Developing Portfolios of Water Transfers

This project is the subject of Brian Kirsch's doctoral research into improving the efficiency of Western U.S. water markets.  Click here to see an abstract of the first paper from his dissertation which was published in Water Resources Research.

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), which in the Western U.S., are often mediated by water markets.  This raises questions regarding how best to coordinate the use of these transfers in meeting cost and reliability objectives.  This work combines a hydrologic-water market simulation with an optimization approach to identify portfolios of permanent rights, options and leases that minimize 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 risk neutral 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 the use of temporary transfers can reduce expected water supply costs substantially, while still maintaining high reliability levels.  Also evaluated are tradeoffs between expected costs and cost variability that occur with variation in a portfolio’s distribution of rights, options and leases.  While this work represents firm supply capacity as permanent water rights, a similar approach could be used to develop portfolios integrating options and/or leases with hard supply infrastructure.