Interbasin Transfer: The Role and Reason for Compensation

By

Milton L. Holloway, Ph.D.

Resource Economics, Inc.

Austin, Texas

Presented to TWCA

March 10, 2000

MiltonLHolloway@sbcglobal.net

March 10, 2000 2

Source

Third Party Compensation for Interbasin Transfers of Water in Texas:Alternatives for Funding and Payment, Prepared for the Texas Water Development Board by Resource Economics, Inc. Austin, Texas, July, 1999. (Contract No. 99-483-269).

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Compensation Defined

A Payment Made in Exchange for a Good or Service– Payment for water made to the owner of the resource– Payment to third parties for water use related benefits foregone

A Payment Made as an Incentive to Act– An advance payment--guarantee or earnest money

A Payment Made to Share Benefits– A gift of good will– A transfer payment to help a deserving party– A grant for a designated purpose

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The Reason for Compensation

There is not enough water to “go around” Water is not where it is needed Institutional constraints limit the

willingness of water surface right holders to transfer water out of basin

Unreasonable prices will be paid for groundwater

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Some Recent Purchase Prices

Groundwater– San Antonio

Groundwater Purchases– $51 per acre foot in the ground (6% amortization for 30 yrs)

– Amarillo Groundwater Purchases

– $22 per acre foot in the ground (6% amortization for 30 yrs)

Surface water– LCRA

Garwood Irrigation District– $36 per acre foot run-of-river in the stream (6% amortization for 50

yrs) Rio Grand Valley

– $109 per acre foot (6% amortization for 30 yrs) How much will San Antonio have to pay?

March 10, 2000 6

Water Market Typology

Sale/Source Surface Water Groundwater

Private to Private

Public to Private

Private to Public

Public to Public

focus of the study the pressure is here

A Typology of Transactions in Raw Water Markets

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The Role for Compensation in SB 1 Transfers

Provides an Incentive for the Exchange to Occur– Benefits to the basin of origin can exceed the regulated price for

water set at the cost of service, plus payments for third party impacts

– Provides a means of relieving the pressure on groundwater sources to satisfy interregional demands

Will Help Avoid Uneconomic Choices Made by Desperate Communities

Can be Accomplished Through the Sharing of the Net Income Benefit of the Transfer with the Basin of Origin

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Our Two Water Law Systems Are Creating an

Increasingly Bifurcated Market Reminiscent of the natural gas market of the 1970-80 era

– regulated gas sold for as low as $0.30;, deep deregulated gas sold for $10.00 per mcf; average cost pricing by utilities shielded consumers from the the $10.00

– institutional barriers capped the price of most gas at historical costs– some folks called for more regulation to solve the problem; fortunately they

lost the contest and deregulation, brought gas prices back below $2.00 per mcf

We could see some equally absurd results in the water market There is an unregulated part of the water market (groundwater);

groundwater districts will not be able to prevent private property owners from exercising their rights to sale water

Since inadequate incentives and institutional constraints restrict the availability of surface water, the pressure is on groundwater to solve the problem

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Some Current Proposals That Would be Unlikely to Develop in a Competitive Market

A Proposal by Boone Pickens to Pipe Groundwater from the High Plains to San Antonio

Serious Proposals to Develop Desalting Plants

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Needed Changes to Move Toward Workable Water Markets

Eliminate cost of service based rate limits for contract sales of surface water

Remove the junior water rights provision of SB1 Assure that market based prices for water right sales

are not declared to be against the public interest Create bidding rules that guarantee competition in

water sales Note: Such changes will be a long time coming, if ever,

so…..

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In The Meantime

Compensation Will Help Until We Develop Markets That Can Be Trusted

– Most Surface Water is Managed by Public Entities– Some Significant Interbasin Transfers Need to Happen in the Near

Term

Let’s Look at How Compensation Can Help Reach Reasonable Solutions to Water Trades While Regulation Still Applies

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Three Classes of Compensation

Class A alternatives will achieve payment of income foregone and the sharing of net regional income gains.

Class B alternatives will achieve payment of only income foregone.

Class C alternatives will achieve some form of public and/or private compensation in the form of in-kind payments, cost sharing on public projects or subsidies that approximate the size of the basin income foregone, but ignores the sharing of net regional income.

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The Focus Needs to Be on Class A Type Compensation

Historical focus has been on Class C Compensation

But Class C Compensation means exporting basins will get water projects in the exchange for a transfer regardless of whether water projects are needed

Class A compensation allows focus on economic development that is usually the justification for water development in the first place

Class C is better than no compensation at all

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Class A Compensation Meets the Legal Tests

Texas Supreme Court ruling in 1966 in City of San Antonio v. Texas Water Commission. The court held that the Texas law prohibits interbasin transfers if the transfer would “prejudice any person or property” within the basin of origin; prejudice is to be determined by weighing the detriments to the basin of origin against the benefits of the diversion. Compensation based on the income value of water will satisfy the Supreme Court’s ruling.

Complies with requirements of SB 1

– ( §295.13). Interbasin [Interwatershed] Transfers– while Chapter 295.13 has a more limited idea of compensation,

the definition provided here is not in conflict with it

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Mechanisms for Class A Payments

Direct payments for water to the water right holder Third party impact payments

– payment directly to uniquely identified parties or their agents– payment to communities through economic development

programs or development of community projects

Income sharing payments to economic development programs

Note: This three part payment will never sum to more than the cost of the next best alternative

Note: Several river basin authorities are already set up to handle all three types of payments because Art. 717p authorizes certain river basins to engage in an economic development program. These economic development programs, as a general matter, can accept public or private funds from another basin.

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Mechanisms for Class B Payments

Direct payments for water to the water right holder

Third party impact payments– payment directly to uniquely identified parties or their agents– payment to communities through economic development

programs or development of community projects

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Mechanisms for Class C Payments

Direct payments for water to the water right holder

In-kind payments, cost sharing on public projects or subsidies that approximate the size of the basin income foregone

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Revenue Sources

A systematic state wide program to implement Class A type payments could be funded by a tax or fee on the quantity of transferred water.

In the absence of a state wide program, individual transfers can be negotiated in special cases where river authorities as the exporting entity have the existing ability to accept and administer all three types of payments (direct pay for the water, payment for third party impacts and payment for income sharing). Receiving entities should not have any problem making such a three part payment.

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Class A Compensation Example

Sabine to Houston (600,000 acre-feet per year of contract water from Toledo Bend)

– The calculus of $16.25 per acre-foot payment for the water (cost of service) minimal third party impacts of $1.91 per acre foot net income sharing payment of $58 per acre foot (50% of the net

regional income value of Sabine water when compared to the next best alternative for Houston)

– The payments per acre foot $16.25 to SRA for the water $1.95 to wildlife agencies for fish & wildlife impacts $58 to SRA for economic development program

– The joint benefits NPV of annual benefits = $467.8 million to each region

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Class A Compensation Example (conti)

Approximate Income Value of Water in Houston

(Measured on the Output Side of Treatment Plant)

0

200

400

600

800

1000

1200

1400

0 600,000 1,200,000

Acre Feet per Year

Do

llars

/Acre

Fo

ot

MVP=Demand

MC=Supply Sabine

MC=Res 1

$360,000,000/600,000=$600$300,000,000/600,000 = $500 Difference = $100

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Class A Compensation Example (conti 2)

1) Order the Alternatives

Alternative Plans Water CostTransportation

CostTreatment

Cost

Cost on Output Side

of Treatment

Plant in Houston

Sabine $16.25 $383.75 $100.00 $500.00Reservoir 1 $300.00 $175.00 $125.00 $600.00Reservoir 2 $400.00 $250.00 $150.00 $800.00

Three Houston Alternatives Ordered by Cost

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Class A Compensation Example (conti 2)

2) Calculate Shared Net Benefits

Item Sabine Next Best DifferenceAc Ft 600,000 600,000 $/ac ft $500 $600 $100Total Cost $300,000,000 $360,000,000 $60,000,000Less Income Sharing $30,000,000Approximate Net, Direct Income to Houston $30,000,000Income Multiplier for Houston 2.0Total Income Value in Houston (after income share) $60,000,000Income Value in Sabine is Zero $0Combined Regional Income Gain $60,000,000Houston Payment to SRAWater @$16.25/ac ft $9,750,000Income Sharing for Economic Development $30,000,000Total Income Value to Sabine (Including Income Multiplier for Sabine of 2.0) $60,000,000Total Annual Payment of Houston to SRA $39,750,000

Houston Cost per ac ft to Rate Payer is Less than the next best alternative by ($50.00)Total Cost Saving to Houston $30,000,000

Approximation of Shared Annual Income Value of the Sabine Deal

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What Will Compensation Accomplish?

Compensation Will Help “Order” the “Disorderly” Water Market– Two markets separated by institutional constraints– Complicated by important third party interests– Where delivered prices are dominated by transportation and

treatment costs– Where utility-stile average cost pricing defeats the economics of

marginal cost and marginal productivity Growing Demand in Search of an Institutionally Limited Supply

Will Have a Better Chance of Succeeding User Markets Geographically Separated from the Marginal

Supply May Find That Water is Available Both Importing and Exporting Basins Will Benefit