Optimisation of water procurement decisions in an irrigation district: the role of option contracts

Abstract

Water supply instability is one of the main risks faced by irrigation districts and farmers. Water procurement decision optimisation is essential in order to increase supply reliability and reduce costs. Water markets, such as spot purchases or water supply option contracts, can make this decision process more flexible. We analyse the potential interest in an option contract for an irrigation district that has access to several water sources. We apply a stochastic recursive mathematical programming model to simulate the water procurement decisions of an irrigation district's board operating in a context of water supply uncertainty in south‐eastern Spain. We analyse what role different option contracts could play in securing its water supply. Results suggest that the irrigation district would be willing to accept the proposed option contract in most cases subject to realistic values of the option contract financial terms. Of nine different water sources, desalination and the option contract are the main substitutes, where the use of either depends on the contract parameters. The contract premium and optioned volume are the variables that have a greater impact on the irrigation district's decisions.

Optimization of Water Resource Management Using Chooser Option Contracts under Uncertainty

“…By using call options in water resource management, water managers can make purchase decisions and lock in the water prices until the water availability and requirements became clear [8]. Therefore, water options are flexible, cost-minimising and risk-reducing instruments for managing limited water resource [10].…”

“…By using water options, water managers can make decisions until obtaining more information about water levels. As the holders of the options, water managers have the right to buy or sell some water at a certain price accordingly [8]. In this way, water options can greatly help water managers reduce water shortage risk and improve economic benefits [10].…”

Retos Y Oportunidades De La Implantación De Los Bancos De Agua en España

“…Al objeto de minimizar decisiones subóptimas y mejorar la eficiencia en el uso del agua, este tipo de bancos se implementan mediante la negociación de contratos de opción sobre el agua. Con ello, este tipo de bancos de agua permite mejorar la garantía de suministro de los compradores de los contratos de opción (a base de empeorar la garantía de los vendedores de tales contratos), posibilitando de esta manera la transferencia efectiva del riesgo entre usuarios con distinto nivel de aversión al mismo (Howitt 1998;Ranjan 2010;Rey et al 2016).…”

Water Banks: What Have We Learnt from the International Experience?

“…If the aforementioned option is eventually exercised, the buyer pays additional compensation to the seller, called the "strike price". These contracts allow the buyer to hedge against the risk of not having enough water for their activity, while simultaneously ensuring that the seller does not forfeit the water entitlement (the right to use the water) [23,24].…”

“…In order to minimize sub-optimal decisions and improve water-use efficiency, these banks work by negotiating water options contracts. This helps to improve supply security for the buyers of water options contracts (by reducing supply security for the sellers of such contracts), thereby enabling an effective transfer of risk between users with different levels of risk aversion [23,24].…”