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Article Excerpt
I. INTRODUCTION
Farmers in the American West use roughly 80% of the region's water, often in low-value or subsidized crops, such as alfalfa, cotton, or rice. Farmers typically pay only for the pumping or conveyance costs for the water and not for its scarcity value. (1) Accordingly, much water use in agriculture has less value than if it were used in the West's rapidly growing urban areas and in many environmental and recreational uses. As a result, significant allocative gains arise if some water is moved from agriculture to other sectors.
For example, in 1992, Ronald Griffin and Fred Boadu reported that the value of water used in agriculture, capitalized over 50 yr, was $300-$2,300 per acre-foot (approximately 326,000 gallons) in the Rio Grande Valley of Texas. In contrast, urban water values, capitalized over the same period, ranged from $6,500 to $21,000 per acre-foot. Griffin and Boadu estimated that the average reallocation of water produced net benefits of $10,000 per acre-foot. (2) For more contemporary evidence, in California, an acre-foot used in the semiconductor industry produces $980,000 in gross state revenue; that same acre-foot used to grow cotton and alfalfa generates $60. (3) Groundwater for farming near Marana, Pima County, Arizona, costs approximately $27 per acre-foot, whereas the same water supplied by Tucson Water, with an increasing block rate structure, will cost customers from $479 to $3,267 per acre-foot. (4) In recent efforts to secure water from southeastern California's Imperial Irrigation District (IID), San Diego offered $225 per acre-foot for water that IID farmers paid $15.50. (5) Even more dramatically, IID farmers paid $13.50 per acre-foot in 2001, while a development near the South Rim of Grand Canyon National Park was prepared to spend $20,000 per acre-foot to deliver the same Colorado River water. (6) Although the costs of treating and distributing water for urban residents tend to be far greater than for rural and explain some of these price differences, the size of the differentials indicates the higher marginal benefits received by many urban versus rural users for water.
These disparities in the value of water have occasioned calls for reallocation of water from lower value to higher value activities through water marketing. Such trades can benefit both parties: farmers receive more for their water than they could earn in agriculture and cities (7) secure additional water at a lower cost than available alternatives, such as desalination. The need to develop water markets for the smooth, incremental transfer of water across sectors with minimum transaction costs has increased over the past 20 yr due to brisk population growth, urbanization, increased environmental concerns, and a rise in the economic contribution of services simultaneous with a relative decline in agriculture.
As the legal summary in Section II will make clear, water markets are more complex than markets for other resources, such as land. Property rights to water are less complete due to the mobile and uncertain nature of water supplies, the incomplete adjudication of water rights in many watersheds, and the fact that individuals have usufruct rights subject to state oversight. (8) Further, because water rights often involve sequential users of the same water, water trades that change the location, nature, and/or timing of use, as is the case with most agriculture-to-urban transfers, are regulated by the states in order to limit harm to third parties, who might be adversely affected. Third-party objections to water transfers can and have slowed, limited, or blocked water transfers. (9) Even though the interconnected nature of water rights has the potential to drive up transaction costs, water transfers are taking place.
This article addresses the extent and nature of western water marketing. It documents trading activity, identifies the sectors and states involved, describes the contractual forms used, and illustrates the trends in water transactions over time. Water markets as we define them involve three different types of voluntary transactions: sales of water rights, 1-yr (short-term) leases, and multiyear (long-term) leases. Water transfers are affected by the timing of the transaction, location, quantity of water, and priority of water right (discussed below). We are primarily interested in three types of water trades: agriculture-to-agriculture, agriculture-to-urban, and urban-to-urban for the 12 western states. Our objective was to provide a comprehensive portrait of how water markets have developed in response to the price differences noted above.
Our data reveal a number of important features regarding water markets: (1) prices are higher for agriculture-to-urban trades relative to within-agriculture trades. (2) Agriculture is the origin of the majority of transactions. (3) The annual flow of water traded and the amount of water committed for transfer in a given year through long-term contracts (long-term leases and sales) reveal very different patterns regarding the movement of water. As measured by the amount of water contractually committed in a given year, the volume of water traded in the West is increasing over time, whereas, if measured by the annual flow of water traded, the amount is not rising. (4) The number of market transactions is increasing over time primarily due to agriculture-to-urban trades. (5) Sales and multiyear leases are growing, while 1-yr leases are not. (6) Whether measured as annual flow or committed water, Arizona, California, and Texas are among the top four states in the quantity of water traded. (10) And, (7) agriculture-to-urban trades involve the majority of the water moved in most states when using the committed measure, whereas agriculture-to-agriculture trades involve the majority of water in most states when using the annual flow measure.
We report annual water transfers from 1987 through 2005 as listed in the trade journal, Water Strategist, a monthly publication that details transactions, litigation, legislation, and other water marketing activities. Self-advertised as "the only source of published information on water transactions in the West," (11) the Water Strategist publishes each month a "Transactions" section that lists, by state, each water transfer that occurred. From the publication, we can learn all or a subset of the following: the year of the transfer; the acquirer and supplier of the water (both labeled variously as municipality, developer, company, irrigator, farmer, rancher, conservancy district, irrigation district, state, federal agency, etc.); the amount of water transferred; the proposed use of the water; and, if applicable, the terms, such as the price and nature (lease or sale) of the contract. Our data set only includes transactions reported by the Water Strategist and no doubt misses some transactions. These are most likely to include within-organization (within-irrigation district) short-term trades. (12) Even so, Water Strategist listings are the most comprehensive available and, hence, capture the general pattern of water trading. (13)
In Section II, we offer an overview of water rights in the West and consider some critical legal and regulatory issues that affect water markets. Section III discusses issues raised in the economics literature that relate to water transfers, while Section IV addresses general data collection methodological issues and Section V explains how we measured the volume of water traded using a "committed" variable. Section VI presents price trends in western water markets, and Section VII offers an overview of the markets with data on the contractual forms used, the categories of trades, the number of transfers across time, the changes in contract type over time, and differences in the markets across states. Finally, Section VIII offers a summary of some key findings.
II. APPROPRIATIVE WATER RIGHTS AND WATER MARKETS
To operate properly, any market requires reasonably secure property rights. Unfortunately, water rights are weaker than those for most resources due to water's physical characteristics and unique legal status. Because water moves, surface water cannot be bounded or partitioned easily across claimants and uses. Surface water often is hydrologically connected to groundwater, which also migrates and is unobserved. (14) Moreover, simultaneous and sequential users of water make exclusion difficult and create numerous interdependencies. Consequently, the trade of water can inadvertently affect multiple parties.
In western states, individuals do not own water as they might own land. The state owns the water, which it holds in trust for its citizens. Individuals only hold usufruct rights to the water, subject to the requirement that the use be beneficial and reasonable and to oversight by the state in monitoring transfers to ensure that they are consistent with the public interest. (15) Accordingly, water rights appear to have less protection or be more fragile than most other property rights. (16)
In general, western surface water rights are based on the prior appropriation doctrine that allows rights holders to withdraw a certain amount of water from a natural water course for private beneficial purposes on land remote from the point of diversion. (17) Ownership of water is allocated through the rule of first possession or priority of claim. (18) Those with the earliest water claims have the highest priority, and those with subsequent claims have lower priority or junior claims. As such, there is a ladder of rights on a stream, ranging from highest in priority to the lowest. This allocative mechanism ranks competing claimants based on priority in order to ration water during times of drought. Lower priority water rights carry greater risk in water transfers because of possible shortfalls and accordingly are often of less value in water markets.
Failure by rights holders to continue to use their water may result in the rights being lost through the doctrines of abandonment or forfeiture. (19) These doctrines create a perverse incentive for rights holders to use all their water. In many states, farmers who conserve water receive no benefit, as the water saved will go to the next-priority user on the river. As a result, farmers are motivated to devote large quantities of water to grow low-value crops. Until the development of water markets and recognition by state legislatures that conservation measures are consistent with beneficial use, farmers could do little else with their excess water. California eliminated this disincentive to conserve with a statute that provides that, when the use of water is reduced through conservation, the conserved water may be sold, leased, or transferred. (20)
Because appropriative rights can be separated from the land and sold or leased, they can form the basis for private water trades. (21) Even so, the process can be complicated. Appropriative rights are measured in terms of diversion, but transfers of water that change the point of diversion, timing, or nature of use are usually based on the amount of water consumed. (22) Measuring transfers by consumption is important because it protects the rights of subsequent downstream diverters who have come to rely on the return flow from the first diversion. Hence, limiting trades to consumptive use reduces third-party effects on downstream diverters. However, calculating consumptive use is more difficult, thus driving up the transaction costs of trade. (23)
Water markets also are affected by differential water quality, especially cross-sector trades from agriculture to urban. Urban utilities generally prefer and will pay more for high-quality water that has less need for additional treatment. Within-sector trades may be easier because the level of water quality demanded and supplied may be more homogeneous. As we will see, municipalities and irrigators routinely transfer water among themselves.
Water markets also depend on conveyance opportunities, and the lack thereof can significantly reduce arbitrage possibilities. (24) This requirement includes access to canals and aqueducts, as well as to rivers or streams whereby water can be released by one diverter and appropriated by another.
Finally, water markets are generally local or, at most, statewide markets. There is little private water trading across state lines due to a variety of state regulatory restrictions and to the costs associated with transporting a heavy commodity (an acre-foot of water weighs 1,358 tons) to great distances. The price data bear out this situation by revealing the large arbitrage opportunities that exist among neighboring states.
III. WATER MARKETING IN THE ECONOMICS LITERATURE
A large economics literature has addressed water reallocation and the potential for water markets, and therefore, we only acknowledge representative articles. It is generally accepted that sharp differences in marginal water values among agricultural, urban, and environmental uses exist. Some authors, however, express puzzlement regarding the comparatively limited extent of voluntary exchange (Young 1986). One response has been to focus...
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