methods and challenges in the credible valuation of water rights in texas, dr. charles porter

Methods and Challenges in the Credible

Valuation of Water Rights in Texas

Texas Water Conservation Association Austin, Texas, March 3, 2017

By: Charles Porter, Ph.D., Visiting Professor of University Studies, College of Education St. Edward’s University

www.charlesporter.com (512) 627-3793and

Edmond R. McCarthy, Jr. McCarthy and McCarthy, L.L.P.

All Rights ReservedUse prohibited without prior approval by Charles Porter and Ed McCarthy

Time is of the essence.

Absolutely in all water transactions.

What is demand?

Demand is an economic principle that describes a consumer's desire and willingness to pay a price for a specific good or service.

I think willingness to pay also means ability to pay. Many local governments cannot afford it and their constituents want no new taxes.

“Fair Market Value” Texas Water Code“Whenever the law requires the payment of fair market value for a water right, fair market value shall be determined by the amount of money that a willing buyer would pay a willing seller, neither of which is under any compulsion to buy or sell, for the water in an arms-length transaction and shall not be limited to the amount of money that the owner of the water right has paid or is paying for the water.”

“compulsion to sell” or “duress”

Water Code, Title 2, Subt. B Water Rights, Chapter 11, Subchpt. A, sec. 11.0275.

Question:

Many water transactions are completed under “duress” or “compulsion to buy”…

meaning to a valuation expert that prices paid during droughts or under pressure due to court rulings must be adjusted for duress.

From: Leidner, et al.. “The Water Market for the Middle and Lower Portions of the Texas Rio Grande Basin”. Journal of the American Water Resources Association, 2011, p.3.

“Duress” is ever-present in Texas Water?

Valuation Methodologies

1.Replacement Cost

2. Income Capitalization (Direct and Yield)

3. Comparable Sales or Leases

and (a non-traditional approach)…

4. Court Rulings

1. Replacement Cost Method

Groundwater with center pivot irrigation.

Reasonably easy to determine:

a. the cost of the irrigation well;

b. the cost of the distribution system (likely center pivot); and,

c. other expenses such as electricity line to the well pumps, diesel engines for the pumps.

A Basic Center Pivot Irrigation System

Item Cost Total Cost

600 foot deep groundwater well with casing $ 35 per foot $ 21,000

1,000 foot center pivot sprinkler system $ 104 per foot 104,000

1,000 feet of electricity line and poles $ 5 per foot 5,000

------------

Total System Replacement Cost Estimate $ 130,000

or $1,625 per acre (assume 80 acres)

Conversion of Replacement Cost to Acre-foot Value of the Groundwater Required

for 80 acres of corn

Item Total

1.53 acre-feet of water per acre X 80 acres 122.4 acre-feet water

Replacement cost of irrigation system $ 130,000

Indicated value of the water required $ 1,062 per acre-foot

Indicated value adjusted ten year economic life $ 106 per acre foot

Corresponds roughly to Comparable Leases SAWS in Edwards Aquifer

2. Capitalization of Net Operating Income Method (Direct

and Yield)

What “capitalization rate” to use?

A high one! Why?

RISK

Net Operating Income of an 80 Arce Feed Corn Crop

at $4 and $7 per Bushel: 

$4 per bushel X 143 bu per acre X 80 acres $ 45,760Less: $507.51 per acre X 80 acres planting cost 40,601Less: amortized cost of irrigation well 13,000 ----------Net Operating Income $ (7,841)

$7 per bushel X 143 bu per acre X 80 acres $ 80,080Less: $507.51 per acre X 80 acres planting cost 40,601Less: amortized cost of irrigation well 13,000

----------Net Operating Income $ 26,479

Direct Income Capitalization Method say 10% cap rate = $0 - $264,790

Indicated value per acre foot 122.4 acre feet used = $2,163 per acre foot

Yield Income Capitalization Method Year 1 Year 2 Year 3 Year 4 Year 5

Net Operating Income 80 Acre Crop of Corn @ $7/bu $26,479 $26,479 $26,479 $26,479 $26,479Discount Factor Rate 30% 30% 30% 30% 30%Discount Factor 0.769 0.592 0.455 0.35 0.269Discounted Value $20,362 $15,676 $12,048 $9,268 $7,123

Net Present Value of Receipts $64,476Net Present Value per Acre-Foot (122.4 Acre-Feet) 5 years $527

Net Present Value 4 Year Lease $57,354 $469 per ac.ft.Net Present Value 3 Year Lease $48,086 $393 per ac.ft.Net Present Value 2 Year Lease $36,038 $294 per ac.ft.

Very High Risk Projection Groundwater

Yield Income Capitalization Method Year 1 Year 2 Year 3 Year 4 Year 5

Net Operating Income 80 Acre Crop of Corn @ $7/bu $26,479 $26,479 $26,479 $26,479 $26,479Discount Factor Rate 10% 10% 12% 16% 20%Discount Factor 0.901 0.826 0.712 0.552 0.402Discounted Value $23,858 $21,872 $18,853 $14,616 $10,645

Net Present Value of Receipts $89,843Net Present Value per Acre-Foot (122.4 Acre-Feet) 5 years $734

Net Present Value 4 Year Lease $79,199 $647 per ac.ft.Net Present Value 3 Year Lease $64,582 $528 per ac.ft.Net Present Value 2 Year Lease $45,729 $374 per ac.ft.

Reasonable Risk Projection Groundwater

Yield Income Capitalization Method - 30 ac.ft. Year 1 Year 2 Year 3 Year 4 Year 5Surface Water Lease Up Front Payment Sr. Right

Net Operating Income $6,000 $6,000 $6,000 $6,000 $6,000Discount Factor Rate 10% 10% 12% 16% 20%Discount Factor 0.901 0.826 0.712 0.552 0.402Discounted Value $5,406 $4,956 $4,272 $3,312 $2,412

Net Present Value of Receipts $20,358Net Present Value per Acre-Foot (30 Acre-Feet) 5 years $679

Net Present Value 4 Year Lease $17,946 $598 per ac.ft.Net Present Value 3 Year Lease $14,634 $488 per ac.ft.Net Present Value 2 Year Lease $10,362 $345 per ac.ft.

Senior Priority Right Surface Water

Yield Income Capitalization Method - 30 ac.ft. Year 1 Year 2 Year 3 Year 4 Year 5Surface Water Lease Up Front Payment Jr. Right

Net Operating Income $3,000 $3,000 $3,000 $3,000 $3,000Discount Factor Rate 30% 30% 30% 30% 30%Discount Factor 0.769 0.592 0.455 0.35 0.269Discounted Value $2,307 $1,776 $1,365 $1,050 $807

Net Present Value of Receipts $7,305Net Present Value per Acre-Foot (30 Acre-Feet) 5 years $244

Net Present Value 4 Year Lease $6,498 $217 per ac.ft.Net Present Value 3 Year Lease $5,448 $182 per ac.ft.Net Present Value 2 Year Lease $4,083 $136 per ac.ft.

Junior Priority Right Surface Water

What is the value of a junior surface water right in a drought of record?

$0.But… drought, especially record drought, brings “duress” or causes “compulsion to buy” - $0 is

not fair market value of a junior water right.

3. Comparable Sales/Leases Sources •Attorneys with experience in water rights/permits.

•Existing sales or lease contracts – willing individuals or government agencies.•Real property records.•Pending lawsuits and testimony district court files.•County Ag Agent, Implement/Irrigation/Seed Dealers.

•Court rulings such as Bragg v. EAA. •Petroleum landmen.•Individual GCDs, EAA, River Authorities.

•Real estate agents?

•Water well drillers, local FSA, Farm Bureau.

Simple Value of Leased Water 30 acre feet of groundwater for $200/acre-foot for one year.

Net Operating Income = $6,000 per year

First Year = $6,000 / 30 ac. ft. = $ 200 per acre foot

But over 5 years we need to calculate a net present value by discounting the proceeds.

Comparable Leases SAWS in Edwards Aquifer

From: Leidner, et al.. “The Water Market for the Middle and Lower Portions of the Texas Rio Grande Basin”. Journal of the American Water Resources Association, 2011, p.8.

Sales in Crockett County to Oil Companies in 2013 - 50 Acre-foot tanks (387,918 bbl) at $ .42 to $ .80/bbl =

$3,259 to $6,270 per ac.ft.

Court Case Value Ruling

Groundwater ruled in one recent case, to be

$5,500 per acre foot.

Surface water case?

1. Replacement cost method  

2. Income capitalization method

3. Sales comparison method

4. Court rulings

Summary of Methodology

Thank You

charlp@stedwards.edu512-627-3793