The Evolving Western Water Markets

Expanding population and environmental protection the world over are placing additional demands on existing water supplies. Meeting these demands by traditional structural supply augmentation is dogged by increasing environmental and fiscal costs, which leave excess water demand to be met largely by conservation and reallocation of existing supplies. Water trading clearly has a role in reallocating supplies and stimulating conservation by providing a clear measure of its value for conservation and a voluntary self-compensating mechanism for reallocation. Despite these advantages, traditional markets have been slow to evolve in the western United States for institutional and hydrologic reasons. However, even when institutional, political, and physical impediments prevent textbook water markets from developing, significant gains in efficiency can result from relaxing restrictions on ownership, use, and transfer. Most water markets in the western United States fall between the two extremes of textbook markets in which, on the one hand, price is determined by unfettered market forces, and on the other, there is an outright legal prohibition of trading. Three fundamental reasons probably cause the slow evolution of water markets in the West. First, water has many public good characteristics, benefiting not only the owner of a water right, but also the public at large. Public interest in water is supported by the fact that most western states retain the ultimate property right to water; individual water rights are more akin to use rights than private property rights. Second, fluctuations in water supply result in periodic “thin” markets with few participants. Third, water transfers often require significant costs, in terms of both institutional costs and the cost of physically transporting the resource. Even in the presence of willing buyers and sellers, trades of permanent water rights are often not approved by regulators because they would result in significant externalities—physical impacts on parties not involved in the transaction—and in third party financial impacts to the exporting region. A worldwide survey of existing markets makes it clear that gains in efficiency can occur even in the absence of theoretically perfect markets (Saleth & Dinar, 2004). The efficiency gains are achieved by moving water to higher value uses. To achieve these gains, many states west of the Mississippi River have implemented legislation to facilitate water trading within their borders. However, because water has both private and public good characteristics, it has often been developed with some degree of public financing or subsidies. Hence, its reallocation generates heated controversy—especially when potential profits are involved.