Saturday, October 15, 2011

All-In Auction for SD-6?

I've been working some on the design of an all-in auction (AiA - click here for a rudimentary rundown) - as a different way of reallocating a reduced water supply for any particular area, but clearly looking toward consideration by the SD-6 High Priority Area where we need to take some 28,000 AF down to 22,000 AF to meet the locally stated goals.

The simple model I'm ginning up as a test (fake auction) is:  19 water right owners, in priority, owning between 3 and 15 units of water each (1 unit equaling 20 AF).  Total pre-auction units total 150 (3000 AF) and the goal is to auction off a reduced 112 units (2240 AF).  My model is an annual auction format, which would allow a new restricted amount in any (or every) year.

Basically everyone places their units into the auction (thus the name "all-in") and proceeds to bid at least once for every unit they've put in. They can bid as many times as they like and at any dollar value.  Ideally they would value each unit of water within their operation and bid that value or somewhere close to it.  Once all the bids are placed (my scaled down model found the 19 owners of 150 units making just over 220 bids) the awarding process begins.

The bids are sorted from highest to lowest.  The 112 highest bids are awarded and these successful bidders get to use the 112 units next year. Depending on how all the bids go down, some may get more units than placed in, some may get less, some will get the same number and some may not get any at all.  The idea is that those who value the water the highest and can translate their water use into production valued higher than others, will get the water.  In this scheme, the reduced 112 units of water should end up producing more value than if the 112 units were divvied up any other way.  The final step is the accounting.

The unit price of water is fixed at the first, non-successful bid price, and everyone uses this price - be they seller, or buyer.  In my fake auction, the bids ranged from $36,000 to $200 per unit.  The 113th bid price was $11,201 per unit, so this became the unit price.  Those ending up with more units than they put into the auction, pay the auction $11,201 for every extra unit they came away with, while everyone ending up with fewer units received the same amount for each reduced unit.  In the end, the auction will always be revenue neutral.

If you've been reading anything at all about these kinds of auctions you may recognize this as the current work of David Zetland - from Wageningen University in the Netherlands and perhaps others.  (The link above actually takes you to Zetland's blog where he explains the ideas in a helpful video).  Since we must reduce water use in the SD-6 high priority area, I wanted to see if an AiA might be a workable methodology.

While my spreadsheet ran just fine, I have concerns - or perhaps second-level questions - about the concepts.  They are:

1)  I wonder how easy it will be to get 100% of the water right holders in an area to agree to such an auction. It's not that everyone won't be able to determine their unit values in preparation for the bidding, but I fear many will just not want to take the time and effort to do so, so will decide not to agree.

2)  Our wells and water rights in these special areas are pretty well physically maxed out.  I'm afraid most will not have the capability to pump the extra water they may be awarded, so the owners will not tend to bid beyond their own units.  Now, if the wells would go to the successful bidders, too....

3)  We'd likely have to develop special bidding protocols as our water rights are for maximum annual quantities, and would have to be annually restructured for some if not most of the net positive bidders.  We also have variations of annual water rights, like 5-year allocations and term and temporary permits, that would need special bidding rules.  These issues are not insurmountable, but would take extra attention.  A decision to run a 5-year auction time frame might help, but our 5-year allocations are not all the same 5-years.

4)  Seems to me in a groundwater only setting (like ours) the auction area should be small enough to prevent the possibility of an unusually large slug of buyers being able to grossly over pump a specific area. This could cause impairment problems as a result of the different withdrawal patterns.

5)  Our model was restricted only to the current water right owners. This arrangement would be the most likely to be locally acceptable, but I wonder if a better model would be to open up the auction completely.  Maybe the Kansas Wildlife agency would want to bid in order to supply water to enhance stream baseflows or wildlife habitat.  The outside uses of water are potentially endless - but the local users may deeply resent their participation.  (Update (October 17, 2011):  David Zetland recommended initially limiting participation to only the original unit holders, but , suggested that outside participation could be allowed if desired.  It could also be controlled by being limited to a specified percentage of the total auction units. Both good suggestions.) 

6)  Also, not knowing what the unit price is going to be until after the auction runs I think will confound those bidders who are interested in foregoing irrigation and taking the cash instead.  They're going to be very disappointed if the unit price ends up being half or less of what they valued their water at and would have bid if they wanted to retain their own units.  Eventually the market will settle on some fairly narrow values and more people will have a better idea of what to expect, but initially this could be an issue.  Also, I guess it'd be possible to have subsequent bidding rounds to fine tune this situation, but I'm not sure most folks will stay with the process that long.

7)  With water rights in Kansas being property rights to the use of the state's water that can always be bought, sold, leased, traded or whatever, it may be easier for water users in Kansas, once they are required to reduce pumpage, to lease or trade their water among themselves from year to year rather than subscribe to the formality of an AiA.  This arrangement won't necessarily address the production efficiency issues that the AiA does, but it'd be far more familiar to the users.

I do like some elements of this approach, however, like addressing the production efficiencies and the flexibility of changing the goals from timestep to timestep and even the timesteps.  All in all, our planned SD-6 approach of a regulated allocation system (reducing everyone to 55 acreinches per acre over a 5-year period) gets to the same goal with more of a "sharing the pain" flavor than would a fiscally competitive AiA.  There are some operators that simply seem to have more money than others, and I fear will be perceived as having a leg up in an auction setting.  

I think the AiA concept is interesting enough that it should be at least looked at as an alternative reduced water use, enhanced management plan for any area seeking to, or having to reduce water use.

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