With the advent of water planning in Texas and the expectation by many politicians, regulators, and landowners that looming water shortages will lead to efforts by cities and many areas of the State’s industrial sector to compete for secure sources of water, the interest in selling Edwards Aquifer water rights or pumping rights in areas under the Rule of Capture (ROC) or in negotiating leases or supply contracts has grown substantially in the last decade.
The marketing of groundwater in not new to Texas, as landowners have sold pumping rights or negotiated supply contracts with cities and industries for more than 50 years. What is new is the increasing degree of interest in groundwater marketing. In response to growing expectations about the potential for groundwater markets to expand in Texas, the Environmental Defense Fund published, in 2007, "Myths and Facts about Groundwater Marketing: a Guide for Landowners and Groundwater Conservation Districts."
One of the first questions many potential sellers of groundwater ask is: “What’s my water worth?” On the buyers’ side, the question is: “What’s it going to cost me to purchase that water or that landowner’s water right?”
It remains difficult to answer, with certainty, either of the above questions, especially in ROC areas, because there is not a discernible sense of order underlying most groundwater transactions. The reason for the uncertainty is that, outside of the southern Edwards Aquifer region, Texas lacks two of the most fundamental of components required for an efficient groundwater market to function: (1) a system of assigned, quantified, and transferable water rights (not the same as pumping rights under the Rule of Capture) recognized and enforced by the State, and (2) a means of making information on transactions available to all potential buyers and sellers. Information that participants need to make well-reasoned assessments of the market value of groundwater is not easily found, and there are very few consultants who follow transactions closely enough to have a clear understanding of market conditions and organization among sellers and buyers.
Each side brings its expectations to the bargaining table, hoping to negotiate the best possible deal. Unfortunately, it is not uncommon for speculation and misinformation to trump common sense. Applying economists’ standard linear supply-demand curves to groundwater transactions, one might conclude that selling groundwater in Texas is a guaranteed way to get rich. For some, that might be the case now, but for many others, the prospects might be better over the long run … the very long run ... or not at all.
Before reaching conclusions about the market value of groundwater in any area of Texas, buyers and sellers should take heed of the lack of any defined market value for groundwater in the State. There are, instead, many potential market values driven by a number of factors that influence marketability. Landowners and water entrepreneurs often don’t consider these factors when first entertaining the thought of selling water or buying/selling water rights (pumping rights with respect to aquifers other than the Edwards within the jurisdiction of the Edwards Aquifer Authority).
Furthermore, any attempt to assign a market value to groundwater in one region of Texas based on prices negotiated in other regions of the State is not advisable. Accomplishing this task requires an understanding of variable market structures, market conditions, geology/hydrology, and the relative bargaining power of parties within the different regions of the State. Texas is very large and the population is highly concentrated in major urban areas. Hydrologic conditions are often so different from one region to another that it is necessary to break the whole up into smaller parts. All of these steps are essential to developing a reasonable understanding of the factors which drive differences in market value both between and within regions.
For many years, groundwater in Texas had minimal established value, apart from its association with the overlying land. A standard practice of cities and industries was to acquire enough property to develop a well field, then to pump whatever water was needed to meet their respective requirements. This was possible under a strict interpretation and application of the ROC. The cost of groundwater was associated with the cost of the land, the well, the pump, the pipeline, and the electricity or the fuel needed to power a pump.
DETERMINANTS OF MARKETABILITY AND MARKET VALUE
With a reasonable degree of certainty, one can identify, at least eight factors which seem to be significant determinants of marketability and of the market value of groundwater in Texas. These factors are listed below, not necessarily in order of importance:
1. Number of Competitors for the Resource: Competition for groundwater should drive up the price of the resource. If there are few major users of groundwater in a region, then negotiated prices could be much lower than expected by landowners.
2. Number of Known Sources of Groundwater and Sellers of Land, Water Rights or Water: Competition among sellers, all other things being equal and assuming one major buyer or minimal competition among buyers, should act to lower price. Alternatively, if sellers are able to organize a groundwater cartel, then their bargaining position should be stronger and prices negotiated for water or water rights could be higher than under purely competitive conditions among suppliers.
3. Volume of Recoverable Water and Estimated Life of the Resource: Land with a large volume of water in storage might command a higher price than land with a small volume of recoverable groundwater. In addition, property overlying an aquifer which is recharged quickly might command a higher price than a property which lies above a “mined” aquifer. [A “mined” aquifer is for which the rate of withdrawal exceeds the rate of recharge.]
4. Proximity of the Resource to the Purchaser: Transporting water long distances can be very expensive.
5. Expected Costs of Installing Wells and Other Production and Treatment Facilities. Infrastructure can add substantially to the total cost of a project.
6. Estimated Production Costs and the Quality of Groundwater: The investment required to develop a resource and to maintain, transport, and treat groundwater might be sufficient to justify a lower offer price, in the absence of other competitors, where the quality of the groundwater is an issue for the end user.
7. Regulations Limiting the Volume of Water: Regulations which limit the volume of water that can be pumped from an aquifer or which impose spacing requirements for wells must be taken into account, as such rules have the effect of amending/modifying the ROC.
8. The Value of Agricultural Production Attributable to Irrigation: Many farmers are potentially large suppliers of groundwater. They own land over aquifers which are capable of producing large volumes of water. In such cases, the value of groundwater can be related to the market value of crops if irrigated land is involved. For a landowner, the sale of groundwater or a water right represents an opportunity cost associated with the potential loss of income from irrigation. The sale of groundwater or of a landowner’s water right (assuming no duress) should generate sufficient income to cover, at least, the income or any other income associated with the on-property use of groundwater or sale of groundwater for other uses.
It is not possible to precisely quantify the relative significance of each of the above factors in a transaction involving groundwater. Furthermore, one should not expect any factor to carry the same weight across Texas’ many regions. While economic models typically assume access to information and rational behavior by buyers and sellers, few parties to a Texas water negotiation can claim access to all relevant information. Furthermore, there is no guarantee that all participants in a transaction will behave rationally even if all have access to the same data.
OVERVIEW OF TRANSACTIONS
While writing this post, I reviewed groundwater transactions in Texas over the period 1999 – 2008, as reported by Water Strategist and as recorded in my notes of transactions for which I have offered advice to sellers or to purchasers of groundwater. Most of the groundwater transactions during these years took place in central, south, and west Texas. Leases outnumbered sales, with lease terms typically ranging from 5-to-10 years.
Nearly all groundwater transactions involved leases of groundwater or the acquisition of groundwater rights to support municipal uses. Sales to industrial or agricultural interests were less common. Most lease prices for municipal use ranged from $66 - $77 per acre-ft per year, but the San Antonio Water System acquired Edwards leases for $130 per acre-ft within the last year. Transactions involving the sale of groundwater rights (with no transfer of the surface estate) range from $270/AF (Canadian River Municipal Water District) to $250/acre (Mesa Water). In Central Texas, water rights associated with land overlying the Edwards aquifer sold for $700 per acre-ft 10 years ago, then rose to between $1,750 to $2,000 per acre-ft by 2005, and broke $5,000 per acre-ft within the last two years. There have been a few undocumented sales of Edwards Aquifer rights of $10,000 per acre-ft within the last year. If there is any doubt that a system of assigned water rights leads to higher market values for groundwater, then one need look no further than the disparity between prices paid for southern Edwards Aquifer groundwater rights and prices paid for groundwater in areas still under the ROC.
Clearly, there is no established market value for groundwater in Texas. It is necessary to consider the mix of factors outlined above before reaching any conclusion about current or future lease prices and permanent transfers of water rights. Such exercises are not trivial, especially where an outright purchase is involved transferring a water right in perpetuity. Nevertheless, many landowners are now looking at groundwater, which has, for many decades, been used to support ranching and farming operations, as a resource with potentially greater market value than associated with its traditional uses.
FINAL COMMENTS
Expect market values of groundwater in many areas of Texas to rise over the next decade. This will be in response to efforts by cities and regional water authorities to acquire secure sources of water to meet projected long-term needs. As noted above, there are many factors which influence sales prices. For the foreseeable term, it is highly probable that landowners will prefer leases with terms of 5-to- 10 years, rather than longer-term leases or sales. This strategy will be an outgrowth of expectations by landowners that market values will continue to rise as the population of the state grows and as major users try to lay claim to secure supplies to avoid shortages and economic problems stemming from supply shortfalls. Buyers and sellers of groundwater would be wise to take stock of existing resources and the number of competitors and potential suppliers of water. Other factors to consider include projections of water demand by the Texas Water Development Board and negotiated lease and sales prices, although such data can be difficult to find without the assistance of a consultant. It is advisable to assess both demand-side and supply-side structures and market conditions. By assembling reliable information, one can enter into negotiations as a well-informed participant, bargaining from the strongest position possible.
Over the next couple of weeks, I will post an analysis of pricing over time and by region of the state.
Best regards,
aquadoc
Southwest Groundwater Consulting, LLC
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