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Chapter 18:Water Rights and Market Transfers
Chapter 18-
Water Rights and Market Transfers[*]
by F. Lee Brown and Charles T. DuMars
Abstract
Western water institutions are moving from a period of water development into an era of water management in which water reallocation, water conservation, and water quality enhancement will play increasingly greater roles relative to traditional development projects. Faced with new tasks to be performed, existing institutions are changing and new ones developing. Economic considerations are forging marketlike institutions, and the courts are expediting this evolutionary process by broadening the spectrum of persons who have a stake in water rights transfers and insisting on more efficient use of water.
However, it is unlikely that society will accept an unbridled marketplace allocation of water; it will instead choose between increased regulation at the state level or increased ownership at the local level, with the former assigned the higher probability.
The Nature and Extent of Water Rights Transfers
Although systematic data is sparse or nonexistent in most water basins in the West, there can be little doubt that the number and extent of water rights transfers away from irrigated agriculture has been increasing within the last ten to twenty years. In some cases the increase has been dramatic.[1] It is likely, though again the reported evidence is scanty, that the shift of
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ownership is even more substantial than it appears, because many minerals or energy companies have formed subsidiaries which purchase water rights but leave them in irrigation use until they are needed subsequently for mining or power production. In some basins water rights transactions have become so frequent that specialists have developed and rudimentary water markets can be said to exist.[2]
The prices paid for water rights vary substantially from basin to basin and through time in a given basin, though generally they are higher in those basins in which water is relatively more scarce compared to the competing demands for its use. In basins with little growth, or in which unappropriated water still remains, prices may be as low as $50-$100 per right to a consumptive acre-foot; while in highly developed and growing basins prices in excess of $10,000 per right to a consumptive acre-foot have been reported.[3] The recent agreement between Energy Transportation Systems, Inc. (ETSI) and the state of South Dakota appears to be substantially in excess of this $10,000 figure, though the details of the agreement are somewhat clouded.[4]
The explanation for the increasing number of transfers is not difficult to discern, and rests on the conjunction of several factors. First, virtually all basins in the West have reached, or are nearing, full appropriation, in which it is no longer legally possible to obtain new water by sinking a well or diverting a streamflow. Yet new water uses continue to arise, spurred particularly by the continuing migration to the West and Southwest and the growth in energy and industrial development. Because historically irrigated agriculture has been the dominant consumer of water in the region, it is the most obvious source for transfers. Finally, when the considerably greater ability to pay[5] for water on the part of energy companies, mining companies, and municipalities confronts willing sellers in farmers, whose water rights have become their most valuable asset, the conclusion to sell and transfer becomes clear.
Future Prospects
In keeping with this explanation, future prospects for a further expansion, leveling off, or contraction in the extent of transfers depends on a variety of factors. These include the growth in demand by new water users, the availability of alternatives to transfers in meeting the new demands, the relative value of water in agricultural uses when compared to its value in other uses, and the degree to which the institutions governing water allocation and use allow transfers to occur.
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Because other chapters in this volume concentrate more heavily on many of these factors, they will not be examined in any depth here. Suffice it to say that most projections of new demands, particularly by energy, have been high. Short of a new oil embargo or other disruption, the growth in new uses will probably be less dramatic than some have predicted, though as long as westward migration continues, new uses will steadily arise. This chapter focuses, instead, on the institutional structures which govern water in the West and even more specifically on the role of the marketplace and the courts in facilitating or retarding water rights transfer and water reallocation.
The Water Management Era
For most of this century and part of the last, the dominant force infusing water affairs in the West was the drive to "make the desert bloom" by developing and applying the native water resources of the region to productive use, most notably in irrigated agriculture.[6] The region's water institutions were largely formed and matured simultaneously with the development of the water itself. Yet with the nearing of full appropriation this development phase is ending and being replaced by an era of water management, in which other management techniques such as conservation, reallocation, and water quality enhancement are increasingly important. Chapter 2 describes in some detail the advent of this management era.
Fundamentally, the advent of a new era requires answers to questions which the region's water institutions have not had to answer heretofore. As long as there was unappropriated water, the basic question was, "Is a given use beneficial and under what condition?" Now that there is more than one potential user for each portion of water, the question has become, "Which use is more beneficial and under what condition?" The modern questions are much more complex, particularly for a collection of water institutions to which the questions are unlike anything that has been asked in a hundred or so years of practice. It is little wonder that legislatures, governors, and presidents are having to deal directly with the problems; the water bureaucracies themselves are not suited to make the decisions. Moreover, the decisions will not be easy even in the highest councils. In the next section we examine the capacity and limitations of one type of institution-the marketplace-in performing the water management function.
The Role of the Marketplace
The Management Function of Institutions
Peter Drucker has described an institution as "an organ of society, existing to make specific contributions and to discharge specific social functions."[7] Although Drucker uses the term "institution" in a slightly more restricted sense than the authors, the essence of his statement is the same. Institutions exist to perform specific social functions. Management, in turn, describes the activity of these institutions in matching the subject raw material-whether water, highways or otherwise-to the goals or objectives of the society being served. These descriptions suggest two conditions necessary to any examination of water management institutions. First, there must be some notion of the social objectives, and thereby the underlying social values, of the society to be served by the institutions. Second, there should be consideration of the alternative institutional "technologies" that are available for performing the management function. Both of these subjects are highly complex, and an exhaustive examination of either is beyond the scope of this chapter. However, some consideration must be given to certain aspects of both subjects in order to adequately assess the role of the marketplace in managing western water.
Social Goals
Maass and Anderson[8] have identified six common goals of irrigation communities that they studied in both Spain and the United States. These are (1) orderly conflict resolution, (2) popular participation, (3) local control, (4) increased income, (5) justice in income distribution, and (6) equity or fairness. This exact list need not be considered all-inclusive of social objectives for water, or constant throughout all water management situations, in order to illustrate two propositions that will be the basis for the institutional analysis that follows.
Proposition 1
Some degree of material (economic) improvement is an important social value to all societies, and the allocational institutions for all scarce resources, including water, must fulfill that objective to a degree determined by each society.
Proposition 2
There are values other than total material improvement that are as important, and usually more important, to all societies. Accordingly, allocational institutions must also conform to these values.
The Maass and Anderson analysis provides support for these propositions. Whatever disagreement might arise about the second proposition would likely relate to the relative importance attached to material improvement and potentially competing values. And it is precisely this relative ranking that is critical to the role that market institutions can play in managing the allocation of water. How does material improvement compare with other social goals, particularly with regard to water? Consider the following quote from the Maass and Anderson study.
. . . farmers typically refuse to treat water as a regular economic good, like fertilizer, for example. It is, they say, a special product and should be removed from ordinary market transactions so that farmers can control conflict, maintain popular influence and control, and realize equity and social justice.[9]
The thrust of their assessment of a number of irrigation communities in two countries appears to support proposition two, though not without qualification. It might be argued, however, that such tempering of material goals is confined to irrigation communities and in the larger context of allocating water over all uses, material improvement is less likely to be constrained by competing goals. Certainly this alternative hypothesis is arguable, and ultimately the relative descriptive power of proposition two or its alternatives is an empirical question, which may be answered differently in different social and physical environments for water. However, having briefly considered the possibility of alternatives to proposition two, the subsequent analysis will nevertheless use it as a second postulate.
This short discussion of the societal goals for water may be summarized in the following way. Most societies are ambivalent about water. On the one hand they wish to treat it as a commodity in commerce, and accordingly desire that it move to its highest valued use, thereby maximizing, or tending to maximize, the material well-being of the society served by a given physical supply of water. On the other hand, most of these same societies are concerned about meeting a number of other social goals with respect to water allocation which may, in fact, temper the
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material gain that would otherwise be possible if water were treated exclusively as a commodity. For some societies, such as various Indian tribes, water appears to have even a religious significance. Kenneth Boulding, an economist, has described water as "the object of a very complex structure of evaluations, rituals, superstitions, and attitudes. It has been the subject of sacred observances from very early times in human history."[10]
For these reasons, socially acceptable institutional arrangements for water management must innovatively combine procedures which support the movement of water toward its highest material usage, while at the same time providing ample means for ensuring that social goals other than material enhancement can also be met.
Market Technologies for Water Management
There are a large number of ways that organizations, rules, procedures, customs, and other forms of institutions can be arranged to perform the management tasks of meeting social objectives for water. At polar extremes, both pure laissez faire and pure centralized planning institutional technologies can be conceptualized, though neither would prove socially acceptable on one count or another. The discussion here, however, will be restricted to market-type institutional technologies and their serviceability in meeting the social goals as described by the two propositions given above.
There is obviously an immense literature on the general functioning of markets, which does not need to be recounted here. Suffice it to say that under strict conditions and according to definite criteria of well-being, markets perform well in moving a given resource to uses that will produce the greatest amount of the most desired material products. Moreover, when judged against a number of social goals, markets may measure up well also. In their perfectly competitive form they can provide a vehicle for popular participation, can be localized to individual communities and provide a means of orderly conflict resolution as to who gets what when. They may be less serviceable with respect to justice in income distribution or in achieving equity or fairness. They are not inherently incompatible with the latter two goals, but there is no reason to expect that they will necessarily produce allocational outcomes that conform to a society's criteria relative to these two goals.
In short summary, markets offer attractive institutional technologies for meeting the material goal described in proposition one, and are not necessarily inconsistent with other social goals
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as set forth in proposition two, though they are limited in their ability to fulfill the full set of goals that may be desired by a society. Moreover, attention must be paid in any specific allocational situation to whether the conditions required for markets to perform well their material functions are actually met. Consideration will first be given to the general limitation on the efficacy of markets in meeting the full set of social goals. Then specific problems in the water arena will be examined more closely.
General Limitations on the Efficacy of Markets
As a general statement, there is no compelling reason to expect that water markets will succeed in meeting a community's social goals other than the objective of material improvement as discussed above. Of even greater concern, however, are significant possibilities that unrestrained markets may actually prevent the attainment of the other social goals that may have been set.
Consider again for illustrative purposes the set of goals described by Maass and Anderson, and imagine a water context in which the principal water use in a particular subbasin A has been irrigated agriculture. Now suppose that a large water-using enterprise in an adjacent subbasin B purchases the water rights from individual farmers in A and transfers the water to B. The transaction presumably has been concluded on a voluntary basis, and there is at least a good possibility that the material well-being of the individual farmers in A has been enhanced, else why would they have sold their rights. However, what has become of the other social goals to which the entire community in A originally subscribed? No longer is there local control over water nor popular participation in the allocative decisions about water. In fact, if the water rights were held by individuals, there need not have been any local, popular participation in the basic transfer transaction at all. As for the other goals, there is no assurance that "justice" in the distribution of income will have been achieved. In fact, if there were no compensation to the nonright-holding public, then it is possible that there may have been a significant deterioration in the distribution of material well-being of the community. Conflict resolution may no longer be a problem, since there may be little or no reason for water conflicts to arise if most of the water has departed. On the other hand, what water remains may be the focal point for even greater conflicts. Finally, equity or fairness is a kind of blanket goal-if negative consequences have occurred with respect to the other
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goals, then it is unlikely that the resulting situation would be considered equitable.
Market forces, then, however valuable they may be in moving a resource such as water to its highest material location and use, may have substantial adverse consequences for other social goals of communities. At least two reasons underlie this potentially adverse performance of markets. First, the fundamental assumption underlying the theory of markets is maximization of self-interest. While self-interest must be recognized as a strong force in human affairs and even on moral grounds its free expression should be countenanced, unrestrained self-interest as reflected in the fundamental descriptive assumption of neoclassical economics is generally not acceptable to most societies. Instead, again quoting Kenneth Boulding:
A very important question in social policy, which certainly applies to water policy as much as it does to any other, is whether the distributional impacts from the price structures that are desirable from the point of view of allocation can be modified sufficiently to make them politically acceptable without destroying the necessary motivation for allocation change. (Emphasis added)[11]
In short, society seeks institutional means for achieving its goals which generally involve some constraint on material self-aggrandizement.
Second, markets function by means of a dollar metric. That is to say, whatever is sold to the highest bidder has been measured in the exchange process by a common currency agreed to by both buyer and seller. For most tangible commodities and even services, this valuation process may work well because the characteristics of the item subject to exchange are readily quantifiable and valued in dollar terms. However, for some items and some transactions, a dollar measure is inherently inapplicable. Generally these items possess deep emotional value for individuals, and are considered "beyond measure," meaning dollar measure. These cannot be allocated by the market, for it is simply impossible to transfer emotions in exchange for dollars.
Ultimately the "fabric" which holds communities together and produces constructive collective action is comprised of the emotions that are felt by and actuate the individuals within the community. For all of its power in performing the material allocation function, markets do not provide the cohesive emotions necessary to meet these other social goals. Again, however, it should be stressed that markets are not necessarily at odds with
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those goals. The task is to find successful ways to integrate markets and their capabilities with broader social needs.
Specific Features of Western Water Institutions
Several specific features of western water institutions bear upon the suitability of market mechanisms for reallocating water.
The Problem of Imperfect Competition
Markets most satisfactorily perform their allocational function when there exists what is termed "perfect competition." There is evidence that the budding water markets of the West are developing significant deviations from this perfectly competitive condition. Although current data is fragmentary, circumstantial evidence indicates that imperfectly competitive conditions-specifically bilateral monopolies-may be developing in some basins of the West. A bilateral monopoly exists when there are only one buyer and one seller. Although bilateral monopolies do not of necessity produce economically inefficient allocations, such outcomes are more likely due to the absence of sufficient competitive forces in the marketplace. The existence of bilaterial monopolies or oligopolies further suggests that the community goals of local control and popular participation may be completely ignored by the two parties to the water market transaction.
The Return Flow and Capital Preservation Problem
Surface and groundwater in the West are almost always interconnected. As a result, the water diversion works or pump facility of a particular appropriator may rely extensively on the use pattern of his neighbors.
For example, appropriator B may have positioned his well and established its depth so that he effectively relies on percolation of water into subsurface aquifers from the irrigated fields on his neighbor A's property, or even more likely, from a sink at the edge of his neighbor's field where surplus irrigation water percolates downward. In this example, a change in use by party A, or a transfer of A's water right to a new location, may substantially affect the quantity of water readily available to B. A shallow well that was at a sufficient depth given the groundwater recharge produced by A may no longer reach the water table in the absence of A's existing pattern of use.
The occurrence of these hydrological interconnections among users is the basis for the nonimpairment provisions of western water law. In most jurisdictions, transfers of rights are not
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allowed if there is an impairment of another's water right. In certain states, however, compensation may be paid to the other rightholders who would be affected when the transfer was completed. The complexity of these hydrological interdependencies-the so-called "return flow problem"-has led some economists and others to question the ability of water markets to produce an economically efficient outcome. It is indeed possible, maybe probable, that a single organization is better suited for the management of water at the basin level than are markets with their numerous autonomous, but hydrologically interdependent, parties. However, there has been some misconception regarding the nature of the return flow problem which, when clarified, puts the problem in a different light. If a water right is a legal entitlement to a consumptive use of water, then the protection provided by nonimpairment statutes or rules is actually for the capital investment of the individual rightholders in coffer dams, pumps, sprinkler equipment, or other water acquisition, transport, and application facilities, rather than for access to the water itself. Two implications of this reformulation are important.
If a given water user's capital investment is protected against a change in a neighbor's use or transfer of that use, then the status quo in existing water use practices is favored over the need to adopt more water-conserving technologies as water becomes more valuable.
Secondly, the legal protection given to the capital investment of other rightholders by nonimpairment provisions does not extend to the capital investments of other entrepreneurs whose livelihoods may be equally dependent on maintenance of the existing pattern of water use. For example, farm implement and seed dealers' economic welfare may be predicated on a continuation of existing agricultural uses of water, yet their investments are not protected against damage through transfers of water rights away from these uses. In essence, society has established institutional rules that may provide too much protection for an inefficient water use practice, while not protecting other capital investments related to water at all. These rules were put in place during the water development era. The prospects for expansion or contraction of these doctrines by the courts is discussed below.
Each of the above water market characteristics will likely have a significant bearing upon the ultimate social acceptability of market-type institutions for reallocating water in the West. As
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new demands for water develop in the West and water becomes relatively more scarce, there will be increasing demands for institutional changes which enable the true opportunity cost of water to be more accurately reflected in the price of water and therefore more effectively impact on all water users. The thrust of this conclusion is toward marketlike structures which more openly provide measures of the opportunity cost associated with given water uses. However, it is unlikely that society will allow an unrestricted market allocation of water, but will instead evolve some mechanism for tempering its outcome. The successful weaving of these two threads into a functional set of water management institutions will not be easy. In the next section we demonstrate how the courts have begun to recognize the need for protection of these varied political and economic interests.
The Role of Courts in Implementation of Institutional Changes
The Historical Role of Courts as Social and Economic Decision Makers
Courts at all levels of society, while purporting to "find" the law in the written word, have of necessity built their legal results based upon perceived views of economics and politics. The role of the Supreme Court in fostering a free interstate market is stated most elaborately by Justice Jackson:
While the Constitution vests in Congress the power to regulate commerce among the states, it does not say what the states may or may not do in the absence of congressional action. [Perhaps] even more than by interpretation of its written word, this Court has advanced the solidarity and prosperity of this nation by the meaning it has given to these great silences of the Constitution. . . . Every consumer may look to the full competition from every producing area in this nation to protect him from exploitation by any. Such was the vision of the founders; such has been the doctrine of this Court which has given it reality . . . (Emphasis added)[12]
The notion that court-made judicial doctrine is based on promotion of certain economic principles such as the obligation of the state to protect investment of private capital has been followed with equal force in the area of water law.[13] In its early origins court-made water law doctrine had as its main focus the promotion of the interests of the earliest appropriators and the
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protection of their capital investments. As the kinds of conflicting demands for water have increased, a number of changes in water law doctrine have come about-all of which have an effect on the potential supply of water for agriculture and the capacity to transfer water out of agriculture.
Changes in the Law Relating to the Necessity of Diversions
Traditionally, to acquire a water right in the western states a diversion of the water has been necessary.[14] This principle was grounded in the notion that investors in water rights should have to invest some capital. In addition, actual diversions from the stream put people on notice of the existence of diversionary rights already in place. This requirement of a diversion eliminated a number of potential competitors for water who sought water for environmental purposes in the form of "in-stream" flow rights. The diversionary obligation was thought to be embedded in the constitutional provisions of most western states. However, in State of Idaho Department of Parks v. Idaho Department of Water Administration,[15] the Idaho Supreme Court followed the state legislature's lead in perceiving a need for water rights for in-stream flows without a physical diversion. There the Idaho constitution expressly stated: "[the] right to divert and appropriate the unappropriated waters of any natural stream to beneficial use shall never be denied." Notwithstanding this language, the court, in upholding a statutory water right for in-stream flows, concluded: "Our constitution does not require actual physical diversion."[16] Thus, this opinion adds to the market another potential buyer for agricultural water rights.
New Limitations on the Right to Demand Water Otherwise Lost
Traditionally, the prior appropriator had the right to make a "call on the river" for his water right even though this caused extensive evaporative losses. This is best exemplified by the Nebraska Supreme Court case of State ex. rel. Carry v. Cochran.[17] There, a prior right holder was seeking to enforce his right to delivery of water on the North Platte River. To deliver the river water to him involved extensive carriage loss. Notwithstanding, the water was ordered delivered.
There has been state legislative reaction to this type of doctrine.[18] More recent cases have upheld replacement plans which protect senior rights by substituting groundwater and thereby reducing carriage loss.[19] This move toward maximum utilization by allowing substitution of groundwater may well satisfy the
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need of the far downstream surface water user, but it may not meet the needs of others. For example, junior appropriators may have relied on the senior's call on the river to keep the river bed wet so that their water could be delivered with minimum seepage. Also, water that has seeped into the ground is not necessarily "lost." The senior's surface "loss" may, in fact, be the source of water for junior wells upstream.
The Introduction of Benefit-Cost Analysis
The traditional method for acquisition of a water right involved only the question of whether there was a diversion of the water and application of it to a beneficial use.[20] Jurisdictions are changing. These changes have shown up with a movement toward economic and political balancing when a new appropriation is sought. The state of Washington is particularly explicit:
Allocation of waters among potential uses and users shall be based generally on securing the maximum net benefits for the people of the state. Maximum net benefits shall constitute total benefits less costs, including opportunities lost.[21]
A narrow material interpretation of this provision would ignore the myriad of social and nonquantifiable values attributable to water being used in agriculture. Also, it may provide a basis for reducing the protection of minimal and inefficient capital investments by persons with early priority dates.
Evolving Conflicts with Federal Statutes and Their Implications
Because much of the federal legislation affecting water rights was drafted in the early 1900s, these federal laws of necessity incorporated much of the water law of the time. They have not been amended. Thus, for example, the Reclamation Act of 1902 contains a requirement that all water in such projects be considered appurtenant to specific parcels of land.[22] This kind of federal legislation limited its transferability to other uses.[23] Notwithstanding the express language of these acts, the United States Supreme Court in recent decisions has leaned strongly toward an interpretation sensitive to the needs of changing state water laws. As stated most recently in California v. United States:
The history of the relationship between the federal government and the states in the reclamation of the arid lands of the western states is both long and involved, but through it runs the consistent thread of purposeful and continued deference to state water law by Congress.[24]
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This federal policy is also reflected in the language of Section 101(g) of the federal Water Pollution Control Act: "It is the policy of Congress that the authority of each state to allocate quantities of water within its jurisdiction shall not be superseded . . . "
Finally, the reserved water rights of the federal government for enclaves such as national forests, while once thought to be expansive, have been held by the Supreme Court to be much more limited.[25] And, while some have argued that the reserved water rights of Indian reservations are not transferable[26] and can be used only for irrigation, the Supreme Court has held they can be used for other purposes,[27] and others argue they are transferable.[28] The outcome of this transferability issue may have great impact on agricultural uses. If, for example, Indian water rights are transferable, then they will provide substantial competition to the non-Indian seller of an agricultural water right. This is true because the priority dates of the reservations will generally antedate those of the non-Indian agricultural water users.
New Obligations to Improve the Method of Diversion and to Prevent Waste
The general rule with respect to the need for efficiency in the means of diversion, and the irrigator's obligation to change his means of diversion to a more efficient one, was succinctly stated in an early Montana case: "When ditches and flumes are the usual and ordinary means of diverting water, parties who have made their appropriations by such means cannot be compelled to substitute iron pipes . . ."[29] That the law is also changing in this area is reflected in the landmark case of A and B Cattle Co. v. United States.[30]
In a recent equitable apportionment case between New Mexico and Colorado, the special master demonstrated once more the concern for efficiency in evaluating senior agricultural water rights. He discredited the loss of water to a conservancy district in New Mexico and ruled in favor of industrial use in Colorado because of his view as to the "inefficiency" of the district.[31] Thus, the movement toward cost-benefit analysis on the issue of obligation to improve efficiency seems clear.
Protection of Groundwater Diversion Methods
While a few jurisdictions have given no protection to groundwater rights[32] and groundwater was considered something of a mystery in the early 1900s, recent decisions have struggled with two basic questions: (1) how much protection should be given to
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a well user who suddenly finds his well weakened or dried up by a new well owner, and (2) in aquifers that are being mined, how does a water administrator determine a proper rate of mining?
While some early decisions afforded strict protection of a prior appropriator's well right irrespective of diversion method, a leading California case established the rule that the method of diversion must be reasonable.[33] In Colorado Springs v. Bender[34] the court clearly laid out the issue. It held that:
The plaintiff cannot reasonably "command the whole" source of supply merely to facilitate the taking of a fraction of the entire flow to which the senior right entitles them. On the other hand, plaintiffs cannot be required to improve their extraction facilities beyond their economic reach.[35]
The court went on to conclude that if a senior well system fails because of the junior's activities, the junior should compensate the senior for the cost of substituting a new means of diversion.
The issue of what is a reasonable means of diversion is becoming much more relevant, as jurisdictions become increasingly more aware of the hydrological connection between ground and surface water. Indeed, one New Mexico case suggests that if groundwater pumping reduces one's surface water diversion, the failure to seek a groundwater well permit may constitute forfeiture.[36]
As to the issue of what is a reasonable rate of drawdown of a mined aquifer, the courts are having an understandable amount of difficulty. They must balance the interests of future resident domestic users of the area, present agricultural appropriators with existing capital investments, and future industrial appropriators. Courts have been mindful of the need for such a concept;[37] unfortunately it is still in its infancy. As a result, attempts at definition often result in tautologies: "The safe yield of a groundwater basin is the amount of water which can be withdrawn from it annually without producing an undesired result."[38] This problem of determining a "safe" rate of drawdown is complicated further as courts begin to give more protection from saline pollution due to aquifer withdrawals.[39]
The agricultural water user who seeks to transfer a senior well right has to be concerned with these issues. If the salinity of a mined aquifer is steadily increasing, transfer to a potential agricultural buyer is extremely unlikely, because while the potential agricultural buyer may have access to a substantial quantity of water under the right, if it is of poor quality it has no value to him.
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The "safe yield" formula also has a direct bearing on the market for agricultural water rights. An agricultural well water right only has value if there are a fixed number of wells that can be drilled in the basin. If an industrial user can drill his new well without impairing the administratively determined "safe yield," he will have no motivation to purchase an existing right.
The Potential for Unlimited Interstate Competition
Many states have devised water plans and have emerging water markets based upon state statutes, which make appropriation for use out-of-state illegal.[40] The United States Supreme Court has decided that the limitation in Nebraska cannot withstand the constitutional challenges under the Commerce Clause. The United States Supreme Court in Sporhase et al. v. Nebraska ex rel. Douglas, Attorney General, No. 81-613 (July 2, 1982), ruled that Nebraska cannot constitutionally embargo its groundwater solely for purposes of economic protectionism. In so holding, however, it left open the issue insofar as arid states are concerned: "A demonstrably arid state conceivably might be able to marshall evidence to establish a close means-end relationship between even a total ban on the exportation of water and a purpose to conserve and preserve water."[41] Hence this decision leaves a number of relevant policy questions unanswered.
What is clear from the above discussion is that the courts are becoming increasingly aware of the existence of the economic variables in water law decision making; that the law is slowly changing to promote maximum utilization of water along with protection of vested rights; and that this change seems to be reasonably orderly. In the more difficult areas of protection of groundwater means of diversion, ensuring aquifer "safe yield," and the possible creation of interstate water markets, the directions and outcomes are much less clear.
Summary and Conclusions
The Current Direction of Change
With the advent of full appropriation in the face of continually increasing demands for water, the region's water institutions are beginning to change. In large measure it is the energy sector that is serving as a major force for this change, both directly as a major user of water in energy production and indirectly as the reason for much of the population growth that the West is experiencing. Moreover, there can be little doubt that the energy
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industry can afford to pay the often large costs required to bring about change in the previously accepted rules governing water use. Water costs are such a small portion of the total capital investment necessary to produce usable energy from natural resources that energy firms are easily able to bid water rights away from less economically valuable uses such as irrigated agriculture. Given these large discrepancies between the economic value of water in agriculture and its value in energy, firms can not only afford to compensate existing right-holders for their rights, but they can also afford large expenditures to litigate, legislate, or lobby for whatever institutional change they desire.
Associated with the increasing frequency of transfers of water rights from agriculture to energy and municipal uses, markets for these rights have begun to develop in the various basins of the West. Rudimentary as these water markets generally are when compared to smoothly functioning markets for many other commodities, they nevertheless exist and serve to establish prices for water rights.
Accompanying this evolution of markets for water rights, however, are several related developments which may not prove as socially acceptable. First, there is fragmentary evidence that conditions of imperfect competition are developing in some basins. Second, as water rights are moved away from irrigated agriculture through market transactions or by other means, the asset base for the rural communities that irrigated agriculture has heretofore served is diminished. While singleminded pursuit of material goals might dictate that such communities should simply contract if they no longer are economically sustainable, other social goals, discussed in connection with proposition two previously, may require that these communities at least be given the opportunity to find and develop a sustainable economic base. The distributional consequences of the loss of water rights to rural economies may be quite severe. A third probable consequence of the increasing dominance of economic factors in reallocating water is further exacerbation of the unsettled ownership question for water rights, particularly those disputes involving Indian tribes. As water becomes economically more valuable, the conflict over ownership will become more and more heated, with less and less flexibility on both sides in finding solutions. The courts are beginning to acknowledge these new demands on agricultural water rights and are handing down decisions that reflect a broad range of interests in water use and incorporate the notion of maximum utilization into western water law.
Alternate Paths
If the conclusions reached in the previous section are correct, while markets will continue to develop, it is unlikely that society will allow continued, unrestricted evolution of market reallocations; rather it will instead seek to temper the market outcome. If this assessment is accurate, two courses seem available. The first, and most probable, is that the regulatory structure imposed by states upon water affairs will be strengthened and extended. For example, the public interest provisions in water statutes will continue to be reinterpreted to include the welfare of other parties in addition to other rightholders. These modifications could include changes in statutes and rules that would provide incentives for existing private water users to find and adopt water-conserving innovations. This enhanced regulatory approach is the most likely course since it involves the least departure from the current course of events and basically only involves an expansion in the authority of existing institutions. It does not involve public acquisition and ownership. For societies accustomed to a large degree of individual freedom, some degree of increased collective regulation may be all that is tolerable.
The major alternative to this path is a more active assertion of collective interest by local governmental entities. For example, local communities at the basin or subbasin level could create a publicly owned corporation which acquires through purchase or condemnation most or all of the water rights in the hydrological area. This corporation would then allocate water among different users under some sort of water leasing procedure.
Under a water leasing scheme, an allocation based exclusively on economic criteria could first be proposed, using markets as the allocational instrument. However, if the market-directed allocation was substantially at variance with other social goals for the community encompassed by the water corporation, then a political mechanism would exist for bringing the actual allocation into conformity with the full set of goals.
This alternative institutional path would involve substantial change in existing institutions and for that reason must be judged as less probable. Still, it has attractive features and could evolve from the subbasin upwards, rather than being imposed by some central authority.
The choice between alternative institutional paths will be important, and perhaps critical, to the future of irrigated agriculture in many parts of the West. When judged on strict economic criteria, some agricultural activity is unlikely to be able to
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compete, and the continuing pressures are for institutional change in the direction of greater economic competition. The degree to which material goals are successfully integrated with nonmaterial values will vary with different societies and cultures in the West. In all cases, however, the forging of new institutions is almost certain to be a difficult task.
Discussion:
Raymond L. Anderson
Brown and DuMars comprehensively outline the major issues involved in transferring water from irrigated agriculture. They touch on the vexing problems of meeting water needs of a growing West with the increasing complex restraints placed on water supplies by various interest groups. In the abstract they say that economic considerations are forging water markets and that the courts are expediting the process by broadening the base of those who have a stake in water transfers and by insisting on more efficient water use. They assert that society is unlikely to accept an unbridled marketplace allocation of water resources. Because water rights are highly localized and site-specific, it is more
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likely that each state will develop its own mechanisms for allowing water transfers.
In Colorado, we have been looking at water transfers for over twenty years. One of the smoothest running water markets in the West has been in the Northern Colorado Water Conservancy District (NCWCD) for Colorado-Big Thompson (C-BT) water. C-BT is supplemental water developed by a Bureau of Reclamation project. When the project was started during the 1930s depression, the original allotment holders wanted an escape hatch in case payment for the supplemental water became a burden and threatened foreclosure of the farm for nonpayment of water assessments. Farmers wanted the right to sell the water or give it away if the water didn't pay its costs. This little gimmick paved the way for a source of water that could be purchased by rural-domestic systems, cities, and industries as growth came to the Front Range during the 1960s and 1970s.
Within the NCWCD, the original allocation gave 14.5 percent of the water to nonirrigation users. By 1982, over 35 percent was owned by nonirrigators. This amounts to about 63,000 acre-feet of water. The price has risen from zero or $30 per unit to as high as $2,000. Because the rules allow only one use of the water, irrigated agriculture has not suffered as much as one might suppose. Return flows are available to agriculture.
Up until the present, water transfer from agriculture, at least in Colorado, has always been the least preferred way to obtain water. When the need arises to find ways of obtaining water supply for newly developing uses, most new users prefer to develop additional water supplies, if such possibilities exist. They prefer to build reservoirs to capture unused flows. Denver, for instance, has long pursued a policy of developing water on the West Slope rather than competing for water from existing agricultural users on the South Platte. Some of the newly developing suburbs around Denver have chosen to invade agricultural water supplies through condemnation proceedings, but have discovered in the process that there are many pitfalls in taking currently employed water. Where cities overgrow irrigated lands, the transfer to urban uses is normally accepted and is accomplished with a minimum of controversy. It is the removal of water supply from existing irrigated agriculture that creates transfer problems.
In certain instances, where new users (cities or industries) offer high prices for irrigation stock, they can induce some stockholders to sell water to them. As long as the proportion of water held by cities and industries does not place too large a drain on
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an irrigation company's water supply, irrigators are willing to let nonfarmers own some of the irrigation system's water. In northern Colorado, the cities and industries buy water long before they intend to use it, so that much of the water is rented back to the farmers for some years. When the outside owners take large amounts of water out of the irrigation systems, this will undoubtedly lead to severe problems.
So far, the bulk of the irrigation water taken for new users has come from formerly irrigated lands that have been converted to urban uses. The cities tend to grow best on irrigated lands in Colorado. We've done a preliminary survey of irrigation company stock ownership on four major streams north of Denver, and it appears that the bulk of irrigation water stock transferred was from land that had gone into urban development.
Brown and DuMars refer to social goals that are held by irrigation communities with regard to the use of irrigation water. These six goals of irrigation communities are taken from the book authored by Professor Arthur Maass and myself, . . . and the Desert Shall Rejoice.[1] In our discussion, we were concerned mainly with how these goals related to the internal operation of irrigation companies or districts. In this case, the arena is sharply delineated. The goals apply mainly within the confines of a physical system, the service area of the company. The irrigation organization has good control of the critical resource and can distribute it according to rules that have the common consent of the interested people-the stockholders-water users. Once water moves into the larger economic and social sphere beyond the individual canal system, as described by Brown and DuMars, control by the local water users becomes much weaker. The community may retain these goals, but there is little they can do to achieve them once water has slipped beyond their grasp. The Milagro Beanfield War[2] is a case in point.
In the case of northeastern Colorado, perhaps it is the larger geographic area covered by the NCWCD that makes the market for C-BT water successful. While an individual irrigation company loses control of C-BT water when it is sold out of a system, the water cannot pass beyond the boundary of the NCWCD, so that the Conservancy District, representing a larger community, maintains control of future use of all of its water. Thus the NCWCD can be concerned about the effect of transfer on the various goals of an irrigation community, whereas a small company would have no control over water use once it passes out of its canal system. It seems to be a matter of geographic scope
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whether community goals will affect water use after sale and transfer.
At the end of their chapter, Brown and DuMars envision a dramatic change in institutions in which a water basin authority gains control of all water in a basin and allocates said water in a two-step process. The first step is an auction to see who will pay the most for water, followed by a second step where the directors of the water authority examine the auction bids to see if the uses square with community values. For those uses or portion of uses that do not meet community values, water stocks would be restricted and sent to community approved uses.
This, as they admit, is rather improbable. A more probable course will be for the existing institutions governing water use and ownership to gradually loosen and evolve to provide for new uses. That is the traditional way institutions react. Institutions are made by people to serve people, and institutional rules are not set in concrete to be observed for all time. But institutions also have the very important characteristic of being stable, to provide a basis for secure expectations so that economic and other decisions can be made with some degree of assurance that the rules will not change precipitously.
Therefore, I am not terribly pessimistic about current water institutions being able to handle the job. A pragmatic view of past performance of water institutions shows an accommodation to changing needs, and there is no reason to suppose those administering the water institutions or the courts settling legal contests over water will suddenly be unable to cope with change. The change will be slow, torturous, and expensive.
This view, of course, will not be greeted with enthusiasm by certain groups pushing special interest programs such as Indian water rights, federally reserved water rights, or in-stream flow rights for various purposes. These advocates are anxious to push through their claims and are impatient with the slow change of institutions. But slow change is necessary to fully examine the impact of many of these proposed claims on the limited water of the semiarid West.
Discussion:
Dallin W. Jensen
The authors present an interesting and scholarly discussion of the water transfer process, and raise a number of perceptive legal, policy, and institutional issues for consideration. This discussion will focus only on certain aspects of this chapter. As the authors point out, unallocated water is virtually nil in many river basins, and offers no realistic hope of meeting future needs. Even if some water is available, it may not be in an area where new development is proposed. Also, a late priority application to appropriate may not offer the certainty of supply that would justify investment of capital. The only viable alternative to accommodate much of the new industrial and municipal development is to acquire and convert existing agricultural rights to satisfy the new uses. Thus, a sound and functional transfer process is critical to the continued vitality of the West.
With certain exceptions, most states have historically allowed the transfer of existing rights to satisfy new uses so long as other existing water rights on the same source are not impaired. Thus, if the return flow from an upstream irrigator returned to the natural watercourse and formed a portion of downstream rights, the upstream irrigator could not by transfer subsequently diminish the return flow to the downstream user without compensation. Subject to the caveat of nonimpairment of other rights, the majority of the western states have followed a policy with respect to proposed changes which has generally facilitated the marketability of water rights and has not unduly restricted their subsequent conversion to satisfy other uses.
Some opportunity exists under such a system to accommodate new uses without materially disrupting existing agricultural uses. Such a result was recently accomplished in Utah, where the Intermountain Power Project (IPP) proposes to construct an electrical generating facility in the Sevier River Basin near Lynndyl, Utah. IPP needed to secure 45,000 acre-feet of water annually-but the Sevier River and its tributaries are fully appropriated. Thus, the only option available to IPP was to purchase existing irrigation rights and convert those rights to industrial use. The bulk of the water was acquired from stockholders in five mutual water companies under an agreement whereby each shareholder was limited in the amount of stock (water) he could sell. Change applications were then filed by the irrigation companies to convert the water represented by these shares from agricultural to industrial use. The individual users will retire
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only their marginal lands from irrigation, and must make a more efficient use of their remaining agricultural water. The net effect is that there will be very little disruption to the existing agricultural industry. Admittedly, this project was accomplished with a maximum of voluntary cooperation from the parties involved, but nevertheless the legal and institutional machinery provided the basic framework.
The foregoing discussion is not to suggest that improvements could not or should not be made in the legal and institutional framework governing water transfers. As the authors point out, some states have taken steps to allow for consideration of other factors in the decision-making process governing water transfers. However, it would appear that if there is going to be any major modification of state policy in this regard, such modification will have to come through the legislative process. It seems somewhat questionable that the courts will be the vehicle to impose significant public interest criteria upon such changes, as the authors suggest. The criteria governing such changes are reasonably well-established in most states, and have been the subject of both administrative and court review over the years. The result is that the courts in the various states have had occasion to define the limits on transfer procedures under existing law. This definition occurred at an earlier time, when the public interest in water use was perceived primarily in an economic and developmental context. Thus, while there may be some opportunity to expand the change process in some states to include other factors, it seems doubtful that most courts are going to make major adjustments in this area as a policy matter without some further legislative expression on this subject. In this regard, a number of states have adopted legislation to recognize in-stream values, for example, and to provide some measure of protection to these values once they are identified. It is not the purpose of this discussion to identify or evaluate these programs, but simply to point out that once these strategies are in place, presumably any water transfer would be subject to them, and this would then form an additional constraint on future water transfers.
It does appear that the institutional and regulatory structures governing change applications are likely to be the subject of some reevaluation in the future. As the size and number of water transfers continue to increase, so will efforts to broaden the traditional evaluation of such changes to include other public policy considerations. However, the states need to maintain a balanced and functional transfer process so that necessary and
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desirable changes can be accomplished. Any institutional modifications in this area will depend largely upon the public policies of the various states as perceived by the state legislatures.
The alternative path identified by the authors, more active involvement by local government entities, seems less likely. Legislation implementing such a program may be difficult to enact-particularly if it contains condemnation provisions. Further, as a practical matter, the prospect of a public corporation acquiring the needed capital and setting up a water purchase and leasing program for water rights in an area on a large scale basis seems doubtful.
Discussion:
Ronald B. Robie
Brown and DuMars provide an unusual perspective on water markets. Instead of the usual concerns about overcoming institutional barriers which inhibit the establishment of water markets, they emphasize the need for institutional arrangements capable of constraining market transfers of water between private individuals to protect the broader public interest from an unfettered water market. From the California experience, this perspective, emphasizing regulation at the local level of market transactions, confuses both the essential issue of the appropriate role for government in water markets and the efficiency and equity aspects of these transactions.
At the present time in California, there is little threat to the public interest, however broadly defined, from the allocation of water through unregulated water markets. There is essentially no private market for water. As for the future, I am less sanguine than the authors about the prospects for unregulated water markets becoming the dominant mechanism for allocating water, at least in California.
Public agencies dominate the California water industry. The significance of this public dominance was noted in a study of Southern California's water industry: "The public character of most of its key organizations places buyers and sellers under constraints normally not found in the private sector."[1] Virtually every water transaction of significance within the state is scrutinized and subject to approval by some type of public organization.
Under existing law, a holder of a post-1914 appropriative right must petition the State Water Resources Control Board for
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approval of any water right transfers involving a change of place of use, point of diversion, or purpose of use. The federal government's Bureau of Reclamation has control over the allocation of over a quarter of the approximately 40 million acre-feet (MAF) per year of water used in California through the operation of the Central Valley Project (CVP) and the Bureau's Colorado River Project. The State of California, through the State Water Project (SWP), allocates some two to three MAF yearly. The Metropolitan Water District of Southern California alone allocates over half of Southern California's water supply. In irrigation districts the boards of directors have substantial authority to determine water allocations; even the State Treasurer can have a say, as California water districts must receive approval from the District Securities Advisory Commission for a lease of surplus water outside the district for more than one year. In effect, the public character of California's water industry guarantees that some notion of the public interest will be represented in any water transaction.
The problem in California, then, is different from that described by Brown and DuMars for other western states-there is no problem in creating public overseers of private water markets; they already abound. One reason for so few transfers to date are too many overseers! The important question concerns what and whose interests these public agencies represent. How broadly or narrowly do these public entities define the public interest? Do they represent the state as a whole or a small client group?
This points up a problem with the chapter's reliance on local agencies to solve the equity issue. Local public agencies are no more likely to represent broad public interest than the market. All of this suggests a role for government the reverse of that outlined by Brown and DuMars-namely, government, at least at the state level, has a major role to play in promoting and fostering market transactions that move water to higher-valued uses.
If public agencies are motivated to move water to higher-valued uses, the state government has a very clear role in promoting this behavior by reducing transaction costs, such as locating buyers and sellers, and monitoring the actual quantity exchanged to assure nonimpairment of return flow rights of such transfers. As the authors note, these transaction costs are presently substantial. Reducing transaction costs may also help overcome the problem of monopoly distortions in water markets.
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Finally, what about the concern stressed in the chapter that the public has an interest in protecting irrigated agriculture and the rural society it supports? While legitimate, the problem is to some extent exaggerated.
Accompanying the increasing frequency of transfer of water rights from agriculture to industrial and municipal uses in the West is the belief that there are some "bad" economic consequences which will occur if this process continues. Brown and DuMars share this belief. While discussing the return flow problem, they point out that the nonimpairment provision applies only to other rightholders and does not extend to protect the capital investment of other secondary entrepreneurs. They also state their concern with the distributional consequences of the loss of water rights to rural economies.
The issue involved here is that of efficiency versus equity. Although the outcome of a market transaction is efficient, it may not be socially acceptable. Let us examine how justified this concern is for deterioration of rural communities due to the transfer of water rights from agriculture to industrial uses.
In 1978, industrial, residential, and governmental water uses in California amounted to about 14 percent of the total. The remaining 86 percent went to agriculture. Industrial uses accounted for no more than 6 percent of the total. While using only 6 percent of the water, industry generated 84 percent of gross state income and 78 percent of total employment.[2] As for the use of water in production of energy, fresh water used in producing energy (thermal electric generation; extracting and processing oil and natural gas) amounted to about 1.1 MAF or 3 percent of developed water supplies in 1976. For comparison, in 1975, a total of about 31.7 MAF was used for irrigated agriculture. Of this amount, about 13.5 MAF or 37 percent of developed supplies was used to produce livestock feed.
Water requirements for energy will not increase significantly in the near future. Since the anticipated increases in energy demand have not developed, the forecasts of future increases have been lowered and major utility companies of the state have cancelled or postponed plans for major new in-state power plants.[3] Nor has the shift from foreign to domestic oil and gas sources been as strong as anticipated.
In summary, under a less restricted intertransfer situation, some water might move out of agriculture, but since the demand for water in domestic, commercial, and industrial uses is relatively price-inelastic and there are few unsatisfied demands, the
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amount of water transferred may not be very great. Those nonagricultural users who anticipate future growth might buy up water, but might lease it back to agriculture until the growth occurred. Most of the water exchanges would be expected within agriculture, from low value to high value crops.[4]
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