Developing portfolios of water supply transfers

Abstract

[1] Most cities rely on firm water supply capacity to meet demand, but increasing scarcity and supply costs are encouraging greater use of temporary transfers (e.g., spot leases, options). This raises questions regarding how best to coordinate the use of these transfers in meeting cost and reliability objectives. This paper combines a hydrologic-water market simulation with an optimization approach to identify portfolios of permanent rights, options, and leases that minimize the expected costs of meeting a city's annual demand with a specified reliability. Spot market prices are linked to hydrologic conditions and described by monthly lease price distributions which are used to price options via a riskneutral approach. Monthly choices regarding when and how much water to acquire through temporary transfers are made on the basis of anticipatory decision rules related to the ratio of expected supply to expected demand. The simulation is linked with an algorithm that uses an implicit filtering search method designed for solution surfaces that exhibit high-frequency, low-amplitude noise. This simulation-optimization approach is applied to a region that currently supports an active water market, with results suggesting that temporary transfers can reduce expected water supply costs substantially, while still maintaining high reliability. Also evaluated are trade-offs between expected costs and cost variability that occur with variation in a portfolio's distribution of rights, options, and leases.

Developing predictive insight into changing water systems: use-inspired hydrologic science for the Anthropocene

“…Numerous pragmatic challenges arise when attempting to understand human-water interactions. For instance, quantification of the role or value of water in different social-economic (Olmstead et al, 2007;Harou et al, 2009;Characklis et al, 2006), or socio-ecological settings (Schroter et al, 2005;Suen and Eheart, 2006;Bekele and Nicklow, 2005;Poff et al, 2010) is non-trivial. The different methods, scales, institutions and legal frameworks by which societies around the world manage water (Gleick and Palaniappan, 2010;Röckstrom et al, 2009) generate tremendous specificity in water systems, while variation in norms and cultural practices leads to a diversity of water management behavior.…”

Reducing the costs of meeting regional water demand through risk-based transfer agreements

“…untreated) water drawn directly from a surface-or ground-water source (Dinar et al, 1997;Wilchfort and Lund, 1997;Characklis et al, 2006). These studies tend to focus on arid regions such as the western U.S., Chile, South Africa, and Australia where water rights are an increasingly transferable commodity (Pigram, 1999;Bauer, 2004;Niewoudt and Armitage, 2004).…”

Managing hydroclimatological risk to water supply with option contracts and reservoir index insurance

“…An alternative to markets and banks is an option contract for the exchange of water for compensation in drought years [ Lund and Israel , 1995; Jercich , 1997; Howitt , 1998; Michelsen and Young , 1993; Gomez Ramos and Garrido , 2004; Hollinshead and Lund , 2006; Characklis et al , 2006]. The contract is negotiated between two parties to an acceptable price and provides the confidence and reliability of a certain exchange when needed.…”

“…Instead, the dry year option contract can provide the reliability in drought years that would otherwise require expensive infrastructure investments to achieve [ Michelsen and Young , 1993; Characklis et al , 2006]. Assuming there are willing water sellers, the contract water price might be substantially less than the unit cost of water provided through infrastructure expansion.…”