Can water markets help solve the American West's water crisis?

It's no secret that the American West is facing a serious water crisis.

The region — home to over 60 million people and a huge chunk of US agriculture — is in its 15th year of drought. Texas has suffered more than $25 billion in damages so far. Las Vegas is worried about plummeting water levels in Lake Mead. California has received so little rain that farmers are pillaging the state's hard-to-replenish groundwater aquifers at a shocking rate:

Maps of dry season (September–November) total water storage anomalies (in mm equivalent water height; anomalies with respect to 2005–2010) in the western United States. (Famiglietti et al, 2014)

And things are only likely to get worse in the years ahead, particularly since population growth is soaring in many arid states and global warming is expected to make the West's water supplies even less reliable (by, for instance, shriveling snowpack in the mountains).

So what should the West do? There are lots of outlandish solutions out there. Some people have suggested diverting valuable water from the faraway Missouri River. Or towing icebergs from the Arctic to California. But this would be staggeringly expensive. Other, more modest proposals include water recycling or even desalination.

But still other experts insist that part of the answer lies in a much more boring but effective solution: water markets. Basic economics, they say, can help fix the water crisis.

One way to alleviate the West's water woes — markets

One key fact about water in the American West is that it's often underpriced. There's little relationship between the cost of water and how scarce it actually is. And that gives farmers and cities less incentive to conserve.

water markets would give people more incentive to use it efficiently

On top of that, a complex thicket of regulations (and, in some places, a lack of delivery infrastructure) makes it quite difficult to trade water like you can any other commodity. That means that water isn't always going to the places where it would create the most value.

This can create all sorts of perverse situations, says Robert Glennon, a law professor and water expert at the University of Arizona. In the summer, for instance, when temperatures are soaring and water is scarce, many farmers in southern California are still using enormous quantities of water to grow alfalfa, a fairly low-value crop that gets shipped abroad for use in dairy industries. (All told, 14 percent of California's water use goes toward alfalfa.)

Why is that? In part because the water these farmers get from their irrigation district is so cheap, they may as well grow something with it. What's more, it isn't always easy for these farmers to sell their water rights to other people in California who might find better use for it. So they use the water to grow alfalfa. Sure, it's a bit of a waste. And alfalfa isn't the most valuable commodity around. But at least they can sell it.

Glennon would like that to change. He recently co-wrote a paper for the Hamilton Project that scrutinized a number of rules that impede water trading. "We think those rules create disincentives and impede efficient use of water," he told me. "And we'd like to see them changed." The paper acknowledges that this is a complicated affair — and reforms might take many, many years. But, the authors argue, it's a far better way for the West to manage its dwindling water resources and avert future crises.

And the impacts could be significant. Right now, farmers and ranchers account for 80 percent of water use in California alone. If they increased efficiency by a mere 4 percent, that could boost the amount of water available to cities and businesses by 50 percent:

(The Hamilton Project)

How water markets might work in practice

Let's take a look at how this would actually work. The basic logic is that someone who really, really needs water should be able to pay someone else to stop using so much water or to invest in conservation — and, in return, get some of that water.

The basic idea is that one farmer could pay another not to use water

Glennon offers an illustrative example of the sort of trading that's already possible in California (to some extent). Imagine two farmers, a broccoli grower and an almond grower. They both have access to a certain amount of water. But they also have different tolerances for drought. If water becomes scarce, the broccoli grower can just let his fields go fallow for a time — it's painful, but he can grow broccoli again as soon as the water returns. The almond producer is in a very different situation. If he doesn't get any water, his orchards will die — and it will take many years for them to regrow. Drought is much, much more painful.

Efficient water markets create an easy opportunity for trade. The almond grower can pay the broccoli grower a little extra during wet years. In exchange, the broccoli grower can agree to let his field go fallow during a drought and let the almond grower use more of the scarce water so that his trees don't die. Both sides come out ahead.

California has made some early steps along these lines, but the approval process for trades is often cumbersome and there's a lot more that could be done to make trading and banking routine. "This is the sort of risk-mitigation strategy that has developed in lots of other contexts," says Glennon. "We're all perfectly familiar with futures contracts, options, exchanges, insurance contracts. Those are all tools to mitigate risk and to hedge exposure." And we could be doing more of this with water.

Now, the actual details can get quite complex and the design of the market matters a great deal. In their Hamilton Project paper, Glennon and his co-authors suggest that states can start by allowing short-term transactions as they review various regulations. Local governments could later establish various institutions like water banks or water exchanges. The paper further suggests rules so that water purchasers pay for any environmental damage caused by water transfers.

The authors also note that regulation of scarce groundwater is a key step here. Some Western states (including California) allow anyone to stick a drill into an underground freshwater aquifer and start pumping. That creates few incentives to conserve. Given that these aquifers have a finite supply of water — and replenish only slowly in wet years — they are likely to run out if things don't change.

So one alternative might be to tightly regulate groundwater access and allow people to trade those access rights (Arizona has a version of this). Note that this is roughly analogous to cap-and-trade schemes that environmentalists have often proposed for dealing with climate change, at least at a broad conceptual level.

But water markets are also politically contentious

Drought in Australia, where water markets actually do exist (Tim Hume/Flickr)

But here's another question. If water markets are so great, why aren't they widespread?

California has been trying to create better markets for years — with little success

One reason is that they can be politically contentious. Among other things, farmers often worry that robust water markets would force them to compete with cities for scarce water resources — and that that could drive farming out of business. In their paper, Glennon and his co-authors try to alleviate these concerns, by arguing that water transfers would essentially let urban users pay farmers to adopt more efficient practices. But it's certainly a contentious subject.

Similarly, some environmentalists worry that treating water like a commodity does little to protect the environment. (Glennon, for his part, counters that the West's current system of allocating water doesn't do a great job of this either — few rivers currently have protections for minimum flow levels, for instance. And markets could be harnessed to provide environmental protection — see the example of Australia below.)

These obstacles are formidable. John Fleck, a journalist for the Albuquerque Journal who does a terrific job covering water issues, points out that experts have been making similar suggestions about reforming water markets for years. But it never seems to happen. Even during its most recent severe water crisis, California has been struggling to regulate groundwater depletion — the best the legislature could do was pass a bill that monitored aquifer use and may possibly enact limits on use in the future.

"This is not for lack of smart scientists and policy people pointing out that the problem is deeper and requires stronger action," Fleck notes on his blog. "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."

That said, there are a few counterexamples elsewhere in the world. Australia, for its part, has slowly developed robust water markets over the past 30 years that allow people to buy and sell water up and down the Murray-Darling River.

McKenzie Funk described these markets in his recent book Windfall: The Booming Business of Global Warming, and gave me a picture of what they look like in practice. During a severe drought in 2010, some farmers were able to sell off their water rights and let their fields lie fallow for a spell without going into total ruin. The Australian government also was able to buy up water rights for conservation purposes and keep the river flowing — preventing it from drying out.

But even Australia's system can be contentious at times, as Andrew Maddocks explains in this Circle of Blue report. Farmers have opposed some of the government's conservation buy-backs, and regulators are still tweaking the rules as they go.

Further reading

-- For more background on the West's water crisis: These maps of water use show why the Western US is in trouble

-- Anyone interested in water markets should really read the full Hamilton Project paper, "Shopping for Water: How the Market Can Mitigate Water Shortages in the American West," by Peter Culp, Robert Glennon, and Gary Libecap.

-- See also John Fleck's reply: "So how are we going to build these western water markets?"

-- And for a case against water markets, see this piece by Mitch Jones: "Water Markets: A False Solution to A Real Crisis."

-- Jonathan Adler, a law professor at Case Western University, has also written extensively on water markets. Here's a paper suggesting that water markets could help countries adapt to global warming. And see this paper too.

-- Back in 2013, Circle of Blue wrote an excellent rundown of Australia's water markets — both how they're working and where they're falling short.

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