Private Investment in Water

Private Investment in a Public Good

A look at the Intersection of Water Law and Corporate Law

Grace Summers

June 19, 2024

The vast fields of vibrant green growing stark against the surrounding desert landscape of southwestern Arizona were more than just eye-catching. In April of 2023, the fields of alfalfa also caught the attention of national news outlets when they uncovered a story eight years in the making: a Saudi Arabian company was pumping groundwater in Arizona, and they were pumping a lot of it. Fondomonte, a subsidiary of a massive Saudi dairy company Almarai, had been using thousands of acres in La Paz County, Arizona to grow alfalfa as cattle feed. After harvest, Fondomonte was shipping the crop all the way back to the Arabian Peninsula for consumption by Almarai’s 195,000 head of cattle.

The story made headlines for several reasons. First, and most obvious, Arizona is not particularly known for its abundance of water. Moreover, alfalfa is an unusually thirsty crop, requiring an estimated five acre-feet of water per acre of crop. Almonds, another notoriously water-intensive crop, require roughly 4 acre-feet of water per acre of crop, and the average American household uses less than half an acre-foot of water per year. Despite the limited availability of water, Fondomonte did not have any restrictions on water use on its Arizona farms.

Media attention brought outrage and increased scrutiny, and ultimately Arizona declined to renew the company’s land leases. But for 8 years Fondomonte was able to profit off unlimited groundwater pumping in Arizona, with little to no costs.

Fondomonte, however, is not the only corporation that has been eyeing opportunities with water in the western United States. Private investment firms have their sights set on profiting off water, and to do so, they have begun to purchase water rights in Western States. But to understand the growing interest in water rights, and how an investor can be profitable in the face of drought, it is helpful to understand the arcane water law that governs the American West.

As early settlers made their way west in the United States, they found a landscape very different from the lush East Coast and Midwest. Water was no longer plentiful, and the legal doctrines imported from a similarly wet England, where water rights were tied to land alongside rivers and streams, made little sense. With limited surface water sources, people had to dig ditches or otherwise pump water from afar to make land arable.

To govern this new landscape, a new legal regime sprouted from the roots of mining law in the 1800s: the first to claim the surface water and put it to use would gain a property right in the water. Given the amount of work required to divert water from a source and move it to a tract of land, the courts and state governments ultimately supported this new legal approach in hopes of encouraging western land development. This system, called Prior Appropriation, is one based on seniority, giving rise to the phrase “first in time, first in right.” As more users appropriate water from a given source, the new surface water rights established are more junior to the rights of those who had come before them.

Water law, however, continues to be haunted by the settlement and development focus of the 1800s. In times of scarcity, senior appropriators have their full water rights fulfilled before more junior appropriators receive any water, rather than some form of proportional diminishment. Water rights are also subject to a “beneficial use” standard meaning the water must be put to an appropriate use. Otherwise, an appropriator might lose a water right via “abandonment.” In other words, “use it or lose it.” Non-use for modern conservation efforts is generally not recognized as a beneficial use.

For similarly archaic reasons, groundwater is also treated differently under the law. At the time western water law was developing, groundwater was not scientifically well understood. Although modern science now recognizes the connection between surface water and groundwater via the hydrologic cycle, the law developed separately, treating each source of water as distinct and unconnected from the other. Historically, groundwater rights were associated with land ownership and landowners could pump however much water below their land as they wanted. While states eventually developed more nuanced groundwater doctrines and implemented groundwater regulations and permitting requirements as groundwater use increased in the twentieth century, the legal division between surface water and groundwater remains.

Western water law has not adapted well to growing scientific knowledge, both in understanding the connections between surface and groundwater and in the recognition that scarcity conditions require different management standards.

Investors, however, have recognized a potential for profit within this system. Water rights in both surface water and groundwater function as property rights, and these rights are transferrable. Some of these property rights are also more valuable than others. Very senior surface water rights guarantee water delivery, even in years of drought. Similarly, groundwater rights with limited or even no restrictions provide access to an underground water source that is less dependent on changing weather patterns. While demand for water continues to grow, water itself grows more scarce, increasing the value of water rights in the West. To take advantage of the potential increasing value, investment firms have been targeting and acquiring water rights in Western States.

One oft-cited firm makes its goals clear, titling itself Water Asset Management. But other prominent investors are also joining this new world of water investment. Michael Burry, famously depicted in The Big Short for his foresight of the 2008 mortgage crisis, noted that one of his major focuses moving forward is trading in water as an investment vehicle. And even Harvard University has begun buying up farmland rich with water rights in California.

Water rights in both surface water and groundwater function as property rights, and these rights are transferrable.

While there are a variety of ways to invest in water, a typical investment takes the form of purchasing agricultural land with strong associated water rights. For surface water, this means the water rights associated with the land are more senior on the priority list. Although groundwater investments will differ depending on the state’s individual groundwater law, investments are likely to be associated with land overlying strong aquifers or groundwater basins. Harvard, for example, targeted vineyard farms overlying one of the largest aquifers in the western United States.

A handshake is depicted in front of a Western river landscape

ImageFX by Google, AI Generated Image

After a firm invests in water rights, however, the water use doesn’t immediately change. “People want to paint this as a Wall Street hedge fund that is buying up Arizona’s water, ruining agriculture,” says Grady Gammage, Jr., an Arizona-based lawyer who has represented one of these firms in water investment deals. “In fact, what they have done is buy farmland and farm it.” A Colorado water lawyer, James Eklund, echoed these sentiments, noting “the investors I’ve worked with in private equity are leasing the farms back to the families to keep the land in ag production.” In the short-term, investment firms maintain ongoing agricultural activities.

While part of the reason behind continued farming is the need to put the water to “beneficial use” to maintain the water right, this also makes a deal more appealing to farmers. Farmers receive potentially significant purchase prices but can remain on the land and continue to farm in the near-term. Additionally, it presents a lucrative retirement plan for small, generational farms. “Agricultural folks that I’ve spoken to, they have sons or daughters that aren’t interested in continuing farming anymore,” says Mohave County Supervisor Travis Lingenfelter who serves a region with a number of agricultural communities in Arizona. “These corporations come in and they make them an offer that’s just too good to refuse.”

Proponents of investment in water also believe that outside investment will encourage a more robust water market that could help solve water scarcity issues in the West. But water market advocates also recognize that buying and selling water is often viewed negatively by the public. Eklund describes how an average person might react to the idea: “If you asked the average person, ‘hey, do you think we should let private companies own water?’ They’d say, ‘No way.’ But if you explain, ‘Well actually we’ve operated a system of water use as a property right capable of private ownership in the West since before statehood, just like real estate,’ they’d say ‘oh, ok, well if it has been functioning like that, I guess I wouldn’t want someone limiting what I can do with my assets.’”

In some sense, there has always been some kind of market for water; water rights have always been able to be sold and transferred to other users. Historically, however, water markets haven’t been explicitly targeted for profits by investors. Instead, water transfers have taken place when new users enter a system, or old users leave.

Proponents of investment in water also believe that outside investment will encourage a more robust water market that could help solve water scarcity issues in the West.

“Demand for water has changed and evolved over time,” says Ellen Bruno, an agricultural and resource economist at University of California-Berkeley, “and the historical assignment isn’t going to be right today.” As water demands change, water rights can be transferred to meet the needs of today. This, economists note, is a good thing. “The benefit of allowing the trade of water is so that we can achieve some sort of allocation that we think overall is a better use of that water” says Bruno. For example, as populations grow in western cities, it is helpful that those cities can acquire more water rights to meet their citizens’ needs.

But just as the demand-side has changed, so has supply. As Andrew Ayres, an environmental economist at University of Nevada-Reno, notes, water markets perform an important function in “enabling our society to be able to move water around effectively as scarcity conditions dictate.” As the supply of water in the West fluctuates, water markets allow users to sell or buy water as they see fit.

As scarcity increases, Ayres sees another benefit of water markets: “conflict reduction.” Because water markets make clear who has water and thus who another party can negotiate with to purchase more water, “that reduces conflicts in terms of bringing together parties collaboratively instead of having them compete in a political arena for access to water.”

Investors, however, are a different and new type of player in water markets. Unlike other stakeholders whose interest in water is putting it to use, investors who purchase farmland are not interested in the agricultural use of water. “Their principal motivation is not long-term farming, but it is the value of the water,” Gammage says of investors. Although investment firms will often lease land back to farmers after the initial purchase, over time water rights will likely increase in value and eventually be sold or leased to the highest bidder.

Some who work in the water space view investors as positive additions to western water markets by helping solve some of the existing problems in the marketplace. “Transaction costs are really high in water markets,” notes Professor Ayres. “Investors are another entity alongside traditional water users who are in a position to invest in overcoming transaction costs, whether that’s building infrastructure, stoking collective action to change rules around moving water, or just doing the fact-finding and market-making that is necessary to find buyers for sellers of water.”

Modern complaints about western water markets, including pricing discrepancies and lack of conservation, are rooted in how water was historically allocated and how the law works. Agriculture and mining were the two original sources of western development, and many of the original water appropriators of the west were farmers who cultivated the arid landscape. Vast amounts of water rights, especially senior rights, have remained in the hands of farmers and irrigation districts. Today, over 80% of western water is allocated for agriculture.

Moving water out of agriculture to other uses can be difficult, and because of high transaction costs, the few transfers out of agriculture tend to be large deals with municipalities. Agricultural water markets thus tend to function separately from other markets. Because farmers generally only have to pay for water delivery rather than for the actual water, given their water rights, there are large pricing discrepancies between agriculture and urban use. “Agriculture to agriculture trades are one tenth of what cities pay for their water,” says Leonard. “That suggests that there are potentially quite large gains from trade or from reallocation between those two settings,” notes Ayres, who agrees that pricing between the two uses can differ by “an order of magnitude.”

There are also few incentives for agricultural users to reduce water consumption or use water more strategically, especially those with the most senior water rights. Even in times of drought, those with senior rights are guaranteed their water deliveries. Additionally, not using their full water rights could risk farmers losing them under the “beneficial use” rule. With water cheap and often plentiful for farmers, some farmers continue to use wasteful practices. “The fact remains most of the water we have in the West is used to grow pretty low value crops” says Bryan Leonard, an environmental economist at the University of Wyoming.

Some think investors could play a role in solving these problems by building a more robust water market through their financial involvement and political pressure. More robust water markets and more water transactions could significantly increase the ability to transfer water from agricultural uses to other water users. This would potentially stabilize the price differences among users, at least to an extent. If farmers felt the true opportunity cost of water in such a marketplace, they may be more incentivized to implement water-conserving strategies.

Other stakeholders recognize, however, that an increase in investment firms in the water space could also have significant negative impacts. “If you have large corporate entry into water markets, and a lot of water changes hands from farmers to cities, produce is going to get more expensive,” says Leonard. The benefit of low water costs to agricultural users is that it keeps food relatively cheap. If agricultural users must pay more for water, that cost will be passed along to consumers through increased food prices.

Even if agricultural water prices do not see an increase, investment in water rights will likely still cause water prices to rise for those already paying the highest prices for water: municipal users. Most big water transfers out of agriculture move water rights to urban areas where demand is growing. Municipalities already regularly purchase water rights directly from farmers. When investment firms enter water markets, they act as middlemen.

In some cases, the investment firms might add value by undertaking due diligence or finding buyers or sellers. But there’s also a concern that the investment firms only act as passthroughs, inflating prices without adding any value to the system. Municipalities cannot always compete.

“If you have large corporate entry into water markets, and a lot of water changes hands from farmers to cities, produce is going to get more expensive.”

“The problem is that the investors can go in and offer more money,” says Alexandra Davis, who works for Aurora Water but spoke in a personal capacity. Farmer’s will sell to the investment firms instead of directly to municipalities. But eventually, when the need is high enough, those municipalities will have to pay the price investment firms have set. “They throw in a, say, 20% markup, and because the cities have to acquire the water necessary to meet future needs,” Davis says the cities will ultimately pay the price.

Additionally, water transfers affect more than just the buyer and seller. Once investors find an opportunity for profit, they will sell and transfer the water rights to another user. Large water transfers away from agricultural communities to urban centers have already taken place. The communities impacted by these transfers are less positive about investor involvement.

The Colorado River passes through Cibola, a small, rural town of about 200 people in southwestern Arizona, providing the community with water. Here, the investment firm Greenstone saw an opportunity. In 2013 and 2014, Greenstone bought up 485 acres of farmland in Cibola for $9.8 million. After four years of leasing the land back to farmers, Greenstone sold the water rights to Queen Creek, a Phoenix suburb located 175 miles away. Queen Creek was in need of new water sources to meet state requirements and approvals for its development boom. For some, this is exactly how a water market should work. Queen Creek had a greater need and was willing to pay a higher price, $24 million dollars to be exact, in order to meet its water demand.

Google Map showing 175 mile distance between Cibola, AZ and Queen Creek, AZ

The Cibola water transfer will move the water 175 miles away to Queen Creek, AZ

But local community members and politicians are upset at the prospect of water being shipped hundreds of miles away rather than remaining a benefit to the community. “The river communities really see it as not only a transfer of water, but a transfer of opportunity,” says County Supervisor Lingenfelter. “It’s a transfer of wealth away from the river communities who rely on that water for their municipal and industrial growth, but also for tourism and a host of other things.” Lingenfelter’s Mohave County, located just north of Cibola’s La Paz County, has its own fair share of Colorado River communities who could be targeted by investors soon.

While the Cibola water transfer will not affect the town’s municipal water supply, communities are not without reason to worry. With large profits to be made, more water users may be enticed to sell their water rights to Queen Creek or other developments who need water, and once that water is gone, it might be hard to get back. “The river communities, they don’t have a Plan B when it comes to water supplies,” says County Supervisor Lingenfelter. And without water and the related agriculture industry, the towns themselves can collapse.

“The river communities really see it as not only a transfer of water, but a transfer of opportunity.”

“If you take the water out of those communities, even temporarily, you could change the economy such that you destroy the [agricultural] industry,” notes Andy Mueller, Director of the Colorado River District in Western Colorado. “And if you destroy the industry, then you destroy all these cool little towns.”

Mueller is familiar with the effects of big water transfers on small agricultural areas. Crowley County, Colorado, had been a productive agricultural area fed by water from the Arkansas and Colorado Rivers. As Colorado cities like Aurora and Pueblo began to grow in the 1960s and 1970s, the farmers in Crowley County were offered higher and higher rates for their water. But as more farmers exited the local ditch irrigation system and transferred their water to urban areas, remaining farmers couldn’t afford to keep the irrigation systems functioning, and ultimately almost all the farmers were forced to sell.

The shift in the local economy caused a domino effect, sending both the local environment and economy into a downward spiral. Today, only 4,000 of the previously 60,000 farmable acres are still being cultivated, the County’s small towns are filled with boarded up buildings, and desertification of the region has eliminated much of the wildlife. It would be difficult to bring water back into Crowley County, as most users have been priced out.

Increased investor activity could lead to more of these large transfers out of rural areas and the loss of smaller, family farms. Catherine Van Dyke works with small farms and agricultural communities in California, and she sees these potential losses as environmentally significant in ways that are hard to quantify. “Family farmers are living on the land, so they really care about what’s happening there. They’re tied to the community and to the well-being of that place in a different way.” To Van Dyke, small farms are more in touch with their surrounding environment and are best suited to be environmental stewards. She notes, “Even though they can’t pay the most for water, if you think about the ecosystem holistically, they’re having a really important impact on what’s happening there, which is perhaps more valuable than we could put a dollar amount on.”

Van Dyke also thinks a purely economic view of whether these communities deserve to survive as missing an important aspect of human dignity. “Pure market mechanisms cannot capture people’s ties to the land and why those communities might be important. This may be the only place people can afford to live. So how are we continuing to support real livelihoods that do have value?”

Targeted investments in water rights are just a new piece in the bigger water puzzle of determining who gets water in the midst of scarcity. “I see water as a misallocation problem,” says Leonard. “Scarcity is really driven by a question of how do we reallocate water from where it’s currently being used, and predominantly has been used historically, into uses that have become more valuable over time.” Water transfers between different users will certainly be a part of the future of the American West, it’s just a question of whether or not investors play a large role as a middleman.

Looking ahead to the growing water scarcity crisis in the West, decisions will have to be made about water allocations. One outstanding question is how the management of water and water transfers will take into account the unique nature and importance of water.

“Water is different. Water is a basic, fundamental need, without which nothing exists,” says Davis. “You don’t exist, I don’t exist. We all die if we don’t have water. Nothing we have exists, all of our clothing, all of our furniture, all of our food, everything we use requires water to make it.”

As the Crowley County and Cibola transfers illustrate, a transaction can affect more than just the buyers and the sellers. But just as water law fails to capture the interconnectedness of surface water and groundwater, it also does not do a great job at capturing the interconnectedness of water, our communities, and human life.

“Water is different. Water is a basic, fundamental need, without which nothing exists.”

The only standard legal limit on surface water transfers is the “no injury” rule, which requires that a water transfer or change in water use not materially injure another water rights holder. If a transfer or change in use affects the river or stream in a way that injures another user, a state won’t approve the change. But this protection is available only to other appropriators. Generally, western water law does little to protect third parties that don’t also have a water right in the system.

Some western states have attempted to incorporate a public interest review into their water rights approval process via statute or constitutional amendment, but there are consistent issues that greatly limit their protective reach. First, many states do not articulate a clear definition for public interest, which limits the usefulness of the public interest protections. By not defining what constitutes a public interest, water management decisions either routinely ignore public interest considerations or any review of decisions is unstandardized. Second, it is not always clear whether the public interest protection extends to water transfers or is limited only to new allocation permits. Transfers clearly have the potential for detrimental effects to the public, so excluding transfer processes from a public interest review would significantly decrease the protective nature of a state’s water law. Finally, in some states there is no standard process or clear caselaw for how public interest should be considered in the approval of a water right or transfer, so even if the state technically protects public interest, it has a reduced and often arbitrary effect.

Arizona serves as an example. While Arizona law does technically require a water rights application to be rejected if it violates public interest, there does not appear to be actions implementing this statute nor is there caselaw enforcing it. It is also unclear whether the statute would extend to water transfers.

A screenshot of a recent court order in County of Mohave v. United States Bureau of Reclamation

Screenshot of recent Court Order from GovInfo.Gov

Illustrative of this legal gap is the recent lawsuit filed by La Paz County, Mohave County, and Yuma County in Arizona against the Cibola transfer. Given the lack of a state water legal hook to contest the water transfer, these counties brought a lawsuit under the National Environmental Policy Act (NEPA), a federal statute that requires federal agencies to assess the environmental impacts of their actions. Because the federal Bureau of Reclamation approved the water transfer, the Counties argued NEPA required an environmental impact statement to be prepared for the transfer. But NEPA is not specific to water law, and it is considered a purely procedural requirement. Even if the Bureau of Reclamation is required to complete an environmental impact statement, the Bureau would still be free to approve the transfer, no matter the findings of the report.

Similarly, investors’ legal obligations offer little protection to third-party stakeholders. Corporate investment firms only have fiduciary duties to their clients. Firms are obligated to act to maximize risk-adjusted returns for clients without taking into account public interest impacts. If a water deal would clearly cause harm to a community, but would be in the best interest of clients, investment firms might even be legally obligated to go forward with the deal. Those working in water recognize this could cause problems. “Their job is to make money,” says Andy Mueller of the Colorado River District, speaking of investment firms. “Their job isn’t to help agriculture stay agriculture to help those local communities.”

Investment firms also often do not have personal connections or community ties in the areas where they own water rights. “Instead of dealing with farmers and ranchers who are humans and actually care about other humans” notes Mueller, “they’re dealing with investment firms who are looking to cash in.” The loss of a more personal or human element in a deal could allow for public interest and community impacts to be overlooked.

While stakeholders on both sides of the water investment issue agree that our water management system needs to account for water’s role as a basic human need, how to do so is still open for debate.

Some argue the public interest should be accounted for in policies outside of water management and that water markets should remain as unregulated as possible. “We have to think about [the effects of water transfers] not from the perspective of water resources management, but from a broader perspective of economic policy,” says economist Ayres. Rather than placing the burden of these issues on water buyers, Ayres believes that impacts should be dealt with “regional economic planning processes that provide an economic model for a region when the water leaves.”

Others disagree that an unregulated, market-based approach is appropriate in the water space. “There’s this adoration of the market as a solution for problems in America. It’s a myth that the market creates efficient, cost-effective solutions that are fair or somehow fairer. But when you have the wealth inequality that this country has, and you have, as you do in America, the amounts of money concentrated in certain individuals or individual investment entities, there is no fairness,” says Davis. “I think that it’s totally appropriate for government, local, regional or State agencies to have a significant say – particularly in the context of water use and allocation – in what’s in the best interest of our community, of all of the people, of the environment, of business. The idea that individuals can profit off of a critical resource that everyone needs is an idea everyone should be concerned about.”

One practical policy to regulate the water markets in the interest of the public is a proposal by the Colorado River District to implement a “demand management” program. Demand management would allow the government to compensate water rights holders for their voluntary reductions in water use. In other words, agricultural users could be paid to reduce their water usage temporarily without losing their water rights. Any conserved water could then be stored for future use. While this program may reduce the amount of agricultural users selling their water rights outright, it would not provide specific public interest protections for water transfers.

“The idea that individuals can profit off of a critical resource that everyone needs is an idea everyone should be concerned about.”

The water law scholar Mark Squillace has also suggested explicit policies for the law to better capture and protect the public interest. Given the identified flaws in water law’s public interest protections, he encourages every state to explicitly define what “public interest” means and set out clear processes for conducting a public interest review of all water management decisions, including all transfers. Squillace also recommends engaging the public more directly in water management through either “waterkeeper” style organizations or a public ombudsman. Having the public aware and engaged in water management issues would likely enhance oversight of decisions that could affect the public.

One of the greatest barriers to protecting the public’s interest in water is that the current water rights system is deeply embedded in Western culture. Water rights have been allocated to certain uses for hundreds of years. A better system would likely have different initial allocations, reserving certain volumes of water for environmental and in-stream uses as well as reserving an initial portion of water to serve all domestic needs.

In the current system, however, decisions will have to be made between competing water allocations. Without changes in the law or other policy efforts, increased investment in water rights might mean that decisions will be dictated by who is willing to pay the most for water, without regard for the impact on communities and the broader public.