Comparison of different water supply risk management tools for irrigators: option contracts and insurance

Irrigators must cope with the risk of not having enough water to meet crop demands. There are different tools for managing this risk, including water market mechanisms and insurance. Given the choice, farmers will opt for the tool that offers the greatest positive change in expected utility. This paper presents a theoretical assessment of farmers’ expected utility for two different water option contracts and a drought insurance policy. We analyze the conditions that determine farmers’ preferences for these instruments and perform a numerical application to a water-stressed Spanish region. Results show that farmers’ willingness to pay for the considered risk management tools are greater than the preliminary estimates of these instruments costs. This suggests that option contracts and insurance may help farmers manage water supply availability risks.