Liquid Gold: The Economics of Water Trading Markets

Presidio Graduate School’s Macroeconomics course for Spring 2012, is authoring a series of articles. The articles on this “micro-blog” reflect reactions and thoughts on news items, economic theory, and other issues as they pertain to the concept of sustainability.  Follow along here.

By Nick Sanderson

Water scarcity is a global reality — nearly half of the world’s population will suffer from severe water shortages by the year 2050 and over $335 billion in investment over the next twenty years is needed to maintain our current drinking water infrastructure.

The distribution of water throughout the world is inefficient and new market tools are being developed to address the issues revolving around water rights and allocation.  In the United States, water rights and allocation limits are assigned in a “first-in-time, first-in-right” method where property owners are allowed to withdraw a percentage of water each year because they happen to be “the first ones to spot it.” Critics argue that water right allocation laws do not create any incentives for conservation efforts and some still have clauses built in that require holders to withdraw the maximum amount of water allocated or lose their rights entirely.

An alternative to traditional water tariff scheduling is being developed throughout the world to address these issues of inefficiency and is pricing water relative to supply and demand. The most established market exists today (and has so for over 20 years) in the Murray-Darling Basin in Australia. It is here that the country’s National Water Initiative has created permanent and seasonal water allocations that can be traded through water brokers when amounts are in excess of demand. The price at which it can be traded depends, of course, on the demand for the water and relevant market forces. This model places a more desirable price on water and “punishes” major consumers who cannot take the necessary measures to curb consumption. The efficiency of the water trading market is such that the initial price for water will be equalized throughout the community of consumers, but the marginal price for water during the secondary trade will fall along every consumer's individual demand curve.  This will force users to shift resources from low value activities to high value activities and in turn give a more economically viable price to water.

In the United States today, there are a host of water market programs that differ slightly from the Australian precedent, and one in particular, payments for watershed services (PWS), has gained significant traction in protecting valuable watersheds throughout the U.S. but the coordination required to combine the 81 active market-based water management programs throughout the country is difficult.

Ecosystem Marketplace estimates that over $10 trillion in water transfers occur each year impacting 3.24 billion hectares of wetland ecosystems. A new program developed by Ecosystem Marketplace has attempted to coordinate all the existing water trading markets into one dashboard called the Watershed Connect and has been operating for three years now.  Additionally, the USDA just announced on May 25^th that it will launch the Water Quality Network in September, a program designed to target companies creating impactful water market changes and support them through federal grants.

Sprinklers running in the middle of the day and people hosing down sidewalks will be a figment of the past if true pricing water markets develop throughout the world.  If one traces the evolution of energy markets from transaction costs to true costs they can see that the ability to provide clean, reliable sources of energy is dependent upon the reduction in consumption.  One reduction method in the case of water is to establish a market for water that can respond to supply and demand and make consumers choose between wasteful practices and conservation.