Water markets (C7.02)

Characteristics 

There are various situations in which raw water is bought and sold at a price determined by the interplay of supply and demand. For example, the owners of water rights sell their rights to use water to others, on a seasonal or permanent basis (such markets exist in parts of Australia, Chile and some Western States of the USA). Although farmers are the main players in these markets, some large trades are done by cities to secure water for household use. Water markets are one strategy used to avoid monopolies in water access or distribution.

Public authorities might purchase water for “banking” as a precaution against severe drought, or to release into rivers to preserve minimum environmental flows (e.g. in California and the Murray-Darling Basin of Australia). This may also be done by an NGO or other civil society body, acting as an environmental champion. Other situations include public auctions of water on a daily or weekly basis (e.g. in Spain) and ground water markets (e.g. in South Asia), where farmers with ground water rights sell surplus water to others. 

The rationale for all such markets is similar. Rights to use water have evolved historically, are anchored in law or custom, and cannot easily be revoked or amended. Such rights are reflected in property values and rents. This complicates the redistribution of water which might be necessary to cope with severe drought, or a growth of potential demand in excess of available supply, or to deal with temporary mismatches between the demand for water and its availability. 

Water markets can be: 

  • An efficient means of transferring water from lower to higher value uses, or from purposes with a lower to a higher social priority. This is particularly important in serious droughts (e.g. Australia in the 2000s);
  • A way of overcoming the resistance of entrenched property rights holders;
  • A cheaper way for communities and/or farmers to obtain their water than the alternatives, which may include creating a new source of supply;
  • A cost-effective alternative for public authorities to insure against drought;
  • An option for environmental champions to buy out existing users and preserve the water for habitat or other natural amenity;
  • A source of public revenue, where rights are held by public authorities. 

Certain preconditions are necessary for water markets to be successful: 

  • A clear legal framework permitting holders of water rights to transfer their rights, either temporarily or permanently, to other parties (see A2);
  • Regulation of the impact of these trades on third parties (e.g. downstream users) and provision for compensation; 
  • Recognition of the potential environmental impact of trades (e.g. aquifer depletion in Chile), and the need to invoke relevant safeguards;
  • The physical means of transferring water between potential users;
  • Regulation to avoid monopoly build up is essential.

Lessons learned 

  • There is a need for a mechanism to allocate initial rights (whether for water or pollution discharges), which should be fair, equitable, and effective. 
  • Trading schemes can be intensive in terms of information and enforcement, hence costly to administer; the high transaction costs of certain markets may outweigh their benefits. 
  • Markets do not substitute for regulation and monitoring, but they can make such systems more flexible and make pollution control less costly to society. 
  • Markets can help identify the highest value use and assist in conflict resolution (see C5.03). 
  • Water auctions may be useful to adjudicate water allocation under competitive conditions, but must be regulated to prevent monopoly build-up. 
  • Markets work best where there are a large number of traders and transactions, so that the risk of build-up of monopolistic market power is minimised.