In order to understand the new legislation, it is necessary to know the broader context. The Central Valley Project (CVP) is the largest water development project in the United States and is owned and operated by the Bureau of Reclamation (USBR), part of the United States Department of the Interior (DOI). It includes 20 dams and reservoirs, 11 power generating stations and over 500 miles of canals and pipelines for the development and distribution of water supplies for agricultural irrigation and municipal uses. The CVP largely controls the flows of the Sacramento and San Joaquin Rivers and their tributaries, which together drain a significant portion of California. The amount of water captured and delivered varies annually based on hydrologic conditions and operational constraints, but is approximately 7 million acre-feet (MAF) per year, of which about 5 MAF is delivered for agricultural irrigation purposes.

The CVP was largely constructed between 1937 and the 1970s, and its capacity was increased incrementally with each new component up to its current state of development. Project construction was financed by the federal government, with repayment obligations assumed by the beneficiaries through long-term service contracts. Federal reclamation law provided for interest-free financing and other financial benefits, so that the contractors will not bear the full cost of the CVP and project water supplies will always be subsidized at some level. Congress expressly intended these subsidies in order to gain the broad national benefits of food security and economic stimulus that the CVP provides.

Starting in the 1980s, it became clear that while the CVP had achieved fantastic success in developing water supplies and controlling floods for the benefit of the Central Valley and the United States as a whole, it also was causing the deterioration of the natural environment, including habitat for fish species such as salmon and steelhead trout. Additionally, operation by the USBR was considered by many to be excessively rigid, resulting in the loss of available water supplies during certain conditions. In order to increase the flexibility of CVP operations for the benefit of both project contractors and the environment, Congress passed the Reclamation Projects Authorization and Adjustment Act of 1992, commonly known as the Central Valley Project Improvement Act (CVPIA).

While the shifting of water supplies between CVP contractors was widely discussed as one method of achieving flexibility in project operations, it was not expressly authorized by federal law until the CVPIA. Section 3405(a) of that act provided express authorization for CVP contractors to transfer their water supplies to other users, in accordance with California state law, which had been modified in the 1980s to expressly encourage water transfers as a means of increasing flexibility of the state water management system. Both the CVPIA and state law impose restrictions on water transfers, which have been responsible for largely stifling the water market in California other than a few highly publicized transactions. Water transfers can be accomplished in California, and I have been personally involved in a number of successful transactions for either the seller or buyer, but there are significant transaction costs and delays associated with regulatory approvals and environmental review that decrease the likelihood of transfers being undertaken. As a result, there are many circumstances where water that is not needed in one location cannot be put to use elsewhere in the state because of legal difficulties, for an overall societal loss.

One of the complaints regarding transfer restrictions within the CVP is that the CVPIA limits transfers of contract water to: (1) the average deliveries to the seller over the three years of normal water delivery prior to enactment of the CVPIA (which were 1986, 1987 and 1989) in Section 3405(a)(1)(A); and (2) the amount of water that would have been consumptively used during the year or years of the transfer in Section 3405(a)(1)(I). While both of these restrictions are part of state law for the protection of third-party water rights holders under the No Injury Rule, critics argue that they do not make sense within the CVP, which is a single project operating under integrated water rights. They would argue that the restriction is like imposing a tax on an individual shifting money from one back account to another. Imagine if you had to pay income tax on money that you shifted from your checking account to a savings account, or vice versa! Similarly, those sections of the CVPIA require a transfer to take a “haircut” even when the water is shifted from one CVP contractor to another within the project.

This limited problem is the first part of what Sen. Feinstein’s language addresses. Section 207(a) of Division B, Title II of H.R. 2055 (found on page 81) provides in its entirety that:

Subject to compliance with all applicable Federal and State laws, a transfer of irrigation water among Central Valley Project contractors, from the Friant, San Felipe, West San Joaquin, and Delta divisions, and a transfer from a long-term Friant Division water service or repayment contractor to a temporary or prior temporary service contractors within the place of use in existence on the date of the transfer, as identified in the Bureau of Reclamation water rights permits for the Friant Division, shall be considered to meet the conditions described in subparagraphs (A) and (I) of section 3405(a)(1) of the Reclamation Projects Authorization and Adjustment Act of 1992 (Public Law 102-575; 106 Stat. 4709).

This language is noteworthy not only for what it does, but for what it does not do. For example, Ms. Schifferle criticizes the measure as allowing a small group of landowners to make significant profits from selling water, and specifically calls out Westlands Water District and Stewart Resnick. Her concerns are misplaced, as Section 207(a) only removes restrictions on transfers of irrigation water within the CVP. That inherently limits both the market and the price for water supplies. It does not remove any restrictions currently in place on transfers outside the CVP or for municipal purposes. Transfers between agricultural users within the CVP do not command high prices, and would only be expected on a short-term basis to improve flexibility of CVP operations. The transfers that Ms. Schifferle cites in her parade of horribles would not be affected by Section 207(a). For example, contrary to Ms. Schifferle’s suggestion, the 2009 transfer from Paramount Farms that has become a favorite target of the Progressive Left was not of CVP water, but of water rights formed under state law without any federal or state subsidy. In addition, the holders of most CVP water contracts that would be either sellers or buyers are public agencies, subject to state laws regarding open, transparent public decision-making. This includes Westlands Water District, which is generally not a seller, but a buyer in the water markets.

The second problem addressed by Sen. Feinstein’s legislation is that of costs and delays that are imposed on transfers, particularly for the most common transfers that are only in effect for one irrigation season from April through October. The cost and time consumed in seeking regulatory approvals and environmental review often leads to parties not trying to consummate a transfer that would increase water availability and promote system efficiencies. In the drought year of 2009, this led the California Department of Water Resources (DWR) to coordinate a one-year Drought Water Bank to streamline the process. That effort was followed by a joint USBR-DWR program in effect for the two years of 2010 and 2011. Currently, the USBR is pursuing environmental review for a 10-year transfer program within the CVP, and Sen. Feinstein’s legislation simply encourages that effort (which has stalled), without changing any federal or state substantive restrictions on transfers. Section 207(b) states that:

The Secretary of the Interior, acting through the Director of the United States Fish and Wildlife Service and the Commissioner of the Bureau of Reclamation shall initiate and complete, on the most expedited basis practicable, programmatic environmental compliance so as to facilitate voluntary water transfers within the Central Valley Project, consistent with all applicable Federal and State law.

In addition, Section 207(c) requires USBR to make a report to Congress once every four years about the status of efforts to facilitate and improve water transfers within the CVP.

In all, Sen. Feinstein’s legislation provides a very small, incremental improvement in the way that water transfers are handled within the CVP. It does not fundamentally change any of the existing federal and state laws that have restricted water markets in California, and certainly does not facilitate any private party making untoward profits by selling water in a manner that harms the public. Any resulting transactions will be between willing sellers and buyers, with generally positive effects for the CVP, California and United States as a whole. Negative externalities, including environmental protection, are well prevented by existing federal and state laws.

If anything, federal and state laws should be modified to incrementally reduce the transaction costs and barriers for transfers, so that the waters of the state may be put to the greatest, and most valuable, uses possible, including environmental resource protection and enhancement. Many environmental organizations, such as the Natural Resources Defense Council, Environmental Defense and The Nature Conservancy, recognize the value of water transfers and markets for improving water management. As we enter a new era of seeking true environmental and economic sustainability for the next century, water transfers will need to play a critical role in reallocating water from lower to higher value uses, while providing funding for water conservation improvements and economic enrichment of areas of origin.

For the majority of my readers who are based in the US, some background may be helpful. The UK water utility industry was reorganized in 1989 with the privatization–or, as they would say, privatisation–of all retail water and sewerage services. Water and sewerage services are divided among 34 private companies, each of which has a monopoly within its own service area. Environmental and water resource regulations are overseen by the Environment Agency, while the Water Services Regulation Agency (Ofwat) governs economic issues such as capital investments, customer fees and competition. Despite the fears of many in the US regarding water services privatization, the UK experiment has largely been successful.

In order to address identified challenges, Defra proposes a number of water resource reforms, which would be implemented through new legislation and regulatory agency action. Large-scale goals include protecting and restoring the environment, increasing resiliency of the water utility sector through efficiency and innovation, ensuring that water is affordable to all citizens and appropriately valued, and enabling economic growth.

Regarding over-abstraction from water sources, the government proposes to modify the existing system of abstraction licenses created in the 1960s to create greater certainty in light of future changes to water resource availability, protect in-stream flows and incentivize efficient water use. Examples of specific policy reforms include:

• Varying water abstractions based on the volume available at the given time rather than a fixed volume;
• Issuing abstraction licenses to approximately 30,000 currently exempt abstractors;
• Holding reverse auctions to buy back licenses in over-subscribed catchments;
• Invoking a power in the Water Act 2003 to limit abstractions that cause serious damage to rivers without compensation;
• Improving connections between water systems;
• Removing barriers to bulk water transfers;
• Increasing abstraction charges to better reflect scarcity of water resources;
• Better connecting water resource planning and Ofwat economic regulation, including price review; and
• Requiring water companies and businesses that rely on water abstractions to better manage risks of reduced water availability with a long-term perspective.

These actions will be undertaken at the catchment level, and specific solutions will be based in part on experience gained through pilot projects in the Restoring Sustainable Abstraction (RSA) program administered by the Environment Agency.

Of particular interest to me, having just come from a December 12-13, 2011 meeting of the Western Governors’ Association and Western States Water Council on innovative water transfers, is the proposal to increase use of water markets for bulk water transfers. The UK government noted the advantages of markets to coordinate supply deficit solutions across basins, allow businesses to obtain new or expanded water supplies without the issuance of new abstraction licenses, promote efficient use of water and encourage abstractors to invest for climate change adaptation sooner rather than later. The initial stage of water transfers will be limited due to the perception of relatively high expense and carbon emissions to transport water over long distances, but may be expanded in future as envisioned in the Assessment of regulatory barriers and constraints to effective interconnectivity of water supplies (Defra, 2010) and Exploring views on the potential for more active water rights trading (Synovate UK, 2008). Defra plans to work with Ofwat, the Environment Agency and water companies to remove barriers to water transfers, particularly through the use of economic incentives. The Environment Agency started these efforts by publishing new rules for water rights trading in October 2011.

Regarding water use efficiency, Defra proposed to encourage household water use reduction measures, such as use of rain barrels, efficient appliances and leak reduction. Water companies will be required to conduct a thorough review of water use efficiency improvements as part of their water resource management plans every six years. Interestingly, Defra does not support blanket use of water meters at the individual customer level, instead looking to regional differences as to whether metering is appropriate. In England and Wales, only 37 percent of households pay for water according to usage; the remainder pay for water and sewerage services based on the value of their homes. Use of meters is increasing, particularly in water-stressed South East England, and Ofwat has established a Smart Metering Advisory Group. Defra is looking at additional ways of conserving water by non-water companies, especially in energy generation, agriculture and the public sector.

Defra noted that water companies have an important, but not singular, role to play in resource management. Responsibilities also lie with government agencies, businesses and individual citizens. The government expressed concern about the impact of proposed reforms on affordability of water and sewerage fees, especially for low-income customers. The water companies will be encouraged to develop “social tariffs” targeted at vulnerable customers, and Defra proposed national-level subsidies to South West Water to deal with uniquely high rates facing customers of that company based on need to develop infrastructure more fully in recent years.

Finally, Defra plans to look at ways to increase competition between retail water companies for non-household customers. Current rules limit the market to a few large customers, which has resulted in few market entrants in England. This is in contrast to the situation in Scotland, where an alternative regulatory regime has led to 42 percent of eligible customers switching or renegotiating their water supplies, with significant attendant cost savings. This proposal follows the recommendation of the Cave Review released earlier this month and, as might be expected, is very controversial among the water companies and business customers. It will be interesting to see if the UK can experiment with retail water competition in a way that provides lessons (or warnings) for other jurisdictions.

Specific reform proposals from Water for Life will be developed with consideration of linked policy objectives such as food security, energy security, climate change mitigation and international competitiveness. Defra has promised a public process, including formation of a national advisory group of key stakeholder representatives in 2012. New legislation is scheduled to be introduced in 2013, with many reforms being implemented on a river basin level, starting with those under the most stress and finishing by the mid to late 2020s.

The Defra report proposes many policy reforms in the right direction, but as with many reforms, there can be a significant distinction between the direction and magnitude of the reform vector. I am struck by the significant gap between Defra’s aggressive policy goals and the list of specific actions that will be taken to achieve them. As seen in the 1989 reforms and more recent austerity actions, however, the UK seems politically willing to make needed reforms. That is one way in which the UK is ahead of the US, which seems to be stuck with little will to respond to our water resource, infrastructure and economic challenges.

While this law is undoubtedly a step in the right direction, it’s a very, very modest step. Couldn’t we ask a little more from the Legislature to promote efficient water use?

Related to this blog, P3s may be used to procure water and wastewater infrastructure projects, particularly those that require innovative technology or are outside the expertise of the sponsoring agency. Such projects often include water treatment plants, wastewater treatment plants, water recycling facilities, brackish groundwater or seawater desalination plants, long-distance water pipelines, remote groundwater well fields, groundwater storage banks and new surface water reservoirs. Water and wastewater projects fit well into the P3 model, because water and wastewater rates provide a steady revenue stream for repayment of private financing.

As the current and foreseeable future status of federal, state and local government budgets make significant infrastructure investments difficult, private financing can provide a valuable replacement or supplement. Unfortunately, federal and state laws often make P3s difficult to accomplish in the most effective and efficient manner, if at all. As much as the President and Congress have spoken about infrastructure and its potential for jobs creation over the past five years, they have done very little to actually encourage infrastructure projects for the long-term. A directed effort by the Super Committee to remove legal and regulatory barriers for P3s would be welcome for the furtherance of infrastructure projects across the United States.

Government agency procurement laws are typically legislated at the state level, although some local home-rule jurisdictions have also adopted their own rules. In California, there are a number of statutes authorizing P3s for various types of infrastructure projects. This post concerns one of those statutes, the California Infrastructure Financing Act (IFA), codified at Government Code §§ 5956 et seq. That act provides one of the most broad and flexible authorizations for P3s in the state, although there are limitations on its applicability as well. The IFA is particularly useful for water and wastewater infrastructure projects, which are the focus of this blog.

The IFA was adopted by the California Legislature in 1996 to authorize the use of private financing for government infrastructure projects. The statute does not require the use of private financing, however, and allows the private entity or entities in a P3 to “study, plan, design, construct, develop, finance, maintain, rebuild, improve, repair or operate” the project. The main limitations are that the infrastructure project must be fee-producing (not a hard requirement for most water or wastewater projects to meet), that the project may not include any state funds, and that the length of the P3 contract may not exceed 35 years. Overall, the IFA is a very useful statute for implementing P3s. Perhaps the greatest limitation of the IFA is that so few local government agencies are aware of or understand it.

For more information on the IFA, please see the slideshow below that I presented at a meeting of the National Council for Public-Private Partnerships (NCPPP) last week. If you have specific questions about the IFA, please comment below or contact me directly.

As described in my earlier posts here and here, mutual water companies are corporate organizations that have a primary purpose of delivering water to their shareholders. Private water companies have been formed throughout the history of the state, but many were formed in the early years of the 20th Century to meet the water demands of growing urban and agricultural areas. In 1911, the California Legislature responded by forming the Railroad Commission (now the California Public Utilities Commission) with jurisdiction over the terms of service and rates charged by private water companies. A distinction was recognized early on between private water companies that are owned by developers or investors for the purpose of earning a return on investment, and mutual water companies that are owned and governed by water users themselves. Section 2705 contains the codification of the legal distinction between the two types of private water company. Any interpretation of § 2705 must take into account the purpose and function of the provision, which is to protect water end users (or “customers”) from the monopoly power enjoyed by retail water suppliers. Customers of an investor-owned utility are entitled to regulation by the CPUC for their protection, while it is assumed that customers of a mutual water company do not need such protection, since they control the company through shareholder voting. This is the same reason that government-owned utilities are not regulated by the CPUC, since they are controlled by a customer-elected board or city council.

Consistent with the public policies described above, § 2705 states that “[a]ny corporation or association that is organized for the purposes of delivering water to its stockholders and members at cost … is not a public utility, and is not subject to the jurisdiction, control or regulation of the commission.” The term “at cost” is defined to mean “without profit.” Section 2705 goes on to provide that, “[h]owever, a mutual water company may perform the following acts without becoming a public utility and becoming subject to the jurisdiction, control or regulation of the commission: … (c) May transfer water or water rights to, or exchange water or water rights with, another entity pursuant to state or federal law, or both.”

It is clear from the language of § 2705 that while the central purpose of the statute is to describe the general circumstances under which a mutual water company is exempt from CPUC regulation, there are also special actions that a mutual may undertake without becoming subject to regulation. One of those is the implementation of water transfers or exchanges, in subsection (c). I have heard the argument that the phrase “at cost” in the main text of § 2705 should apply to each of the five subsections (a) through (e), but that argument fails as a matter of statutory interpretation because three of the subsections – (a), (b) and (d) – repeat the phrase “at cost,” which would be redundant if that concept applied to all the subsections based on the main text. Rules of statutory interpretation require that all language of the provision be given effect to the extent possible, and for § 2705 that means not applying the phrase “at cost” to those subsections – (c) and (e) – that do not expressly include it. It is best to conclude that the Legislature intended to apply the “at cost” limitation only to those subsections in which the language appears.

This interpretation of § 2705 is consistent with the historical acceptance by the courts of water transfers at the wholesale level that do not trigger CPUC regulation. Examples of such cases include Garrison v. North Pasadena Land & Water Company, 163 Cal. 235 (1912) (sale from a mutual to an investor-owned water utility), Marin Water & Power Company v. Town of Sausalito, 168 Cal. 587 (1914), and City of San Diego v. La Mesa, Lemon Grove and Spring Valley Irrigation District, 109 Cal.App. 280 (1930). Those courts concluded that bulk water transfers do not fall within the jurisdiction of the CPUC because the private water companies at issue did not offer water for sale to the public, but only sold water to other entities that could be assumed to have the commercial sophistication to represent their own interests. A buyer in a water transfer is not like a utility customer who is subject to the utility’s monopoly power; such a buyer may seek a water transfer with a number of potential sellers and may negotiate the terms and price of the transaction. Those cases are consistent with the fact that in addition to satisfying the requirements of § 2705, a private water company is regulated by the CPUC only if the company has dedicated its assets, including water supplies, to public use. That common law test has been in place for a century now, and has been reviewed and accepted by the California Legislature and courts as high as the United States Supreme Court.

California law supports the ability of water rights holders to engage in water transfers. The California Constitution, Article X, § 2 mandates the greatest use of water resources of the state, and effective and efficient reallocation between water users is a necessary component of achieving that fundamental state policy. The California Water Code expressly authorizes water transfers in a number of ways, including but not limited to:

• State policy to facilitate the voluntary transfer of water and water rights (§ 109);
• Transfers by public agencies (§§ 380-387);
• State assistance for water transfers (§§ 470-484);
• Transfer of water made available by conservation or use of recycled or desalinated water (§§ 1010, 1011);
• Water leases (§§ 1020-1031);
• Temporary transfers (§§ 1725-1732);
• Long-term transfers (§§ 1735-1737);
• Transfer of decreed water rights (§ 1740);
• Transfers by water suppliers (§§ 1745-1745.11);
• Use of water conveyance facilities to implement water transfers (§§ 1810-1814);
• State policy supporting water transfers within integrated regional water management plans (§§ 10531, 10537(c)).

None of these provisions states or implies that mutual water companies are not able to engage in water transfers or that such transfers should be conducted without financial compensation to the seller. The essence of a water transfer is a voluntary transaction between a willing seller and buyer, and almost always the consideration for a seller to enter into such a transaction is monetary. Thus, California law generally supports the right of any water rights holder, including a mutual water company, to sell water for financial remuneration.

I think what this argument shows is that opponents of market mechanisms and private sector participation in water are increasingly looking for legal grounds by which to challenge transactions they would disfavor. Every water rights holder, whether it is a mutual water company, private investor or even a public agency, should be aware that opponents are likely to challenge any attempted water transfer, but it should also be aware that the law and good public policy are on its side.

On August 25, 2011, the Second District Court of Appeal published its decision in the Palmdale case. While the decision had been rendered earlier in the month, the court decided to publish its opinion on the 25th, meaning that the decision now has precedential effect in the courts. Given the outcome described below, there is a good chance Palmdale Water District will appeal the decision to the California Supreme Court, with continued amicus support from the Association of California Water Agencies (ACWA).

The Palmdale Water District, located in the Antelope Valley area of Los Angeles County, sought to raise its revenue in 2008 due to rising expenses and decreased revenues from its then-current rates. The board of directors hired a financial consultant and considered several options for rate design, eventually deciding to proceed with a “Fixed/Variable Cost Allocation” (FV) method. The FV rate design was established to recover 60 percent of revenues through fixed monthly service charges and 40 percent through commodity rates. The commodity rates were divided into five tiers, with higher prices for each progressive tier, and the tiers defined by percentages of a water budget set for each customer. The budget was determined for residential customers based on indoor and outdoor use allocations, commercial customers based on a three-year previous use average, and irrigation customers based on an outdoor allocation only. In addition, the speed at which each customer type moved up the tiers was different, as shown in the figure below. As is apparent, the FV method increased rates for irrigation customers more rapidly than for residential or commercial customers.
The district’s financial consultant also provided the board of directors with a second rate design option, ominously called “Cost of Service,” which collected a lower proportion of the district’s costs through fixed service fees. That option was expected to further incentivize efficient use of water based on higher commodity rates, but would have caused greater volatility in district revenues. This dilemma has been faced by many water utilities over the past few years, as there has been a push to drive water efficiency through customer incentives rather than specific directives (which approach, in my opinion, is well justified in a liberal society). I have written about the dilemma of conservation and utility revenues in a prior post.

The City of Palmdale challenged the district’s FV rate design based on the different commodity rate tiers imposed on irrigation customers, as opposed to residential or commercial customers. The city is an irrigation customer based on its maintenance of parks, playing fields and playgrounds. According to the city’s argument, the district violated Proposition 218 by treating irrigation customers differently without a cost-of-service justification, i.e., because it costs the district no more to provide irrigation water than it does residential or commercial water. In addition, the city argued that the fixed service fee for each water meter, the commodity rate tiers and the water budget allocation to each customer were not proportional to the cost of providing service.

Proposition 218, also known as the Right to Vote on Taxes Act, was adopted by California voters in November 1996. Codified at Articles XIIIC and XIIID of the California Constitution, Proposition 218 places both procedural and substantive limitations on property-related fees or charges, including water utility rates. Procedurally, a government-owned utility must adopt rates through a public hearing process and give voters the opportunity to protest. Substantively, utility rates must be set so that revenues do not exceed the funds required to provide the service, and the fee or charge imposed on any ratepayer must not exceed the proportional cost of the service attributable to that ratepayer.

The district first defended its rates by claiming the establishment of commodity rate tiers is not subject to the requirements of Proposition 218. The court rejected this argument, citing Bighorn-Desert View Water Agency v. Verjil, 39 Cal.4th 205 (2006), the seminal case holding that water rates are property-related fees subject to Proposition 218. In Bighorn, the California Supreme Court held that “all charges for water delivery are charges for a property-related service, whether the charge is calculated on the basis of consumption or is imposed as a fixed monthly fee,” and the Palmdale court concluded that such language applies not only to water rates as a whole but also to each constituent part.

The district then argued that its commodity rate tiers were set appropriately to incentivize the efficient use of water pursuant to the California Constitution, Article X, § 2. The district specifically cited Water Code § 372, which authorizes water utilities to adopt conservation rates that rely on allocation budgets. The court sidestepped the issue of potential conflicts between Proposition 218 and Article X, § 2, holding that conservation rates are not at odds with Proposition 218 as long as such rates are set in a proportional manner. The court noted that § 372 provides only general authority for conservation rates and does not mention inequality of tiers between different types of customers. As stated in § 372(a)(4):

A conservation charge shall be imposed on all increments of water use in excess of the basic use allocation. The increments may be fixed or may be determined on a percentage or any other basis, without limitation on the number of increments, or any requirement that the increments or conservation charges be sized, or ascend uniformly, or in a specified relationship. The volumetric prices for the lowest through the highest priced increments shall be established in an ascending relationship that is economically structured to encourage conservation and reduce the inefficient use of water, consistent with Section 2 of Article X of the California Constitution.

The court held that the district’s rates violated Proposition 218 because they treated irrigation customers differently than residential and commercial customers with no cost-of-service justification. Although the district argued that the rates were designed to disincentivize use of urban water for irrigation, the court noted that both residential and commercial customers may use water for irrigation, but it was only those customers in the “irrigation only” category that paid higher rates. In addition, the record was clear that the Cost of Service rate design provided greater incentives for water efficiency than the FV design, and the district seemed to choose the latter over the former based solely on concerns about its own revenue stability.

Although the city argued that the fixed service fee, commodity rate tiers and water budget allocations of the FV rate design also violated Proposition 218, the court did not reach those issues. Thus, the court did not resolve many of the difficult questions that exist at the intersection of conservation rates and Proposition 218. While conservation water rates are commonly seen as good public policy, and there is express statutory authority for their adoption, there are serious questions about their viability in light of the California constitution. It seems likely that future cases will force the courts to address the issues head-on.

One approach that may satisfy the twin goals of promoting water efficiency and complying with Proposition 218 is the adoption of water rates based on the marginal cost of supplies. Under this approach, a water utility would create commodity rate tiers based on each of its water supplies, with the lowest-cost supply for the first tier, and higher-cost supplies for the following tiers. Some water professionals have suggested setting the highest rate tier at the cost of developing new, currently undeveloped supplies, and that fits well with a marginal cost approach. This would appear to be defensible under Proposition 218 because it expressly connects each rate tier to the cost of service, and good policy because it effectively communicates the cost of developing new water supplies to ratepayers. Such an approach might be difficult to implement because water supply costs are often fixed regardless of utilization and could not be entirely dependent on customer usage. Very few, if any, public agencies have sought to adopt rates based on a marginal cost approach.

While we wait for the Palmdale case to be resolved by the California Supreme Court and for a future court to address the issues left unanswered by the Court of Appeal’s decision, water utilities will need to proceed with caution, knowing there is a fog of uncertainty about what lies ahead. If the courts were to resolve future disputes about the intersection between conservation water rates and Proposition 218 without a clear understanding of the significant policy questions implicated, there is the possibility of a major collision that will snarl progress on water resources management for many years to come.

The Tehama-Colusa Canal Authority (TCCA) is a joint powers authority made up of 16 CVP contractors in the Sacramento Valley. Each of those contractors has its own water service contract with USBR, originally entered into during the 1960s or 1970s, and renewed in 2005. The terms of those contracts are standard across all contractors, including the Article 12 provisions related to water shortages. During the last 33 years, USBR determined that a water shortage existed in 10 years, including 2008 and 2009. In 2008 and 2009, respectively, the Sacramento Valley contractors received 100 and 40 percent of their full contract supplies, as opposed to 50 and 10 percent for San Joaquin Valley contractors. Nevertheless, TCCA claims that its members are entitled to 100 percent allocations before San Joaquin Valley contractors may receive any Sacramento River water from the CVP, based on the awarding of prior rights to water users within the area of origin of the Sacramento River.

The CVP is an extensive system of reservoirs, pumps and canals that delivers water for irrigation, municipal, industrial and environmental purposes within the Central Valley of California. Its largest reservoir is Lake Shasta on the Sacramento River, which holds 4.552 million acre-feet of water and was completed in 1948. The CVP began as a project envisioned by the State of California in 1933, but was assumed by the USBR as a federal project in 1935 due to a lack of state funding. The purpose of the CVP is to develop, store and deliver water from the Sacramento River and other streams draining the Sierra Nevada mountains for beneficial use in the Sacramento and San Joaquin Valleys. The Sacramento River and its tributaries are the largest source of water for the CVP.

When the CVP was being developed, there was a concern expressed by residents and lawmakers in the Sacramento Valley that the export of Sacramento River flows to the San Joaquin Valley would deprive them of adequate water resources. This is a common concern seen in opposition to interbasin water transfer projects across jurisdictions and throughout history, including new projects being planned today. It was manifested in 1933 by the California Legislature adopting California Water Code §§ 11460-11463, known as the “area of origin” statutes. Those statutes provide that the appropriation of water for export from a watershed may not deprive potential users within the area of origin of water in the future. Federal and state courts and the State Water Resources Control Board (SWRCB) over the years have determined that the area of origin statutes allow a person within a watershed to apply for an appropriative water rights permit that is senior to the rights of exporters, even though the area of origin application is filed later in time. Thus, the statutes create an exception from the doctrine that the relative priority of appropriative rights is determined by when each appropriation was initiated, commonly known as “first in time, first in right.”

At issue in the TCCA v. US decision was whether the area of origin statutes also require the USBR to allocate water within the CVP to Sacramento Valley contractors with a higher priority than to San Joaquin Valley contractors. The first question presented was whether the USBR has legal authority to allocate water according to a method that does not include area of origin priorities, and the second question was whether the USBR exercised its discretion arbitrarily and capriciously by allocating water in 2008 and 2009 without regard to area of origin priorities.

Regarding the first question, the court held that USBR is not required to allocate water within the CVP based on area of origin priorities. The court relied heavily on Section 4 of the Act to Authorize Sacramento Valley Irrigation Canals, Central Valley Project, California, Pub. L. No. 81-839, 64 Stat. 1036, § 2 (1950), which directed that the canals used to deliver water to TCCA members be “coordinated and integrated” with “the existing features of the [CVP] in such manner as will effectuate the fullest and most economic utilization of the land and water resources of the Central Valley of California for the widest public benefit.” (Emphasis in court opinion, at 14.) As read by the court, Section 4 does not evince a Congressional intent for water to be allocated among CVP contractors according to any particular set of priorities, such as to an area of origin, but rather gives USBR considerable discretion in the operation of the CVP. USBR has historically allocated CVP water supplies pursuant to the shortage provisions of Article 12 of the CVP service contracts. Each of the TCCA members executed such an agreement and subsequent renewals with USBR, despite USBR’s refusal to include an area of origin priority, which undercut their assertion that the allocation method was illegal.

The court also cited a California Attorney General Opinion in 1955 that analyzed the scope and effect of the area of origin statutes. The Attorney General opined that the statutes create an inchoate priority only, and in order to seize that priority, a water user must comply with the general state laws regarding the formation of a water right. In the case of an appropriative right such as held by the CVP or, potentially, a TCCA member, that would mean filing and prosecuting an application with the SWRCB. Neither TCCA nor any of its members has ever filed such an application, leading the court to conclude that they could not have obtained any rights with area of origin priority. Furthermore, TCCA did not claim any water rights, but only a priority to water deliveries from the CVP, which is entirely outside the scope of the area of origin statutes. As the court explained, “[a]rea of origin statutes do not dictate the allocation by the Bureau of CVP water. Area of origin statutes help determine the quantity of water available to the Bureau for allocation, not how the water is allocated by the Bureau’s Contracting Officer.” This is reflected in Term 22 of the USBR permit issued by the SWRCB, which provides that USBR’s diversions are subject to rights initiated by applications for use within the Sacramento River watershed “regardless of the date of filing applications,” which is the hallmark of the area of origin laws.

Within federal reclamation law. the court noted the lack of any statutory provision supporting TCCA’s claim of area of origin priority. The acts governing the CVP do contain two provisions giving area of origin priority to certain water users, in the Trinity River and Stanislaus River watersheds, but there is no such provision favoring Sacramento Valley contractors. The court noted that the provisions favoring other areas of origin demonstrate Congress’s awareness of the policy issue and ability to create a priority when intended, so that the absence of a specific statutory section for the Sacramento Valley means Congress did not intend to create area of origin priority for north-of-Delta contractors.

TCCA’s best argument in favor of area of origin priority came from language contained in an important state court decision, State Water Resources Control Board Cases, 136 Cal.App.4th 674 (2006). The opinion in that case stated that:

To the extent § 11460 reserves the inchoate priority for the beneficial use of water within its area of origin, we see no reason why that priority cannot be asserted by someone who has [or seeks] a contract with the Bureau for the use of that water. (See Robie & Kletzing, Area of Origin Statutes – The California Experience (1979) 15 Idaho L. Rev. 419, 436-438 (discussing right of area of origin users to contract with Department [of Water Resources] for SWP water). This does not mean a user within the area of origin can compel the Bureau to deliver a greater quality of water than the user is otherwise entitled under the contracts [sic]. It simply means the Bureau cannot reduce that user’s contractual allotment of water to supply water for uses outside the area of origin, absent some other legal basis for doing so that trumps § 11460. (Emphasis in original.)

The federal court rejected TCCA’s reliance on this language, because operation of the CVP and its water service contracts were not at issue in the SWRCB Cases (making it non-precedential dictum), the focus of the law review article cited was on the State Water Project rather than the CVP, and interpreting the area of origin laws in this way would bring them into conflict with the federal law that requires operation of CVP facilities for the widest public benefit. The court did not mention, but I will add, that the language quoted above merely states that a water user with an established area of origin priority could request that USBR deliver such water to it, similar to the arrangement by which USBR delivers water to pre-existing water right holders on the Sacramento River pursuant to Settlement Contracts. Consistent with that language, USBR has no discretion to reduce deliveries of water to Settlement Contractors except in critical years, and even then only by 25 percent pursuant to the terms of those agreements. The TCCA members have water service contracts with USBR, not water service agreements.

Based on the analysis above, the court determined that USBR possesses the legal authority to allocate water without regard to any area of origin priority for north-of-Delta contractors. The court next turned to whether USBR acted in an arbitrary or capricious manner in its implementation of the CVP water service contracts.

The water service contracts executed by USBR and the TCCA members provide that in the event of shortage, defined as a condition when USBR cannot fulfill complete deliveries to all CVP contractors, USBR will allocate water among the contractors pursuant to the then-existing M&I Water Shortage Policy. The current policy generally allocates water on a pro rata basis, except when “specific operational constraints require otherwise,” and does not distinguish between north-of-Delta and south-of-Delta contractors. The court held that USBR has not acted in an arbitrary or capricious manner in applying those provisions or in refusing to allocate water to Sacramento Valley contractors according to an area of origin priority, because there is no contractual language requiring such a priority.

In addition to interpreting the contract language, the court analyzed the course of dealing and course of performance of the parties under the CVP water service contracts. The court noted that USBR has consistently refused to recognize any area of origin priority in its negotiation or performance of the contracts or renewals, despite TCCA’s repeated requests. The court noted that TCCA and its members had their water service contracts validated as a matter of state law after execution, including the shortage provisions. In a final coup de grace, the court found that TCCA and its members are equitably estopped from claiming that USBR allocation of water pursuant to the CVP contracts is unlawful, because they intentionally misled USBR into believing that the parties were in agreement with the meaning of the shortage provisions. The court agreed with the defendants’ argument that “TCCA’s strategy of feigning agreement to induce the Bureau to execute the Renewal Contracts so it could then claim there was no agreement to the essential terms governing shortage is behavior equity should not countenance.” Accordingly, TCCA was barred from seeking any equitable relief from the court, including a declaration of rights or injunction.

In summary, the court rejected every argument that TCCA offered to establish a priority right to CVP water allocation based on area of origin. Under this ruling, USBR may allocate water according to its M&I Water Shortage Policy without regard to whether contractors are located north-of-Delta in the Sacramento Valley or south-of-Delta in the San Joaquin Valley. While TCCA or parties with similar interests may continue making future claims to priority allocations of CVP water supplies, as of now those claims do not appear likely to gain a favorable result from Judge Wanger. As he has become in many respects the de facto watermaster of the Sacramento River and Delta, this is significant. It remains to be seen whether TCCA will appeal the decision.

Outside the context of the CVP, this case has provided a good discussion of the process for obtaining prior water rights in an area of origin in California. Such area of origin rules continue to create uncertainty for large interbasin water transfer projects, which are subject to the possibility that their yield may be decreased based on later appropriations for intrabasin use. Such rules threaten the investment-backed expectations of project owners and discourage the making of investments in water infrastructure in the first place. While it may be hard to imagine the successful permitting of an intrabasin water project in the Sacramento Valley that would have a significant impact on CVP operations, there are a number of potential projects across the United States that face opposition from residents in the area of origin, and such rules are often proposed as a way of mitigating the conflict. Legislators and project sponsors should be wary of establishing or accepting such rules.

UPDATE: TCCA has appealed Judge Wanger’s decision to the Ninth Circuit. That review will likely take approximately two years to complete. TCCA might withdraw its appeal, but given the importance of the issue to the parties and the strong nature of Judge Wanger’s decision, I would not expect any settlement of the direct merits of the dispute.

SAWS and LCRA entered into a Definitive Agreement for joint development of the water conservation and transfer project on March 1, 2002. The two agencies initially contemplated that the project would generate up to 330,000 acre-feet per year, of which 150,000 acre-feet would be exported to San Antonio with the remainder left in the lower Colorado River Basin for agricultural use. The contract provided for two phases, a Study Period followed by an Implementation Period. From 2002 through 2009, the two agencies conducted a number of technical studies, which showed that the yield of the project would be less than originally anticipated. In April 2009, LCRA determined that the project would not generate sufficient water supplies to meet its goals and notified SAWS that it would not proceed with the project. SAWS filed suit against LCRA shortly thereafter, claiming that the project continued to be feasible and that LCRA had breached the Definitive Agreement based on improper political and financial considerations. SAWS had spent approximately $43 million in development of the project and sought recovery of that investment, plus damages for the alleged difference between the cost of water from the project and an alternative source, totalling $1.23 billion.

In February 2010, the trial court held that LCRA was immune from suit and therefore dismissed the case. SAWS appealed that decision, and the Third District Court of Appeals addressed the issue de novo. In an opinion released on July 29, 2011, the Court of Appeals reversed the trial court and remanded the case for further proceedings.

In reaching its decision, the Court of Appeals analyzed the waiver of immunity contained in Texas Local Government Code § 271.152, which provides in part that: “A local governmental entity that is authorized by statute or the constitution to enter into a contract and that enters into a contract … waives sovereign immunity to suit for the purpose of adjudicating a claim for breach of the contract.” LCRA argued that the waiver of immunity should not apply for two reasons: (i) the statutory subchapter concerns contracts for providing goods or services to the local government entity, and the proposed water transfer would not supply goods or services to LCRA; and (ii) Texas Local Government Code § 271.153 contains additional requirements for waiver that did not exist in this case. The court held that the Definitive Agreement was a qualifying contract because it provided for SAWS to fund feasibility studies that subsequently became the property of LCRA, which constituted “providing goods or services” to LCRA. The court also held that the requirements of § 271.153 limit the statutory waiver of liability rather than the § 271.152 waiver of suit. As the court described the distinction, “[i]mmunity from suit bars suit against a governmental entity altogether and deprives a court of jurisdiction, whereas immunity from liability bars enforcement of a judgment but does not affect a court’s jurisdiction.” Because § 271.153 only limited the waiver of liability, it did not act to deprive the court of jurisdiction over SAWS’ lawsuit.

The Court of Appeals decision does not represent a significant development in water resources law, although it does clarify the scope of the waiver of local government immunity contained in Texas Local Government Code § 271.152, which is important since most water providers in Texas are local governmental entities. Rather, the primary result of the decision is to give new life to the dispute between SAWS and LCRA over their failed water transfer. SAWS has to some extent moved on from the transaction to other water supply planning efforts, such as a smaller collection of proposed import projects with private parties and brackish groundwater desalination. Nevertheless, if SAWS were to prevail in its lawsuit against LCRA, the financial consequences would be significant for both agencies. It is a good reminder of the damage that shifting politics can inflict on water projects, and that such projects also are commercial arrangements, in which participants can effectively protect their investments against changes in political will through properly drafted contracts.

P3s are a method of combining the strengths of both the public and private sectors for the accomplishment of infrastructure projects in sectors as diverse as water and wastewater, highways, rail, ports, aviation, transit-oriented development, green buildings and schools. A P3 allows the public agency to envision the project and control its development, while using the experience and creativity of private sector firms to deliver the project on time and within budget. A well-structured P3 also allows the public agency to shift certain risks associated with large infrastructure projects to the private firms involved, and creates incentives that align the interests of the public agency and private firms to the greatest extent possible. P3s are used extensively outside the United States and have proven to be a superior delivery method for achieving timely and cost-effective projects. They can be quite complex, however, and have not been used widely in California, so this conference is intended to provide public agency officials with a good basic understanding of what P3s are and how they can be used to benefit the public.

I will be attending the conference and speaking about the legal framework for P3s in California, and hope to see you there. You can find the conference brochure with all the pertinent details here: NCPPP Conference Flyer.