Oh California.

Thanks this website
Thanks this website
Thanks this website
Thanks this website
Thanks this website
Thanks this website

So as we all should know, there’s a serious water shortage going on there, climate change, where-are-the-deniers-now, and so on.

Background notes:

  1. The governor has introduced compulsory water restrictions.
  2. But the compulsory water restrictions don’t apply to farmers.
  3. 80% of California’s water gets used by farmers.
  4. Not by leaving the tap on while toothbrushing.

A chart:

Thanks this website
Thanks this website

Things that I thought until recently:

  1. The real water guzzlers are the almond trees.
  2. Curse those almond farmers for using all that water.
  3. The price (for water) is not right – and that’s the whole problem here*.
    *Okay, so I didn’t actually think that the price of the water was the whole problem. The drought is the whole problem, and prices are irrelevant when there is no water. However, prices are still a problem when they don’t sufficiently adjust to the fact that there is less water than before.

But here are things that I learned yesterday:

  1. The trouble with almonds is that they grow on trees. And the trees will die if you don’t water them – meaning that there is no short-term drought measure for almond trees. There are only long-term measures. And in terms of value creation terms, you get some of your best bang for your gallon/litre with an almond tree.
  2. That aside, this graph:

    Thanks Bloomberg
    Thanks Bloomberg
  3. So alfalfa then.
  4. Most of which gets grown for California’s dairy cows.
  5. But a growing amount of which gets exported to China to feed their cows.

The Awkward Economics of California’s Trade Deficit

California runs a massive trade deficit – importing plenty of Asian goods and not exporting plenty of California goods.

Which sounds too much like economic theory. So here’s what that means in practice:

  • The Container Ships crossing the Pacific from Asia are packed to capacity.
  • The Container Ships returning to Asia tend to run empty.

And what that means: transportation costs for any Californian exports to the East are dirt cheap.

So if you could find something to make cheaply in California, that couldn’t be made as cheaply in the East, then you’re in the money. And if you could find something to make cheaply in California that can’t be produced in the East, then you’re in plenty more of the money.

It’s a giant opportunity just dying for a product.

Did we mention that China lacks enough of its own water and arable land to produce livestock feed? Especially given the fact that China’s middle class boom over the last three decades has meant that hundreds of millions of Chinese nationals are now in a position to choose beef over pork and chicken?

The Tragic Economics of Farmer Water Rights

Back in California, in the Imperial valley where much of the alfalfa is grown, farmers have historic rights to use their allotments of water from the Colorado river. If they don’t use it, they lose it. So they use it.

Just to backtrack here, the big argument against Free Market economics is the Tragedy of the Commons. In this tale:

  1. There is a patch of communal land upon which the villagers can graze their sheep.
  2. It is in each villager’s individual interest to graze as many sheep as possible on the land (I mean, the grass if free, and more lamb means more money/milk/meat).
  3. But if each villager keeps adding more sheep to his/her flock, there will not be enough grass, and the patch of communal land gets desertified. And no more lamb for anyone.
  4. Tragic.

The water rights situation results in something similar:

  1. Each individual farmer needs to use their full allocation of water, otherwise they’ll lose that allocation.
  2. Even if there isn’t enough water.
  3. And actually, it’s in their interest to be lavish with it – because that might result in higher future allocations.

So the water gets used on alfalfa. And not particularly well either – because why use drip technology when you can just flood the field?

And in some ways, it’s almost irrelevant what the price is, if the risk is losing your allocation.

Californian farmers: totally incentivised to use more water. In the middle of this crazy drought. And to send the water-products to other places that don’t have enough water. Like China.


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Rolling Alpha posts opinions on finance, economics, and the corporate life in general. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.