Inching toward water markets

Markets and prices are the best way to bring supply and demand back into balance after Colorado River allocation cuts. Barriers against them are beginning to crack.

I’ve long advocated that Arizona respond to a reduction in supply from the Colorado River by moving toward more robust water markets and using pricing to allocate scarcity. The state is inching toward slightly more robust water markets. However, not even that much progress is being made on having the retail price of water reflect its scarcity, not just the cost of production and provision.

For perspective, it is useful to view the state’s water supply and demand holistically. Arizona gets 36% of its water from the Colorado River. How much of a cut Arizona will have to take to render the river sustainable over time is very much up in the air. For purposes of illustration, let’s assume that the state will lose half of its allocation when the dust settles.

That would be a reduction of 18% of the state’s total water supply. Agriculture still uses more than 70% of the state’s water. Of non-agricultural uses, a substantial amount, perhaps even a majority, is for outdoor purposes, primarily lawns and swimming pools. As a guesstimate, say 15% goes to sustain households and commercial and industrial production. 

In a holistic overview, an 18% reduction in overall supply could be absorbed through greater efficiency or reductions in agriculture and a continuation, and acceleration, of reducing outdoor uses in the urban areas. There would be nothing about losing half of Arizona’s CAP allocation that would threaten the ability to supply residential, commercial, and industrial needs, now or in the future.

Water in Arizona, however, is not fungible. There’s a byzantine legal framework restricting who can use how much water from what source and where.

There are encouraging developments regarding treating water as more of a fungible commodity, able to be bought, sold, and transported.

A federal judge recently declined to enjoin a deal Queen Creek made to purchase water from an investment group that bought up farm land with Colorado River surface water rights. The Arizona Republic’s Joanna Allhands, who keeps a watchful eye on these things, reports the formation of a consortium of landowners in the Harquahala Valley to orderly mine groundwater and sell it to Phoenix area users. Transfers from this basin are permitted by state law, although more clearing of legal thickets may be necessary for the systematic approach the consortium wants to pursue. 

There are some developments that appear to be moving toward water markets and allocating scarcity through pricing, but really aren’t. The federal government is paying the Gila River Indian Community not to take part of its Colorado River allotment. Some farmers in Arizona and California want in on the action, although at a higher price. Some Arizona cities might even be interested. 

Such forbearance agreements may be needed in the short-term to keep an adequate supply of water behind some of the dams. But they aren’t a way to reconcile supply and demand for the longer term. Moreover, the price may be informed by the terms of arm's-length exchanges, but it is a politically negotiated price, not a true market price. And it doesn’t get reflected in the retail price of water, and thus offer an incentive for additional conservation. 

A similar problem afflicts what is otherwise a welcome development on the water augmentation side. 

The City of Phoenix seems serious about building a treatment facility to reclaim wastewater to drinking water standards. This is a much more sensible approach to increasing potable water supplies than Gov. Doug Ducey’s quest to land a desalination white elephant. 

But the city is looking at the funding source Ducey created to pursue the desalination white elephant, a cool billion plus that was appropriated to the Arizona Water Infrastructure Finance Authority. The city is also eyeing federal grants for water projects in the infrastructure bill. 

The plant’s output, however, will have guaranteed buyers. It could easily be financed with private capital through a bond. There’s no need to tie up taxpayer dollars in the way Ducey has set it up. 

The capital obtained through the state’s water finance authority is supposed to be paid back through water rates. So, there will be a conservation price signal from that part of the financing plan. But not so a federal grant, if obtained. That will act as a pure subsidy, sending the wrong conservation signal.

Except for a lifeline rate for basic household needs, the retail price of water should reflect its scarcity, not just the cost of production and provision. That’s the most efficient way to bring water supply and demand into balance. And I would argue that it is also the fairest, since it allows individual consumers to make their own conservation decisions, rather than government dictating them for everyone.

Phoenix does seem to be exploring water rate changes that might tiptoe in this direction, but water rates above the cost of production and provision are fraught politically. 

There’s a long way to go. But the barriers are cracking a bit on using markets and prices to bring supply and demand back into balance after losing some Colorado River supply. The more lost, the more important market reforms become.

Reach Robb at robtrobb@gmail.com.