Evaluating and managing drought-related financial risks in California’s North-South Water Transfer System

Abstract:

Financial exposure to extreme weather and climate events has historically been assessed largely using metrics linked to natural systems, like rainfall, streamflow, or wind speed. Increasingly, however, risks are analyzed with an emphasis on the interactions between the natural, engineered and economic systems. In critical industries related to agriculture, water provision, energy generation, and real estate, systems-based approaches have demonstrated an ability to identify important feedbacks between environmental processes, the engineered infrastructure networks used to manage this variability, and the economic institutions that drive investment and operational decisions related to this infrastructure. One salient example is the financial risk faced by irrigators in California’s San Joaquin Valley, where imported water from the San Francisco Bay-Delta accounts for approximately 30% of the total surface water supplies. These imports help irrigators maintain production across a region that includes four of the five highest-grossing agricultural counties in the U.S, but hydrologic conditions, infrastructure capacity, and environmental regulations drive significant variability in actual water deliveries. Irrigation districts and groundwater banks, which generate revenue through fees related to water deliveries, are financially vulnerable to variability in delta imports. Dry years jeopardize their ability to meet fixed costs (e.g., debt service), potentially leading to lower credit ratings, higher interest rates, reduced infrastructure investments, and/or cuts to experienced staff. Districts and banks manage this physical and financial variability using a range of techniques which have not yet been evaluated. We develop a rule-based simulation model that links hydrologic variability, environmental regulations constraining delta pumping, and groundwater banking operations in Kern County. Annual revenues are evaluated at a number of irrigation districts and groundwater banks to determine the impact that financial tools have on mitigating drought-related financial risk. Results suggest a financial mitigation strategy that combines elements of a reserve fund with index-based insurance payments can reduce budget shortfalls at a lower annual cost than a reserve fund alone.