Singularity University recently closed its 2015 Impact Challenge Contest, asking for “exponential technologies” to solve the California water crisis. (Winners will be announced in a few days from this writing, October 26th.) We decided to share our thoughts on the “crisis”, and the many solutions that exist. This includes solutions that can apply “exponential technologies” like artificial intelligence and big data approaches to the problem. (We’ve previously discussed the concept of “exponential” technology growth in the context of the superintelligence. As most experts readily admit, exponential technological growth is not actually a new phenomenon.) In particular, there is one tried-and-proven 19th-century technology that today widely employs “exponential” technologies like artificial intelligence. For some reason, California is not (yet) applying this technology to the water “crisis” despite America’s widespread familiarity with it. We found over 16 water conservation technologies (some we just remembered from old textbooks) that have been successfully applied elsewhere in the world, but not in tech-savvy California. Normally, when you see a very effective 1960s technology like drip irrigation not applied here, it indicates some subsidies or some other government interference in the marketplace. Generally, if the government wants to use taxpayer dollars to support certain favored industries, there are better ways to do this than subsidies, which discourage conservation and innovation. It turns out we aren’t the only ones with these suspicions. It has been argued elsewhere (such as in this Reddit AMA with a prominent water economist) that the California water crisis is primarily political involving reluctance to end subsidies. If the problem is primarily political, is Futarchy a proven 19th-century way of applying so-called “exponential” technologies like artificial intelligence to the solve problem?
Introduction
There is a very clear, proven “exponential” technology. This 19th century technology is widely used in the United States today. In modern times, it relies heavily on computers and artificial intelligence technologies. Although it is not currently much applied to California water shortage issues, this heavily computerized (and therefore “exponential”) technology can be adopted to the water crisis. This requires, however, an enlightened understanding of this technology on the part of government leaders and regulators, who are essential to its successful implementation. (There is some evidence that this enlightened understanding of existing exponential technologies may be lacking at the moment, which may be contributing to the crisis, as we shall see.)
Before describing this “exponential” technology, we must first convince readers that there are many old-school non-exponential technologies for dealing with the water crisis.. Most of these have been proven elsewhere in the world but have not been tried in California These proven but largely unimplemented and “non-exponential” technologies can be made exponential by incorporating them into an exponential planning system.
There are many of these “old school”, “non-exponential” technologies. Some of have been used very effectively in other parts of the world. They are not used in California because of historical concerns about their costs. (Compared with other parts of the world, water has historically been cheap and plentiful in California.) The key to solving the water crisis in an exponential way is to use exponential technologies to better coordinate, facilitate, and choose among these many effective but expensive “old school” water technologies.
Old-school water solutions largely unused in California
Therefore, let us begin this essay on “exponential” solutions to California’s water crisis by first considering the many “non-exponential” solutions that are not currently being used:
1. Agricultural best-practices, such as drip water irrigation systems. Agriculture accounts for 40% of water use in California but contributes less than 5% of Caliornia GDP according to Wikipedia. (Those are almost farm-industry figures. Critics of California industry claim agriculture uses 80% of the water but accounts for only 2.1% of the economy. Reference: LA Times) Primitive drip-irrigation systems have been in use in China since the 1st century BCE (just not much in techy California). Modern drip-irrigation systems, which use an inexpensive plastic pipe, were famously pioneered in the Israeli desert by the early 1960s. Although widely used in Israel and elsewhere, it is rarely used in California because water in California was historically inexpensive compared with Israel and other parts of the world (http://time.com/3063/california-drought-5-way-to-bust/). As noted above, when a proven cost-effective technology isn’t applied in a tech savvy place like California, it usually indicates subsidies or some other government interference in marketplace. (We aren’t alone in these suspicions.)
2. Dynamic shifting of crops. Within California agriculture, crop-selection remains somewhat traditional and not-water optimized. For example, despite the lack of water, California continues to grow significant amounts of water-intensive rice. Crops should be optimized dynamically given current and expected crop and water prices. Our “exponential” solution provides for dynamic optimization of crop selection by farmers. However, it should be noted that the current crop selection in California is sub-optimal and can be optimized even without our exponential technology.
3. Xeriscrapping, water recycling, and conservation (as already noted in the above-referenced Time article).
4. Extract water from air (“atmospheric water generation.”) This is a proven technology, and is in use in some rural areas, or under emergency circumstances. However, it is generally much more expensive than desalination. Large-scale use of this technology would likely modify the weather as well, and thus may be considered a form of weather modification. https://en.wikipedia.org/wiki/Atmospheric_water_generator
5. Improved desalination and/or increased use of desalination. California has a very long Pacific Ocean coastline, so this is a somewhat obvious solution. Although desalination is used in some areas of California, such as in San Diego, it has historically been considered too expensive. The principle cost in desalination is energy input, or electricity.
6. Thus energy and electricity technologies are closely related to desalination. Improved or less expensive sustainable power generation (energy) technologies, e.g., solar, wind, fusion, &c should be considered water technologies. California is on an ocean, so in principle any amount of water can be extracted via desalination, provided the energy is available. The primary cost issue (other than the immediate issue of constructing the facilities) is that desalination currently requires a lot of electricity/energy. Even if the amount of energy required were to be greatly reduced through improvements in desalination technology, there will always be a theoretical minimum energy required for desalination. This is because desalination moves matter from a more disordered (salt) state to a less disordered (fresh water) state. Consequently, the laws of thermodynamics require some energy expenditure to always be associated with desalination. Once this limit is approached, future cost improvements in desalination will mostly likely come with reduced energy costs. This is consistent with the Kardashev-Sagan scale for civilization, that links energy and information processing power to civilization and technological advancement.
7. Weather modification / geoengineering/astro-engineering. Amongst other things, make it rain, or modify the climate to make it rain more. We have already discussed atmospheric water generation as essentially a form of weather modification. Weather modification, of course, has all sorts of legal, political & ethical problems associated with it. If it rains in one place as a result of weather modification, is this “stealing” water from another region? What about ecological harm? Unintended consequences? On the geo-engineering side, if global warming is responsible for reduced rainfall, then engineering techniques to reduce CO2 in the atmosphere or otherwise alter the planet’s albedo might come into play. Geo-engineering techniques are extremely controversial and generally considered currently illegal under international law. This may change as these technologies improve or at least become more familiar and/or the world becomes increasingly desperate to address climate change. If climate change is responsible for California’s water shortage (as at least some scientists believe) geo-engineering technologies offer the possibility to kill two birds with one stone.
8. Improved groundwater sensing technologies (e.g., satellite, ground-penetrating radar). In addition to helping locate new sources of groundwater, this technology can also be used to determine appropriate sustainable levels of groundwater extraction. Thus, it might be used to calibrate extraction rates, reducing groundwater consumption today in favor of improved longer-term management of resources.
9. Deep-earth mining and/or chemical synthesis of water. (http://www.sciencemag.org/content/344/6189/1265 https://en.wikipedia.org/wiki/Beijing_Anomaly).( http://www.washingtonpost.com/news/morning-mix/wp/2014/06/16/study-deep-beneath-north-america-theres-more-water-than-in-all-the-oceans-combined/) There is three times more water below North America alone than in all the world’s oceans. However, this “water” is chemically “locked-up” in the form of hydrated minerals. (One wonders whether this mantle “water” is in some kind of geo-chemical equilibrium with the Earth’s oceans, and whether this under-reported and recently discovered phenomenon is in any related to the early emergence of life on Earth. The depth to which the biosphere extends into the mantle is unknown but thought to be significant due to extremophile archaea, thought to be related to the first earliest life forms. Deep-earth water, even if “locked-up” as mineral hydration, would likely further extend the biosphere downward, deeper into the Earth, permitting further geochemical planetary stabilization by microorganisms. Furthermore, if a geochemical equilibrium between oceans and mantel hydration did exist, it would affect early-Earth models of the heavy bombardment and asteroid impacts, some of which have Earth’s oceans evaporating completely for extended periods.) Bottom-line: there is no shortage of water on this planet, although getting at some of it may prove prohibitive. Desalination should be much cheaper than deep-earth mining. Deep-earth hydration is nevertheless worthy of study, as there may be hidden relationships between ground-water and deep-Earth hydration that impact water management. Although the price-tag is prohibitive, we can expect additional deep-Earth wells to be dug as part of deep-Earth sensor efforts in fields such as earthquake and volcano prediction. As more resources become available due to exponential growth in other technologies, society will focus increasingly on threats from super-volcanos and earthquakes. As a result, we anticipate these sensors wells will be dug in the future despite their cost. Sensors for deep-Earth hydration will also be added, so these sensor wells can also be considered a groundwater-sensing technology.
10. Astro-mining of water. Astro-mining will indeed be needed for many other precious resources for which fewer practical terrestrial options exist, so the capacity to mine water in space will exist shortly. A number of companies, including some funded by Google (now Alphabet) are interested in developing astro-mining technologies. Although we now know of significant sources of water elsewhere in the Solar System, retrieving it back to Earth would be completely impractical and cost-prohibitive given all of these other options. Furthermore, water will be extremely useful to future space colonies in these regions, and so is best left there as a precious future resource. It is enumerated here merely in the interests of completeness.
11. Construction of additional aqueducts and other engineering measures to divert water from regions that have access water, such as Idaho or Canada. These are tried-and-proven water technologies but historically have required substantial planning and financing.
12. Converted oil ocean tankers to move water from Canada. This technology was successfully used in the 1980s to relieve Californians drought, and was apparently halted for primarily political reasons. Oil tankers (sea going or highway trucks) can again be used to transport large amounts of water from less expensive sources to California for agricultural use. Restrictions on export of freshwater may be any issue with this solution.(Reference: https://en.wikipedia.org/wiki/Droughts_in_the_United_States )
13. Electronic toilets. Unlike old-fashioned water-saving toilets, electronic toilets have the potential to become an ‘exponential technology.’ In addition to automating multiple-flush systems, a dual-water version of these devices might switch between sea and freshwater, with freshwater used for cleaning and automatic medical testing. Although commercially available for a number of years and popular in countries such as Japan, electronic toilets have not caught on in the United States outside of a few early adopters such as the Google headquarters. It is thought that the subject of toilets is taboo in the United States, and that attempts to market these products merely brings an emotional response such as a giggle rather than any serious consideration. This is unfortunate. From a consumer-standpoint toilets are self-cleaning, which means they can significantly reduce house-holding cleaning time and expense. From a government and insurance standpoint, these devices can provide early detection of a variety of serious illnesses, potentially adding billions to the economy. In addition to early warning of various metabolic illnesses, these ‘bathroom appliances’ should most notably provide early & complication-free warning, through continuous monitoring of stool, of colon cancer and pre-cancer, which is otherwise extremely difficult and expensive to timely detect. These devices also provide important hygiene benefits, further lowering health-care costs. And they do save water. Like dual-water systems, however, these devices require some planning in the form of revised construction codes. Specifically, the devices require installation of an GFCI electrical outlet. Since these outlets are expensive to retrofit, new construction should include them, which makes installing this kind of ‘bathroom appliance’ much more affordable.
This is an ‘exponential technology’ as both the on-board computer and laboratory-on-a-chip can be continuously upgraded to take advantage of Moore’s law. (Although the Moore’s law benefits would likely apply more to health monitoring that further water savings. However, an onboard computer, together with a dual-water system, could indeed continuously devise new water-saving strategies in response to current market conditions.)Unfortunately, outside of late-night comedy television, there will likely continue to attention given to planning for these devices.
14. Conversion of wastewater and stormdrain water to human use. Apparently, similar economics to desalination, but applicable in areas away from the ocean. With estimates suggesting residential use is only 6% of water use in California, not clear “human use” technologies will address the problem.
15. Satellite/aerial optimization of agricultural watering. This has been used successfully and cost-effectively in countries such as France.
16. Dual-water systems. Showers and toilets each account for roughly 20% of residential household water use in California. Water for both of these activities can instead be sourced from untreated or lightly-treated seawater. In addition, other household appliances, such as dishwashers and washing machines, could be modified to use seawater in some of their cycles. (For example, the first wash cycle in a dishwasher could use seawater.) Dual-use water systems are an old technology in the United States. The city of St. Augustine, FL, the oldest city in the United States, converted to dual-water several decades ago. (These systems were also widely installed in the former Communist countries in Eastern Europe, where brine from groundwater is used instead of ocean water.) Thus conversion to dual-water is more than economically feasible. With untreated seawater essentially free in California, dual-water systems could potentially reduce the residential freshwater bill by 50% or more.Dual-water systems do require some planning. We here talk about the current drought extending until 2030 or more. If that is the case, construction codes should be changed to mandate the installation of dual-water pipes in all new construction. (The salty-side of ‘dual-water’ need not be activated until later.) Manufacturers should be encouraged to develop dual-water dishwashers, washing machines, and electronic toilets. Existing household appliances such as shower heads and traditional toilets can safely run on salt water with little or no modification, but it may be desirable to have a valve on the decide to permit temporary use of fresh water, such as for cleaning or medical reasons.However, with such a large fraction of water in California going to agricultural and environmental use (although the exact percentages are debated), it is not clear if residential water-saving technologies are worth the expense. (Reference: https://en.wikipedia.org/wiki/Dual_piping among others)
Futures markets
It’s already been noted that California’s crop selection is likely sub-optimal given current drought conditions. (For example, as of this writing California grows far too much rice, a water-intensive crop that can be efficiently sourced from many other rice-growing parts of the world.) On the other hand, if every farmer in California selected the same “water-efficient” crop, this would also lead to calamity.
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How should farmers coordinate an efficient selection of crops? While some regions of the world have opted (largely unsuccessfully) for central planning of agriculture, Chicago developed an efficient solution back in the 19th century.
That solution are the Futures and Commodity markets, which were originally developed to ease overcrowding (and resultant price collapse) of farmer’s crops as they were brought to the 19th-century Midwestern rail hub. The solution is still technically relevant today. (Moreover, futures trading, and even dynamic availability of new futures instruments, has become truly computer-driven and extremely high-tech. This means that is possible to apply exponential technologies to Futures markets as we’ll see in a bit.
To solve California’s water crisis, two types of Futures instruments are needed: crop-price futures (which have existed since the 19th century and are well established) and water-price (or water delivery) futures or contracts. For later, California (or its market authorities) would designate one or more water hubs, from which agricultural water could be contracted for delivery at a future date. These futures markets solve the earlier dilemma in which every farmer unfortunately planted the exact same “water-efficient” crop.
Probably Not Needed Outside California
Note that a futures market probably isn’t (yet) needed in other communities. A water futures market makes sense in California because (1) the current “drought” is expected to last for at least 30 years according to some experts and (2) as we’ll show below, in California water and oil prices will be linked due to de-salination and ocean oil tanker conversion, among reasons. As a result, California water prices are expected to be uncomfortably high and probably also somewhat volatile for the foreseeable future. There is a third reason: due to historically low water prices, California hasn’t yet implemented all of the best-practices for expensive water regions (such as drip irrigation), for example. A futures market is needed to help coordinate, finance, and reduce risks from making big investments in water conservation technology. Since most other parts of the country are not (yet) expected to experience prolonged high or volatile water prices, a waters futures market might not make sense elsewhere in the United States.
Futures markets do not function with significant government interference in markets
These markets also eliminate the need for central government planning, water subsidies, or water rationing. This latter point cannot be emphasized enough. In general, unless there is a war-time emergency or other immediate threat to food or water security (which is not the case for the current water crisis) government should not step in and ration or subsidize water (residential or otherwise). (There is a role for government to prevent a dust-bowl situation, prevent water theft, hoarding, or poisoning, preventing ground-water depletion, preventing excessive family relocations due to farm failures, and preventing poor families from thirsting. With the exception of ground-water depletion issues, none of these require rationing. Low-income families should receive periodic rebate checks rather than water rations or “free water” so that they also have an incentive to conserve.) Instead of promoting central-planning tendencies and inefficient rationing, government should serve as an agent to facilitate efficient price-discovery by well-established market mechanisms. (It is particularly bizarre, and suggestive of mismanagement, that residential water is being rationed whereas agriculture water is not. Residential water accounts for a tiny fraction of California water use, but non-agricultural residents account for 95% of California GDP. Agricultural water accounts for 40-80% of California water use (depending on whom you ask) but at last report was not being rationed. Either way, “agricultural” and “environmental” use together water account for the vast bulk of California water use, with “residential” water use accounting for a relatively small sliver despite its greater economic importance. (Reference: Wikipedia and LA Times among others)
However, since agricultural and environmental usage consume the lion’s share (and also cannot be replaced with dual-water solutions as many residential applications can be), it would seem the focus should be on agricultural and environmental water use. This doesn’t seem to be where thought leaders have started, however, for some reason. The PR campaign in California has initially focused on residential water use. (The obnoxious “If it’s yellow, let it mellow. If it’s brown flush it down” is aimed at the residential market. This author is unaware of any similar campaign aimed at agricultural or environmental use. Has someone done a study on the health care costs related to this little bit of advice? The ancient Romans had running water, and sanitation was one of the key technological innovations driving the growth of cities. These cities produce 95% of California’s GDP. According to some estimates, residential use is only 6% of water use in California. But for some reason all of the initial political focus is on residential use and technologies. This has been widely noted for some time elsewhere, yet still nothing seems to been done to address failed economics (which would provide implementation of ‘exponential’ technologies like artificial intelligence as part of standard practice as we argue here). See for example this excellent Reddit AMA with a water economist.
Futures markets cannot function properly if there is significant government interventions in the markets. Unfortunately, that is undoubtedly the case currently in California. As mentioned elsewhere, there is a pending lawsuit against a federal government agency, accusing it of maintaining a 1930s sweetheart deal with a major multination that essentially gives that multination millions of gallons of essentially free water off public land for a tiny annually fee. If this is true, it is not clear a certain favored multination gets privileged access to water while the rest of California corporations and consumers must pay through the nose. This is essentially the government subsidizing a major multination corporation.
It should be immediately clear this type of alleged corporate welfare, if continued, would break a futures market. (Amongst other things, major multinational could simple resell its almost “free” water on the futures market, greatly disrupting its ability to accurately predict prices.) Similarly, subsidizing or rationing farm or residential water would cause similar problems. (Farmers would be tempted to resell their subsidized water back onto the futures market.) Most types of rationing, water price caps, or price minimums, would cause similar distortions. The exact water rules differ wildly from one community to the next, but it is clear that some water rationing and subsidizing is happening in many communities, both at the individual & farm level, and also likely implicitly in the system of ancient water drawing rights in some communities.
Proper implementation of water subsidies
Obviously, there will be low income families and small business farmers that may require support for social good or to prevent dust bowls. It may be important to keep these individuals and entities in California. Rather than subsidizing or rationing water, the government should offer them a rebate (such as a grant or negative income tax). If they use below their quota, they get to keep the “water grant” difference. This encourages them to conserve water, rather than sell rationed water back onto the futures market, waste it, or engage in other market distortions. Essentially, the pay the same price as everyone else, but the government gives them a negative income tax because it understands water prices are high. They can actually earn an income by conserving water. These sorts of economic incentives are well understood by economists.
Government does have a role in establishing long-term sustainable levels of groundwater withdrawal (and other regulation). Government needs to ensure that market prices factor in sustainable levels. (Ground water may be excessively depleted at the moment, suggesting that ground water prices are too low.) The California legal system, whereby communities have ancient claims to watersheds may be outdated. Rather, California should establish a single, efficient market for water use. If a community exceeds the sustainably available groundwater, its water supply should seamlessly switch (or, better yet, continuously draw throughout the year) from other water sources available on an open California water market.
Importance of Regulation in Futures Markets
It is also crucial that any futures water market be well-regulated. Again, it is somewhat disturbing for California politicians to reference the Enron electricity crisis of a few years back, claiming that California ran out of electricity. This is simply not true. California always had the technologies to supply itself with adequate electricity. What happened in the Enron crisis (at least according to some sources) is that Enron co-opted key regulators and legislatures at both the federal regulatory and state level. (For example, a key federal regulator was reportedly given a plush Enron job after she succeeded in effectively eliminating key federal regulatory oversight. Similarly, the flawed California electricity grid legislation was reportedly drafted “with influence” from Enron (a polite phrase for dubious political practices). It stipulated that the energy grid operator had to purchase the lowest bid under any and all circumstances, even if that bid was clearly of a fraudulent nature (as then transpired). Thus the California electric crisis was, according to many accounts, not a technological failure but a bi-partisan political failure at both the federal and state levels. Recent news stories, such as the recent lawsuit against the federal government accusing a large multination of allegedly un-permitted drawing of vast amounts of water from federal land in California, suggest a significant political dimension to the current water crisis as well.
Some years ago (before the Enron or even the housing crisis) this author had the pleasure of long discussions with managing directors at a major Wall Street firms. Although there are many anti-regulation types on Wall Street (particularly traders), many leading executives at these firms emphasize the importance of sound regulation of financial markets. As this one Managing Director remarked, Wall Street cannot operate if the public does not have confidence in the financial markets. This confidence is provided through competent regulation. Key pieces of historical financial regulation, such as recently widely-noted 1933 Glass-Steagall Act, were drafted with considerable advocacy from industry players at the time (such as the then-president of a major bank) who reportedly felt the regulations were absolutely necessary at the time. (Years later, the industry consensus shifted towards the view that Glass-Steagall was outdated, and was putting the country at an international disadvantage.) Today, Wall Street is much in the news, perhaps deservedly, for opposing reform regulation. However, not ever financial institution has the ethics of Enron. Sound regulation is absolutely necessary to a properly functioning waters futures market. There is at least a historical precedent for such regulation to be accomplished in cooperation with an enlighten financial industry.
Why an “exponential” technology
Futures markets are an “exponential” technology. Current practice in these markets draws heavily on bleeding-edge computer systems and models. This includes state-of-the-art use of artificial intelligence systems. Current practice includes deployed systems that perform economic and weather modeling, as well as natural language (AI) processing of Twitter and news feeds. There is a well-developed body of academic literature that shows how the related concept of prediction markets (considered illegal gambling in the United States but legal in places such as New Zealand) can accurately predict the outcome of political elections much more accurately than traditional polling. In futurist literature (and books such as Nate Silver’s classic “Signal and the Noise”) the concept of Futarchy is presented, in which government is replaced by a functioning system of Futures and Predictions Markets that make critical government decisions previously reserved to political leaders. (In practice, particularly given the need for competent regulation of these markets, a working Futarchy system would merely have futures markets advising traditional political leaders.) Since, in current practice, futures markets are constantly linked to Artificial Intelligence systems, a Futarchy system is a pathway towards government by an artificial super-intelligence (which will consist of an ecosystem of natural and artificially intelligent entities) within the existing traditional frameworks of a democratic society.
In this case, the waters future market would not be anything as exotic as Futarchy. It is a simple futures market, tried and proven since the 19th century. It is an “exponential” technology because futures traders already use very sophisticated artificial intelligence systems as part of routine practice.
The actual system for preventing all California farmers from planting the same crop does not rely on computers or artificial intelligence. It merely uses the “dumb” 19-century market mechanisms invented (more or less) in Chicago (and then ignored by the central planning governments and would-be water-rationers.) We don’t claim originality here. A number of others have called for futures water markets (as should be obvious given the centuries-old experience of the US with these markets): http://www.cnbc.com/2014/07/02/why-trading-water-futures-could-be-in-our-future.html. The point here is to explain how these markets can be made “exponential.” Given that we have calls for water rationing, it seems that water futures markets are not obvious to everyone (even if this idea seems blindingly obvious to me).
How a California futures water markets would work
Essentially, at any time, the futures markets provide a future price for California water and for a specific crop. A given farmer need merely select the most profitable combination at any given time (knowing how much water a given crop requires, and how much profit can be expected given the current future price of both water and crops.) For example, suppose the futures market is currently showing a very high price for rice (for future delivery at the end of next season). Furthermore, suppose rice (a water-intensive crop) requires 10 hypothetical water contracts, for future delivery to the farmer during the planting season. The farmer sees a profit, and buys the water contract (thus locking in his water supply) while selling future delivery of rice. This locks in the farmer’s profit for the year. It also adjusts the price of the contracts.
By selling future rice, the supply of rice goes up, lowering the projected price for other farmers. Furthermore, by buying water, the farmer has raised the price of water for other farmers. In response to decisions by individual farmers, the marketplace adjusts the price of water and crops. This prevents all farmers from growing the same “most-profitable” or “most water-efficient” crop, since the price of individual crops will fall as more farmers commit to planting, while the future price of water rises as more farmers commit to using water.
In a well-developed financial system, such as in the United States, there are safe-guards ensuring delivery on the contracts. Farmers generally need to have some kind of insurance (against, say, crop failure) that ensures their contractual obligations will be met (with, say, an insurance pay-out if they cannot deliver the promised crop). Futures exchanges, insurance companies, and other market participants are regulated to ensure they can meet their contractual obligations. Safeguards are engineered into the system so that, e.g., systematic crop failures do not ripple through the system. Furthermore, effective and vigorous law-enforcement prevents speculators from successfully carrying out illegal schemes to, say, dynamite an aqueduct to affect water futures. (Indeed, according to some theorists, the sole purpose of government is to act as an insurance agent against systematic shocks to economy. Unsystematic shocks are best handled through private insurance and market mechanisms. A futures market does not eliminate government or self-regulatory organizations. It does eliminate central planning and rationing, limiting the role of government to prevention and recovery from systematic shocks such as intentional, illegal sabotage of infrastructure by market participants.)
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Regulation by futures exchanges
To be enforceable, these contracts do need to be placed on exchanges (“self-regulatory organizations” or SROs in finance speak.) Open interest on exchanges should be made public and limited to prevent excessive speculation (a source of a potential systematic shock), and contract terms standardized by the SRO exchange to facilitate an efficient market. Futures are a form of derivatives. Requiring use of an SRO for non-insurance contracts and publishing & limiting open interest eliminates most of the problems associated with derivatives contracts. It allows enforcement of rules generally designed to prevent excessive open interest, “cornering” of the market, extreme price swings, and other irregularities. These regulatory systems have been well-understood in the United States for well-over a century (although appear to have been somewhat forgotten when Enron was trading in electricity futures).
So this is the “dumb” aspect of futures markets. As shown, this would already help farmers more efficiently select water-efficient crops. It would do this by aiding price discovery, allowing farmers to efficiently coordinate with one another in their selection of crops and water purchases.
Futures markets would also help on the water supply side. We listed a large number of water technologies. Having a waters futures will help select the best technology at any given time.
The invisible hand of futures exchanges
For example, conversion of ocean-going oil tankers to instead transport water from Canada is a fairly elastic technology. These oil tankers can quickly be brought on-line, as has been done in the past. A typical well-regulated water futures market can easily provide liquid water contracts for a year or two. (US financial markets, as well as prediction markets, have experience with longer-term price discovery products such as LEAPS or multi-year predictions contracts on New Zealand’s iPredict markets. Unfortunately, these products, while generally commercially viable, then to be less liquid than near-term contracts.)
Thus, as the future price of water begins to rise, an oil-tanker company could use the Futures market to lock in a transportation contract. (Generally, this would involve constantly comparing the future profits on the existing CME GLOBEX oil deliveries contracts with the future profits from water delivery contracts & factoring in the small conversion cost to switch between oil to water.) An oil tanker company could “lock-in” a profit for many water runs. Once committed to the water delivers, the future price of water would fall, enabling uncommitted farmers to switch to more water-intensive (and more profitable) crops. In this way, a waters futures market facilitates coordination between ocean-going oil/water tankers and farmers.
Given the caveat about longer-term liquidity of futures, the futures market would also facilitate investment in longer-term projects. Critical decisions need to be made whether to invest in desalinations projects or in building aqueducts from places like Idaho. By providing investors with a way to “lock-in” long-term profits from water deliveries, water Futures and water price-prediction markets provide a means of financing these projects. (Investors considering building an aqueduct short the future price of water for several years of deliveries, which should already provide most of the financing for many smaller projects such as desalination plants.)
Energy and desalination as “long-term” exponential technologies
We’ve already pointed out that, under the Kardashev Civilization scale (presumably well known to the folks at Singularity U sponsoring the original contest), energy and civilizational progress are closely linked. This is also largely true when considering water technologies. Desalination, in particular, is energy dependent. Thus, in addition to crop and water markets, California should also invest to ensure that our historically controversial energy futures markets remain liquid, functional, and competently regulated.
A small desalination investor would be able to finance a desalination plant by going long electricity futures (the essential raw material for desalination) and shorting water futures. Thus California should have water, electricity, and crop futures markets. With well-functioning markets in those areas, farmer should automatically allocate water-efficient crops, and at least small desalination plants should build themselves (in the absence of more economical water-delivery technologies).
The role for government is not to ration or centrally plan, but to facilitate that these markets operate smoothly, and police abuses such as un-permitted water withdrawals from politically privileged but unethical players. Some planning may be required for long-term projects where Futures markets are too illiquid for efficient price discovery. Even here, however, an illiquid futures market can provide some guidance; planning and financing can still be facilitated by private entities, albeit a bond issues might be needed in place of shorting futures contracts.
Futures markets and Futarchy short-term exponential technologies
Finally, we can begin to explain how futures markets are “exponential.” We’ve already discussed Futarchy. As artificial intelligence becomes more sophisticated and reliably takes over more trading, liquidity (through arbitrage by AI systems) will become more sophisticated. (For example, trading systems have long applied artificial intelligence techniques natural language processing to news releases and twitter markets to automatically place trades. Weather futures traders presumably use sophisticated weather models, while some oil traders are known to use sophisticated oil inventory modeling. The price discovery from these models would feed into water and crop futures markets.) As a result, water, electricity, and crop contracts become liquid further into the future (together with an appropriate regulatory infrastructure that ensures these contracts are honored). As this happens the system becomes exponentially more intelligent. It can make longer-term decisions. It can invest efficiently in more expensive but longer-term technologies, such as multi-year aqueduct projects.
One key to Futarchy is public confidence that the futures prices being set many years in advance are accurate. In general, these prices will be set by sophisticated, and increasingly complex, “black box” computer algorithms at proprietary trading firms. As we have argued elsewhere, to insure confidence, the government will need to invest in public computer models (through e.g. university research). These public models provide a baseline against which the general public can check the more sophisticated proprietary models for reasonableness. They also form a starting point on which private corporations can build these more sophisticated proprietary models. The price difference between the academic model and hopefully more accurate proprietary “black-box” models creates the profit incentive to invest in sophisticated exponential technologies like Artificial Intelligence.
Additional types of futures
Ultimately, one can imagine weather futures. (These already exist: http://www.cmegroup.com/trading/weather/. What is being proposed are more detailed weather futures for California.) Sophisticated computer models would influence these weather futures. Long-term weather futures (at a very granular level, such as aggregate rainfall) would also be possible, and influenced by modeling of El Nino, solar cycles, greenhouse gases, and other predictable long-term weather drivers. In this way, through the use of artificial intelligence, factors such as green houses gases would impact multi-year water delivery prices.
Via the futures market, farmers would be using sophisticated artificial intelligence models to decide on crop commitments, without knowing anything about the computer models. Moreover, weather modification and geo-engineering programs, once legal, political, and environment concerns are overcome, could be financed through these futures and Futarchy markets. (A weather modification investor would simply short an inverse-rainfall contract. The resulting prediction of increased rainfall, anticipating the application of the weather modification technology, would then also affect water delivery prices, and hence farmers’ decision making.)
Example California water future arbitrage trading strategies
1. A farm converts (“arbitrages” in trading parlance) water into crops. If the price of water falls below the price of a crop’s futures less the farmers’ cost, the farmer locks in a profit by planting that crop. Crop futures and the need for long-term agricultural planning and rail transport is what led to Futures being invented in Chicago in the 19th century. Farmers are thus very familiar with the concept of futures markets. As noted earlier, water futures are specific to regions of the country where water is expected to remain expensive and volatile in price; most regions of the country (and certainly not the 19th Century midwest) do not need water futures just yet. In modern farming, energy is another important input, so the farmer can also factor in energy futures (gasoline or oil) into his decision model.
2. A desalination plan converts (“arbitrages”) energy (oil or electricity futures) into water. As already discussed, for thermodynamic reasons, “energy” (entropy) will also be a significant cost in desalination. When the future price of water exceeds the futures price of energy plus other operating costs, the operator can lock in a future profit by operating the plant. For small enough desalination plants, a high enough future price of water may justify building the plan. “Small enough” may become increasing larger as the time-horizon for the futures markets moves further forward in time with increasing liquidity.
3. Similarly, diverting an oil tanker for water transport converts (“arbitrages”) oil futures into water futures. If price of water futures rises above oil futures, it becomes cheaper for an ocean-going tanker to deliver water rather than oil (from a source where freshwater is cheap). The oil tanker or barge operator can then lock in a profit by delivering water. (This arbitrage opportunity would also apply to highway tanker truck operators delivering water instead of oil or other liquids.) In this way, water transport strategies will compete somewhat with desalination facilities. Regulations surrounding export of freshwater as well as the ability of desalination to use forms of energy other than oil (electricity from renewable sources) may give desalination a longer-term edge.
4. Water and weather futures can be “stat arbitraged” or “pair-traded” against each other. Since at least some freshwater comes from rainwater, and rainwater futures already exist, sophisticated traders can potentially model the relationship and engage in what is called “statistical arbitrage.” In this way, the long-term weather models used to price weather futures will indirectly help price water futures. Incentives will be created for more accurate long-term statistical forecasts of precipitation.
5. Water can be stored (in reservoirs or tanks), and thus water futures expiring in one month can be arbitraged against another month. Water prices in peak demand months (e.g., summer irrigation season) will automatically be lowered through participation of reservoir systems in the futures market.
Conclusion
The establishment of liquid, multi-year weather, electricity, crop, and water-delivery futures contracts for different regions within California has some ways to go. The underlying technology, however, is very old. It is a tried and proven technology. Aspects of these futures markets for weather, electricity, and crops already exist. With addition of simple water delivery contracts, financing of small, short-term projects, such as ocean tanker delivery of water and small desalination plants, can already begin today. Moreover, these futures markets are already very heavily computer and artificial-intelligence driven. They are exponential technologies. As computers and AI improves, these markets will become more liquid. They will be able to make more accurate predictions further into the future. This will spur investments into the many other water technologies outlined above. Many of these water technologies are proven “old” technologies. Drip-irrigation, for example, has been around since the 1960s, but has not been used in California as has been historically been seen as too expensive. A futures market would encourage residential conservation of water, since municipalities would also interact with these futures markets, and offer rebates and market-incentives to residents. An efficient waters future market would facilitate long-term price discovery of water, enabling residential consumers and urban planners to make informed decisions regarding proven but expensive technologies such as urban dual-water supplies. With an exponential water futures and Futarchy system on-line, artificial intelligence would begin to guide much more efficient “exponential” multi-year planning and investments that would incorporate these many proven but largely unused “non-exponential” water technologies into an exponentially more efficient system.
Legal disclaimer: This is a journalistic opinion piece on the California water crisis. It is not intended as advice for your specific situation, or as financial or traditional engineering advice. Consult an appropriately credentialed or licensed professional before trading on the futures markets, constructing an aqueduct, or diverting an oil barge. See our terms of service for complete disclaimers.