Water Rights Markets An Introduction

Water rights markets, or systems of transferable water rights, have generated considerable interest in recent years in the literature on water management and economic development, in spite of the fact that formal water rights markets exist, at least until very recently, only in a few places, most notably in the Western United States,110 Spain, Brazil, Australia, Mexico and Chile. The interest arises primarily out of the potential of such markets to foster efficient use of an increasingly scarce resource. This section of the chapter examines the nature of water rights markets, issues that need to be addressed, their advantages, and the minimum requirements for their adoption.

The enthusiasm for water markets is tempered in the minds of some practitioners. For example, in the opinion of the World Bank's Middle East and North Africa Regional Office:

. .. market mechanisms are particularly problematic in water. . .. No doubt local water markets often operate successfully. But it is unrealistic to expect that a general reallocation between sectors or improvements in water quality can be effected through the market, at least for the foreseeable future. . .. Moreover, renewable water is a fugitive and variable resource associated with pervasive externalities. It is thus inherently difficult to manage, becomes embedded in complex institutional structures, and cannot be apportioned and regulated solely - or even significantly - by the market. Thus, government is inevitably required to: (1) establish the policy, legislative, and regulatory framework for managing water supply and demand; and (2) ensure that water services are provided, notably by constructing large-scale projects ... for which economies of scale or social externalities preclude private supply.111

109. E. B. Rice, 1997, p. 60 [emphasis in original].

110. Mainly California and New Mexico, with some markets in Colorado and elsewhere and markets for temporary transfers of water in Wyoming.

The proponents of water rights markets take as the point of departure the fact that such markets exist, albeit without official sanction, in many places. Examples of informal sales of agricultural water in Bangladesh, Yemen and Tamil Nadu, India, have already been mentioned. Experiences elsewhere can be cited as well. Rosegrant and Binswanger refer to extensive water markets in India as a whole and in Pakistan:

Shah (1991)112 estimates that as much as one-half of the gross area irrigated by tubewells in India belongs to buyers of water; Meinzen-Dick (1992)113 and Chaudhry (1990)114 document the rapid development of markets for groundwater in Pakistan. Water trading within surface water systems is also expanding. A recent survey in Pakistan found active water markets (trading or purchasing of water) in 70 percent of watercourses studied (Pakistan Water and Power Development Authority).115

In another context, Thobani points out that in Mexico informal water rights existed before the passage of the 1992 Water Law which established a system of codified rights, and that 'semi-formal' rights have long existed in Brazil and elsewhere.116 The trend toward formalization of water rights as water becomes more scarce is a parallel to the growing formalization of land titles, as population pressure on land increases, which has been discussed in Chapter 5. 'When water is plentiful relative to demand, laws governing water use tend to be simple and enforced only casually. Where water is scarce, more elaborate institutional systems evolve'.117

Leaving water trading as an informal activity, instead of establishing a legal and institutional framework for water markets, has disadvantages:

In some cases these [informal] trades have not performed well and have resulted in an economically inefficient allocation of water. In parts of South Asia, wealthier farmers with deep wells charge neighboring smaller farmers a high. . . price for water. As a result, crop output is lower than it would be if the water were priced at its opportunity cost - and income inequality is exacerbated. The opportunity to sell such a valuable resource also increases the exploitation of groundwater, which can deplete underground aquifers. . . . Moreover, because such transactions are illegal, it is difficult to . . . protect the aquifers.

. . . illegal markets may allow upstream users to sell more than they actually consume (because they may sell the return flow component of their water right), thereby infringing on the rights of third parties. In addition, the buyer lacks the security of an enforceable contract. Trades are therefore limited to spot sales or to sales for a single season, often between neighbors; longer-term trades are nonexistent, depriving potential investors or water companies [of] secure long-term access to water. . . informal markets do not. . . provide sufficient incentives or means for the creation of new infrastructure (M. Thobani, 1997, pp. 165-166).

112. T. Shah, 'Managing Conjunctive Water Use in Canal Commands: Analysis for Mahi Right Bank Canal, Gujarat', in R. Meinzen-Dick and M. Svendsen (Eds), Future Directions for Indian Irrigation, International Food Policy Research Institute, Washington, DC, USA, 1991.

113. Ruth Meinzen-Dick, 'Water Markets in Pakistan: Participation and Productivity', draft research report under USAID to Pakistan Grant No. 391-0492-G-00-1791-00 for the Ministry of Agriculture, mimeo, Government of Pakistan and International Food Policy Research Institute, Washington, DC, USA, 1992.

114. M. J. Chaudhry, 'The adoption of tubewell technology in Pakistan', The Pakistan Development Review, 29, 1990, pp. 291-304.

115. M. W Rosegrant and H. P. Binswanger, 1994, p. 1616.

Water markets work on the basis of legally recognized and registered water use rights which are separate from land titles, an infrastructure which allows for reallocation of water, regulatory provisions for the protection of the public interest and third parties, institutions for contract enforcement and conflict resolution, and rules for apportioning shortages and surpluses of water. As in the case of other allocational mechanisms, responsibility must be assigned for operating and maintaining the water infrastructure.

The system may be defined so that only groups of irrigators may make sales of water to non-agricultural interests, but individuals can trade rights within the group. Alternatively, individuals may be free to make any kind of transaction. Sales of water rights may be made on a long-term basis, even permanent, and they may also be 'rented' on a short-term basis. In all cases, the price of the rights is freely negotiated between buyers and sellers. In Mexico, the water rights may take the form of concessions of up to 30 years. This period is long enough to encourage investments by the user, for example, in water conveyance structures (both on and off the farm), land leveling, drainage structures, and the planting of high-value but long-maturing fruit trees.

However, water rights markets do not function like most other kinds of markets. The conditions of competition - many buyers and sellers -usually are not fulfilled, and transactions require approval from various groups, from water user associations in Chile and Mexico to state governments in the Western United States. 'To an extent that is determined by state laws, water rights transactions must be approved by the state. This will typically involve an application for a transfer submitted to the office of the state engineer who examines the proposed transfer for any adverse effects on third parties. In some states, the transfer is publicized and any interested party can challenge the transfer at hearings conducted by the state engineer'.118

Although the concept of formally tradable water rights is relatively new, water rights themselves are an established institution in most parts of the world: 'it must be stressed that usufructuary rights to water already exist in most developing countries, either implicitly (through custom) or explicitly (through bodies of law and regulations). Establishment of transferable property rights is a matter of reforming or modifying existing water rights systems'.119 The infrastructure for reallocation of water among sellers and buyers does not necessarily have to be extensive; if the quantities traded are large enough to warrant it, the buyer may invest in new conveyance facilities. This may happen when the buyer is a municipality or a large industry. Most commonly, transactions occur within the same watershed so that, for example, an upstream seller agrees to cease diverting a defined quantity of water from the river, leaving that amount available for the downstream buyer to take out of the watercourse. Many transactions occur among farmers in the same irrigation system. In these cases, the irrigation infrastructure must be flexible; for example, it would need gates instead of proportional flow dividers.

The main motivations for establishing systems of tradable water rights have been summarized by Thobani:

The potential to sell water rights makes them more valuable and provides an incentive for conserving water and reallocating it to higher-value uses. In this sense, the outcome is similar to that under opportunity-cost pricing. Trad-able water rights also allow leasing of water (for a season, say) and spot sales; in fact, they facilitate such transactions. Finally, by allocating initial water rights, without charge, to existing users or holders of water rights, tradable water rights can circumvent the political problems associated with raising water prices and setting non-uniform charges. Governments can monitor operations and more effectively

118. R. G. Cummings and V. Nercissiantz, 1992, pp. 748-749. See also the illuminating case studies of water rights, though not necessarily markets for them, in Bryan Randolph Bruns and Ruth S. Meinzen-Dick, Negotiating Water Rights, International Food Policy Research Institute and Intermediate Technology Publications, London, 2000.

119. M. W. Rosegrant and H. P. Binswanger, 1994, p. 1615.

In Mexico water rights markets are nascent but growing:

Since 1995, when the massive effort of registering water rights began in earnest, the National Water Commission has approved 517 transfers of water rights, resulting in a total annual volume of water rights transferred of about 160 million m3. Because total annual water use in Mexico is estimated to be over 200 billion m3, the amount of transfers approved so far is small. However, when water can be made available to meet demand through water markets, it reduces the need for constructing costly supply-oriented infrastructure and leads to a more rational and economically viable allocation of water resources (Karin E. Kemper and Douglas Olson, 'Water Pricing: The Dynamics of Institutional Change in Mexico and Ceara, Brazil', in A. Dinar (Ed), 2000, Chapter 16, p. 352).

enforce laws and regulations aimed at preventing the abuse of monopoly power, at ensuring that sales do not negatively affect the water available to third parties (that is, addressing the problems of return flow), and at protecting the environment.120

In order for these benefits to occur, a number of issues must be addressed in the course of designing a water rights market, including ensuring that equity concerns are satisfied. The principal issues are reviewed in the following section.

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