The Worth of Water

In today’s post, we provide insight into the current water crisis that is gripping the country, breakdown the types of water rights, and explore wall street’s growing interest in the industry.

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Feb 17, 2023

Reservoirs across the United States are experiencing a significant decline at an unmatched rate, highlighting the severity of the current drought. The challenges we face as a result of the drought are not just limited to water scarcity, but could also lead to serious issues related to food security, particularly in agriculture, air quality decline, and biodiversity impacts. Currently, the Southwest is experiencing a mega drought, that hasn’t been seen in decades. The water shortage is so extreme that it is putting a strain on essential reservoirs like Lake Mead, which supplies water to more than 25 million people in Arizona, California, and Nevada. In today’s post, we provide insight into the current water crisis that is gripping the country, breakdown the types of water rights, and explore wall street’s growing interest in the sector.

The Water Crisis

The southwest has been in a megadrought for 22 year, marking it the regions driest drought since at least 800 year, according to nature climate change. The current water shortages can be attributed to several factors, including a growing population that requires more irrigation for crops and agriculture. This increased demand for water has put additional stress on the already-limited water resources, resulting in reservoirs being depleted at an alarming rate. Climate change is also contributing to the problem. Rising temperatures have led to reduced surface water, lower precipitation, and prolonged periods of drought, making it harder to replenish these vital resources.

Lake Mead, located on the Colorado River, is the largest reservoir in the United States by volume and has been a vital source of electricity for millions of Americans through hydroelectric power stations. However, its water levels have fallen to record lows due to the drought, which has put its ability to generate power in jeopardy. The situation is further exacerbated by the fact that this is not a new problem. The country has been struggling with water shortages for many years, and Vice President Kamala Harris highlighted this fact in a speech she gave in 20211. She warned that water could soon become a source of conflict, much like oil has been in the past, and emphasized the need to address the inequities in access to clean water.

While water levels continue to be on the decline, water investments are on the rise. Funds like Fidelity Water Sustainability Fund (FLOWX), Invesco’s Water Resources ETF (PHO) or First Trusts Water ETF (FIW) allows investors exposure to companies that invest in water technologies or efficiencies to help the industry. An alternative route we are increasingly seeing in private companies investing in water rights. Water rights allow the investor to purchase the rights to the land that contains a body of water or water source because investors cannot buy the water directly. We will explore water rights and who’s capitalizing on them a little later in this post.

Colorado River

The Colorado River is primarily used by seven states, including Arizona, California, Colorado, Nevada, New Mexico, Utah, and Wyoming. Over 40 million people depend on the river for their water supply. By February, these states were expected to develop a plan on how they would reduce their consumption, but disagreements led to a missed deadline. Six of the states came up with a plan that would cut their consumption by two million acre-feet of water. However, California, which has the highest consumption rate, would need to cut one million acre-feet. As a result, California vetoed the joint proposal that would require each state to make specific modifications in water consumption from Lake Powell, Lake Mead, and the Colorado River.

The proposal stated that Lake Powell and Lake Mead could not be further diminished without unacceptable risk to the Colorado River System, which feeds into each lake. It is essential to note that operations in one lake would affect the other. The six states are currently working together to reach a consensus on how to reduce consumption. Once the plan is further established it will be further reviewed by the US Bureau of Reclamation.2

Source: CNN

Lake Mead

Lake Mead, a reservoir located on the Colorado River, has been experiencing a continuous downward trend for the past 22 years. As of July 31, 2022, the lake's water level had dropped more than 1040.92 feet, which is a significant decrease. If the reservoir continues to drop, experts predict that it will reach the "dead-pool" level. This means that the water level will be so low that it will no longer be able to flow downstream, which would have a severe impact on the millions of people who rely on the lake for water, power, and irrigation. The declining water levels have also led to some concerning issues such as boats, trash, and even human remains surfacing over the past couple of years, which have made headlines. The situation is concerning and requires immediate attention to ensure that the lake can continue to serve its vital functions for both the environment and the people who depend on it.3

Source: NBC

Breaking Down Water Rights

Water law is a complex and multifaceted legal field that deals with the allocation, use, and protection of water resources. It encompasses a wide range of legal issues and concerns, from the balance between public and private water use rights, to the regulation of water quality and discharge. In general, water law can be divided into two main substantive areas: the rights to use water and restrictions on water pollution.4

The rights to use water, which we will focus on today, covers a wide range of topics, including the balance between public and private water use rights, the relative rights of individual water users, and the allocation of water rights. In many states, water allocation is governed by the states themselves, with each having its own regulatory system and limited federal intervention. State laws and regulations control specific uses of water, such as transferring water from one watershed to another, withdrawing groundwater, impounding water, and constructing wells.

Restrictions on water pollution, on the other hand, are governed primarily by federal law, with the Clean Water Act being the most significant piece of legislation in this area. Water quality regulations aim to ensure that water resources are protected from contamination and that water is safe for human consumption and use.

In terms of the evolution of water law and water rights, two distinct legal doctrines have developed over time: the riparian doctrine and the doctrine of prior appropriation. The riparian doctrine is based on the idea that water is a shared resource and that water users have the right to use water in proportion to their land holdings. The doctrine of prior appropriation, on the other hand, holds that water rights are acquired by the first user and can be sold, transferred, or otherwise disposed of as private property.5

The Prior Appropriation Doctrine

It wouldn’t be a proper Green Tea discussion without a little history thrown into post. The prior appropriation doctrine, which was first established during the early days of western settlement, was a response to the water needs of miners, irrigators, and city dwellers. Miners, who were in need of water to develop their mines, staked a claim to the water by physically taking, or "appropriating," the water they required. This often involved diverting water from streams and rivers, even to mines located far from the watercourse. The prior appropriation doctrine was devised to address the needs of these pioneers as they carved out their new homes in the American West. With the increasing demand for water resources, the prior appropriation doctrine helped to ensure that these essential needs were met and properly managed6

The right to use water is a crucial aspect of water resource management, and the concept of prior appropriation incorporates this key element. In essence, the "first in time-first in right" principle governs the allocation of water rights under prior appropriation. In this system, the right to use water is allocated by a permit and the first person to obtain a permit to divert water has priority over those who come later. This means that the water is considered publicly owned, and the state is responsible for administering the right to use it. The prior appropriation system is based on priority, and the most senior appropriator has the highest priority in times of water shortages. Unlike riparianism, there is no requirement that a senior appropriator use less water in times of shortage. Instead, water users can take their full appropriative right in order of their respective priorities, until the water is gone.

Appropriative rights, allocate water based on historical usage rather than land ownership. This means that water rights are based on seniority, or "priority date," and can be lost if they are not used regularly. Senior rights holders have first claim to water and can use their allocation, even if there is not enough for junior rights holders.

Under prior appropriation, the water use permit allows the user to divert a specific amount of water from a specified location for a specified purpose. The permit has a definite date of priority, and if there is not enough water to meet all permit requirements, the earliest permit (senior water right) takes precedence over later permits (junior water rights).

Riparian Doctrine

Water rights based on the riparian doctrine are held by landowners whose property is adjacent to a water body such as a river, pond, or lake. Most states located east of the Mississippi River follow this system of water rights which is derived from English Common Law and grants a water right to a property owner who has a piece of land touching a water body. This right is transferred when the land is sold and remains valid even if it is not exercised or the water is not used.

Under riparianism, only those landowners with riparian land, (land that is adjacent to a watercourse) are allowed to use the water. To be considered a riparian landowner, one must own land next to the watercourse from which they intend to use the water. The riparian landowner is allowed to make a "reasonable use" of the water as long as it does not interfere with the reasonable use of another downstream riparian landowner. The reasonableness of the use is determined by comparing it with the other uses of other riparian landowners.

Today, almost all riparian states have moved towards a regulated riparian system where a central state agency controls who can use the water, how much they can use, and when they can use it. In this system, water usage is regulated through a permitting process.7

State by State Differences

Each state in the US has adopted either a riparian or prior appropriation framework, or a combination of both frameworks, to regulate their water use. The choice of framework is generally predictable based on the state's hydrologic balance, with eastern states being more likely to adopt riparian doctrine and western states more likely to adopt prior appropriation. Georgia, Alabama, and Arkansas, for instance, have water laws that are all based on the riparian doctrine, which means that water use rights are tied to the right of property ownership that abuts a water source, such as a river or stream. On the other hand, Oklahoma and Texas are considered transition states and have hybrid doctrine, which combines elements of both riparian and prior appropriation. New Mexico, which is a primarily arid state, has adopted the prior appropriation doctrine. This framework grants water use rights to those who were the first to claim and use the water for a beneficial purpose, regardless of whether they own the property adjacent to the water source. Florida, unlike its neighboring states, has developed its own appropriative approach to water management. Despite having abundant surface and ground water and high rainfall, Florida has experienced pressures from growing population, agriculture, and environmental concerns, which led the state to adopt a unique approach to water management. This approach is a combination of both riparian and prior appropriation frameworks and is tailored to meet the specific needs of the state. The states that have unique polices are broken down further below.

Source: Water Markets LLC

New Mexico

New Mexico is facing a critical water shortage due to the driest conditions in over 1,000 years. Climate change and its impact on aridification have worsened the situation, leading to declining water supplies in many of the state's reservoirs, aquifers, and rivers such as the Rio Grande. This has resulted in irrigation ditches running dry at crucial times for crops, and an increase in the frequency and severity of wildfires.

To address these challenges, the Governor of New Mexico has taken a proactive approach by forming the Water Policy and Infrastructure Task Force. This task force is comprised of experts in water and natural resources, senior state agency staff, and stakeholders from across the state. The objective of this task force is to study the problems in depth and recommend actions that the state can take to address the water shortage crisis. The findings of this task force will be instrumental in helping New Mexico mitigate the impacts of the ongoing drought and the effects of climate change on its water resources.

In New Mexico, all surface and ground water is considered to be publicly owned and subject to appropriation through permits. The administration of these permits is under the control of the State Engineer. There are four different types of groundwater permits, each with different purposes and regulations. The majority of surface and ground water has already been appropriated, so new water rights are mainly for groundwater. To manage the distribution of water resources, the State Engineer has initiated the Active Water Resource Management (AWRM) program which created different water districts. Each district has their own specific rules and regulations for water sharing (goal to extend water supply among multiple users), rotation (water users take turns using water based on a set schedule) and water banking (temporary relocation of water while still protecting senior water right holders).8

Rio Grande River outside Taos, New Mexico

Florida

Florida's water rights are distinct, owing to the state's numerous water bodies, including miles of coastline, rivers, lakes, and ponds. The state's water rights are intricate and nuanced. In order to determined water rights, Florida assess if the body of water in question is navigable. If a waterway is deemed navigable, meaning that it is suitable for recreational use, the state of Florida assumes ownership of the water. This explains why Florida's beaches are owned and controlled by the state. Conversely, water that is classified as "non-navigable," such as ponds and lakes, can be privately owned. This differentiation between navigable and non-navigable water underscores the complexity of Florida's water rights system.9

Texas

In the state of Texas, water rights are allocated differently depending on whether the water in question is groundwater or surface water. Groundwater is owned exclusively by the landowner, while the state claims ownership of all surface water. The regulations surrounding surface water usage are governed by the doctrine of prior appropriation and riparian rights, which dictate the order in which water rights are granted and prioritize the senior water right holder. In Texas, the state holds the senior water right for surface water, which grants it a unique position in terms of resource allocation.

While the state owns all surface water, permits can be obtained by individuals or organizations to make use of it for various purposes. These may include activities such as mining, public parks, and agriculture, provided they are deemed to be "beneficial uses" of the water. However, to receive such a permit, specific criteria must be met, including no impairment to existing water rights, adequate availability of appropriate water, ensuring that the permit will put the water to a beneficial use, and consistency with the State Water Plan. These regulations ensure that the use of surface water in Texas is both sustainable and equitable, and help to ensure the responsible use of this valuable resource.10

Cashing in on Water Rights

The recent attention given to private firms such as Water Asset Management for their acquisition of water rights is not a novel occurrence. In fact, prominent asset managers foresaw the burgeoning water-related investment industry over a decade ago. Citi's Top Economist stated in 2011, “Water as an asset class will, in my view, become eventually the single most important physical-commodity based asset class, dwarfing oil, copper, agricultural commodities and precious metals.” Major financial institutions like Goldman Sachs and Credit Suisse identified water as the "petroleum for the next century" and the "Paramount Mega Trend of our Time" respectively in 2008. Credit Suisse further stated that this tend is due to the potential societal risk of water scarcity that may affect two-thirds of the global population by 2025.11

Water Asset Management (WAM) is a private equity firm that focuses on investments in water-related assets. WAM has purchased over $20 million worth of land in Colorado, making it one of the largest landowners in the grand valley. However, WAM's investment strategy goes beyond simply owning land - the firm specializes in acquiring specific water rights and advising farms to use water more efficiently, with the aim of profiting from water scarcity by selling parts of the water rights to other farmers or cities in need. WAM's co-founder has noted that the U.S. presents the best risk-adjusted returns for private equity in water, which is estimated to be a $1 trillion market opportunity.

In addition to generating returns for its investors, WAM states that with climate change intensifying droughts and floods, we are in a transformation period which allows an investment opportunity for the water industry. Overall, WAM's investment strategy is a reflection of the growing recognition of the critical role that water plays in society and the economy. The firm's commitment to sustainability, along with its focus on generating returns for investors, positions it as a unique player in the industry with critics and supporters.

As we wrap of these weeks post we leave you one last quote stated by Nobel Pease Prize recipient Adolfo Pérez Esquivel, “the real war will be fought not for oil, but for water”.

Hot Tea

Our hot tea highlights a variety of regulations and disclosure updates that made headlines over the past week.

Public Companies: SEC Making Adjustments to the Climate Disclosure Proposal
Investors: Goldman Makes $1B investment in Biomethane
Regulators: ASA’s Published Guidance on How to Market Carbon Neutral & Net Zero Claims
Regulators: IFRS Sustainability and Climate Reporting Standards to Take Effect in 2024

Mover & Shakers

One of the biggest IPO’s of the year happened last week, and it was a solar tracker software company called Nextracker. Nextracker raised $638M which is almost 20% higher than the company originally was targeting. The company sells solar trackers and licenses its energy management software to solar project developers and engineering first that construct grid scale solar projects. According to the company, they have developed an intelligent independent row tracking system with proprietary technology that produces more energy, lowers operating costs, and is easier to deploy compared to other tracker products. The software solutions use advanced algorithms and artificial intelligence technologies to optimize the performance and capabilities of our tracker products for our customers around the world. As stated in their S-1, the company has $2B worth of contractors as the end of 2022, customers in 30+ countries, and has impressive revenue growth over the last year.