Assessing and Managing the Financial Risk of Variable Hydrology in California

Multi-year droughts in California create financial challenges for large urban populations and irrigation-dependent agriculture that can be both significant and highly uncertain. Climate change projections suggest that these periods will become more difficult to manage in the future, and a growing concern for the ecological benefits of in-stream and other environmental water uses shifts a larger portion of the resulting losses to municipalities and irrigators. These issues have recently received increasing notice from lenders, investors and credit ratings agencies, driving increased interest in evaluating and managing the related financial risk. Both hydrologic variability and complex water infrastructure make the assessment of financial risk, and developing effective strategies for managing it, particularly difficult. This is particularly true for irrigators in the Central Valley, as favorable conditions for growing lucrative cash crops like nuts, citrus, and grapes make it the most economically productive agricultural region in the United States. Several large-scale water projects in the state supplement valuable irrigation supplies in arid parts of the Central Valley, like the Tulare Basin. This imported water allows producers to expand their planting of perennial crops, but year-to-year variability within the biggest supply projects creates significant financial risks for irrigators. The up-front costs of planting a perennial orchard can be an order of magnitude larger than those for annual crops, and even a temporary irrigation failure can kill trees, the replacement costs for which are not commonly covered with federal crop insurance. How do producers in this volatile region manage the financial risks caused by drought? Using the novel California Food-Energy-Water System (CALFEWS) model, we simulate existing risk management strategies used by orchard growers in the Tulare Basin region and analyze how they could be impacted in the future by climatic and/or regulatory stressors. We also propose several more sophisticated financial risk management strategies that involve groundwater banking and a new form of index insurance that can more cost-effectively reduce the risk. While this approach is investigated within the Central Valley, similar strategies could be employed in semi-arid regions throughout the Western U.S. and the world.