WATER FOR CASH – A PRIMER ON WATER MARKETS

By Dipak Kumar

January 17, 2019

Originally posted by Wharton Public Policy Initiative: https://publicpolicy.wharton.upenn.edu/live/news/1803-water-for-cash-a-primer-on-water-markets

 

Introduction

Despite heavy rains and snowfall last winter, the water issues in the western United States have not been resolved for the long term. Groundwater tables are still low after being relied upon heavily during the previous drought years. The underlying legislative and infrastructural conditions prior to the drought have not changed. A sustainable, free-market solution, addressing future water crises could be a market for water trading. Instead of the government allocating water resources, water trading incentivizes and monetizes water conservation on the demand side while also helping water get to where it is most needed ¹.

A water market and its benefits

Water rights are central to any discussion about a water market. In the western United States, water is allocated primarily by historical precedent and fixed ². In California for example, if a piece of land came with a right to 10,000 acre feet of water 100 years ago, that water right is likely still bundled with that land. Moreover, any piece of land that is adjacent to a body of water or over a groundwater source comes with a right to the adjacent water. Under most current arrangements, owners of water rights lose their right to water if they do not use their entire allocation ³. This arrangement incentivizes a “use it or lose it” mentality, where users of water are encouraged to utilize their entire allocation instead of conserving water. The perverse incentive scheme results in a race to the bottom of the water barrel. Users are pushed to pump as much groundwater or utilize as much of the surface water as possible so that other users cannot take advantage.

A potential free-market solution that addresses these poor incentives is a water market. As explained on an NPR segment on water, a water market can be described as a stock market for water ⁴. Instead of offering financial products like stocks and bonds, sellers in water markets can offer short or long term leases on their water rights and even sell them outright.

A water market offers numerous advantages. First, it encourages conservation. By creating a price for water, it can visibly demonstrate the effects of saving it ⁵. According to the Nature Conservancy, there is still much potential to implement water conservation technologies and irrigation techniques in the United States ⁶. If a user can trade their water savings for cash, they will be much more likely to invest in conservation technologies ⁷.

Water trading, done right, also has the reciprocal effect of getting water to where it is most needed. In the short-term, transfers can reduce the economic effects of droughts by shifting water to activities and places where a lack of water will cost the most ⁸. In the long-term it can account for geographic changes in water demands and in turn a shifting economy ⁹. Proponents of the transfer benefit can point to successful real world examples. When a stable market for water rights was opened in Nebraska, a conservation group invested to restore the Platte river without the hassle of legislation ¹⁰. In Washington State, farmers with junior water rights saw their allocation evaporate in 2015, but because of a water market they were able to purchase the necessary water from senior rights holders to keep their fruit orchards in production ¹¹. In Australia, a water trading market designed during the worst years of the Australian drought increased conservation and preserved the Murray-Darling river basin agricultural industry ¹². Water markets offer the clearest opportunity where environmentalists, urban users, and agriculturists can work together to optimize water allocation.

 

Procedural Challenges

The benefits of a water market are only realized if the market is managed effectively. An effective water market needs the following characteristics: established and clear water rights, an ability to undertake transactions related to those water rights, and access to relevant market information ¹³.

Most water markets in the western United States do not meet these conditions. Many states, just like California, have a lack of clear water rights ¹⁴. In addition, these rights are not easily tradeable. For one, they are often bundled to the land and cannot be separated ¹⁵. Secondly, sellers undertake a significant amount of risk. A lack of clarity in water rights law leaves the potential for attorney involvement in any water transaction ¹⁶.

Even without legal interference, the exchange market as it currently exists is difficult to navigate. A seller must gain permission from countless local and state government water authorities before leasing or selling their water rights ¹⁷. Even then there is no guarantee the water will be delivered. Sellers do not have control over the decision to operate state aqueducts that ultimately determine where water goes ¹⁸.

Additionally, it is hard to tell whose water is whose, and if people own the rights to the water they sell. The nature of water itself dictates that it must be stored somewhere, and this storage is frequently communal. Also, there must be some way to measure the seller using less and the buyer using more as it is impossible to trade the same water that is on one’s property to someone else miles away. This measurement information must be accessible by all potential sellers and buyers, and currently the infrastructure for providing this information does not exist. “Because water is liquid in the liquid sense, it is not at all liquid in the financial sense.” ¹⁹ Building a water market then will require tremendous coordination amongst buyers, sellers, governments, and technologists who will engineer the online systems that would make water trading feasible.

Potential Drawbacks

For all its benefits a water market does come with considerable risk that must be acknowledged and addressed.

The need for greater coordination amongst different stakeholders does invite the potential for increased government regulation, especially as it pertains to measuring water use. The water market in Australia could not have existed without mandatory meters on every water pump in the water trading area ²⁰. In the 1990s, when water users utilized a water trading platform to substantially increase water trading in California, the platform was managed by a temporary government entity called the State Drought Water Bank ²¹. Without substantial private investment, it is hard to imagine a water trading market without similar types of government involvement.

On the contrary, private investment could also be a drawback. One of the greatest dangers of a water market are that current private water users will divest completely liquidating their water rights. In Colorado, perhaps the State the most developed water markets, “some communities turned into virtual ghost towns when Denver suburbs bought their water rights.” ²² The reality is that many rural communities across the Western United States are similarly built on agriculture, sustained by water, and are subject to similar risk as those Colorado towns. Unfettered selling raises even further ethical questions regarding whether those investors not involved with the underlying core water needs should become involved in the market. Many rural communities simply do not have enough control of their own resources to resist geographically distant investors with access to troves of capital or middlemen who will try to make a quick buck. A potential solution could be a market solely based on water leases and not on selling water outright.

There is also the drawback of not just encouraging water conservation, but encouraging water production. That is instead of implementing technologies to save water, users will be encouraged to pump more groundwater to sell more which will drain aquifers further ²³. To create an environmentally sustainable water market, there would have to be legislation curtailing the sale of groundwater that is pumped solely to sell on the open market.

Conclusion

In the West, the water issue has not been solved for the long-term. Water markets might be a viable, free-market solution that optimizes the allocation of water we currently have. They present the best opportunity for urban users, environmentalists, and agriculturists to find common ground, conserve water, and get water to where it is most needed.

However, for a water market to function and benefit all stakeholders, architects of any market must address key procedural issues and potential drawbacks of the system. Without proper design and implementation, water trading could generate further challenges that would outweigh any potential benefits. With the right team, clear intentions, and inclusive conversation we could soon be looking at a world where we together will decide where water flows.