things like water markets today and get some insight into the future of how water could be managed across the exceptionally arid American West. James Eklund joined us from his home office in Denver, Colorado today, James is the former director of the Colorado Water Conservation Board, and now leads the Eklund Hanlon LLC law firm that focuses on water and infrastructure in the Western United States. He has emerged as one of the United States preeminent water attorneys, and he is at the forefront of water policy innovations in that country. Thanks so much, James.

James Eklund:
Yay. A pleasure as always. Thank you so much.

Jay Famiglietti:
Well there you have it. The future of our water futures. As we’ve heard, they can be crucial in managing water scarcity, but they can also be detrimental. With scientists and professionals like James Eklund and Ellen Hanak, I hope you’ve been assured that California’s and Colorado’s water is in good hands. Who knows maybe they’ll even make a movie about it one day. And if I’m in it, I hope I get played by George Clooney, but I’d certainly take Ben Affleck if George is busy. If I were just a bit older, I would definitely go for Jack Nicholson because we both have that raised eyebrow thing going on.

Jay Famiglietti:
And before we go, we want to fill you in about our water film prize. We want you to have an opportunity to share your water story and a chance to win 10,000 US dollars, and have your film featured at our Let’s Talk About Water Film Festival in June 2021. And for our teachers and students, we also have a youth prize that could win your school up to $5,000. All you have to do is submit a two minute film to the Let’s Talk About Water water film prize by April 30th. Do you need to refresher on filmmaking skills first, attend one of our upcoming visual shoot short workshops to brush up on those skills. For more information and registration, head to the Let’s Talk About Water website linked in the show description.

Jay Famiglietti:
Let’s Talk About Water is produced by the Global Institute for Water Security at the University of Saskatchewan and The Walrus Lab. I’m your host Jay Famiglietti. Thanks to everyone who helped put the show together, including Mark Ferguson, Laura McFarlan, Amy Hergott, Jesse Witow, Shawn Ahmed, Nicky Manfredi, Stacey Dumanski, and our producer, Sean Prpick. And as always special, thanks to our good friend, Linda Lilienfeld.

Jay Famiglietti:
You’ve only got one episode left this season and it’s a big one. We’re chatting with Jeff Sachs, the superstar American economist, academic, public policy analyst, and former director of the Earth Institute at Columbia University. So make sure you send a notification to hear the new episode the second it comes out. Remember we’re on Apple Podcast, Spotify, Stitcher, and many other quality podcasting platforms. You can also stream us on Facebook, at Let’s Talk About Water Podcast or follow us on Twitter at LTAW Podcast. See you in a few weeks.