Hedging supply risks: An optimal water portfolio

Anke Leroux, Vance L Martin

Research output: Contribution to journalArticleResearchpeer-review

Abstract

Although water supply diversification has been proposed as a solution to dwindling water reserves, the optimal mix of natural and manufactured sources of water remains largely unexplored. We develop a dynamic portfolio model of water supply that hedges against the supply risks from all potential water sources, by taking into account the size of water reserves, uncertainties of water flows as well as differences in supply costs. The optimal portfolio shares for an existing water supply system are derived and compared with the observed contributions to total water stock, revealing unexploited hedging opportunities between various naturally occurring water sources as well as a general over-reliance on manufactured water. The optimal solution implies that future supply augmentations should target natural sources of water ahead of manufactured water. It is estimated that the optimization of the water supply portfolio for a medium-sized city results in annual cost-savings of up to 463 million.
Original languageEnglish
Pages (from-to)276 - 296
Number of pages21
JournalAmerican Journal of Agricultural Economics
Volume98
Issue number1
DOIs
Publication statusPublished - 2016

Cite this

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Hedging supply risks : An optimal water portfolio. / Leroux, Anke; Martin, Vance L.

In: American Journal of Agricultural Economics, Vol. 98, No. 1, 2016, p. 276 - 296.

Research output: Contribution to journalArticleResearchpeer-review

TY - JOUR

T1 - Hedging supply risks

T2 - An optimal water portfolio

AU - Leroux, Anke

AU - Martin, Vance L

PY - 2016

Y1 - 2016

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AB - Although water supply diversification has been proposed as a solution to dwindling water reserves, the optimal mix of natural and manufactured sources of water remains largely unexplored. We develop a dynamic portfolio model of water supply that hedges against the supply risks from all potential water sources, by taking into account the size of water reserves, uncertainties of water flows as well as differences in supply costs. The optimal portfolio shares for an existing water supply system are derived and compared with the observed contributions to total water stock, revealing unexploited hedging opportunities between various naturally occurring water sources as well as a general over-reliance on manufactured water. The optimal solution implies that future supply augmentations should target natural sources of water ahead of manufactured water. It is estimated that the optimization of the water supply portfolio for a medium-sized city results in annual cost-savings of up to 463 million.

U2 - 10.1093/ajae/aav014

DO - 10.1093/ajae/aav014

M3 - Article

VL - 98

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EP - 296

JO - American Journal of Agricultural Economics

JF - American Journal of Agricultural Economics

SN - 0002-9092

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