Not that I'm a hydrologic engineer, but it's certainly more complicated than "My land my water!"
Actually, it seems to be exactly that simple, only the beneficiary of that broad-stroked law is the city... As the article reads: "The law established that the city of Medford would hold the rights to all the sources of water in the Big Butte Creek watershed and tributaries."
The city holds the rights to "all sources of water", including rain and runoff. It is legally theirs to give or keep. Unless the journalist dumbed it down substantially, the most intuitive interpretation of this paraphrasing is that the city government will fine or imprison you for any water taken without their permission, even if it is on your land.
Fine, I'll accept that over-broad nonsense as justified (because unless the majority of his 170 acres is a big hole in the ground there is no way he's affecting the local water-table in any substantial manner), so did this guy, too, because he paid for the permits.... Which means that the time and resources which went into creating those reservoirs was done so under oversight and the protection of the law. In order to stop a reservoir from being a reservoir, you have to fill it back in, which, surprise surprise, requires more time and money.
When the state withdrew the permits, in effect pulling the city out of the deal they made with him, did they also provide him with compensation for his trouble and loss? Did they offer to do the work for him? I'm gonna go out on a limb and guess they didn't.
Unless there are facts the writer left out, namely, things like a financial settlement for the burden the state/city put on this guy, they are in the wrong.