Agricultureto-Urban Leases Median price Average price Number of trades $74 $190 204
hen EBJ last reported on water rights markets in the latter part of 2008, the sense among industry analysts and market players was that the U.S. market for water rights trading was not living up to expectations. Perhaps for political reasons, reliance on markets to distribute access to an increasingly over-allocated resource, especially in the American West, simply wasnt catching on to the extent expected or desired, even as innovative approaches to resource allocation were sorely needed. That was about the time the financial crisis struck, taking the U.S. and much of the global economy down with it. The water rights market was certainly affected, as the real estate and land development markets were at the center of the debacle (real estate values being historically linked to water rights values). The recession didnt change some fundamental facts about water, however. It remains essential to life, with no substitute at any price, as water industry analyst Steven Maxwell, president of TechKNOWLEDGEy Strategic Group (Boulder, CO), puts it. Fixed in quantity even as populations grow, water becomes more scarce and ever more precious regardless of economic cycles. Whats happened, then, has been a decoupling of water right values from real estate values, with the prices of water rights generally increasing, even if not uniformly across all regions, while real estate values remain depressed. Indeed, for some properties, the associated water rights are the primary source of value in todays market. Even if deal flow isnt quite what investors would like it to be, more and more people are realizing they have something thats increasing in value and finding more and more ways to move these sup10
Source: Gary Libecap, Water Woes,The Milken Institute Review, Q4 2010; Units in 2008 dollars per acre-foot (12 Western states)
plies, says Maxwell. Lots of farmers are making more money in terms of present value by selling the water rights than by actually farming. Their kids arent staying on the farm, so theres increasing interest in changing water uses from agricultural use, which commands 80% of use today, to municipal use. I think were beginning to see these markets emerge in a few select areas, he continues. Investors, brokers, and nascent buyers are starting to move in, and thats a harbinger for the future. Right now, there are only six to eight trading regions in the United States, as well as an active market in Australia. The reasons they have emerged is primarily because theres a severe imbalance between supply and demand, and markets are a way to correct that efficiently. The market for water rights is thus growing, if not explosively. By its nature, that market is nowand is always likely to remaina very localized market by states, with their separate legal regimes, and more precisely by basin jurisdictions, within which actual transactions take place. The values of water rights are thus very local. Indeed, comparing water rights prices across jurisdictions is like comparing housing prices, says Maxwell. According to Maxwell and other water rights analysts and consultants, there is also still a substantial amount of price discovery that needs to take place in order to define the market. It remains a very local business, says Disque Deane, Jr., chief investment officer and co-portfolio manager at Water Asset Management, LLC (New York, NY). He adds, you need a lot of discipline, and you need to be to be able to say no. Its still a market that needs capital and intellectintellect to shape policies and op-
portunities, and capital to be able to fund those opportunities. The capital is getting more intelligent and is searching for more answers. A small number of investment houses, such as Water Asset Management, San Diego-based Summit Water Development Group (Maxwell is a partner and advisor), and Blackhawk Partners (New York, NY) are eying the market potential and are building funds to invest in water rights transactions. Ziad Abdelnour, Blackhawks president and CEO, has gone on record several times characterizing water as the new gold, claiming in March 2011 that various factors, including climate change, industrial agriculture, and rising populations have increased the global demand for clean water and in turn have pressured free market economists to suggest that wealthy market players are the most efficient solution to addressing water issues (Water-technology.net). According to Chris Corbin, whose firm Lotic, LLC (Missoula, MT) is a dedicated water rights consultancy, the water rights market is dominated by three trading interests: Agriculture, which as noted above accounts for about 80% of all water rights in the west; environmental interests, which pursue deals leading to the preservation of in-stream flows, the establishment of wetland or mitigation banks, and other uses designed to keep water bodies intact for habitat protection purposes; and urban interests, including energy production. The competition between these three sectors drives the markets, says Corbin. If you have one of these sectors and not the other two in any jurisdiction you dont see much market activity. The markets are in select locations where those three drivers are in play, or at least two of them.
Strategic Information for a Changing Industry
Colorado, for example, is primarily an agriculture-to-urban market, and will largely stay that way, he observes. Environmental players have been priced out of that market. They dont have that kind of financial clout. The more active markets have been historically driven by urban growth. And since the mid-2000s, those markets have cooled off. In fact, says Clay Landry, managing director and principal of the water rights and advisory services firm WestWater Research (Boise, ID), the recession turned the market on its head to some degree. With the mass exodus of real-estate developers from any actual development, these interests have become a source of supply of rights to the market, whereas they had previously been seeking them out, says Landry. Water Asset Managements Deane recalls that, in 2008 and 2009, we were being contacted by real-estate developers who didnt have much going on in development, they needed cash, and banks were not lendingbut they had water rights. One caller, Deane recalls, had five-year financing that he wanted to roll over, with a building in a western city that was fully let with good tenants. His note was coming due, he couldnt get financing, he needed to raise cash, so he considered the value of his water rights and called Deanes firm to explore a valuation. This happened to us at least a half a dozen times. The market is starting to come back, Deane remarks. Were about ready to come into the marketplace next year with a private equity fund. We recently closed a co-acquisition of a 35,000 acre-foot property that were developing for alternative energyfor pumped storage. We think there are growing opportunities around that type of development, as part of the solution to enable alternative energy to be dispatchable. Corbin believes one hopeful sign is the fact that several jurisdictions have put in place the legislative framework that will make the market ready for recovery. In these jurisdictions, theyve allocated all of the water rights, so as development picks back up, the market will follow. Depending on geography, says Landry,
Strategic Information for a Changing Industry
a number of municipalities remain active as buyers in the market, for the purpose of securing long-term water supplies. There are some places where thats true, and others where the cities are cash-strapped and unable to spend, and are looking to sell off some of their assets. Landry affirms that the Rocky Mountain Front Range is one of the more established markets, from Colorado Springs through Denver to Fort Collins. There you see ranches that price the value of the ranch based on the water valuessometimes accurately and sometimes not, he notes. Ill come in and do that pricing for them.
He adds that Colorado was the highest traded market at about $6,000, and Idaho was the lowest, down around $100. Generally speaking, urban use drives the highest values. Corbin cites a 2010 paper in which Gary Libecap, an economics professor in the University of California-Santa Barbaras Bren School of Environmental Science and Management, suggests that the market faces significant challenges in determining consistent pricing for water rights. For a whole host of reasonseverything from the fact that it is a both a private and public good to the reality that it can be consumed by multiple parties simultaneouslywater fits uneasily in textbook models of market allocation, Libecap wrote in Water Woes (The Milken Institute Review, Fourth Quarter 2010). Indeed, the interconnected, overlapping nature of water demands and uses explains in part why various stakeholders have resisted letting markets work their magic.
for existing clients as opportunities arise. I see them expanding that product mix into this area, into my core competency, says Corbin. There are some other specialized firms that provide the same kinds of services. Most seem to be trained as economists.
now big supporters, because its another revenue stream. The other option would be to regulate through the regulatory authorities, which the ranchers despise. Ten years ago, the idea of marketing water for beneficial use was crazy talk, Corbin continues. It was the same with in-stream flows for environmental purposes, where I first cut my teeth. I was at a meeting where that was discussed, and a rancher said that was the worst idea since the reintroduction of wolves. Some states still impose barriers to trading for environmental purposes, including Wyoming, Utah, and Colorado. In Colorado, the ownership of environmental water rights is limited to an elected state board.
to place a value on their water source. Corbin provides a similar upbeat note. I think the outlook is good. Its obviously going to depend on urban growth and development. What gives me hope is that I see a lot of states putting a lot of legislation in place. They are doing a good job of allowing the private sector to drive the trades, and putting the framework in place to allow markets to do what markets can do. But a lot depends on growth in the overall economy.
Water is a real asset class, it is something you can touch, and I think were at the very early stages of market maturity.
Asked to describe the outlook for U.S. water rights markets, Landry laughs nervously and expresses a bit of uncertainty, owing to the lingering potential of a double-dip recession. This market is definitely not insulated from the greater economy as a whole. Another Greece could come up to tank the economy. Hes quick to point out, however, that this is a real asset class, it is something you can touch, and I think were at the very early stages of market maturity. So I think well continue to see the markets emerge and trading activity increase. The question is, at what rate. Even in a recession, people still need to eat, turn on their lights, and consume water. And all business activity will have some impact on water demand. I dont think this market is going away. As markets develop, well see a lot of price discovery. These are nascent, immature markets, a lot of people are figuring out how they are going to source water for their power plant or their solar facility or other projects, and they are just starting
EBI Inc. presents the 10th annual Environmental Industry Summit March 14-16, 2012 at the Hotel Del Coronado near San Diego. Sessions include: Economic & Market Outlook Political Update & 2012 Election Forecast: What It Means To Budgets and the Industry EBJ Award Winner Roundtable Energy: Shale Gas & Renewables Keynote Speakers TBA Visit www.ebiresearch.com for agenda updates.