Economics of optioning agricultural water rights for urban water supplies during drought

Water supply option contracts have been proposed as an alternate form of water market to reduce urban drought insurance supply costs. Urban water needs during critical low flow periods could be supplied by entering into an option agreement with farmers. The exercise of the option would transfer water to higher valued uses when needed, while returning the water to crop production during normal water supply situations. Option contracts for the multiple use of renewable resources such as water are an untried concept.;This research develops water supply option contract criteria and evaluates their economic and institutional feasibility. An equation to analyze the economic value of multiple exercise option contracts is developed and contract terms and provisions are suggested. A case study area, a part of the Cache la Poudre River Basin in northeastern Colorado, is used for a detailed analysis. The potential for water option contracts between the City of Fort Collins, Colorado and farmers supplied by the North Poudre Irrigation Company is analyzed. Models simulating economic, hydrologic and institutional conditions are developed to estimate drought frequency and severity, institutional and priority drought water allocation and agricultural drought water values for alternative conditions.;Analysis of the economic, hydrologic and institutional criteria indicate that the fundamental conditions required to develop option contracts already exist in many areas of the semi-arid western U.S. Water supply option contracts are found to generate net economic benefits over a wide range of economic and hydrologic conditions. The factors that have the greatest influence on option contract value are initial water right prices, expected future water right price appreciation and the interest rate. The current productive value of water and the frequency of drought (option exercise) have less effect on the value of water option contracts.;Water supply option contracts are feasible and can provide substantial economic benefits as an alternate means to secure urban drought water supplies. The willingness of farmers and urban users to enter option contracts may be the greatest limitation to their development. Further research is recommended to ascertain urban and agricultural option contract acceptance, agricultural benefits and secondary impacts.