Water Into Wine: A Case Study

Water into wine — Jesus got it right, from one comes the other. But the real miracle at that wine-deficient wedding in Galilee was his judicious use of a scarce natural resource: one measure of water for one measure of wine. An enviable ratio in anyone’s book and one that today’s water-conscious winemakers would do well to replicate.

They’ve got a long way to go.

The Water Footprint Network, a natural resource think-tank based in the Netherlands, estimates that 29 gallons of water are required to produce a 4 ounce glass of wine. That’s a startling number. Researchers at UC Davis are more sanguine. They calculate that for the same glass of wine a stingy California winery requires just 15 gallons. (For perspective, a pound of tomatoes uses 26 gallons; a pound of olives—361 gallons; a pound of asparagus—258 gallons; and a pound of broccoli—34 gallons.)

Take any estimate you want, it takes a lot of water to make things grow. It’s no wonder then, in times of drought and diminishing supply, that responsible water use is such a contentious issue. In California, the issue burns hot.

The New Land Grab

Ironically, just as vineyard land in the parched Central Valley is coming out of production (tens of thousands of acres in the last decade) the Central Coast region just to the west is booming. And with the boom comes an increasingly unsustainable demand for water. Indeed, two of the state’s critical groundwater basins (aquifers) are beneath the Central Coast and both are in decline. 

The Sustainable Groundwater Management Act (SGMA) of 2014, California’s first attempt to untangle groundwater rights from property rights, has identified the Cuyama Basin and the Paso Robles Sub-basin as high priority sites with critical overdraft issues.

“SGMA requires governments and water agencies of high and medium priority basins to halt overdraft and bring groundwater basins into balanced levels of pumping and recharge.”

This means the water pumped from private wells must be replenished, measure for measure, with captured water. And the law makes no distinction between domestic and agricultural use. Sadly, it’s estimated that a return to historical water levels may take years of astute husbandry, if not total abstinence.

Despite this new mandate many farmers are skeptical about its implementation and wary of the potential for politically motivated carve-outs, as evidenced by the recent purchase of large tracts of land by the Harvard University Endowment Fund.

To boost lagging returns from traditional investments Harvard’s endowment has put its money to work in several natural resource classes. Physical assets such as timber, oil and gas deposits, and agricultural land, including vineyards, now make up more than 6% of its $39 billion portfolio. To date the endowment has plowed $100 million into the Central Coast. Most of that in bearing vineyards within the Paso Robles Sub-basin and a newly planted 850 acre vineyard within the Cuyama Basin.

Speculative investment in vineyards is nothing new. Real Estate Investment Trusts (REITs) were first adapted to the agricultural setting in the late 1990s with the aim of creating tax-free revenue streams. Their structure is similar to commercial property REITs. Cash-strapped farmers sell their land to a REIT, lease it back for a fixed period of time, and with the rents collected, a fixed stream of revenue is distributed to investors. From the sale and lease-back farmers retain control of their vineyards and receive much needed cash for expansion or capital improvements.

Early agricultural REIT’s, however, proved disappointing to investors. Almost all were plagued by above-average risk and below-average returns. Local land use restrictions frequently capped resale values in the event of a fund’s liquidation, and unless the vineyard was located within a prime grape-growing region, capital appreciation was often negligible. The added risks of agricultural uncertainty—including climate events, crop failure, and supply and demand dynamics—often proved too destabilizing for most conservative REIT investors. Thus the category has few players and limited appeal.

Partly because of these uncertainties and the need for higher returns, the Harvard investment fund takes a different approach. It is now squarely in the business of growing and selling premium wine grapes.

What is most puzzling to local skeptics is the above-market price Harvard paid for its Central Coast vineyards—a premium of $5,000 to $10,000 per acre—at a time when Central Coast grape prices are stagnant. On the surface this might seem like a bad investment, but the endowment’s latest tax filing shows otherwise; it now values its vineyards at $305 million—a three-fold increase in five years.

What gives?

It’s About the Water

The suspicion still persists among Paso Robles neighbors that the Harvard investment is a straight-up water play. That suspicion was articulated in a response to a March, 2014 article highlighting Harvard’s activity:

Matt Turrentine, the California representative for Brodiaea, Inc. (Harvard’s land acquisition and investment entity) is a board member of PRAAGS (Paso Robles Agricultural Alliance for Groundwater Solutions). PRAAGS is aggressively trying to establish a water district over the Paso Robles Groundwater Basin that will have the power to export our basin water. I strongly believe various outside corporate investors have ulterior motives in “investing” above the Paso Robles Groundwater Basin. I believe that the investments you are researching with respect to Brodiaea, Inc. and Ontiveras/Turrentine might be less about the future investment in grapes and much more about the water “futures” market.

An April, 2015 story in the Wine Spectator offered a different perspective:

What is being called nefarious actually makes good business sense. Buying direct and paying more is a smart way to secure land in a timely manner, sidestepping costly bidding wars. And hiring a longtime Central Coast resident and vineyard-specific real-estate agent who also sits on the PRAAGS board (Matt Turrentine) seems smart at a time when water is scarce. Any investor looking to buy vineyard land would look for land with water rights, on which additional wells can be drilled—what good is a vineyard if you have no water?

With the battle lines drawn, where do things stand today?

Quite simply, Harvard’s vineyard investments are at risk. In Paso Robles, PRAAGS was disbanded and the influence of its wealthy supporters—Harvard among them—was diluted. In December 2017 the citizen-led Estrella-El Pomar-Creston Water District (EPCWD) was formed to manage the sub-basin’s groundwater assets. One of its first orders of business was to prohibit the exportation of sub-basin groundwater to entities outside the county. This was a huge blow to interests like Harvard’s and a substantial encumbrance on property rights presumed to include the unassailable right to sub-surface water.

A seeming coup de grâce was inflicted in December 2018 when a Santa Clara County Superior Court jury ruled in Steinbeck v. County of San Luis Obispo., et al., that prescriptive water rights attach to the county and to its designated suppliers, and, moreover, these rights supersede those of private landowners. The court recognized that county water is a community asset to be shared by all, landed or otherwise. Agricultural interests, large and small, must now get in line for their allocation of water. This decision— and two others like it—set a dangerous precedent for agricultural speculators to ponder: Are rising land values sustainable without predictable water rights?

For now, the battle has shifted to the Cuyama Basin and Harvard’s North Fork Vineyard project where two pending issues threaten its water rights.

The first involves the temporary stay of a hastily issued permit that allows for the construction of three large groundwater storage ponds earmarked for irrigation and frost management. In a complaint letter to the Santa Barbara County Board of Supervisors a local resident alleges that North Fork’s sustainability claims are incomplete and misleading. At issue is the projected evaporation rate of the ponds and the amount of water deemed necessary to manage frost events. Both, the letter alleges, are severely underestimated. Harvard is now appealing the Board’s 3-2 vote in favor of a new environmental review.

The second issue involves North Fork’s claim that the aquifer beneath its land is separate and distinct from the main basin (for complex geological reasons) and that it merits an exemption from the authority of the Cuyama Basin GSA. The issue will no doubt end up in state court with hopes for an authoritative, unambiguous ruling.

Bottomline: If either or both of these issues is decided against North Fork, they may be forced out of business.

The Unintended Consequences

The SGMA is California’s first attempt to regulate groundwater use by private entities. Its implementation is already wreaking havoc on presumptive water rights and the uncertainty of its reach may affect future investment. If strictly enforced, it has the potential to shrink the existing vineyard landscape and to limit opportunities for future growth.

The recent scramble for North Coast vineyards by Gallo and Constellation Brands, among others, is a byproduct of SGMA regulation and an indicator of things to come. According to the latest Basin Analysis Report the Napa Sub-basin appears to be well within sustainability guidelines imposed by the SGMA and is unlikely to be impacted in the near future. In fact, 2016 water levels exceed those measured during the 1976-77 drought. The ready availability of groundwater in the Napa Valley provides a floor for land prices and a powerful incentive for Big Wine to preemptively secure prime acreage. They are already well under way.

Nearby, several of the Sonoma County Sub-basins appear to offer an even better outlook for predictable regulation. All are assessed the lowest priority with sufficient surface and groundwater assets to meet current needs. It’s no accident that vineyard acquisition there—by the likes of Jackson Family Estates, Ferrari-Carano and Silverado Premium Properties—is ramping up and that property values are rising out of proportion to less fortunate, more heavily regulated areas. Hello Harvard.

Big Wine’s premiumization initiatives are also a contributing driver toward consolidation. Regular access to premium grapes and predictable water rights will be essential going forward. The change in investment thesis is already under way with the shedding of high volume bargain brands (from grapes grown is less prestigious locations) to so-called luxury brands with significant pricing power. Get ready for more Meiomi/Prisoner/Orin Swift/Elouan look-a-likes and less diversity.

Unfortunately, the losers under this scenario are the small wineries without land and the consumer. Both will be subjected to higher prices and fewer choices. Anyone out there an expert in dry-farming vineyards?

You might want to polish up your resumé.