What you're missing is that water is not an input cost for many of these farmers. The farmers that have cheaper access to water are increasing production of these same water intensive crops, because they are more lucrative. The problem is in assuming a level playing field in the market, which it isn't entirely, due to how water is dealt with in CA.
If water wasn't an input cost for all farmers, then the price of nut wouldn't have gone up in the first place. As I said, there must be some farmers who face increases in costs, and there must be some farmers whose costs increase enough that they produce less. Otherwise, prices would not have gone up in the first place.
Why not? It's possible (I make no claims as to whether it's correct) that a large portion of farmers do have water as a cost, enough so to affect price, and as the price increases, the farmers that weren't growing nuts (or were more diversified) that don't have water as a cost (or its cost is less than it is for other farmers) may switch to the lucrative crop, exacerbating the problem.
I don't think it's that much of a stretch to think that instability in market prices for a good may cause odd market behavior that has consequences in related areas.
