The Colorado River, which supplies water to 35 million people and four million acres of irrigated agriculture across seven states (plus two in Mexico), is running dry after 15 years of drought.
That's both a problem and an opportunity for impact investors.
A new report lays out a menu of approaches through which private capital can help restore the 246,000 square mile Colorado River Basin. The river is one of the most heavily regulated and developed water systems in the world, meaning that if sustainable, market-based approaches work there, they may be applicable elsewhere.
"This is not simply a problem of drought, but it is a problem of long-term demand for water far outstripping supply," said Ricardo Bayon, an author of the report and co-founder of Encourage Capital, an asset management firm that has developed innovative financing approaches to a range of social and environmental problems.
"Our investigation has found that there are now substantial opportunities for investment that could help address these systemic problems, while still producing interesting financial returns."
The nearly 400-page report, "Liquid Assets: Investing for Impact in the Colorado River Basin," reflects the complexity of water issues, especially along the Colorado, which has been managed around rigid allocations and publicly funded infrastructure. The report calls that the "big engineering, grey infrastructure" approach to water management.
Given the deep level of uncertainty about water availability - Lake Mead is at levels not seen since it was first filled in the 1930s - more flexible systems are needed to respond to changing conditions, values and demands, says the report, which was co-authored by the law firm Squire Patton Boggs and funded by the Walton Family Foundation.
The authors say their goal is to help individual water users adjust to changing conditions from year to year and to protect critical economic and ecosystem values from the growing risks. Blueprints for the investment approaches, including financial models, are available at www.encouragecapital.com.
The recommended approaches draw on financing structures that have been applied in other areas, such as cap-and-trade regimes for reducing greenhouse gases, wetland mitigation credits under the Clean Water Act and catch limits and catch-shares in fisheries. "Properly designed, the water management systems of the future could help to internalize the ecological externalities that have been at the heart of the environmental problems on the Colorado," the report says.
Water is a hot investment topic these days. "People get it. Water is scarce and this is going to create a problem," said Stephen Freedman, head of sustainable investing strategy for UBS Wealth Management Americas in New York. "If you are contributing to the solution, it's going to be an investment opportunity."
The nine approaches outlines in the report include a "Forest Health Environmental Impact Bond" that reduces the risks of forest fires and improves the watershed, with investor repaid through savings from reduced firefighting costs and water risk. A similar bond would pay for riparian restoration and removal of invasive species.
Three approaches are intended to reduce agricultural water use, including by converting croplands to higher-value, lower-water-use crops, and by purchasing grazing lands to deploy higher-yield and more sustainable grazing practices.
Two approaches would bolster the efficiency of municipal water systems with "green bonds" tied to environmental improvements, and with "pay-for-performance" contracts to reduce water-system losses.
The most far-reaching proposal may be for a water-storage trading market in surface-water reservoirs and groundwater aquifers. The current system contains "perverse incentives," including use-it-or-lose-it provisions and open access to groundwater resources driving substantial over-pumping.
A system of storage credits would allow storage facilities to provide tools "to manage physical risks and control speculation, as well as insurance-type arrangements to cover water users and/or critical ecological values," the report says.
"The blueprints encourage new thinking in how we design systems of water use that can survive and thrive in the face of variability and inevitable disruption in water supply," said Tom Melton of Encourage Capital.
Follow David Bank on Twitter: www.twitter.com/ImpactAlpha
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