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The Evolving Western Water Markets Richard Howitt and Kristiana Hansen 1st Quarter 2005 • 20(1) A publication of the CHOICES American Agricultural The magazine of food, farm, and resource issues Economics Association The Evolving Western Water Markets Richard Howitt and Kristiana Hansen Expanding population and environmental protection the A worldwide survey of existing markets makes it clear world over are placing additional demands on existing that gains in efficiency can occur even in the absence of water supplies. Meeting these demands by traditional theoretically perfect markets (Saleth & Dinar, 2004). The structural supply augmentation is dogged by increasing efficiency gains are achieved by moving water to higher environmental and fiscal costs, which leave excess water value uses. To achieve these gains, many states west of the demand to be met largely by conservation and reallocation Mississippi River have implemented legislation to facilitate of existing supplies. Water trading clearly has a role in real- water trading within their borders. However, because locating supplies and stimulating conservation by provid- water has both private and public good characteristics, it ing a clear measure of its value for conservation and a has often been developed with some degree of public voluntary self-compensating mechanism for reallocation. financing or subsidies. Hence, its reallocation generates Despite these advantages, traditional markets have been heated controversy—especially when potential profits are slow to evolve in the western United States for institu- involved. tional and hydrologic reasons. However, even when insti- tutional, political, and physical impediments prevent Water Market Determinants textbook water markets from developing, significant gains What factors determine whether and how markets in efficiency can result from relaxing restrictions on own- develop? Why is trading heavier in some states than in ership, use, and transfer. Most water markets in the west- others? The importance of water’s physical characteristics ern United States fall between the two extremes of cannot be emphasized enough. In many parts of the West, textbook markets in which, on the one hand, price is the water supply is uncertain; there is tremendous tempo- determined by unfettered market forces, and on the other, ral and spatial variation in rainfall. Furthermore, supply there is an outright legal prohibition of trading. and demand peaks do not generally coincide within the Three fundamental reasons probably cause the slow water year. For example, when snow pack melts in the evolution of water markets in the West. First, water has spring, it is stored in surface reservoirs until late summer many public good characteristics, benefiting not only the when farmers’ irrigation demand peaks. These fundamen- owner of a water right, but also the public at large. Public tal characteristics of precipitation make water market interest in water is supported by the fact that most western development all the more desirable, but they hinder the states retain the ultimate property right to water; individ- creation of markets in the first place. Transportation and ual water rights are more akin to use rights than private storage facilities have been constructed throughout the property rights. Second, fluctuations in water supply result West, largely at public expense, to convey water across in periodic “thin” markets with few participants. Third, time and space. Not surprisingly, water markets have water transfers often require significant costs, in terms of tended to develop in locations where the Bureau of Recla- both institutional costs and the cost of physically trans- mation and state water projects have invested resources in porting the resource. Even in the presence of willing buy- creating an infrastructure to facilitate the transportation ers and sellers, trades of permanent water rights are often and storage of water. not approved by regulators because they would result in Yet obstacles remain. Even though water garners sub- significant externalities—physical impacts on parties not stantial political attention and controversy, its economic involved in the transaction—and in third party financial value at the margin is actually quite low relative to the cost impacts to the exporting region. of conveyance. For example, the option purchase price for ©1999–2005 CHOICES. All rights reserved. Articles may be reproduced or electronically distributed as long as attribution to Choices and the American Agricultural Economics Association is maintained. Choices subscriptions are free and can be obtained through http://www.choicesmagazine.org. 1st Quarter 2005 • 20(1) CHOICES 59 water in a 2002 transaction between of losing their right to the water in tal resource. Reduced or altered flows Glenn-Colusa Irrigation District in the longer term. Further, permanent on a waterway affect water quantity northern California and the Metro- transfers of water rights under prior and quality downstream. Drawdown politan Water District serving the appropriation have usually been in an underground aquifer affects Los Angeles area was $110/acre-foot. costly and time-consuming. Perma- neighbors’ pumping costs. Such The cost of transport (including a nent transfers and leases have externalities may be positive or nega- mandatory 20% environmental miti- recently become easier, as state laws tive. When they are negative, there is gation requirement and 300-mile have changed to facilitate market a role for regulatory agencies to transport and pumping fees) is transactions. ensure that nonmarket values placed approximately $143/acre-foot, for a One water market in the West on the waterways by society are taken total delivered cost of $253/acre-foot. where property rights are clearly into account. The absence of ade- Such high transaction costs reduce defined, enforceable, and transferable quate protections for those adversely the number of trades that are finan- is a Bureau of Reclamation project on affected by negative externalities may cially viable and the geographical the eastern slope of the Rocky Moun- result in trade volume that exceeds scope of markets. tains: the Colorado-Big Thompson the socially efficient level. On the Water’s mobility also makes prop- (CBT). Water rights in the CBT are other hand, these concerns have tra- erty rights enforcement a challenge. correlative; shares fluctuate annually ditionally been handled through Property rights are easier to monitor in response to water conditions, and lengthy court procedures, which may in some settings than others. For all shareholders benefit or lose each discourage socially beneficial trad- example, annual fallowing transfers year in like manner. The shares are ing. Over time, regulatory agencies from rice growers in the north of entirely homogeneous, and transfer should develop procedures to address California to urban users in the south occurs with minimal fees and paper- these issues in a less costly manner, of California are relatively easy to work. However, the CBT system has perhaps through the development of monitor. If the fields are fallowed, the the great advantage of using water a body of precedent cases to guide water must still be in the river and imported from another watershed, water traders and through the stan- presumably flows to the purchasers. thus freeing it from the impacts of dardization of environmental impact In contrast, monitoring sales of water reduced or altered flows on down- reports. saved by more efficient field applica- stream users or externalities that Although water trades may tion methods requires the detailed complicate water trades along natural increase overall efficiency within a assessment of current and past irriga- rivers. In contrast, California water market, there can be negative finan- tion technologies as well as the level rights are far from homogeneous. cial impacts on third parties in the of implementation. California continues to recognize area of origin through local loss of For trades to occur easily, prop- riparian rights (water rights that are income and employment and erty rights must be clearly defined, attached to the land adjacent to the through impacts on neighboring enforceable, and transferable. In waterway) alongside appropriative groundwater users. Trades are more most western states, water property rights, which makes defining water likely to occur where impacts on rights are governed by prior appro- rights with sufficient precision to sell third parties in the area of origin are priation, whereby the first to claim them costly and litigious (Carey & minimal (perhaps because the water the water in a waterway for beneficial Sunding, 2001). Furthermore, in does not leave the watershed in use has first priority to the water, and many parts of California (as else- which it originates) or where state a water right not exercised for a where in the West), federal owner- law does not recognize them. Stan- period of some years is relinquished. ship of developed water resources dard economic theory does not usu- When appropriative rights were codi- complicates market development. ally consider these third-party fied into state laws in the late 19th The differential in water values financial losses to be legitimate. and early 20th centuries, state law- between current owners and poten- However, many trades do provide makers did not envision widespread tial buyers is often great enough to some compensation to third parties, leasing and permanent transfers of stimulate potential trades. However, often to appease
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