Water Markets Increase Water Supply

What Shortage?
Mount Shasta in Distance
Mount Shasta – Source of the Sacramento River

Editor’s note: Each year about fifty cubic kilometers of fresh water are captured by California’s reservoirs and released through a system of massive canals and aquaducts to points throughout the state. About twice that, roughly 100 cubic kilometers, comprise the total rainfall received in California in an average year. If one considers an aquifer and a watershed as part of a single integrated resource, then California probably is withdrawing, at 50% of all runoff, probably about all it can. Because in California the water falls mainly in the north and gets used mainly in the south, Californian’s have built a system of aquaducts which are the largest bulk water transportation system on earth, managing and allocating this immense volume of water. Vitally needed additional cubic kilometers of water enter California each year via the Colorado River Aquaduct. Although water is often in scarce supply, in California water is sold to farmers rates that are far, far below the rates that industrial and residential users pay. Is there a water shortage, or just an over-regulated market? In California, if farmers could sell their water rights to urban customers without losing their water rights, many people believe there would never be water shortages again…

Map of California's Major Aquaducts
California’s major Aquaducts
(yellow lines)

California’s water programs don’t work well because they are predicated on politics, not market factors…

Just when El Nino rains were sending rivers over their banks, the Resources Agency of California released a draft of the California Water Plan predicting statewide shortages early in the next century. Doomsday predictions are typical of such reports as are the calls for bureaucratic planning to correct the problem. Neither the predictions nor more bureaucracy would be necessary if the plan put more emphasis on water markets.

So what is the solution? More concrete and steel and more bureaucratic controls. David Kennedy, director of the California Department of Water Resources, calls for “water management options” including new storage and conveyance facilities, water recycling and conservation, water transfers, local agency surface water and groundwater supply projects and desalination, to mention a few.

These “management options” suffer from two major problems. First, they lack any meaningful sense of economic and environmental costs and benefits. Second, they ignore the obvious solution–water markets–that is catching on around the West and around the world.

Supply-side solutions including more storage and conveyance facilities, recycling and desalination are common in state water plans, despite the fact that they seldom pass economic benefit-cost muster. A classic example of government water economics comes from Utah. It will cost $300 per acre-foot just to deliver water to farmers from the recently funded Central Utah Project, never mind the sunk costs of dams already built. The same acre-foot of water will produce crops worth $30, but cost farmers only $8. Is anyone surprised that the Utah congressional delegation was able to move this project forward and is there any question whether California projects will be any different? Water may not run uphill on its own, but it surely gushes uphill under political pressure.

Rows of Vines
California agriculture
Can farmers sell water?

At costs as high as $2,000 per acre-foot, desalination does not make good economic sense, and recycling does not look much better with costs as high as $500 per acre-foot.

The second major problem with the plan is that is does not even pay lip service to water marketing, even though this is the surest way to solve water shortages. A search of the plans’ summary bulletin revealed not a single reference to water markets or water prices. Yet markets provide the surest way to encourage water use efficiency and eliminate shortages.

If there are water shortages, you can be sure that it is because water prices are too low. Data from every corner of the world show that a 10 percent price increase reduces urban water-use by as much as 12 percent and farm water use by 20 percent.

Consider two of the success stories of water marketing.

The California Aquaduct
main north-south section

When the state of California experimented with its Drought Emergency Water Bank in 1991, an offer price of $125 per acre foot yielded offers to supply water in excess of the 500,000 acre-feet that the state was trying to obtain.

In the drought year of 1987-88, water trading between the Australian states of new South Wales and South Australia involved over 1 million acre-feet and increased farm incomes by an estimated $17 million by improving water use efficiency.

Trading between California and Arizona for Colorado River water could provide similar benefits. The Central Arizona Project (CAP) pumps water 3,000 vertical feet from the Colorado River and delivers it to agricultural users who pay between $17 and $41 per acre-feet. Even at these subsidized prices Arizona users demand only 55 percent of the 1.5 million acre-feet they are guaranteed by the Colorado River Compact. Moreover, the project operates at a loss of $24 million per year. Much of the remainder is being captured by California and Nevada, but the supply is certainly not secure.

Why not encourage some interstate trading between Arizona and California?

A price of $140 per acre-foot would enable the Central Arizona Water Project to be operate in the black. This price is below the $150 being paid in California and Nevada for water from irrigation districts and far below the $1,600 for desalinated water. Arizona has expressed interest in changing the decree that governs water use among the Colorado river states to allow leasing of unused water. California’s Water Plan ought to jump on this bandwagon.

Los Angeles Skyline
Los Angeles – A very thirsty city

In 1982 when the Peripheral Canal initiative was defeated by California voters, Thomas Graff, general counsel for the Environmental Defense Fund raised a prophetic question when he asked, “Has all future water-project development been choked off by the new conservationist-conservative alliance?” The California Water Plan suggests not, but this plan is open for comment. Now is the time for such a “conservationist-conservative alliance” to make itself heard and put some market sense into California’s water problems.

About the Author:

Terry Anderson is the Executive Director of the Political Economy Research Center in Bozeman, Montana, “The Center for Free Market Environmentalism.” Mr. Anderson is also a senior fellow at the Hoover Institution at Stanford University, and an economics professor (emeritus) at Montana State University and co-author of Water Markets: Priming the Invisible Pump (Cato Institute, 1997). An earlier version of this article originally appeared in Southern California’s Orange County Register on February 16, 1998, entitled “Market Plan Can Ease State Water Shortage.”

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One Response to “Water Markets Increase Water Supply”
  1. Interesting article. I’ve done some independent research on carbon dioxide markets and recently made some similar comparisons to water.

    1. The supply for both commodities is constrained. A failure to meet this constraint will result in significant public negative externalities
    2. Both commodities have the potential for vast improvements through cost effective research and innovation
    3. Enforcement must be feasible and all-inclusive to successfully maintain the aggregate target for each commodity

    Given these similarities it may be worthwhile to extrapolate some of the lessons learned from the more developed carbon dioxide markets into the newly emerging water markets. In particular, there are two major disadvantages from market mechanisms that need to be addressed in the future for them to become mainstream successes:
    * It’s harder to enforce than supply side regulation, higher enforcement costs
    * It’s difficult for companies to make cost efficient decisions due to price volatility from external market factors such as liquidity and speculation

    I’ve included two articles I’ve written on the comparison that you might enjoy. Thanks for the read though.


    The QLC Consultant


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