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Can Math Save The Nut?

Posted by Ory Zik on May 7, 2015 11:28:33 AM

The ongoing water crisis in California has generated some dire predictions about the state's future. The New York Times recently asked whether the “state’s driving engine has run against the limits of nature.” But California isn’t running out of water. It’s running out of cheap water. The drought damage is estimated as $2.2 billion, which is significant, but hardly the "end of growth" for California’s $2.2 trillion economy. The problem for businesses, however, is that cheap water jeopardizes water security. Executives need visibility into the issue and strategies to manage it, but unfortunately, the slow policy response and inconsistent price signals slow innovation. So let’s do the math.

We are what we measure – and water is measured (and charged for) by volume. But the value of a gallon of water is highly dependent on where and how it is consumed. In California, the difference is extreme. The typical difference in annual total rainfall between northern and southern California is fifty-fold – 100 inches and 2 inches, respectively. Clearly a gallon of water in the north has different value than the same gallon of water in the south.

Use matters as well, particularly in economic terms. It's been widely noted that agriculture accounts for the majority of the population's water usage, around 80%. Almonds and alfalfa are the frequently discussed crops; they occupy similar land acreage in the state, and an acre of almonds consumes about 1,140 kgal of water per year while an acre of alfalfa consumes about 30% more. But there are real economic differences: almonds generate about $6,000 of revenue per acre per year, compared to alfalfa’s $1,000. Therefore, the economic value of almonds is about $5.3 per kgal of water and alfalfa is only about $0.7 per kgal – almonds are eight times more valuable than alfalfa per unit of water.

Looking at a map of precipitation versus water usage dispels a few additional water myths (see Figure 1). First, contentious regulations that relate to urban water consumption have a small impact that is limited to the San Francisco Bay and the South Coast. California will not conserve its way out of the crisis by reducing urban water use. The second myth is that environmental "usage" (water that is left in lakes and streams) is responsible for more than half of the water losses. That is true in aggregate, but most of the environmental use is in the north, in areas that the water cannot readily be used for agriculture or cities.

Figure 1: California Water Use vs. Drought

OZ Article Image.

The most logical proxy to use to sort out the geographic and economic differences in the value of water is energy. There is no shortage in water for those who are willing to pay for the energy to treat, convey, distribute, and collect it after use. However, water needs to be regulated to make sure that withdrawal does not lead to depletion, and it is priced in a way that captures the value of the energy and environmental externalities.

When we price water as energy, we gain visibility. The energy intensity of water in California can be as low as 2 kWh per kgal or as high as 37 kWh/kgal (including desalination and conveyance). Assuming an electricity price of $0.15/kWh (to create a “value of water” benchmark), the energy price of water will range between about $0.3 per kgal and $6 per kgal. Almond farmers can easily pay for the low end (which is less than 10% of resulting crop value), which is what they have been doing until recently. They cannot pay for the high end. Alfalfa farmers can pay for neither, and the popularity of the crop in the state depends on the fact that the state's byzantine system of water rights means that water can be virtually free for some agricultural users. In some locations, however, today’s drought prices are as much as $3 per kgal and driving an outcry among farmers. In the absence of clear and consistent water pricing, econometrics that use energy as a proxy can provide decision makers with visibility into the value of water.

This analysis highlights the challenges California faces in deploying what should be its greatest asset in addressing water issues: innovation. The lack of clear pricing has led to lack of interest by Silicon Valley entrepreneurs and investors. New pricing mechanisms and regulations may change this situation, but the track record of government is not encouraging. Last year, finally, the governor signed a bill to regulate groundwater extraction, but the regulation is set to be fully implemented only in 2040, and until then, farmers that have the money to drill deeper for water can suck aquifers dry.

The Israeli experience may be relevant. From the water perspective, Israel is like a "miniature California": It is 60% desert, had a seven-year drought between 2004 and 2010 and the driest winter on record in 2013-2014. It has one big surface water reservoir (the Sea of Galilee) and ground water aquifers that need to be protected, and relies on desalination plants for additional water. Fresh water is expensive, so farmers minimize use and, when possible, use brackish water. Even so, agriculture is 2.4% of GDP (compared to 2% in California) – Israel even exports carrots to Russia. Like California, it's an entrepreneurial hub, and there the price of water helps drive thriving water innovation, such as promising start-ups like Desalitech, which builds improved reverse osmosis systems that farmers can use.

How should executives respond to the water crisis? They cannot wait for policy makers. They have to acquire the right data and determine the internal value of water to decide what technology can be effective where. For example, Nestlé uses an internal ‘shadow price’ of water to assess innovations and proposals for new equipment.

As California runs out of cheap water, and as the regulators are moving too slowly, companies have to distill complex information into crisp decisions. They should use data and analytics to determine the value of water, using the energetic price as a starting point. From there they can choose the innovations that can provide value.


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