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Audible. There's more to imagine when you listen. Go to audible.com slash imagine and discover all the year's best waiting for you. Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today's episode 425. It's titled, How Profits Motivate Change.
Last Saturday, LaPrielle and I attended a presentation by Kirsten Engel. She is a professor of law at the University of Arizona. She teaches and researches in the areas of environmental and administrative law. Engel served as a member of the Arizona House of Representatives and the Arizona Senate, and last fall she lost an election to Congress.
Arizona in U.S. Congress, in the House of Representatives. Engel mentioned two things that really stood out to me. One I knew, and the one really caused me to ponder. The first is that 72% of water use in Arizona is for agriculture, and her presentation was all about the water situation in Arizona and other areas around the Southwest. I knew that
The water usage by agriculture in Arizona was very high. I've mentioned it on the podcast, and that's similar to other areas in the Southwest. There is a deep agricultural heritage in Arizona and other Southwestern states.
She also mentioned, though, that that percentage is dropping. As water becomes more expensive, it becomes uneconomical to pursue agriculture in certain areas of the state. Martin Wolf, who is a columnist with the Financial Times, wrote, Start with a simple proposition. If something is profitable, it will be done.
by profits when revenue or benefits are greater than the cost.
Wolff was referring to the transition to renewable energy. He wrote, asset managers may dispose of shares in fossil fuel businesses, and banks may refuse to finance them. Some investors might refuse to own or fund companies that do things they consider wicked. But my fellow columnist, Stuart Kirk, is correct that someone else will then own and finance them, provided they are profitable. Those
Those actors might be foreign governments and businesses or domestic private entities. Regulation might curb some activities, but political resistance is likely to make such regulation difficult. If one doubts just how difficult it is to halt a profitable business, take a look at the history of drug prohibition.
I have made that point in regards to ESG investing, that if investors choose not to own particular securities, but how
households and businesses continue to buy the products of those companies, then if there's less desire to own the stock shares, then the value of those shares could fall, the price. But because of the profits, the dividend yield could go higher. And those companies could actually outperform other areas of the market, the companies that pursue activities that might be objectionable.
In order to really change what is going on in the world and the economy, what needs to change are the profits. Where is the profit to be made?
We can look at the example of coal. This is from another Financial Times columnist, John Byrne Murdoch. He pointed out in 2009, coal was still a very attractive option for countries that were looking for affordable energy. By 2020, though, wind and solar was cheaper than coal per unit of energy. Even after installing new solar or wind plants, that was cheaper than coal.
the cost of running existing coal plants. When something becomes more economical, cheaper, then there's more demand for it and less demand for it.
for what is more expensive. And Bern Mirdauch gave the example of India. In 2019, the International Energy Agency forecast that India's installed capacity of coal would grow by 80% between 2018 and 2040. A year later, as renewables became much less expensive, the IEA was forecasting only a 10% growth rate for coal. Now that's a long-term forecast,
We'll see how it pans out, but we can see what's actually happening in energy use. One reason coal is becoming less desirable is due to natural gas. Natural gas consumption around the world increased 28% from 2010 through 2021. There is
Lots of natural gas. It's ample. It's cheap. It is a fossil fuel, though. But if we compare the 28% increase for natural gas over that 11-year period, oil consumption grew 6.8%, and coal consumption grew by 5.9%. As of 2021, coal still makes up 27% of the global energy share.
It's not growing very quickly. Its market share is falling, but there is still an installed base. Renewables are growing very quickly, but still only make up 7% of the energy share. Hydro makes up 7% also. That's not really growing. Nuclear, around 4% of the energy share, starting to grow very, very slowly. But natural gas is 24%, and oil and other liquid fossil fuels are 31%.
Continuing with Martin Wolf then, he asked, how close are we to making renewables the dominant technology for energy supply? Well, they only have a 7% market share at this point. And so even though they're growing very quickly, there is an installed base of other energy sources.
Wolf points out reasons for the relatively slow adjustments to renewables. One is the overhang of low marginal cost installed capacity in electricity generation, heating, transportation, and industry. If you're already using something and it's working, the profit incentive to switch to something else needs to be greater. Otherwise, we'll keep using it.
If you have an internal combustion engine car that works fine, there's not much of incentive to purchase an EV vehicle. We had looked closely at getting the Ford Lightning. We were on the list. But after they raised the price 40% since we were on the list, and the Ford dealerships were not as clear as they should be, in our opinion, as to the potential surcharge above $1,000,
the manufacturer suggested price to actually get the Ford Lightning, the incentive from a profit or cost basis just wasn't there. And so we keep driving our existing vehicle.
Other reasons the renewable energy transition isn't happening faster is the cost of alternatives. To roll them out quickly gets more expensive. There is resistance by existing businesses that make money on fossil fuels, and they're refining the distribution. There is local resistance to building solar and wind farms, the not-in-my-backyard phenomena.
There can be resistance to taking the needed investments to integrate renewable energy into the existing grid.
I saw one report in the New York Times that there are more than 8,100 energy projects that are awaiting permission to connect to electric grids. That was at the end of 2021. That's up from 5,600 the year before. There are so many projects out there trying to connect, and it can take upwards of four years to get approval to connect to the grid. And even then, it might take additional investment on the part of
the Renewable Energy Project to build out the infrastructure to do that if the grid is at capacity. There are impediments then to the energy transition. What can be done? Well, the incentives could change. There could be more of a profit incentive that could increase the revenue or lower the cost or potentially raise the cost for oil and coal compared to other alternatives.
Wolff suggests a number of policy changes, increasing investment in scientific research, which would include battery technology, potentially increasing subsidies for new technologies in order to accelerate the learning on how to use them and lower the cost, stop subsidizing fossil fuels, which subsidies were upwards of $700 billion worldwide in 2021,
We could introduce carbon pricing, carbon tax to adjust the incentives. We have to recognize, though, that those incentives, even though profits are a huge incentive to foster change, the government is always involved at some level, either through regulations or financial support.
Something like the energy transition is a huge, complex endeavor with many unintended consequences, a topic that we discussed in episode 399.
As humans, households, businesses, governments take action in a complex adaptive system, those actions can cascade through the system, leading to both positive and negative consequences. Last year, the U.S. government passed the Inflation Reductions Act.
There is $400 billion in federal funding to clean energy as part of that act, including incentives to purchase electric vehicles. It's a huge infusion of government revenue into the clean energy sector. It's been highly controversial, particularly some of the trade restrictions in the bill. But hopefully the...
Those incentives work from the bottom up, work from a profit incentive. Because after listening to Kirsten Engel's presentation, I did additional research on the water situation in Arizona, including the Central Arizona Project, which is a very large canal project that takes water from the Colorado River all the way to Tucson,
Arizona, where we live. The Colorado River is 1,440 miles long. It goes from its headwaters in Colorado down to the mouth of the Gulf of California. Forty million people rely on the water in the Colorado River. The foundational document for how that water is to be divvied up was established in 1922 through the Colorado River Compact.
That compact divided up the supply of water between the upper basin states, Colorado, Utah, Wyoming, New Mexico, and the lower basin, Arizona, California, and Nevada.
Each basin got 7.5 million acre-feet of water annually, and then an additional 1.5 million acre-feet of water was allocated annually to Mexico as part of a 1944 treaty. That's 16.5 million acre-feet of water. In 1922, no allocation was made to Native American tribes who weren't considered U.S. citizens at the time.
Since then, there's been further legislative actions and Supreme Court decisions to where there are 29 federally recognized tribes in the Colorado River Basin, and 22 of those tribes have rights to 3.2 million acre-feet of water annually. That's over 20% of the river's annual water that flows through it. Now, those allocations are generally baseless,
being taken out of the state's allocation.
This week, the U.S. Supreme Court is hearing arguments from a lawsuit brought by the Navajo Nation that believes it should also have additional access to Colorado River water. The Navajo Nation stretches across 27,000 square miles of Arizona and Utah, and a third of those 170,000 residents don't have access to clean, reliable drinking water, according to the tribe.
The Colorado River Compact was based on the assumption that the average annual flow would be around 16.5 million acre-feet per year. It's been much less than that. The historical flow from 1906 to 2022 has only been 14.6 million acre-feet. And between 2000 to 2022, where we've been in a 23-year drought, it's been much less than that.
It's averaged 12.1 million acre-feet. That has led to a drawdown in the two major reservoirs along the Colorado River. The Lake Mead, which was formed by the construction of the Hoover Dam, which opened in 1935, and Lake Powell, which was formed by the construction of the Glen Canyon Dam,
which was opened in 1963. Combined, those two are only 26% of capacity and getting to levels where their hydroelectric plants won't work or water won't even be able to pass through the dams without making some modifications. Natural flows in the Colorado River have dropped about 20% in the last century and part of that's due to climate change. Warmer temperatures has meant less precipitation, but
but also the drought has led the water that comes through snow and rain soaks into the ground faster and isn't necessarily hitting the river. As a result, the Bureau of Reclamation, which is an office of the Interior Department, has told the states they need to cut their allocation of water by 2 to 4 million acre feet. That's 20 to 40 percent of the annual river flow.
It's been brutal negotiations. Six of the states came up with a proposal, but California, which has the most senior water rights of the lower basin and uses the most water, said no because the six states' proposals included counting evaporation of the
the river water as part of what the states got. And because California is further away, it experiences more evaporation. And California feels like we have the most senior water rights. We shouldn't have to take the biggest cuts. Under the proposal of those six states, California would immediately see a cut of 18.5%.
and potentially a reduction up to 32%, while Arizona would only see a cut of 13% and Nevada 6%. California has its own proposal where it would have less cuts on a percentage basis compared to Arizona and Nevada.
Jack Schmidt, who's director of the Center for Colorado River Studies, said, The truth of the matter is the difference of opinion has been around for more than a century. In many ways, it's been everybody against California. Nothing has changed. And California is the biggest, most important economy with the biggest population. It may be one state, but it's got a lot going for it. Before we continue, let me pause and share some words from this week's sponsors.
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While the Colorado River runs on the border of Arizona, for much of its geographic area, a lot of it's not easily accessible due to the Grand Canyon and other canyons. That's why in the 1950s and 60s, politicians fought.
farmers, and others came up with the Central Arizona Project. It's the largest, most expensive water transfer project ever constructed in the U.S., 335 miles long aqueduct. It can transport one and a half million acre feet of the Colorado River from Lake Havasu on the western side of Arizona all the way across the state to Phoenix and then down to
to Tucson. It was completed in 1992. It cost $5 billion. It was authorized in 1968 and construction began in 1973.
The idea behind it was agriculture would always be the biggest user of Central Arizona Project water, at least initially, because farmers in Arizona were overdrawing the groundwater supply. Between 1940 and 1968, the groundwater levels in many areas of Arizona that would be serviced by the Central Arizona Project had dropped anywhere from 125 to 600 feet.
The overpumping of groundwater in the Central Arizona project area was fairly extensive. For example, between 1953 and 1968, in Central and Southeastern Arizona, farmers were pumping 4.5 to 5 million acre-feet per year
but the natural recharge was only 1.5 million acre-feet per year. So there was this fossil water that was being used up, and the idea was, let's pull from the Colorado River, then farmers can use that.
except that once they went through the analysis, this was such a massive project. Not only do you have to build the infrastructure, but there was pumps and electricity to pump the water, to raise it as it went further east. And it became very clear that cap water, the Central Arizona project water, would just be too expensive for farmers, especially compared to groundwater, which they could just pump. It was
It was closer to the source. Now, somewhere like Yuma, which is right on the banks of the Colorado River, there, pulling from it is very, very inexpensive compared to pulling it from Lake Havasu and then pumping it 350 miles or so to farmers there. As a result of the cost of
This project of which agriculture and urban users were responsible to repay the federal government $2.1 billion of the $5 billion cost. And they're continuing to pay. The Central Arizona Water Conservation District was formed to basically market the water, but it was too expensive. The farmers wouldn't use it. And so water was just not going to be used.
And it was at that point there was an agreement to basically subsidize the water, that the farmers would take even lower, more junior rights of the water to be able to get water at a price that was comparable to pumping groundwater. And that agreement was made in 2004 and 50,
Farmers in, for example, Pinal County, just north of us here in Tucson, they've been paying very, very low rates, which are set to expire in 2030. But because of the cuts to the Colorado River, they've had to give up their water rights to the Colorado River water. And now this year, about 60% of the agricultural land in Pinal County will be fallow.
It was just ironic, though. Here's this huge project to get water from the Colorado River, but it was so expensive that the main users, farmers, they couldn't use it unless it was heavily subsidized. And that's how it's been.
Now, as the urban population has grown, there has been more demand for the water. But in a paper written by W. Michael Hanneman of the University of California, Berkeley, back in 2002, he asked, where did civic leaders and water planners go so wrong when it came to the Central Arizona project? He pointed out it was a huge engineering success.
But from an economic and financial perspective, it was a failure. He wrote, the civic leaders made the mistake of being carried away by the symbolic importance of water in an arid region and the political and emotional issues associated with protecting Arizona's share of the Colorado River. Water is crucial to the prosperity of an arid region. And from Arizona's perspective, it was essential to protect its allotment of Colorado River.
river water. But while water may be more important than money, that is a viable philosophy only if one can find somebody else's money to pay for the water. Grady Grammage Jr., who was a former president of the Central Arizona Project's Board of Trustees, said, when I talk to lay groups about water, people ask, do we have enough? Are we going to run out? And I always say that is equivalent to asking whether you have enough money.
The answer depends on what assumptions you make and how much risk you're willing to take. He considers this fossil water, this groundwater, an inheritance, and so is the Colorado River water. And if we're overtaking our share, then that can be depleted. As part of the agreement to build the Central Arizona Project, Arizona...
had to establish active management areas. The federal government mandated it through Congress, and they established five areas in Prescott, Phoenix, Pinal County, Tucson, and Santa Cruz. And it required, over the long term, to balance out the amount of groundwater being taken each year with the inflow. So they can't be taking more than is flowing in, protecting that inheritance.
But just in those five areas. In other areas of the state, any big corporate farm that has the money can build a very, very deep well and take as much water as they can, including corporations from Saudi Arabia that have signed lease agreements with the state of Arizona to lease land, drill wells, and basically take as much water as they want, grow, grow.
grain, and then ship it 8,000 miles to Saudi Arabia to feed dairy cows in Saudi Arabia.
politicians have failed to manage the groundwater in Arizona, and it's being depleted. The pumpage of this groundwater has been so severe that fissures are forming below homes, below roads. Roads are breaking up because as the groundwater drops, there's more pressure on the ground, and the ground sinks, and it breaks up the roads.
Part of the legislation that formed these active management areas allowed citizens to come together and vote in new ones. The citizens around Douglas, Arizona, were so fed up by the over-pumping of water, which was leading to domestic wells drying up, it was leading to these fissures, damage to the road and other infrastructure, that they voted in, last fall, a new active management area. And now there's going to be management of that groundwater resource.
When I look and think about the Central Arizona project, this huge aqueduct, how expensive it was, so expensive that it wasn't economical for farmers to even use the water unless it was subsidized. That provides some caution when you look at some of the other major projects that Arizona politicians are considering. To build a desalinization plant in Mexico on the Sea of Cortez.
and then moving the water all the way up to Lake Havasu to the Central Arizona project to put it in the canal, or to pump water from the Mississippi River all the way to Arizona. Huge bills to do that. And then when I look at what the cost of water is in Arizona, the average cost is $53 per month, half of what it cost in
in West Virginia, which is $105 per month. Water is way more expensive in West Virginia because they have so many hills. And so there's a lot of pumping of water uphill to get to the home. So it's very, very expensive water.
When we talk about the profit incentive, including reducing cost, there's very little incentive for households in Arizona to conserve water because it's so cheap. There are farmers that are finding it more expensive, but their water is subsidized if it's coming from the Central Arizona Project. Potentially, it's free other than pumping it if you're outside of these active management areas. So there's a lot of conflicting incentives.
But the profit incentive, it does lead to bottom-up innovation. But there can also be externalities if the cost of something isn't priced correctly, such as water outside of the active management areas in Arizona. So you do need some coordination between government, between households and businesses. We always need to understand the incentives. And when those incentives aren't correct, it leads oftentimes to behavior we don't
We don't want. In the case of water in Arizona, it's leading to depletion of the aquifer outside of the active management areas. In the active management areas, there's been a better balance.
And there is enough water in the Colorado River, but it's going to require a transition not to farm water-intensive crops in areas far away from the water supply. Better to farm highly profitable crops, vegetables, for example, near the water supply. That's how the profit incentives work. So I don't overly worry about...
about the water situation in Arizona because the incentives will work out. I worry that there won't be more conservation incentives and instead the government will fund another huge infrastructure project to pump water hundreds of miles when in fact it's way cheaper to incentivize conservation. Those are some thoughts on profits, incentives, and waters. Thanks for listening. That's episode 425.
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