Topic Area: Water Markets
Geographic Area: California, USA
Focal Question:What is needed to create a more efficient market?
l ) California Department of Water Resources- http://tiger-2.water.ca.gov/dir-dwr_programs/DWR PGMS-CA Water_Plan.html April 25, 1997
2) Saliba, B. C. and D. B. Bush (1987). Water Markets in Theory and Practice: Market Transfers, Water Values. and Public Policv. Boulder, CO, Westview Press.
Reviewer: Megan Leigh Dingler, Colby College '96

Water markets based primarily on appropriations rights in California are different from most other markets due to the fact that the water is not considered a part of the land but is often needed to realize gains from the land.4~The high costs associated with water markets are largely due to the substantial number of agencies and interesth groups involved in the sale of water as well as the opportunity costs of varying water uses. For these reasons, proposed water transactions often take vast amounts of time and resources prior to completion or rejection, resulting in inefficient public resource allocation. As the demands on existing water supplies increase, finding mediation techniques which require fewer resources will aid the market in discovering a greater degree of allocative efficiency.

The current market structure is governed by a pyramid of agencies with the primary governing body of the Federal Central Valley Project(CVP), which controls approximately 65% of the state's water. This agency, primarily serving the farming sector, is also responsible for the greatest portion of the conveyance systems bisecting the state, a system heavily subsidized by the United States tax payers. Under the CVP is the State Water Project(SWP) and the California Department of Water Resources(DWR), both having jurisdiction over transfers crossing specified water district boundaries of which there are nine. The next tier down involves the approximately 3,000 organizations and agencies responsible for the pricing and transport of water to special irrigation districts and municipal customers.

The number of agencies involved in any given transaction outside of a small district substantially increases the transactions costs of negotiations. This is especially true since the farmers do not actually own the water but contract for the use of the water on an extended basis. The cost of negotiation and the subsequent increase in risk often outweigh the potential gains to either party of entering into an agreement.

The water available to California is subject to one of three classifications: real water, new water, and paper water. Real water is the most common approved for transfer since it does not injure any other water rights holder. New Water is water which was not previously available such as groundwater or desalinized ocean water. Paper water is that water which is available only through the fallowing of land which was previously irrigated. New and paper water are difficult to transfer due to the environmental and economic consequences to the region from which that water is removed. Loss of wildlife habitat, jobs, community taxes and desert encroachment are a few examples of these losses.

The State Water Code which defines the conditions for all transfers within the state dictates that all proposed transfers meet the "no-injury-rule," laid out in sections 1706, 1725, 1736 and 1810(d) of the Code. This means that down stream water rights holders must not be adversely affected by the loss in return flow resulting from the removal of the transferred water, environmental habitats must be respected, and local communities must be compensated for the loss in employment and allied industry income resulting from fallowing. The proof of no-injury lies with the proponents of the transfer.

In the case of increased groundwater reliance, no-injury is very difficult and costly to prove due to the uncertainty mvolved in hydraulic movements through the earth's crust. A farmer who overlays an aquifer has riparian right to that water. If that farmer also holds a contract for surface water, the surface water may be available for transfer. As the farmer increases pumping of groundwater, a cone of depression will form around the pump, drawing the aquifer level down. The aquifer will recharge by drawing from adjacent surface water sources. If this transfer is allowed, other water rights holders will effectively be subsidizing the farmer who transferred water rights, by supplementing the increased groundwater withdrawals. Such was the case with many of the 1991 Water Bank transfers which were intended to mediate the effects of the drought.

Growing municipalities in Southern California, are increasing the demand for water and ultimately the price. Unless new water is created, either through desalinization of ocean water or increased extraction from existing sources currently reserved for habitat maintenance, farmers will feel an increasing pressure to conserve. By conserving the water which is provided to irrigators at prices below marginal cost, water districts and farmers will be able to capture the increasing scarcity rents provided by the municipalities. This is the case with deal struck by the Metropolitan Water District(MWD), which serves the Greater Los Angles area, and the Imperial Irrigation District(IID), serving the Imperial Valley.

In 1987 the MWD agreed to pay the costs of conservation technologies to the IID. The average cost of ditch lining to reduce ground seepage for 400,000 acre feet of conservation investment is $240 acre foot conserved. This price is the least expensive of the options which were available to the MWD at the time. A portion of this price was to implement technologies allowing a portion of the water to seep into the ground, thus maintaining wildlife habitat and seepage recharge of aquifers which would have been dramatically altered had a portion of the water not been allowed to enter the surrounding soil. Through MWDs increased investment, allowing aquifers to be artificially recharged by water which is initially subsidized, the growers relaying on groundwater to irrigate their crops are receiving water effectively subsidized twice by the tax payers. This situation creates inefficient allocation of financial and environmental resources as the price paid by groundwater users does not reflect the true market price were all externalities included in this price.

Until the agencies involved in transactions can be decreased or reorganized so as to lower the risk, and transactions costs involved in selling water the market will continue to be thin and a "going" price will remain elusive. The development of a going price will facilitate farmers in making socially optimal decisions regarding the amount of water to use for irrigation, and the type of crop to plant.

~In order for an efficient market to form a greater investment must be made into evaluating the hydraulic properties and habitat needs of the irrigated area so that the price paid for transferred water may effectively represent the externality costs involved in the reallocation of the resource. The creation of such a market will allow water to flow to the socially optimal point as determined by the market, thereby reducing waste and pollution resulting from over irrigation and chemical input run-off.

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