Interbasin Transfer: The Role and Reason for Compensation

1. 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

2. Source • Third Party Compensation for Interbasin Transfersof 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).

3. 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

4. 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

5. 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?

6. Water Market Typology

7. 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

8. 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

9. 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

10. 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…..

11. 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

12. 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.

13. 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

14. 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

15. 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.

16. 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

17. 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

18. 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.

19. 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

20. Class A Compensation Example (conti)

21. Class A Compensation Example (conti 2) • 1) Order the Alternatives

22. Class A Compensation Example (conti 2) • 2) Calculate Shared Net Benefits

23. 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