In This Issue
Expansion of Frontiers of Engineering
December 1, 2003 Volume 33 Issue 4

Water-Resource Engineering, Economics, and Public Policy

Wednesday, December 3, 2008

Author: Gregory W. Characklis

Interdisciplinary analyses are being used to assess the consequences of water-policy choices.

Water-resource engineering is a branch of environmental engineering that involves the analysis and manipulation of hydrologic systems, particularly in areas related to water quality and water availability (e.g., water supply and flooding). Since the mid-1970s, concerns about improving water quality and meeting future demands have multiplied in scope and magnitude, prompting significant changes in public policy at the federal, state, and local levels (Cech, 2003). The strong influence of public policy on the research agenda in water-resource engineering (and most other environmental fields) differentiates it from other engineering disciplines in some important respects.

In non-environmental disciplines, the primary motivation for developing a solution (e.g., a product or process) is economic--doing something "faster, better, cheaper." The solution is then implemented by consumers and organizations based on their determination of how well the new product or process fits their needs. By contrast, the motivation for developing solutions to water-resource challenges is often related to meeting regulatory objectives (e.g., public health or environmental quality) that cannot be easily quantified in economic terms. Although attempts are made to estimate costs and benefits when evaluating and setting regulatory policy, implementation of a policy is generally dictated by centrally controlled directives that often entail high compliance costs.

A number of factors can justify this command-and-control approach, but the growing number of environmental regulations, and their increasingly restrictive nature, have stimulated a growing interest in supplementing the traditional approach with market principles. The development of market-based schemes for regulating water resources can be greatly facilitated by interdisciplinary evaluations that integrate analytical tools from engineering and economics. An interdisciplinary analysis can not only help in the identification of potential methods of regulatory implementation, but can also improve assessments of the consequences of policy choices.

Water-Resource Policy
Regulations of water-resource systems usually involve limits on access and generally come in two forms. The first, restrictions on the physical removal of water from a system, is based on concerns about causing adverse environmental impacts. The second involves limiting access to a hydrologic system’s capacity to assimilate waste by restricting the kind and amount of waste that may be released into it (e.g., wastewater effluent standards). In both cases, limits are generally based on some form of scientific analysis. Once a target range for limiting access has been defined, engineering analyses are performed to generate information on the effectiveness and cost of available technical solutions. These might involve the development of new water sources or the installation of a new technology that reduces emissions. The cost associated with each alternative is then calculated, and policy alternatives based on these technical solutions are assembled.

Although this approach does provide useful results, it often leaves out important considerations. Water-resource policy making generally involves a combination of moral, technical, and economic factors, and fully informed decisions require that these disparate kinds of information be integrated. The moral aspects are usually judged by elected officials (or their surrogates at the regulatory level) on the basis of personal values or political motivations. Technical and economic information, however, can be more difficult to evaluate and generally requires some level of synthesis before it can be readily "digested" by policy makers. Furthermore, even though the technical and economic implications of water-resource policy decisions are often inextricably linked, they are frequently analyzed independently, using tools specific to each discipline.

Translating technical and economic factors into a common context involves more than just estimating the costs and benefits of a potential regulatory scheme (although these are important). It also entails an analysis of trade-offs and an exploration of alternative means of implementation (NRC, 1996). Interdisciplinary analyses can integrate engineering and economic considerations into terms that policy makers can more readily incorporate into their decision-making process.

The following case study involves a region in which restrictions were placed on aquifer access in response to environmental concerns about declining aquifer levels. In this case, studies have been done to characterize the environmental impact of current pumping rates, with study results used as the basis for setting limits on withdrawals that are designed to mitigate adverse effects. Policy decisions must now be made on the method of implementing and managing these regulatory limits.

Case Study: Edwards Aquifer
The Edwards Aquifer is a porous, fractured-limestone aquifer in south-central Texas that has been the sole source of water for most of the region’s agricultural, municipal (e.g., San Antonio), and industrial users. Regional population growth and economic development have increased pumping rates to the point that the water height in the aquifer frequently drops to levels that substantially reduce the flow of water to several natural springs. These springs provide habitat for several endangered species, and a federal court has ruled that allowing spring flow to drop below specified levels constitutes a "taking" under the Endangered Species Act (Votteler, 1998). As a result, the state of Texas has been instructed to take whatever actions are necessary to ensure that acceptable flow rates are maintained.

This ruling led to a number of biological and hydrological studies to determine the effects of various pumping rates on the aquifer level and water flow in the springs. Based on the results of these studies, the amount of water allowed to be pumped from the aquifer has been limited to 450,000 acre-feet per year, a level that will be insufficient for any party to continue using water at the present rate. In addition to the annual limits, more severe temporary restrictions will be imposed when aquifer levels fall below specified levels. In response to these limits on aquifer access, regional municipalities are considering the development of new water supplies, but the few alternative sources available in this semi-arid region would be very expensive to exploit (SCTRWPG, 2000). Economic analyses of agricultural water use suggest that the value of water in irrigation is quite low relative to the cost of accessing new sources (Keplinger and McCarl, 2000), making transfers of water from agriculture to municipal and industrial users an economically attractive solution.

Consequently, a property-rights system has been put in place to allocate the reduced pumping capacity of the Edwards Aquifer among regional consumers, and institutions have been established to facilitate the trading of these rights. Because of concerns about the impact of this regulatory framework on the rural economy, authorities were generous in their initial allocation of rights to irrigators, but left municipal users with a deficit of approximately 43,000 acre-feet per year relative to their current average use (and a considerably larger deficit during dry years). Municipalities also bear the burden of "emergency" measures, which call for urban users to reduce monthly pumping by 5 percent, 10 percent, or 15 percent during months in which the aquifer level drops below 650 feet (above mean sea level), 640 feet, or 630 feet, respectively.

To augment their supplies, municipalities have resorted to purchasing agricultural water rights, the most inexpensive and immediately available source of water. Although a general policy of market-based trading has been used to allocate the newly scarce pumping capacity, critical issues are still unresolved. Policy makers would like to find a solution that minimizes the amount of water transferred out of agriculture. But if municipalities cannot achieve their supply-reliability goals under the proposed framework, then the market-based solution becomes much less valuable (McCarl et al., 1999).

An analysis that incorporates both hydrologic modeling and market simulation was undertaken to evaluate approaches that would maximize the average volume of water available to agriculture and still meet municipal objectives related to supply reliability (high) and cost (low). Although water transfers from agricultural to urban use are inevitable, if the only transfer mechanism available is a permanent sale, municipalities will be forced to buy rights and maintain a volume well in excess of average usage to ensure supply reliability during periodic droughts. These purchased rights are unlikely to be transferred back to agriculture once they are acquired. Thus, in many normal and wet years a significant fraction of the aquifer’s total capacity may not be used. If more flexible types of transfer were available, such as transfers that would allow water to be acquired on an "as needed" basis, the capacity maintained by municipalities could be reduced and the average volume of water available to agriculture increased (Characklis et al., 1999).

Purchase decisions regarding these more flexible transfer instruments could be greatly facilitated by improved information about future supplies. In the case of the Edwards Aquifer, future shortfalls will be largely the result of the temporary pumping restrictions imposed when aquifer levels drop below specified levels, conditions that can be accurately predicted through hydrologic modeling (Durbin, 2002).

Flexible transfers allow for more responsive purchase decisions, particularly when supply conditions are known in advance. Annual leases provide for the temporary transfer of pumping rights over a one-year period (beginning January 1), and probabilistic information on future aquifer levels at the time of purchase could be used to estimate the volume necessary to meet supply-reliability goals. Another potential transfer instrument is the option, a transaction in which the buyer pays a small fee at the beginning of the year for the right to purchase water, or exercise the option, at a later date (June 1) at a prearranged price. The accuracy of predictions of aquifer level would have a significant bearing on decisions to purchase and exercise options. Finally, spot-market leases would provide ultimate flexibility, allowing municipalities to acquire water at any time, but also subjecting them to price volatility (i.e., dry weather = high prices).

An assessment of the benefits of including all or some of these transaction types could indicate whether the costs of developing the marketing and monitoring framework necessary to regulate these more complex transactions is justified. Because the Edwards Aquifer market is still in its infancy, little information is available on market behavior. As a result, a market simulation was developed to evaluate monthly supply and demand throughout a given year. The information was then used to calculate spot-market prices as a basis for calculating the prices of the other transaction types.

The monthly pumping restrictions imposed as a result of declining aquifer levels can considerably disrupt municipal water supplies, so the ability to assess the likelihood of restrictions can be valuable when formulating planning strategies. Therefore, a hydrologic model was developed to predict the aquifer level in the "J-17" well (the regulatory reference point) as a function of the previous month’s well level, aquifer inflows, agricultural pumping, and municipal pumping. A comparison of model results with empirical data measured over a 25-year period suggests that the model provides a very good estimate of the aquifer level; therefore, the model was embedded in the market simulation.

Market simulations are run many times for a range of initial aquifer levels, with input obtained via Monte Carlo sampling from a joint, multivariate distribution created from inflow and withdrawal data. Simulated supply and demand conditions are translated into market prices for each transfer type, and the expected cost and reliability of various combinations, or "portfolios," of transfer types can be computed. The transfer types are specified for each scenario, and a sequential search method is then used to identify minimum cost portfolios that meet designated supply-reliability constraints. Differences in the cost of the respective portfolios indicate the value of including each transaction type in the market, as well as how the cost of market-based approaches compares with the development of the least expensive new water source (Carrizo Aquifer).

Although the model shows that spot-market leasing would have considerable economic advantages, because of the risk averse nature of municipal utilities, a strategy that involves exposure to spot-market price volatility, even if the expected costs are lower, is not likely to appeal to municipal decision makers. They may, however, feel comfortable entering into annual leasing and option contracts, which provide much greater certainty about water availability and cost. The advantages of using these two instruments include savings of close to $1 million dollars per year relative to the cost of depending on permanent transfers alone. More flexible transfers would also increase the average amount of water available to agriculture by 5,000 to 25,000 acre-feet per year, a feature that is important to policy makers. Consequently, the dual objectives of maintaining municipal supply reliability and reducing the economic impacts on agriculture would appear to be furthered by the introduction of more flexible market instruments. Thus, an excellent argument can be made to justify an investment in institutions to monitor and regulate these types of transfers.

Conclusions
Integrating technical and economic analytical techniques provides a means of identifying and evaluating a range of solutions to water-resource challenges. The example above describes the application of these methods to the development of strategies for managing regulatory limits on resource acquisition; similar approaches could be used for regulating emissions. As demands continue to increase for both water resources and the assimilative capacity these resources provide, the need for creative, interdisciplinary solutions will also increase.

References
Cech, T.V. 2003. Principles of Water Resources: History, Development, Management, and Policy. New York: John Wiley and Sons.

Characklis, G.W., R.C. Griffin, and P.B. Bedient. 1999. Improving the ability of a water market to efficiently manage drought. Water Resources Research 35(3): 823-832.

Durbin, S.W. 2002. Utilization of a Water Market to Optimize Water Acquisition in the Edwards Aquifer Region. Unpublished M.S. thesis, University of North Carolina at Chapel Hill.

Keplinger, K.O., and B.A. McCarl. 2000. An evaluation of the 1997 Edwards Aquifer irrigation suspension. Journal of the American Water Resources Association 36(4): 889-901.

McCarl, B.A., C.R. Dillon, K.O. Keplinger, and R.L. Williams. 1999. Limiting pumping from the Edwards Aquifer: an economic investigation of proposals, water markets, and spring flow guarantees. Water Resources Research 35(4): 1257-1268.

NRC (National Research Council). 1996. Linking Science and Technology to Society’s Environmental Goals. Washington, D.C.: National Academy Press.

SCTRWPG (South Central Texas Regional Water Planning Group). 2000. Water Supply Options for South Central Texas. Austin, Texas: Texas Water Development Board.

Votteler, T.H. 1998. The little fish that roared: the Endangered Species Act, state groundwater law, and private property rights collide in the Texas Edwards Aquifer. Environmental Law 28(4): 845-904.

About the Author:Gregory W. Characklis is assistant professor in the Department of Environmental Sciences and Engineering at the University of North Carolina at Chapel Hill.