20 Apr 2015

Water Markets FAQ

NB: I will update this post over time. Please comment or email questions or quibbles.

Read my free book (especially chapters 5 & 6) for a different take on these ideas.

Australia and Chile have successful, large scale water markets that have allowed farmers to grow more with less and made it easier to reallocate water across sectors. Markets in both countries have had problems, but those pale in comparison to the problems in places without markets.

Bulk water vs urban water
When we talk about water markets, we're really talking about trading bulk quantities of water, not markets for water among urban residents. Urban water is priced/rationed/managed by a local monopoly with a duty to cover its costs and maintain service reliability (read this). Bulk water can be bought and sold by the government, utilities, farmers and environmentalists. In my book, I describe how governments should reserve environmental water flows "for the people" before allocating remaining water in markets among agriculture, industry and cities.

Markets, auctions and occasional sales
Markets, by allowing buyers and sellers to trade water, make it easier for communities to face their realities and harder to blame neighbors. A system of "shared" water is easier to administer while everyone is "fair" but treacherous when water is short and neighbors take "more than they deserve"

Markets are good for ongoing trades. Auctions are good for reconciling many values in a short time. Trading should occur as often as its necessary to make bulk water allocation decisions, which means everything from daily (larger urban systems) to annually (irrigation districts).

Quantity and quality
It's much easier to trade water in one-dimensional quantity than multi-dimensionsal quality, but quantities need to be identified. Surface water trades need to consider conveyance losses between buyer and seller. Only "wet water" should be traded, since "dry- or paper-shares" (shares or rights that may not yield water until there's a big increase in supply) may not ever yield wet water.

The main idea is to trade only in "consumptively used" water, i.e., ignoring the water that is initially diverted but then returns to the local system for another's use. Read more here.

Groundwater and surface water
You CANNOT trade surface water without knowing who has rights to groundwater. Ground- and surface water are usually physically connected, even if they are not legally connected. This post discusses "groundwater adjudication" (rights).

Rights and Laws
Water rights fall into three main categories: riparian, ground and prior appropriation. Riparian rights allow one to take water as long as that diversion does not affect others; these rights tend to be used in water rich regions. Groundwater rights allow one to take "as much as needed for beneficial use" from under one's land. These rights can be problematic if groundwater rests below several properties. Prior appropriation rights, or "first in time, first in rights" to divert a quantity water from a river without regard to the impact of the diversion on others may seem easy to trade, but they are defined in quantity at a place.

Some people think that those who got rights "for free" should not be able to sell them. Such a prohibition ignores the benefits of reallocating water from a social perspective as well as the fact that rights holders either (a) paid money for the rights (by buying land -- including valuable water rights -- from the original owner) or (b) do not pay attention to what they paid as much as what the water's worth (for local irrigation or traded cash). Water markets also make it more likely that farmers will be able to collect cash that can be used to repay debts on water infrastructure.

In many western US states, these rights are heterogeneous, which makes them hard to trade or value. They also tend to be, simultaneously, absolute (in quantity) but poorly defined for trade. This is because rights are often defined as a quantity for a beneficial use, in a place. "Beneficial use" tends to be associated with "use it or lose it, but don't trade it," thereby making it more profitable to flood irrigate alfalfa than sell water in a market because flood irrigation in its defined place is allowed, but trade "to another place" means that one does not have a beneficial use for the water at its defined location. Farmers thus "waste" water on "low value crops" because they are not allowed to sell that water for use elsewhere.

The Australians reformed their water rights by (a) defining them as licenses that the government could take back in the public interest (usually by reserving some water for the environment), (b) simplifying rights into "high security" and "low security" in terms of their wet allocations (not year of issue), and defining trades as "beneficial use."

Dams, canals and rivers
Dams hold water; canals and rivers make it easier to move water. Water markets function best when trades occur within a watershed or distribution network that allows buyers and sellers to complete the deal. In some cases, owners of the "conveyance" should be forced to allow traded water to pass in their infrastructure at a fair price, i.e., prohibited from inhibiting trade with high "wheeling" (water moving) charges. Evaporation and leakage losses need to be factored into water trades, to ensure that buyers and sellers do not "rob" the commons.

Society, the poor and the environment
Water markets benefit society by putting scarce water into higher-valued uses, whether these be lawns, pools, showers, or almond crops. The alternative -- political conflict over allocations -- is more harmful in its opaque waste of resources (via lobbying) as well as less than best allocation outcomes.

The poor need not suffer with water markets. First, they can be paid "dividends" for the rental of "the people's" water by their government. Second, poor farmers will not lose from markets if their rights are protected (my all-in-auctions idea) or if markets make it easier for them to get water otherwise allocated in a political process. Poor people in corrupt countries are usually screwed, but markets make it harder by revealing the value and allocation of water.

Some useful posts on water markets:

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