So how are we going to build these western water markets?

Peter Culp, Robert Glennon and Gary Libecap have published an excellent new analysis of the potential for water markets to help us dig out of the western United States’ water mess:

Culp, Glennon and Libecap

Culp, Glennon and Libecap

Water trading can facilitate the reallocation of water to meet the demands of changing economies and growing populations. It can play a vital role in encouraging conservation and stewardship of water supplies in a way that can address cultural, social, and environmental priorities. It can facilitate building a structure for managing the ever-increasing risks of greater variability in water, including through methods such as insurance contracts, hedging tools, water banking, and other mechanisms. Deploying market tools in the allocation of water can help us to overcome the growing fragility and vulnerability of the water management institutions and infrastructure in the American West.

I agree, and their new work offers a great menu of policy options to move down this path. In brief (again quoting Culp et. al):

  1. Reform legal rules that discourage water trading to enable short-term water transfers.
  2. Create basic market institutions to facilitate trading of water.
  3. Use market-driven risk mitigation strategies to enhance system reliability.
  4. [B]etter regulate the use of groundwater by monitoring and limiting use to ensure sustainability, and by bringing groundwater under the umbrella of water trading opportunities.
  5. To make water markets work at scale, strong federal leadership will be necessary to promote interstate and interagency cooperation in water management

This is great stuff. But how do we actually do any of them?

Each of their first four bullet points is a staggeringly difficult task that will require enormous institutional capacity within the states to carry out. Consider California’s efforts to move on number four, for example. In the midst of the drought of record, with overwhelming problems caused by groundwater pumping, all California could manage was some feeble legislation aimed at just the first part – monitoring and limiting use to ensure sustainability at some future point in time sorta maybe. This is not for lack of smart scientists and policy people pointing out that the problem is deeper and requires stronger action. This rather reflects a shortcoming of the political system that has left us at with a sub-optimal equilibrium because of the ability of individual players, acting in their own short term interest, to block progress toward a more socially optimal solution. We’re stuck in the wrong spot, and years of water politics in California, despite calls to move off of it, have failed. From Kosnick:

There exists a socially optimal level of production of a good…, but without coordination of the overlapping players involved, optimality is not guaranteed. For example, this is a prisoner’s dilemma, where each player acting independently in his own best interest fails to internalize the externalities of his actions on the other players, and so a suboptimal (if dominant strategy) Nash equilibrium results…. Self-interest and a limited perspective reduce the benefits to society as a whole.

Not to pick on California, but nearly two decades of experience in trying to put together markets to move Colorado River agricultural water from Imperial and Palo Verde to the urbanized coastal plain (Glennon’s Unquenchable discusses the efforts at length) shows how hard this can be.

Culp et. al clearly get the difficulty of the task that they’re proposing. In a discussion of the impediments posted by existing water law doctrines, for example, they write:

Comprehensive reform of these doctrines would be controversial and could take decades to implement.

But I think they’re on to something when they suggest the following approach:

[S]tates could immediately act to facilitate effective short-term water trading. Particularly important would be for states to encourage existing water users to invest in conservation by allowing users who free up water to lease their water savings on a short-term basis to other users. This strategy offers obvious, real-world opportunities for win-win solutions, benefitting all parties and increasing economic efficiency.

Having spent years watching the New Mexico legislature’s lack of institutional capacity to make even simple water rule changes, and watching California thrash about this year in the midst of genuine crisis, I think Culp and his colleagues are a tad optimistic to suggest this could be done “immediately”, but whatever. I’m all for optimism. And I’d file this under the critical category of “baby steps,” smaller and relatively easier things that can be done that provide shorter term benefits and the learning experience to help amass the necessary social capital to take on the harder challenges to come.

I also think they’re on to something important in suggesting a federal role:

The federal government has a key role to play in assisting the development of water markets through its leadership on water issues, facilitating large-scale planning and interstate cooperation, developing critical data and information, modernizing the management of existing federal projects, and reforming existing federal agricultural policies.

Minute 319, the U.S.-Mexico agreement that, among other things, allowed last spring’s Colorado River Delta environmental pulse flow (and which Culp helped design) is a great “baby steps” example. It includes some of the elements Culp, Glennon and Libecap are asking for (albeit dressed up quite differently), but it was as much about learning how to do stuff as it was about actually doing stuff. It also demonstrates the importance of the role of the U.S. federal government.

The important thing we need recognize here, I think, is that the investment in the social capital needed to do these things, an investment in what I’ve sometimes called the “institutional plumbing”, is every bit as real and important as the investment in pumps and canals and dams that make up the physical plumbing of water in the West.


  1. If short-term transfers were easy, we’d already be doing them. The problem is that even a short-term transfer can have externalities. Does the loss of return flows imperil environmental flows? Will fallowing aggravate air pollution? Cause unemployment? Take money and jobs out of the local community? Is the recipient really using the short-term lease only to cover an unexpected shortfall? Given the fungability of water, how do we measure, oversee, and enforce the transfer?

    And putting aside the substantive issues, there is always the procedural ones: who decides? who can challenge the decision? who reviews the decision? Virtually every transfer is going to involve at least one public agency, and public agency actions are generally reviewable in the courts. Do we make these public agency decisions unreviewable? Or create an expedited review system?

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  3. As someone who writes for a free market think tank and advocates water markets, allow me to say that the current fad to call for water markets to spur conservation and solve drought is misinformed. California doesn’t operate in a purely socialized system of cheap water nor in a purely private market. It operates in a market in water contracts. Moreover, there is no magical fix for drought in higher water pricing. The best study we have of tiered water pricing in the Edwards Aquifer in Texas found that such pricing results in 5 to 6% greater water use.

    Farming would become obsolete if all farmers had to compete with cities or each other in water market. Moreover, cities would entirely lack water for dry years without farmers paying to keep in place the massive California State Water Project and Central Valley Project supplying water for droughts.

    Farming requires large upfront costs of buying large expanses of land, farm equipment, seed, cultivating land and borrowing capital from farm banks to undertake growing crops. For farmers to have to compete each day, month, or year for water in a competitive market would eliminate farming altogether because the certainty of the price of water to underwrite loans to farmers would not exist.

    Additionally, to amortize the gigantic cost of building dams, reservoirs and aqueducts, bonds have to be issued and paid back over 50 years or so. Neither farming or building dams could occur if every farmer and city had to go into a “spot market” each day, month or year to buy water. The way the costs of the Federal Central Valley Project are paid back is by water rates to farmers. Those water rates have to be established based on cost, not based on market price. If they were based on market price, no bonds could every be issued to underwrite the construction of dams or aqueducts.

    The solution to a situation where there are large upfront costs is water contracts. 95% of system water in California is allocated by long term contracts. 5% of system water is allocated by water auctions or water transfers. In a drought, the 5% should be expanded to at least 10%.

    Moreover, about 60% to 70% of the water for California’s farmers comes from system water and 30% to 40% from farmers’ own groundwater through a system of water rights. So if groundwater also had to be exposed to a “spot market” there would be economic anarchy and constant water warring.

    There is a vibrant market for water in California. But it is a market in long-term water contracts and in private property rights to groundwater that can be traded between farmers or between farmers and cities. Moreover, many land and farm sales convey water rights along with the property rights. So the farm and farmland real estate market also leads to flexibility of water supply (think Central Valley farmers who bought land is Siskiyou County for almond growing because of the water rights that went with the land).

    Moreover, the difference between the cost of water reflected in water rates and the price of water in water auctions during droughts is not a subsidy, contrary to many libertarian water economists. No taxpayers are paying a water subsidy to farmers. Farmers are paying for the old bonds on the Central Valley Project.

    For the most part crop subsidies for rice and cotton and other crops in California are no longer necessary with the globalization of agricultural markets. Farmers can sell surplus crops in the global market and no longer need crop subsidies. The 2013 Congressional Farm Bill eliminated crop subsidies and replaced it with crop insurance programs.

    Imagine what would happen if we told homeowners that the interest rates on their home loan had to be paid in a spot market of interest rates that changes daily, monthly or yearly? We don’t say that households have to go into a spot market each month or year to buy a house, so why do we say that farmers must go into a spot market for water? If there were no long term loan contracts for building and buying homes no new housing would be built or sold and there would not be such a thing as the real estate market. So again, why should farmers or cities have to buy water in auctions except in droughts?

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  5. I’m very interested in the issues of water in CA but I doubt the viability of getting any sort of “leadership” out of Washington. To put it bluntly the current political system is so fractured and dysfunctional that to bring those buccaneers into the picture is like a black person in Ferguson MO calling a police officer. It won’t turn out well. Mike

  6. Michael
    Thank you for your comment and J. Fleck for hosting this forum.

    In the 1930’s California was mired in the Depression and was unable to issue municipal bonds to finance its own planned water project. The Federal government intervened and built out the Central Valley Project which provides about 7 million acre feet of water in a dry year and about 6 million acre feet in a wet year.

    Believe it or not Sen. Dianne Feinstein has been trying to cobble together a non-partisan solution to the drought and stands a better chance of possibly getting the Temperance Flat Dam construction underway before Brown can get the Sites Dam Project underway (IMHO) with a coalition with the Republican Congress.

    In comparison, the State Water Project built by Gov. Edmund Brown, Sr., provides about 2 million acre feet of water in either a dry or wet year. Jerry Brown only has control over only about 3.5% of all water supplies in California in a dry year!!!

    Brown appointed environmentalist John Bryson to the Water Control Board from 1979 to 1982.

    The largest source of water is groundwater at 31%. The second largest providers are local water projects and irrigation districts which amount to about 28% of all water in a dry year. 59% of system water is local, not state or Federal. Brown exerts control over local water districts and groundwater basins through the State Water Resources Control Board, which is used to issue the edict to reduce water use by 10% to 35% this year.

    California has decades of groundwater available in the Central Valley, despite media perceptions otherwise. This water shortage for farmers originated when water was diverted from farms to the environment around 1990, but development of backfill water resources were never completed for farmers for when a drought came.

    The Ferguson, Missouri metaphor is not a good analogy to California’s drought. The water cops are being called in but a new study shows mandatory water rationing two days per week results in MORE, not LESS, water usage! Just as low flow shower heads and low-flow toilets only encourage residents to use more water, it is unintended consequences, not overt bureaucratic abuse, that is likely to be the major problem with Brown’s drought policies.

    I was involved on a Task Force for a large regional water wholesaler in California in 2001 during the California Energy Crisis. The drought crisis will probably be no better managed then that energy crisis. Most of what government can do is muddle through while Murphy’s Law expresses itself.

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