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Keywords:

  • integrated modeling;
  • water leasing;
  • water markets

Abstract:

  1. Top of page
  2. Abstract:
  3. Issues for Water Leasing
  4. Integrating Hydrology, Engineering, Institutions, and Exchanges
  5. Designing a Real Time Water Leasing Market
  6. Summary
  7. Authors Bios and Contact Information
  8. References

Explosive population growth coupled with stable or decreasing water supplies has often led to stress upon already over-allocated watersheds in the western United States. Water markets that allow the temporary transfer (i.e., lease) of a water right are a possible mechanism to provide flexibility to water managers to fulfill water demands in these over-allocated watersheds. This paper addresses the need for an integrated (hydrologic and economic) model to examine the feasibility of a water leasing market. We propose a five stage procedure to designing and implementing a real time water leasing market.

Since 1950, the demand for water has more than doubled in the United States. Historically, growing demands have been met by increasing reservoir capacity and ground water mining, often at the expense of environmental and cultural concerns. The future is expected to hold much of the same. Demand for water will continue to increase, particularly in response to the expanding urban sector, while growing concerns over the environment are prompting interest in allocating more water for in-stream uses. Where will this water come from? Virtually all water supplies are allocated. Providing for new uses requires a reallocation of water dedicated to existing uses.

The last two decades have witnessed the application of economic markets to address problems over a range of areas (Rassenti et al. 1982, Kerr and Newell 2005, Leveque 2006, Burtraw and Evans 2008, Bellas and Lange 2008). Water markets have also received considerable attention as discussed in the following section. Water markets are not without issues, however. One way of resolving these issues is through the use of a coupled economic and hydrologic model. Our paper first discusses one form of a water market and then addresses how the issues raised can be resolved through the use of our proposed model.

Issues for Water Leasing

  1. Top of page
  2. Abstract:
  3. Issues for Water Leasing
  4. Integrating Hydrology, Engineering, Institutions, and Exchanges
  5. Designing a Real Time Water Leasing Market
  6. Summary
  7. Authors Bios and Contact Information
  8. References

To date, a wide spectrum of water market institutions currently exist to allow either a permanent or temporary transfer of a water right. While the permanent transfer of water rights has received much attention (Easter et al. 1998), less formal attention has been paid to the temporary transfer (leasing) of water rights from the perspective of institutional development. However, since Howe et al. (1982), water leasing has been recognized as “an attractive option for both parties because it maintains continuity, preserves ownership by the right holder of the right for future use and accommodates an intermediate use (p. 417)” (Shupe et al. 1989).

Recent efforts to document the extent of water leasing markets in the western United States includes a report by the Washington State Department of Ecology (2004), Adams et al. (2004), and Czetwertynski (2002). In examining current markets, five observations come to the forefront:

  • 1
    Many of the exchanges do not emanate from a fully functioning market (e.g., prices are often fixed in the market, prices are rising over time).
  • 2
    There is little evidence provided as to the temporal transactional nature of the trades.
  • 3
    There is little evidence that the exchanges fully acknowledge the extent (or lack) of the hydrologic impacts of the lease.
  • 4
    Exchanges are often for only a full season duration, thus they do not address intra-seasonal needs for adjustment.
  • 5
    Few inter-temporal (across seasons) or inter-spatial exchanges appear to be taking place.

In sum, based upon the available literature, there does not appear to be a robust set of institutional frameworks that facilitate a real time water leasing market.

Further, while the leasing of water rights is an attractive option, there are many potential obstacles to the formation of an institution for water leasing. Brown (2008) identified ten potential issues to the formation of a water leasing market1.

  • 1
    Adjudication – are the rights in the basin fully adjudicated?
  • 2
    Homogeneity of contracts – do the nature of contracts require they be identical, regardless of the underlying rights structure?
  • 3
    Priority date of the contract – given different priority dates, how would associated risk of delivery in light of drought be assigned?
  • 4
    Impairment (3rd Party Effects) – do issues of third party effects require an underlying hydrological understanding?
  • 5
    Public welfare – do values other than economics necessarily preclude a market?
  • 6
    Conservation of water – do markets provide efficient scarcity pricing of water?
  • 7
    Logistics of administration and accountability – how would a market be administered and what would be the relationship to a State Engineer's office?
  • 8
    Enforcement of the contract – how will legal responsibility of the market be established?
  • 9
    Public opinion – will the public allow the treatment and thus trading of water as a commodity?
  • 10
    Regulation – what level of regulation is required to ensure against abuse?

We believe that there might be more issues. First, a more subtle issue becomes apparent when the relationship among these ten elements is considered. Specifically, it is not sufficient to merely consider each issue individually; rather the collective interplay between hydrology, engineering, institutions, and markets is required. Furthermore, it is curious that we have been unable to find examples whereby an integrated market exists where the hydrological, engineering, and institutional structure is fully linked with a real-time trading interface.

Second, there is need for immediacy within a trading season. In New Mexico, transfer data suggests that the average time can be lengthy due to the multiple step process required for approval (Office of the State Engineer 2007).2Table 1 presents some aggregate data on the time it takes for applications to be approved. While the application process appears to be rather efficient, it is far short of a real time market for transfers.

Table 1.  Water Transactions in New Mexico: Grouped by Elapsed Time from Filing for Permanent and Temporary Transfers Requests.
1990 to 1999
DescriptionAllPercentPermanentPercentTemporaryPercent
0 - 6 Months85956.0367051.7018979.75
6 Months - 1 Year22214.4819615.122610.97
1 - 2 Years1137.371048.0293.80
> 2 Years1539.9814911.5041.69
Others18612.1317713.6693.80
Total1533 1296 237 
2000 to Present
DescriptionAllPercentPermanentPercentTemporaryPercent
  1. Source: Data taken form the OSE Water Rights Administration Technical Engineering Resource System (WATERS). Queries performed by J. Randall Johnson Richard S. DeSimone with the below disclaimer.

  2. DISCLAIMER. The data provided from the New Mexico Water Rights Reporting and Query System is furnished by the State Engineer/Interstate Stream Commission (OSE/ISC) and may include inaccuracies or typographical errors. Changes are periodically added to the information herein. Changes and improvements may be made at any time. The data is accepted for use by the recipient individual or entity with the expressed understanding that the OSE/ISC and author(s) of the data make no warranties, expressed or implied, concerning the accuracy, completeness, reliability, usability or suitability for any particular purpose of the data. The OSE/ISC and author(s) of the data shall not be liable to any individual or entity by reason of any use made thereof.

0 - 6 Months118050.9992047.1126072.02
6 Months - 1 Year37816.3432116.445715.79
1 - 2 Years27511.8825513.06205.54
> 2 Years1014.36954.8661.66
Others38016.4236218.54184.99
Total2314 1953 361 

Third, there is a need as a result of variable water supplies for the ability to adjust water deliveries within a season. As a broad illustration of this point, consider Figure 1 which depicts the variability of water supplies at the Otowi gauge over time. In general, the supply in the Middle Rio Grande Basin to farmers has been consistent; in the Lower Rio Grande Basin, at times the available supplies have varied across and within seasons.

image

Figure 1. Gauged flows at Otowi, NM.

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Integrating Hydrology, Engineering, Institutions, and Exchanges

  1. Top of page
  2. Abstract:
  3. Issues for Water Leasing
  4. Integrating Hydrology, Engineering, Institutions, and Exchanges
  5. Designing a Real Time Water Leasing Market
  6. Summary
  7. Authors Bios and Contact Information
  8. References

At a simple level, one might expect trading water along a river ought not to be more complicated than allowing water property rights holders to set up the equivalent of lemonade stands along the river bank. In many ways, this is how previous attempts to allow for water exchange have been fashioned. However the process is much more complex than this simple example. Trading water is more similar to the complex issues that are encountered in the combinatoric auction that is used to allocate scarce airport landing and take-off slots (Rassenti et al. 1982).

Specifically, water transfers suffer from the interconnectedness that occurs between the surface and ground water systems. Trading water from one location to another may affect exchange rates that in turn affect river flows and ground water levels at the time of exchange or possibly delayed in time. Water also evaporates as it flows through the system. These features can create asymmetries between water that is traded upstream versus water that is traded downstream. Additionally, the supply of water for most of the western United States originates from snow pack that is accumulated over the winter months in mountain ranges. This leads to variability in the supply of water that is available in a system for a given year. Thus, the central issues that arise in designing a real time water leasing market includes the need to know the amount of available water, where the water is located, what happens when it is moved (i.e., the limits of the water delivery systems), who has water claims and under what rules water can be traded. Only when these issues are addressed can an exchange function properly.

While these features of water are complex, it is possible, through the use of computer modeling, to capture the hydrology of a basin in the context of the water/engineering deliver system (Figure 2). Here, we employ a system dynamics modeling framework that facilitates the integration of the physical, engineering, and institutional systems of a basin (e.g., Sterman 2000). The model captures temporally varying main-stream inflows, tributary inflows, reservoir operations, evaporative losses (open water, riparian, and irrigation), irrigation diversions and return flows, municipal pumping, and river-aquifer interaction (see Roach and Tidwell 2009 for more detail). Simulations are implemented at a monthly time-step for each of six river reaches (as defined by long-term gauging stations). The model informs the market concerning available supply. In this way, the hydrologic model provides an assessment of the water that is available to each user and tracks the impact of market transactions upon the physical system, identifying which users might be impacted by market transactions.

image

Figure 2. Schematic of the Middle Rio Grande hydrologic model.

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In addition to the physical aspects of water that complicate market transactions, there is another challenging aspect of water – water demands. Typical claimants for water rights in a river basin include irrigated agricultural use, urban consumption, Native American use, and environmental purposes such as endangered species protection. It is necessary to understand how each of these different water demands could benefit from lease transactions or how they could be impacted by lease transactions.

Market transactions need a vehicle to facilitate exchanges. Multiple market structures exist such as a posted offer market, or a double auction market. We have chosen to focus on the double auction market due to the central nature and the rapidity of the price convergence process (Smith 1962). In a double auction market, all bids and offers are centrally and publicly recorded and market participants are allowed to trade in a series of trading intervals. The public nature of this market structure has generated competitive outcomes more rapidly than under other market structures.

In summary, the use of an integrated model can capture the salient features of a river basin, such as when, where, and how much water is available, the impact of transactions upon the physical system and the relevant water demands. This integrated model can then be used to address the impact on the physical system and potential economic gains as a result of market transactions. Ultimately, this provides a platform for designing and testing a market construct before real money and water are at stake.

Designing a Real Time Water Leasing Market

  1. Top of page
  2. Abstract:
  3. Issues for Water Leasing
  4. Integrating Hydrology, Engineering, Institutions, and Exchanges
  5. Designing a Real Time Water Leasing Market
  6. Summary
  7. Authors Bios and Contact Information
  8. References

We begin with several core goals. First, we seek to couple the hydrologic, engineering, institutional, and market exchange models to create a framework in an attempt to address potential issues for a water leasing market (see Figure 3). As a starting point, we must assume that the water rights are fully adjudicated and that all contracts are transparent, and enforced. The market is administered by the Office of the State Engineer and exchange has been sanctioned through the State Water plan. Further, we assume that water rights are not threatened by leasing.3 We fully understand that water rights have not been adjudicated in the Middle Rio Grande. There is little, if any, disagreement that this is necessary. However, central to any type of exchange operating efficiently this must be resolved. This will take time and we wish to explore issues other than the adjudication process (see JCWRE issue 133, May 2006) and thus, we assume it has occurred.

image

Figure 3. Schematic of the coupled models.

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This assumption enables us to consider an exchange model and does not have implications per se for our results. Further, in our models that follow, we also assume a homogenous right, similar to the idea of a 1907 right in the Middle Rio Grande Valley which would be the senior right, other than Native American rights, if the system were fully adjudicated. Finally, there are issues with regulations regarding assurance that if water is leased, it will be returned to the original owner at the end of the contract period. We assume this to be the case4.

We recognize that it is not possible to fully capture the complexity inherent in the physical, engineering, institutional, and market systems at play in a given river basin. However, modeling of simplified yet representative systems can provide insight into how a market might function. In efforts to efficiently deal with such complexity, we start simple, sequentially adding greater detail as we proceed. In this fashion, five sets of market experiments have been performed:

  • 1
    Stage 1: Prototype Real Time Market
  • 2
    Stage 2: Complex Farming Choices
  • 3
    Stage 3: Futures Contract Trading and Climatic Uncertainty
  • 4
    Stage 4: Examination of 3rd Party Effects
  • 5
    Stage 5: Working with Stakeholders (Mimbres Basin)

We focus on the Middle Rio Grande Basin (traditionally defined as the stretch of river between Cochiti and Elephant Butte Reservoirs) located in central New Mexico as a backdrop for model development. The basin is characterized by basin and range topography with a mountain range on the eastern flank and arid valleys and mesas to the west. Throughout the basin, engineered infrastructure to manage the basin's resources includes five reservoirs (Cochiti and Elephant Butte which lie in the basin and Heron, El Vado and Abiquiu that lie to the north but regulate flows in the basin) for flood control, water supply, and irrigation. This segment of the river is subdivided into six major reaches delineated by the major U.S. Geological Survey gauges.

Demands for water resources include one major metropolis (Albuquerque) with multiple smaller communities (Belen, Bernalillo, Los Lunas, Rio Rancho, and Socorro). In addition, agricultural interests are found throughout the basin with Native American interests primarily found in the northern part. Environmental interests are also present as this section of the Rio Grande is a historic home for the silvery minnow (Hybognathus amarus) with a large riparian corridor providing habitat for hundreds of resident and migratory bird species. The basin has been experiencing a growth in its urban metropolis which places additional demands upon water resources. Currently, there is very little leasing of water within or outside of the basin. Most leasing is within the agricultural sector encompassed by the Middle Rio Grande Conservancy District (Czetwertynski 2002).

In developing the stages, three metrics are used to judge the efficiency and robustness of the model:

  • 1
    Does the observed market price differ from the expected market price? Because of the use of experimental economic techniques we can compare the expected market price to the observed market price using a Student t-test.
  • 2
    Are welfare gains observed from market transactions? Thus, did participation in the market lead to higher economic welfare for the aggregate economy?
  • 3
    What are the impacts of market transaction upon the physical system (i.e., how much water is lost or gained due to evaporative losses)?

Stage 1: Prototype Market

In designing markets, it is commonplace to start with a prototype market as a proof of concept and then work up to a more complex market. For the Middle Rio Grande Basin, this prototype market includes all of the water demands present in the region such as Native American interests, irrigated agriculture, environmental interests, and municipal use. To conduct economic market experiments through the double auction framework, each of the trading agents were given relatively simple water demand and crop production functions. For instance an agricultural user was told that if they obtained X acre feet of water it would yield them Y dollars. This would mean that this user should be willing to pay up to X/Y dollars to obtain each acre foot of water and achieve the payout of Y. This market was found to be functioning efficiently, meaning the observed market price did not differ from the expected market price, welfare gains were found from market transactions and the impact of trading on the physical system was found to have a minimal impact (i.e., small changes to the hydrology of the basin). For a complete review of this prototype market see Broadbent et al. (2009a).

Stage 2: Complex Farming Choices

This stage extends the integrated model from stage 1 to include a more realistic representation of the decision-making process that agricultural users undergo each growing season. Two main types of farmers exist in this model: cash crop farmers and capital crop farmers. At the start of each growing season, a cash crop farmer must decide what type of crops to plant and how many acres to plant. Figure 4 represents the cash crop farming decision with two different types of crops, hay or chili. During the growing season the decision must be made as to how much water to place on a crop. For a harvest, different crops are harvested at different times. For chili, the crop must continually receive water through termination of the growing season to produce a harvest. For a hay crop, multiple cuts of hay may be realized throughout the growing season, meaning hay is a less risky crop than chili in water scarce years.

image

Figure 4. Schematic diagram of the decision process for agricultural users.

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A capital crop farmer must make a decision as to what type of capital crop (e.g., grape vineyard, or apple trees) to plant on their acreage. This is typically a large investment that takes multiple years of investment in the crop before a harvest is realized. This type of crop farmer is represented in Figure 4 as a grape farmer. Because of the large capital investment, a capital crop farmer has a higher incentive to defend his investment. Including these different types of agricultural decisions into the experimental marketplace provided insights as to how different economic agents could engage in market transactions. As with the stage 1 market, this market was found to be efficient as the observed market price did not differ from the expected market price, welfare gains were found from market transactions and the impact of trading on the physical system was found to have a minimal impact (i.e., small changes to the hydrology of the basin). For a complete review of this market see Broadbent et al. (2009b).

Stage 3: Futures Contract Trading and Climatic Uncertainty

Futures markets have been successfully utilized in commodity markets such as corn, wheat, oats, and soybean and are gaining popularity in agricultural markets such as livestock (The Chicago Board of Trade 2006). Futures contracts allow individuals to hedge against risk or protect themselves from uncertainty in the market. For a water leasing market this uncertainty centers on the variable water supply. Further expanding the stage 2 market to include a futures contract allows us to examine how different economic agents can hedge against uncertainty. Allowing futures trading resulted in higher crop yields of risky cash crops (i.e., chili) and allowed capital crop farmers to protect their capital investment. To test the efficiency of this market, the same outputs were examined as in the stage 1 and 2 markets with the market proving to be efficient. For a complete review of this market see Broadbent et al. (2009c).

Stage 4: Examination of 3rd Party Effects

One of the main barriers that prohibits market transactions are 3rd party effects, or the effects of transactions upon intermediate parties (Gould 1988 and 1989). Figure 5 displays a simple structure of a river system and how 3rd party effects might arise as a result of transactions. The first possible effects are within ditch effects. For example, this effect could occur if user C leases their water to user A, or user F leases their water to user D. If user A takes water out of the ditch upstream of user B in order to satisfy the lease terms, the flow of water in that ditch could be impaired or decreased sufficiently that user B (or user E) would not be able to push water onto their field. The second possible effects are across ditch effects. These effects could occur if users A, B or C leased their water to users D, E or F. In order to satisfy the lease terms water is left in the river channel where D, E, or F can divert it. This might have negative effects upon users B or C through decreased flows. Also, it might have negative effects upon users D, E, and F's ditch because increased flows could overflow the ditch bank.

image

Figure 5. Simplistic schematic of 3rd party effects.

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Both type of 3rd party effects have the potential to limit or block transactions from occurring altogether. Understanding if 3rd party effects arise as a result of market transactions is necessary prior to the implementation of a market. Fortunately, through the use of complex hydrologic models, these types of effects can be addressed and assessed. Currently, we are in the process of examining third party effects for the second reach of the Middle Rio Grande. Our initial findings from this research have demonstrated to us that third party effects can be a timing, spatial, and scalar problem.

Stage 5: Working with Stakeholders

During the development of stages 1-3 a presentation was made to the New Mexico Office of the State Engineer (OSE) that detailed the potential of a water leasing market using the Middle Rio Grande as a backdrop. In response the OSE asked us to develop a water leasing market for the Upper Mimbres basin, NM using the lessons that have been learned from the previous stages. In order to develop this market, multiple meetings have been held with the stakeholders in the basin to obtain their input in the market design. Currently, we are in the process of testing the market. Once the market has been tested the results will be presented to the OSE. For a complete review of this market see Broadbent et al. (2008).

Summary

  1. Top of page
  2. Abstract:
  3. Issues for Water Leasing
  4. Integrating Hydrology, Engineering, Institutions, and Exchanges
  5. Designing a Real Time Water Leasing Market
  6. Summary
  7. Authors Bios and Contact Information
  8. References

While real time markets have been found successful in other policy areas, they are still scarcely used in the water policy area. The temporary transfer of a water right between two individuals, known as water leasing, has the potential to increase the efficiency of water resources throughout river basins. However, before such a market can be implemented, it is necessary to understand how the market would operate under different circumstances such as the issues described by Brown (2008) that we have not addressed. In this paper we have outlined a five stage procedure of how to test and implement an integrated hydrologic/economic market for a river basin using the Middle Rio Grande basin as a backdrop. The findings of this five stage process have proved the market to be efficient and robust. However, for a market to be successful it is necessary to have interaction with basin stakeholders (potential market participants). In our fifth stage we have undergone a series of meetings with stakeholders in developing a market for their basin. We are excited to see the outcomes of this market to truly understand the potential for water leasing markets to allow for flexibility in water management.

End Notes
  • 1

    Brown (2008) refers to “bulk” water. For our purposes this is synonymous with “temporal leasing,” that is trades that do not alter the property rights structure.

  • 2

    The “Application Flow Chart” is quite extensive requiring legal notices, opportunities for protest, and hearings.

  • 3

    These assumptions address the issues presented by Brown (2008) points 1, 7, 8, and 9 to a large degree. Regarding point 9, public opinion, we simply assume the call for water markets in the State Plan satisfies this issue. See New Mexico State Water Plan section C2 and C9 available at http://www.ose.state.nm.us/publications_state_water_plans.html.

  • 4

    It is our understanding that this issue is being considered in New Mexico, but resolution to date has not occurred.

Authors Bios and Contact Information

  1. Top of page
  2. Abstract:
  3. Issues for Water Leasing
  4. Integrating Hydrology, Engineering, Institutions, and Exchanges
  5. Designing a Real Time Water Leasing Market
  6. Summary
  7. Authors Bios and Contact Information
  8. References

Craig D. Broadbent is an Assistant Professor of Economics at Illinois Wesleyan University. He specializes in the study of natural resource markets and the use of stated preference techniques in the valuation of non-market resources. Current research efforts focus on the use of hydrologic models in temporary water transfer markets and the precision of estimates obtained from the contingent valuation method and choice experiments. He can be contacted at cbroadbe@iwu.edu.

David S. Brookshire is a Professor of Economics at the University of New Mexico and Director of the “Science Impact Laboratory for Policy and Economics” at UNM. He is a former Policy Sciences Editor of Water Resources Research. He has been a contributor to the development of the contingent valuation method for valuing non-market commodities. He specializes in studies pertaining to public policy issues in the natural resource, environmental and natural hazards areas. He can be contacted at brookshi@unm.edu.

Don Coursey is the Ameritech Professor of Public Policy Studies in the Harris School and the College and served as dean of the Harris School from 1996 to 1998. He is an experimental economist whose research elicits reliable measures of preferences and monetary values for public goods, such as environmental quality. His research has focused on demand for international environmental quality, environmental legislation in the United States, and public preferences for environmental outcomes relative to other social and economic goals. He can be contacted at d-coursey@uchicago.edu.

Vincent Tidwell is a Principle Member of the Technical Staff at Sandia National Laboratories. He has 20 years experience conducting and managing research on basic and applied projects in resource management, energy systems, nuclear waste isolation, petroleum recovery, and groundwater contamination characterization. Most recently efforts have focused on establishing a multi-agency, multi-university center devoted to the creation and application of computer-aided decision support tools and stakeholder mediated decision processes. Current projects focus on the energy-water nexus, watershed management, design of water and thermal credit trading systems, climate change impacts and market penetration of renewable energy systems. He can be contacted at vctidwe@sandia.gov.

References

  1. Top of page
  2. Abstract:
  3. Issues for Water Leasing
  4. Integrating Hydrology, Engineering, Institutions, and Exchanges
  5. Designing a Real Time Water Leasing Market
  6. Summary
  7. Authors Bios and Contact Information
  8. References
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