PART IV-
STRATEGIES FOR MAINTAINING AGRICULTURAL VIABILITY WITH LIMITED WATER SUPPLIES

The estimated annual farm-gate value of crops produced and marketed from irrigated land in the 17 western states in recent years has been about $17 billion, ranging from $15 billion in 1978 to $19 billion in 1980. According to estimates for Texas, 54 percent of the value of irrigated production is used to pay for inputs and services purchased from the agricultural supply sectors.^[1] Yields from irrigated crop production provide inputs as raw materials for the livestock, food processing, fiber processing, and export sectors of the economy. Although specific estimates are not available as to the increment of production throughout the 17 western states that is due to the application of irrigation water (i.e., that part of total yield above the value of yield which could be produced on the same land if it were farmed dryland), it would appear that at least 70 percent of the value of production on irrigated lands can be attributable to irrigation and irrigation-associated inputs. Thus, without irrigation, $12 billion of unprocessed agricultural produce would not be available to the livestock, agricultural processing, and agricultural trades sectors of

- 397 -

local, regional, state, national, and international economies. This amounts to 19 percent of the annual farm value of total national production of all crops. Thus, it should be clear that agricultural processing, trade, transportation, and input supply sectors, as well as consumers, have a significant stake in irrigated agriculture, and consequently should be concerned about maintaining agricultural viability in the face of declining water available for irrigation.

Research and Development[en2]Research and Development^[2]

Wide ranging opportunities for improved soil and water conservation, increased water and energy use efficiencies, and increased agricultural productivity are dependent upon further advances in agricultural research and technology development. A significant correlation exists between the level of investment in agricultural research and the gains in productivity and efficiency which exemplified U.S. agriculture until recent years.

Reductions in federal funding for agricultural research and development have only partially been offset by increased state and private research investments. A renewed and continuing priority for agricultural research and development, with emphasis on more water-efficient crops, cultural methods, irrigation technologies, soil and water conservation and related advances, is needed if U.S. agricultural productivity is to meet projected future demands for food and fiber.

Improved coordination and cooperation is needed among private and public sources of research support. Private support for research through colleges, universities, and experiment stations should be increased and continued. The business community can contribute through the continued in-house development of agricultural tools, products, and technologies both on its own and in cooperation with public research programs.

A significant research emphasis should be placed upon the development of more water-efficient varieties of principal crops and intensive investigation of new crops for adaptation to irrigated and dryland production conditions. As locally adapted plants with commercial potential are identified in the research phase, a market development strategy should be used to insure marketing success.

In addition to increased research and development to improve water management efficiency, a need exists for more large-scale

- 398 -

and on-farm demonstrations of improved techniques and systems in order to accelerate their early and widespread adoption. Examples of conservation and resource use efficiency improvements that need to be emphasized are advances in water application methods and equipment, water-stress-tolerant crops and cropping systems, and conservation tillage practices. The private sector can assist in this effort by providing equipment, manpower, services, and publicity to conduct demonstrations.

An effective information capability at the local level is necessary to translate agricultural research and development advances into widespread use on farms. In addition, the local dissemination of relevant management information such as weather conditions and forecasts, soil moisture, and moisture requirements of crops for irrigation scheduling is needed. Networks in use now in some parts of the Midwest (Nebraska for example) have proven to be effective in disseminating information needed for farm operation.

More direct private and public participation in identifying resource management techniques with best potential for solving local problems will result in earlier acceptance and use of new methods, crops, and other research results. The private sector's news and information media should more adequately cover water conservation topics and explain the potential of new research. It's hard to compete with Hollywood, sensational war and murder stories, and sports, but the news media are letting the American people down in the half-hearted way water conservation, water development, and agricultural research are covered.

Agricultural research and technology development do not need a change in direction. However, a change in emphasis would be appropriate-toward greater yield per unit of input (water, fertilizer or energy), instead of maximum production volume. Continued funding by both private and public sectors is also essential. The job is not done.

Financing

Continued agricultural productivity is dependent upon economically strong and stable farms and ranches which return reasonable rates on invested capital and give fair returns to labor and management. Recent economic indicators reveal a dangerous national trend toward narrow margins of agricultural returns over costs. Without an adequate profit margin, farmers and

- 399 -

ranchers cannot justify soil and water conservation. Financial incentives are necessary to facilitate the availability of investment capital and to encourage its use for purposes of soil, water, and energy conservation measures, and the long-term protection and maintenance of agricultural land and water.

Financial Institutions

Many conservation methods and facilities have complex technical requirements, high costs, and high risks. Financial institutions can increase the availability of investment capital by ensuring that loan officers, personal service bankers, and other decision makers are informed of state-of-the-art conservation and efficiency technology. New attitudes toward risk and investment are needed. For example, a tailwater recovery system does not provide the same collateral security as a piece of farm machinery, but can serve as a valuable and profitable water conservation practice.

The same requirements for state-of-the-art information are relevant for operational financing. A farmer may need to purchase more chemicals than usual in order to adopt a successful minimum tillage operation which may conserve both water and energy. Financial institutions must be aware of current research and development in order to assist the farmer in financing early adoption of effective soil and water conservation equipment, materials, and management technology.

Business Community

Agricultural service and supply businesses can also cooperate with the farmer to accelerate adoption of operational improvements. These businesses must stay informed about products, equipment, and methods which have the best potential for improving efficiency of resource use at the lowest costs. While businesses cannot be expected to invest in unproven technology, early and widespread adoption of proven products and methods is contingent, to some extent, upon availability.

Financing practices such as deferred payments and minimal-interest charges are already available from some farm equipment dealers. These types of assistance need to be made available for new water conservation management tools as they become marketable. Businesses reap benefits when aiding the farmer, in the longer term. If the farmer doesn't have a dollar, no salesman is going to have a chance to get it.

Consumers

In a specialized economy, the food supply of the nation, and to some extent foreign markets, is somewhat contingent upon a dependable, long-term supply of water for irrigation. About 19 percent of crops produced and sold in the United States come from irrigated land. Without irrigation water this production would not occur, and the price of commodities would be much higher. Thus it behooves the general public as consumers to understand that irrigation water and water conservation are extremely important to their own interests. Consumers must be willing to support public funding for water conservation research and for water supply development. The public must understand more about agricultural water problems and more about the processes for solving them.

Conclusions

The farmer, banker, and businessman are interdependent upon each other in an agricultural community. There should be greater communication among the groups in a cooperative long-range plan to maintain economic viability in the community. It is also apparent that the general public is dependent upon the agricultural community. Through communication with legislators and other elected officials, the public can greatly influence the viability of agriculture and the wise and efficient use of the nation's soil and water.

Discussion:
Marvin Duncan

(The views expressed herein are solely those of the author and do not necessarily represent the views of the Federal Reserve Bank of Kansas City or the Federal Reserve System.)

Black has written a paper which effectively presents the viewpoint of farmers. While I find much in that viewpoint to agree with, I will also try to broaden the perspective to include more macro-level considerations.

The perspective of the paper seems to be that because of the importance of farm production to the nation's food supply and to its economic activity, water should continue to be available for irrigation. In the first instance-the importance of irrigation water to the nation's food supply-it is increasingly difficult to convince consumers and policy makers that the nation's food supply is in any jeopardy as a result of marginal shifts of irrigated land out of crop production or into more extensive production. Nowhere is this more evident than in the production of food and feed grains, where carryover stocks are the largest since the early 1960s. With current policy emphasizing reductions in the acreages devoted to such crops in order to reduce the burdensome supply, the loss of water to irrigate such crops is primarily a micro-policy question relating to the economic well-being of the producers affected and the community infrastructure supporting them. Consumers have also become aware at times of excess supply problems among vegetable and fruit producers. Television news programs showing oranges being destroyed in an effort to support prices of frozen orange juice make indelible imprints on consumer audiences.

To be mounted successfully, the food supply argument must be cast in terms of future decades. In that context, a case might be made for strategic irrigation investment, both public and private.

In the second instance-the importance of food production to the nation's economy-the argument is a weak reed if the reference is to the efficiency of resource use in the national economy. Cash receipts from the sale of farm products average only about 5 percent of the final sale of goods and services in the United States each year. Indeed, the reallocation of water resources to higher value uses often enhance economic growth, at national, state, and local levels. This frequently means a partial shift of water resources away from agriculture to industrial and urban uses.

- 402 -

An institutional framework for reallocating water is, of course, necessary. A market system that compensates losers and charges gainers the value of use of the water moves the economy to higher levels of economic performance.

If, however, the economic argument is directed toward a region, such as the Texas High Plains, it is on more solid ground. For without irrigation water, that area may see less economic activity as its agriculture shifts to dryland crop production or reverts to pasture land. The adjustment from intensive agriculture with high land values and a large supporting community infrastructure to extensive agriculture under dryland conditions could be painful. But it is during the adjustment period that the trauma is experienced.

Most economists and policy makers might agree that the transition could require some public investment and policy attention. It is less clear that the need for public investment in water transfer would be indicated. If such a transfer were proposed in the present environment, users would be expected to bear a significant, if not major, share of the cost.

Where interbasin transfers of water might be involved, the problems facing water users would be particularly difficult. The cost of the transfer and the institutional barriers involved are likely to be insurmountable. Those giving up the water, moreover, would have to be compensated somehow. The battle over water sales from South Dakota's Oahe Reservoir for use in coal slurry transportation in Wyoming is, I think, only an initial indication of the economic and legal problems to be resolved.

Black has emphasized the importance of agricultural research in improving the efficiency of water use and increasing agricultural production. This point is an important one. The benefits of previous investment in research have been great and are apparently cumulative, each new technological development building on previous developments. Similarly, it can be argued that reductions in public and private investment in agricultural research will, over time, have an increasingly deleterious impact on the competitive position of agriculture and on its profitability.

The emphasis Black places on making more efficient use of water and on developing crops adapted to lower quality water or smaller quantities of it is also excellent. Finally, he correctly emphasizes the importance of public and private roles in technology transfer. The public-private partnership in support of agricultural research, development, and technology transfer has been highly productive. We would ignore that record at considerable

- 403 -

long-term risk to agriculture and to the American economy. Companion to this point is the need for continued investment in education. Education is the impetus for both research and technology transfer.

Several relevant issues are not addressed in Black's paper. I will now turn to some of the more important of these. The economic and the financial environment in which agricultural production occurs has changed significantly in recent years. As a result of the deregulation of financial institutions and innovations in financial markets, agricultural borrowers and lenders have been thrust rapidly and firmly into the broader U.S. financial market. Moreover, U.S. capital markets have become increasingly integrated into world capital markets. As a consequence, agriculture must now pay competitive rates for capital. In combination with national macro-economic policy and procedural changes, this new environment has resulted in more volatile and somewhat higher interest rates to farmers and to other borrowers.

The Federal Reserve System's pursuit of a monetary policy directed toward restoring price stability combines with the likely prospect of very large federal budget deficits to suggest upward pressure on interest rates throughout the 1980s. In addition to the stubborn problem of cyclical deficits that had existed previously, recent taxing and spending policies by the federal government may have created a secular deficit problem of significant size. The competition for credit from all sources may be strong enough in this decade to cause real interest rates to remain at or above the top end of their historical range of 3 to 5 percent. This would be far higher than the near-zero real interest rates of the 1970s. Moreover, austere government budgets at all levels will likely result in federal government loan funds to individuals and government units being priced at or near the cost of money to the federal government.

If these conditions prevail, public and private investment in agriculture and water development may differ from that of past decades when large long-term projects were undertaken. Public funding will be more scarce, and greater emphasis will be on private funding of projects or full payback of any public investment involved. All else equal, higher discount rates favor projects with short useful lives or those with payouts concentrated in the early years of operation. Projects with rapid payout are also more consistent with the lending activities by most private financial institutions.

- 404 -

A disparity between the market discount rate and a socially desirable discount rate designed to encourage long-term investment in water development projects-or other infrastructure investments-may prevail under the circumstances outlined. Such a disparity could present a problem for public resource development policy. Resolving the problem could involve increased public investment in such infrastructure at all levels of government. However, without such a change in public policy, it seems clear that private investment in water projects, as well as investment by state and local governments, will grow as a proportion of total project costs.

At a micro-level, effective managers of borrowed capital can expect more access to agricultural loan funds in the future, partly because of the finance industry changes outlined. Lenders are apt to be aggressive in serving the credit needs of farmers, but they expect their loans to be serviced in a predictable manner. Moreover, confidence in collateral lending has been shaken by recent declines in farmland values. Thus, greater emphasis will be placed on cash flow lending. For farmers, this likely means:

1) More attention to cash flow analysis in evaluating loan proposals;

2) More performance-oriented evaluation of loan customers;

3) More knowledgeable lenders with increased specialization in institutions and in staff;

4) A greater understanding of long-term trends in agriculture by lenders and farmers; and

5) A more knowledgeable, specialized, and innovative support sector for agriculture.

On balance, farmers can look forward to ready access to credit from an increasingly efficient and sophisticated rural finance market.

Discussion:
W.D. Farr

Whatever expertise I have as a discussant of Blake's chapter comes from a practical knowledge of water and irrigation. I live in the State of Colorado where irrigated agriculture first developed. My experience comes from ownership of intensively

- 405 -

cropped irrigated farms, plus cattle ranches producing hay and pasture for beef production.

Our subject is the impacts of limited water for agriculture in the semiarid West. This is not a new subject or a new problem; we westerners have faced it for a hundred years. Water for agriculture has always been limited by agriculture's ability to pay. Some areas in several states have had Bureau of Reclamation projects. These projects all had repayment contracts without interest, which was a small subsidy. However, the original farmer who signed the repayment contract had to develop raw land, build improvements, and suffer through those pioneering years. These Bureau of Reclamation projects have developed large areas into high tax-producing segments of our western economy.

The nonfederal water projects in the western states were built by mutual ditch and reservoir systems with blood, sweat, and tears and, because of a shortage of capital, always at a minimum. Eventually, if they were successful and if additional water was available, enlargements to the systems were made.

Now, as we approach the year 2000, millions of people want to move west and enjoy the climate and living conditions. These additional millions of people have direct impact on our limited water.

The impacts are many and varied and differ in each state and every river drainage. There is no uniform solution. One basic law of western water is "It must be put to beneficial use." The question finally gets down to "What is the most beneficial use?" In some areas, irrigated agriculture is not especially productive and has seldom been very financially rewarding. In that situation, the water should move to cities and industry because that is the most beneficial use.

In many places the urbanization of large areas increases runoff substantially, which adds to the water supply for downstream agricultural users. This runoff water, plus the increased volume from city wastewater treatment plants, may add nearly as many irrigated acres downstream as was lost due to urbanization upstream.

The climates of our western states vary dramatically. A few states have mild climates; others have fairly short growing seasons. Agriculture does not use water constantly the year around. Cities and industry need uniform supplies every day. With new and additional uses the whole water supply of any given river drainage must be restudied and developed to assure maximum

- 406 -

use. In areas where underground water from a rechargeable aquifer is part of the supply, then the studies and developments need to combine total available water supplies. Business and financial interests need to be very much involved in plans of this kind.

Most of the water that has been developed in the western states was developed for agricultural use and hydro-power production. Now there are additional new needs for water. Most areas have some additional water that can be developed for the increased demands of industrial and urban use. These projects usually have been considered as feasible but too expensive for agricultural use. This is an area where financial and business interests can use their influence and financial resources to see that these remaining water resources be built first before agricultural water is removed from the land for other purposes.

Another area where business and financial interests can be extremely helpful is to insist that the water supplies of each area be better managed in order to assure the best usage of every acre-foot of water available each year.

In my judgment, time and economic values will settle most agricultural problems. Farmers growing high priced fruit and vegetable crops on a year around basis can pay more for water than a farmer in Colorado growing corn silage for cattle feeding.

Agriculture and irrigation helped build the West. Crops that filled the need of eastern consumers were produced. Large industries such as the beet sugar industry developed and prospered. Today it is a declining industry because food demands have changed, transportation costs have increased, and cane and fructose sugars are cheaper. Sugarbeets were a great irrigated crop, but are being forced out because of world food and money problems. Sugar is, however, just one example of the changes being forced on agriculture that actually have little to do with water.

It is obvious that every country of the world and certainly each state in the United States is being forced to study what agricultural crops can be grown in their areas to yield the best financial return. Economic barriers will influence greatly the impact of limited water. In many areas and under differing conditions, people, cities, and industry may be the better use for limited water.

Banks and other financial and business interests need to be well informed of the problems ahead, as well as committed to be part of the solution.

- 407 -

Water is finite in the West. Every community, county, and state will have to make their own judgments as to how their water supply is best divided and utilized. In some areas those decisions are already on the horizon. In other areas they are still one or two generations away. But in the planning and development or redevelopment of our water resources, that is not much time. We must face these challenges and proceed in implementing programs or projects that will be in the best total interests of the citizens of our respective states.

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

- 409 -

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.

- 410 -

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

- 413 -

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

- 414 -

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

- 415 -

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

- 416 -

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

- 417 -

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

- 418 -

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

- 419 -

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

- 420 -

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]

- 421 -

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

- 422 -

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.

- 423 -

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

- 424 -

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

- 426 -

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

- 428 -

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

- 429 -

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

- 430 -

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

- 432 -

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

- 433 -

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

- 434 -

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.

- 435 -

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

- 436 -

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]

Chapter 19:One State's Strategy for Putting Water to Beneficial Use

Chapter 19-
One State's Strategy for Putting Water to Beneficial Use

by Ted Schwinden

Abstract

Increased use and competition for water have made shortages and conflicts today's realities in many of Montana's drainages. Montana has begun the implementation of a water resource management program to ensure adequate water supplies for Montanans, both now and in the future. The program has four basic elements:

1) A water adjudication system to document water rights acquired before 1973. Another objective of the adjudication program is to quantify Indian and non-Indian federal reserved water rights.

2) A study authorized by the legislature to determine how much water will be needed for future beneficial use in Montana. The study also examines how potential future water development in Montana may be constrained by downstream water claims.

3) A water reservation system that allows agencies to apply to the state to reserve water for anticipated diversionary future uses or to maintain a minimum flow, level, or quantity of water instream.

4) A water development program which makes state funding available for water projects. Funds for the projects come from several sources, including the Resource Indemnity Trust and revenues from existing state water projects. The program also authorizes low-interest loans and grants to fund public and private water projects, and provides a $250 million bonding authority to implement water projects developed by the state and approved by the legislature.

Few issues are more important to Montana than water and agriculture. If it's safe to say that agriculture is the wheel on which Montana's economy turns, then water is the hub of that wheel.

- 438 -

In the United States, our limited fresh water supplies cannot satisfy our national thirst forever, if that thirst keeps doubling every twenty years. In some cities, water problems have reached critical proportions; and in some areas, particularly the Southwest, water shortages are threatening agricultural productivity.

Not long ago, Gerald D. Seinwill, of the U.S. Water Resources Council, said that "water is the most serious long-range problem now confronting the nation . . . " Seinwell and other reputable, knowledgeable individuals warn of a water crisis of international dimensions in the 1980s and 90s, of a magnitude comparable to the oil crisis of the 1970s.

I was invited to discuss state and local public policy with regard to strategies and tactics for maintaining agricultural viability in the face of declining water available for irrigation. Accordingly, I will explain in some detail the approach being followed in my own state of Montana.

In Montana, only about 2.6 million acres now are irrigated, but another 10.6 million acres are classified as irrigable. The amount of irrigated land has increased at a very modest pace of about one percent per year, and projections indicate a continued modest growth into the future. That is not to say that all is well with water and agriculture in Montana. The problems that occur are no longer entirely traceable to the vagaries of precipitation patterns.

Instead, increased use and competition for water have made shortages and conflicts today's realities in many of our drainages. In the Milk River, in northern Montana and Canada, for example, the state was forced to impose a moratorium on the issuance of new water use permits. On the Powder River, in southeastern Montana, two companies are in court battling to claim remaining flows-flows clearly insufficient to satisfy their energy-related demands.

In other areas of our state, water quality has become a major concern. Along the Poplar River near my home in northeastern Montana, irrigators fear pollution originating from a Canadian coal-fired generating complex just across the border. In the Tongue River Basin (heart of the Powder River coal area), return flows contribute to a degree of salinity that makes the expansion of irrigation from that source questionable.

Storage frequently offers a solution, but Montana irrigators now pay $5 to $10 for an acre-foot of water. They will not be able to afford the $100 to $200 per acre-foot price tag calculated for some yet-to-be-developed facilities.

- 439 -

Beyond physical supplies, quality, and economics, another category of issues stem from institutional questions. Hydroelectric claims, for example, appear to pose a limit to new upstream irrigation on the Clark Fork drainage of the Columbia and the headwaters of the Missouri. Federal and Indian reserved rights have not been quantified-although major amounts have been filed-nor have the interstate tributaries been allocated between Montana and Wyoming by the Yellowstone River Compact. Disagreements between upper and lower basin states and skirmishes over prospective interbasin transfers are catapulting Montana's water concerns into the national arena. Governor Janklow of South Dakota got the attention of states all the way from Missouri and Nebraska to Arkansas and the desert Southwest with South Dakota's sale of water for the ETSI pipeline.

Benjamin Franklin said, "When the well's dry, we know the worth of the water." In Montana, we can't afford to wait to find out the real worth of water. Our challenge and our goal is to ensure adequate water supplies for Montanans, not just for irrigation, but for other beneficial uses, both now and in the future. We have therefore begun the implementation of a water resource management program which has four basic elements.

The first is our state's adjudication system, a process which has been appropriately called a way to put a "handle" on Montana's water pump. Since 1973 the Montana Water Use Act has provided an exclusive permit-and-certificate method of acquiring a water right. Before 1973, water rights could be acquired in a number of ways, some of which involved no written documentation of any kind. Consequently, as of today, no one knows exactly how much water is being legally claimed and used in Montana.

Under a recently established program, we have finally begun to quantify and confirm pre-1973 rights. The deadline for filing such claims was April 30, 1982; the Montana Department of Natural Resources and Conservation has begun processing more than 200,000 claims received by that date, and Montana's water courts are setting up the adjudication processes. It is critical to have an accurate quantification of how much water is actually being put to beneficial use in Montana. As a major state newspaper put it, "The best offense against those who might want Montana water is a good defense. What better defense than detailed records of our water and its claimants?"

- 440 -

Another objective of the adjudication program is the quantification of Indian and non-Indian federal reserved rights. To avoid endless litigation with tribes, the 1979 Montana Legislature established the Reserved Water Rights Compact Commission, which was given the authority to negotiate and conclude compacts with willing tribes.

The second part of our state's water management approach is a so-called "Use It or Lose It" study authorized by the state legislature to determine how much water will be needed for future beneficial use in Montana. Irrigation currently accounts for 95 percent of the water consumed in our state. Industrial, municipal, livestock, rural domestic, and other uses total less than five percent.

The study will also examine how potential future water development in Montana may be constrained by downstream water claims, such as South Dakota's sale. We are reviewing the legal, institutional, and economic incentives and restraints to future water development within Montana and the other Missouri River Basin states. And, finally, the study will examine the options available to resolve conflicting demands: interstate compacts, equitable apportionment suits, and Congressional apportionment.

A third element of Montana's water plan is our water reservation system, authorized by the unique provisions of the 1973 Montana Water Use Act. Under this law, federal and state agencies, as well as political subdivisions of the state, may apply to the state to reserve water for anticipated future diversionary uses, or to maintain a minimum flow, level, or quantity of water instream. The decision-making body is our State Board of Natural Resources, a seven-member citizen board, which now has a planning tool to allocate present supplies, as well as to evaluate and provide for anticipated future needs.

The reservation process, which is lengthy and complex, has been completed only in the Yellowstone Basin, where water has been reserved for agricultural, municipal, multi-purpose storage, and other uses. Fourteen local conservation districts and two irrigation districts sought irrigation water, along with three state and federal agencies; 655,000 acre-feet per year was specifically reserved for that purpose, and additional supplies are to be made available from four planned state and federal storage projects. The state is doing all it can to support irrigation. The conservation districts received substantial assistance from the state in preparing documented reservation requests and in

- 441 -

representation during the complicated hearings process. Two full-time state employees are helping the conservation districts develop the detailed plans and the administrative processes necessary to put the reserved water to work. The state is moving to establish reservations in other drainages as well, and I am hopeful that adequate future supplies for irrigation and other beneficial uses can be guaranteed.

The fourth and final element of Montana's water management effort provides state financing for water projects. It's no secret that federal funding for water projects has faltered under President Reagan's economic recovery program. For example, the Land and Water Conservation Fund, which had made $3 million available in Montana for water projects annually, has been cut to literally nothing. The Small Loan Program of the Bureau of Reclamation historically provided low-interest loans for irrigation projects, but all of its approved projects have been shelved for the past two years. The Farmer's Home Administration has only one-half of its normal allotment, and the five-state Old West Regional Commission, which provided planning funds for water projects, went out of business a year ago. At the same time, increased competition for (and pressure on) our water resources have made it clear that additional storage, conservation measures, and increased irrigation efficiencies are essential.

In that context the Montana State Legislature unanimously approved my first major proposal as Governor in 1981: Senate Bill 409. This was a bold measure, putting state government into a leadership role in the development of the state's water resources. The 1981 legislation supplies funds for water development from several sources. About $1 million a year comes from the earnings of the Resource Indemnity Trust, funded by a severance tax on all minerals. About $300,000 in annual revenues from our state-owned water projects are being used to: (1) plan the rehabilitation of state-owned projects and develop their hydropower potential, (2) assist conservation districts in implementing their water reservations, (3) encourage the development of offstream and tributary storage, and (4) promote joint state, tribal, and federal projects.

SB 409 also authorized low-interest loan and grant programs to fund public and private projects or activities associated with water. That loan/grant program is funded by coal severance taxes to the amount of about $2.5 million annually. An additional $5 million can be made available for loans through general obligation bonding authority (requests to date exceed $27 million).

- 442 -

Finally, SB 409 provides a $250 million bonding authority, which can be used to implement water projects developed by the state and approved by the legislature.

I consider the passage of the 1981 water development program to be the major accomplishment of my administration. Clearly, it is one of the most important acts in Montana's water history. Nevertheless, there is much work to do in the area of water project financing if Montana's irrigation potential is to be realized. One approach to funding is through the cooperation of federal, state, and local entities. That approach is used on the Tongue River Dam, a state-owned project in southeastern Montana, where the Northern Cheyenne Tribe, the U.S. Bureau of Reclamation, the U.S. Bureau of Indian Affairs, and the State of Montana are cooperatively funding a feasibility study aimed at an equitable allocation of water, and determining the cost for that water. We are trying to reach a "good-neighbor" agreement with Wyoming on how much Tongue River water can be stored in an enlarged project under the provisions of the Yellowstone Compact-the Tongue River being one of the interstate tributaries governed by that document.

Industry can directly assist agriculture. In Utah, for example, a dam proposed to meet the needs of oil shale interests will also provide for the irrigation of Indian lands. In Wyoming, an energy company paid to enlarge and rehabilitate an existing dam to correct safety problems and to protect agricultural supplies, while providing water for its own uses. In Montana, the state might act as an intermediary in the sale of industrial water now available from the Fort Peck, Yellowtail, and Tongue River reservoirs, where proceeds could be used to help offset the cost of irrigation.

On the other hand, the development of heavy oil, tar sands, oil shale, coal generation, gasification and liquefaction plants could seriously disrupt water use by agricultural users. Perhaps energy-rich, but water-short, states should export raw energy resources to more water-abundant demand centers for processing and conversion. In any event, when energy conversion takes place in the semiarid West, we must encourage the use of the most water-conservative technologies, even if those technologies are more expensive.

State governments can employ three other approaches to expand irrigated land, to maintain it at its current level, or to slow the progress of its decline. The relative importance of agriculture in each state will dictate the selection and application of the remedies.

- 443 -

One avenue is to use tax incentives to keep land and water in agricultural production-or, conversely, to impose penalties for converting them to other uses. A second approach is to utilize water law. Montana, for example, prohibits an appropriator of more than 15 cubic feet per second (cfs) from changing an agricultural water right to an industrial right. Other statutory approaches could include a preference system to establish agriculture as a preferred use, allowing municipalities to condemn agricultural water rights, or prohibiting the severance or sale of water rights once they have been perfected for agricultural purposes.

The third approach involves land use controls-ranging from the purchase of development rights, to subdivision regulation, to the type of state-level land-use planning done in Oregon. Government banking of agricultural land for future lease or sale to individuals, as practiced in Saskatchewan, is an innovative land-use concept that deserves review and evaluation.

With respect to local government's role in maintaining agricultural viability, I will mention only two points. The first relates to soil and water conservation districts. In Montana, these districts have evolved into responsible, effective organizations. Conservation districts along the Yellowstone have reserved water for future irrigation, are making plans to develop that water, and in the process, are becoming a significant water management force in the basin. Conservation districts in northcentral Montana have been conducting an effective saline seep control demonstration project for several years, and are a major force in combating that epidemic problem. Enabling legislation in Montana authorizes conservation districts to levy taxes, to initiate projects, and to create and enforce regulations with the effect of law. Those powers have generally been unexercised in the past, but that is beginning to change. Conservation districts have the potential to become major agricultural and natural resource entities in the future.

States cannot expect local government to continually shoulder an increasing share of water development responsibilities without providing them adequate funding. Under the New Federalism, state governments are getting a crash lesson in learning the limits of their abilities to assume the provisions of federal programs-but it's easy to forget that lesson. That's why, in Montana, I'm proposing a new method of distributing funds to local government through a block grant system. Cities and counties will receive, with greatly expanded flexibility, all the present

- 444 -

taxes and fees, and we will ask for an additional state General Fund appropriation and a specific percentage of the state oil severance tax to go to local governments.

The "bottom line" is that it will take more than the initiative and cooperation of local and state governments to resolve the problems facing irrigated agriculture. There must be a responsible federal role. And money!

Chapter 20:Federal Water Ploicies and Irrigated Agriculture

Chapter 20-
Federal Water Policies and Irrigated Agriculture

by Garrey E. Carruthers, Thomas G. Bahr, Herbert H. Fullerton, and Norman H. Starler

Abstract

The cornerstone of this administration's water policy is that control of this nation's water resources is a state's right. Primacy in water allocation and management decisions should continue to rest with the states. Federal water policy should emphasize the importance of strengthening partnerships between federal and nonfederal interests in water development and use.

The introduction to this chapter offers the hypothesis that overregulation and distortion of water markets impair the ability of irrigated agriculture in the semiarid West to respond to changing economic conditions. The second section introduces a working concept of maintaining long-run agricultural viability through application of market incentives; the third section addresses water allocation decisions and economic development as related to long-run adjustments to resource scarcity; the fourth section briefly reviews historic federal policies on supply augmentation, cost recovery, feasibility determination, and expenditure priorities; and the fifth section outlines an opinion on what direction emerging federal policy should take. A discussion of recent federal actions provides a preview of opportunities for joint ventures and cost sharing while placing greater reliance on market transactions and water transfers.

The chapter concludes with reference to the need for balance in federal and nonfederal roles in the development of agricultural water supplies in the semiarid West. Emphasis is placed on deregulation of water markets which heretofore may have limited the ability of nonfederal entities to make full use of the market in resolving water scarcity problems.

Historically, the development of water resources has been crucial to settlement, expansion, and diversification of the economic base of the semiarid western United States. For more than 100

- 446 -

years, individuals, businesses, states, and the federal government have worked with demonstrable success in implanting technologies and creating institutions within these regions which have led to development, control, and utilization of scarce water supplies. Testimony to the success of these efforts is the 20 million acres currently under irrigation in the United States, and the fact that cost-efficient project development opportunities have become less plentiful.

Since the late 1930s, many semiarid regions of the West have experienced very rapid nonagricultural expansion and concurrent large increases in water demand. Continued growth of similar magnitude suggests a future with increasing competition and higher cost for water. Because irrigated agriculture is currently a majority user of relatively low-cost water supplies, projections of continued growth cause some to question agriculture's long-run ability to remain competitive with other users. Clearly the emerging physical, economic, and political realities surrounding the supply and demand for water resources will have significant bearing on water cost and availability to agriculture, and ultimately on the shape of federal water policy.^[1]

The central theme for this chapter is that the long-run ability of irrigated agriculture to remain economically viable and thus to compete without subsidy for limited water supplies will be enhanced by placing greater reliance on markets to guide water allocation and investment decisions. The relative wealth and long-run economic viability of irrigated agriculture are inextricably woven into the question of who pays the cost of access to water, and what conditions, if any, are attached to transfer of water service to other users. The basic assumption which underlies this assertion is that traditional federal water policies have followed a pattern of emphasizing developmental objectives (settlement, cheap food, economic stability, foreign exchange) and federal financial responsibility for water development, without sufficient regard for their market-distorting effects which reduce resource use efficiency, economic efficiency, and water resource value. Such an emphasis facilitates maintenance of institutions, contractual arrangements, and water pricing which discourage further definition of transferable property rights to water and water service, thus foreclosing opportunities for state water laws to function as designed. It also encourages capital-intensive solutions to water problems, and a continuing expectation that leadership in solving water problems rests primarily with the federal government.

- 447 -

The current administration places primacy in water allocation and management with the states, and seeks a true partnership with states and other nonfederal water interests in the planning, finance, and development of water projects. Greater reliance on private water markets will also require (1) recognition of private property interests in federal water service, including third party interests, (2) selective removal of federal distortions to water markets, (3) further definition of conditions for transfer of water use, and (4) encouragement of projects which overcome physical barriers to market transfers.

Agricultural Viability

In keeping with the general theme of this volume on the impacts of limited new (emphasis added) water for agriculture in the semiarid West, the question of agricultural viability is addressed within the context of increasing competition and higher real prices for existing water. In farming, just as in any other business, the market provides the ultimate test of long-run viability. Long run viability requires the ability to turn a normal profit after paying for all those inputs needed in a farm operation, including payment for labor, equipment, the use of money, fertilizers, fuel, pesticides, and water. Although the prices and quantities of water used vary significantly among crops and service systems, water as an input to agricultural production averages from 5 to 30 percent of total input costs. When the price and availability of these inputs change, it is reasonable to expect that the nature, limit, and the location of farm activities might also change. The difference between water and most other farm inputs is that water, especially in cases which involve change in point of diversion and/or use, is restricted administratively through public institutions rather than by the market. The federal government, rather than acting as a financially rational lien holder, acts as an owner without market incentives. Although state laws contain certain administrative restrictions, in many cases they do provide for financially rational behavior.

To the extent that the priorities guiding administrative allocations are coincident with those that would be assigned by a functioning market, economic viability will not be arbitrarily affected. Fortunately, the water laws and administrative procedures of most arid states have allowed, if not encouraged, transfers of water in response to market incentives. Such transfers

- 448 -

encourage efficient water use and increase the availability of existing supplies. With the addition of federal projects, these market incentives may be seriously distorted by subsidies, and restriction on transfers embodied in contract terms.

A central question is what would happen if competition for water supplies caused the supply of water for agriculture to be diminished; the further question is what adjustments in agriculture might be expected when water becomes more expensive. Given an increase in price or cost of water, farmers would likely respond by substituting other inputs for the more expensive water, and by adjusting cropping patterns to reduce acreage or to discontinue producing crops with low value return to water.

Moreover, farmers would become highly receptive to management practices and technologies which use water more efficiently. These adjustments are already happening on a large scale throughout the western states. Ultimately, one would expect that crops which are no longer profitable in a given area will either be produced elsewhere or possibly not all. Thus, the economic realities of increasing competition for water will continue to change the character of agriculture in the semiarid West. The type of agriculture which remains profitable and is competitive with other industries for water and other scarce resources will remain viable.^[2]

Water Resource Allocation and Economic Development

Economic development is enhanced by efficient use of water. In rapidly growing areas such as the western United States, decisions to allocate and transfer water among competing uses will have to be made whether water markets are allowed to operate effectively or not. What is important is the question of whether or not these decisions lead to efficient use of water. Some observations in this regard are:

1) Competition for water and other scarce resources is a fact of life.

2) If water is scarce and marketable, it will move in the direction of the highest value use as reflected by the highest bid.

3) Voluntary transfer of existing and new water supplies in response to market prices enhances economic

- 449 -

efficiency, encourages economic growth, and increases the value of the nation's water resources.

4) Unnecessary restrictions on water transfer (market distortions) inhibit economic growth, reduce economic efficiency, and reduce the value of the nation's water resources.^[3]

5) Removal of market distortions, including assurance that current users and third parties are compensated for any reduction in their use of water, will increase the availability of water to high value users.

Market-based reallocations will most likely result in an economy in which a larger fraction of water is used in the nonagricultural sector. Given an initial 85/15 agriculture/nonagricultural water distribution, a twofold expansion of nonagricultural use would reduce this ratio to 70/30. Numerous studies have demonstrated that adjustments in this range would not seriously affect agricultural viability, i.e., a total economy on a state or regional basis. However, this is not to say that some small areas with a history of groundwater mining and very rapid nonagricultural growth would not be seriously affected. In the long run, alternatives for resolving these scarcity problems should not emphasize federal regulation of use and further subsidization of water price when there is potential for making the necessary adjustments in resource use with voluntary transfer of ownership between willing buyers and sellers.

Historic Federal Water Policies

Supply Augmentation

An historical look at federal water policies may be useful to demonstrate the potential of moving toward a market emphasis. In the past, federal policy emphasized supply augmentation primarily through constructing storage and conveyance facilities. Major emphasis was on development of arid regions in the West. Under the Reclamation Act of 1902, the focus of the Bureau was to increase the supply of water available for irrigation. As the West was developed and as demand for water increased, supply augmentation served de facto as the primary means of solving the problem of getting water to those who did not have it. Supply augmentation picked up the slack, and little water was transferred from one use to another. As a result, a variety of institutions and contractual arrangements were created to

- 450 -

administer these federally augmented water supplies. The primary purpose of these institutions and contracts was not to encourage market transfers, but to assure project repayment and to administer new water supplies.^[4] Indirectly, water marketing among users and uses was discouraged because of overt restrictions or prohibitions on transfer.

Project Cost Recovery

Gradually, as population and industrial activity expanded, the Bureau of Reclamation, as well as other federal water development agencies, added additional project purposes such as hydropower (beyond irrigation pumping needs), flood control, and municipal and industrial water supplies. From its inception, project cost recovery was a central feature of the Bureau of Reclamation programs. However, the extent of repayment varied by project purpose. Irrigation beneficiaries traditionally repaid allocated construction and operation and maintenance costs. Hydropower and municipal beneficiaries repaid construction cost plus interest. In contrast, flood control was provided by the federal government without requiring repayment from beneficiaries. However, extended repayment terms, transfer of power revenues to cover part of irrigation construction costs, and congressionally authorized exemption from interest charges significantly reduced agriculture's repayment obligation.^[5] The Congress, in authorizing Bureau projects, chose to pursue developmental objectives which placed little emphasis on the implications of repayment arrangements on market incentives.^[6]

Project Feasibility

As the best project sites were developed, the cost for additional multipurpose projects increased, thus placing greater demands on the U.S. Treasury. Closer public scrutiny evolved quite naturally because project investments were evaluated at less than market rates and direct beneficiaries were not required to pay the full costs including interest. The combination of higher costs, public subsidy, and a call for closer scrutiny of public water projects stimulated attempts to provide more realistic preassessment of the economic efficiency of planned water supply projects using benefit/cost analysis. Although these analyses attempted to impose the discipline of the market in measuring project benefits from vendible and nonvendible project purposes against project costs, numerous problems have been encountered in their application and interpretation.

- 451 -

Three observations are relevant in this regard: (1) some analyses overestimated benefits by double counting,^[7] (2) anticipated agricultural development did not take place in some project areas, resulting in underutilized water presently in storage,^[8] and (3) follow-up on past analyses and a survey of current analyses indicates that, given current economic indications, the number of economically feasible multipurpose project sites is somewhat limited.^[9]

A federal response which addresses the problem of declining and questionable benefit/cost ratios with sole emphasis on either new structural means, or on conservation and nonstructural solutions to water scarcity, is too narrowly drawn. Predictably, the singular emphasis on restricting demand, to the exclusion of the supply side, by the previous administration did not succeed.^[10] The current administration advocates a balanced policy that recognizes both supply and demand-i.e., a market-oriented approach.

Examples of Market Distortions

Despite the fact that the reclamation program was not intended to encourage markets but to settle and develop the semiarid West, some authors have taken the position that it has directly and/or indirectly prevented markets from functioning efficiently. For example, Rucker and Fishback argue that attempts to enforce the 160-acre^[ limitation ignored economic realities of irrigated agriculture in the U.S. economy and distorted the market.^11] Typical land and water adjustments were precluded by the Act, creating the so-called "excess lands" problem for owners of more than 160 acres (320 acres for a couple).

To obtain water, owners of excess land were required to sign a recordable contract in which they agreed to sell these lands within a specified time period. However, the sale price was restricted, by law, to the land value with improvements excluding water supply. This restriction of price on excess land removed incentives for landowners to sell to others who were or would be in compliance with the acreage limitation and thus eligible to receive reclamation water. At the same time, it provided strong incentive for the landowner to seek arrangements that provided legally defensible means for obtaining water service. Rational behavior on the part of reclamation administrators dictated that they would accept these arrangements and provide water service to the excess lands. This contractual arrangement ensured that the stated federal goal of obtaining project repayment was met.^[11] When excess project capacity was present with all costs committed, there was strong incentive to supply water to potential users

- 452 -

who were willing to pay an amount in addition to operation and maintenance costs.

Historically, water markets have evolved within and along small mutual irrigation companies. Gisser and Johnson argue that the Bureau of Reclamation, in contracting with public irrigation districts to provide subsidized water, contributed to their dominance of water markets and imposed other distortions on these markets.^[12] Districts considered it in their interest to restrict water exchanges for a variety of reasons, including the need to secure their repayment contracts and operations agreements with the Bureau. Gisser and Johnson also document an extension of this rationale wherein an irrigation district used the existence of a repayment contract with the Bureau of Reclamation to block transfer of water rights which predated formation of the district.

Some authors have attributed the lack of reliance on markets, at least in part, to the structure and administration of state water law.^[13] Water demand estimates have been systematically overstated by planners in states where the structure and administration of water law has discouraged voluntary transfers motivated by differential market value. There is general agreement, however, that the appropriation system of water rights used by the semiarid western states is more conducive to market allocation of water than the riparian system. In fact, potential transfers are permitted in some western states, subject only to reasonable protection of third parties. This requires application to the responsible state authority, such as a State Engineer or State Water Board, which has sufficient information and authority to execute water transactions. In other states, transfers require initial recourse to courts which may have access to limited information and be overly sensitive to potential third party damages. An example of this latter situation is cited, regarding court decisions in which users of irrigation water under the laws of Colorado attempted to sell their water rights to the cities of Denver and Ft. Collins.^[14] Traditionally, the federal government has protected third party interests, including international treaty obligations and reserved rights. However, this role did not typically extend to other third party interests, except as they may have been reflected in water service or repayment contracts.

Incentives and Expectations

The primary impact on water markets has been a public perception that the federal government will continue to provide new water supplies at less than full cost. Private investment has

- 453 -

been discouraged because of federal competition in water development and a continuing expectation among water users that the federal government will provide water services at subsidized rates. There has been very limited incentive to invest private funds in water development when public funds are or may be available.

Recent high rates of inflation and unemployment, combined with an escalating federal obligation for defense and entitlement programs, have increased the competition for federal money. Water development budgets have not been exempted. No new water project authorizations had cleared the Congress since the last omnibus bill in 1977 until the current session. A continuation of congressional trends will likely force adjustments in private sector expectations and consideration of alternative approaches to water resource development.

Emerging Federal Policy

An Overview of Direction

Federal policy regarding water supply should emphasize fuller reliance on water markets. This means that:

1) Institutional arrangements should be reviewed with the thought of encouraging voluntary market-based reallocation of water, both within fully utilized water systems and from currently underutilized water systems.

2) The extent of property interest in water on the part of current users should be unequivocally specified by the states.

3) Reductions in water use must be voluntary, with compensation mutually agreed by the contracting parties.

4) Development of new water supplies must involve joint ventures between nonfederal and federal entities to validate economic feasibility conclusions, to ensure financial feasibility, and to specify the federal role.

At this time, the extent of voluntary exchanges where the federal government has involvement appears to be limited. In some instances, contractual arrangements between the Bureau of Reclamation and states or other contracting entities have been

- 454 -

cited as discouraging and in some cases prohibiting transfers between users, even within the same water service system. Such contractual arrangements create strong negative incentives for efficient reallocation of water supplies, because they prevent water users from seeking and receiving compensation for reducing water use. Sale of water is encumbered by uncertainty concerning repayment obligations to the federal government, maintenance of what may be excessive protection of third party interests, and the absence of clearly defined property interests of current users in federally supplied water. Clearly, definition of property rights becomes the primary consideration. If the role of the public sector is restricted to that of financier, then a lien on water and associated facilities is all that is necessary to protect the public's investment. However, the traditional federal role has been that of developer as well as financier. Thus, there was strong incentive to establish and maintain control of water and water rights as well as facilities.

The federal government has taken a first step in the clarification of ownership rights by renouncing the concept of nonreserved water rights for federal purposes, and reaffirming the supremacy of states in the management and control of water. The Interior solicitor concluded that a federal reserved water right was limited to the purpose for which Congress reserved the land, and that the federal government would have to apply to the states for other purposes.^[15] Prior to this decision, the federal nonreserved water rights doctrine cast doubt on individual water rights granted by the states.

Other steps directed to establishing a market orientation for water either already under way or which should be considered are: (1) encouraging sale of underutilized water and storage capacity; (2) encouraging more states to recognize rental or interim sale of water as a beneficial use, in a way that would not reduce the certainty of existing legal claims on water supply; (3) supporting development of institutions, such as water banking, which facilitate market-oriented groundwater and surface water transfers; (4) encouraging joint ventures for the development of new waters; (5) negotiation of new federal/nonfederal water service contracts based on current market value and past commitments; (6) implementing the new full-cost water charge provisions of the 1982 amendments to the Reclamation Act in such a way as to encourage efficient utilization and cost recovery; (7) quantification of federal water rights; and (8) settlement of Indian water claims. Further discussion is limited to the first four steps identified.

Sale of Underutilized Water

Under Bureau of Reclamation management, some water is not being utilized for the intended project purpose. In 1981 the Bureau adopted water marketing policy which encourages states to identify potential markets for underutilized water. An example of this is the attempt to implement an agreement between the state of South Dakota and Energy Transportation System, Inc. (ETSI), which was sanctioned by the Bureau. This would use water from the Oahe Reservoir for a coal slurry pipeline from Wyoming to the southern states. This represents a small portion of water for which potential agricultural uses would be foregone. Nebraska, Iowa, and Missouri have taken exception to this proposal, indicating that their future utilization of Missouri River water would be impaired.^[16] The ETSI contract appears to be a move in the direction of market incentives. However, it illustrates that such transfers can be accomplished only with adequate consideration of third party interests. Voluntary agreement among all parties affected by ETSI was not attained and therefore the courts must provide the decision. This decision will further define the extent of third party interests across state boundaries.

Sale of Storage Rights

An example of a sale or use transfer is the June 1982 sale of conservation capacity in the Bureau of Reclamation's Bonny Reservoir to the state of Colorado. The state will use about 40,000 acre-feet for recreation, fish and wildlife purposes which were initially scheduled for use as irrigation storage. Flood control is the primary purpose of the facility and conservation storage was included for future development. Sale was made possible by the conclusion that irrigation was not a feasible addition. A more typical market situation would have provided the opportunity for other interests to be represented in a competitive bidding process. However, this transaction between public entities, although outside the usual definition of markets, encouraged more efficient use of reservoir storage capacity.

Water Banking

During the drought of 1977, there was cooperation in California among local water districts, the state, and the Bureau of Reclamation Central Valley Project, in facilitating transfers of water via a banking system. Although it has been described as a banking system, it was primarily a system of brokering water. Some

- 456 -

users sold water and others bought it. Subsequently, water exchanges in nonemergency situations have been documented in California.^[17] The interface of federal projects with these kinds of transfers will be carefully examined, and state suggestions for facilitating this process are welcomed on a case-by-case basis to determine if the federal role should extend beyond that of a lien holder to include developmental responsibility. Traditionally, reclamation investments were made in a developmental context to accomplish western settlement and to diversify the agricultural production base. If exchanges are encouraged, they will result in a de facto limitation of the federal role to that of lien holder rather than agricultural developer, because water service would not be restricted to irrigation. To the extent that current water users are allowed to capture the difference between current use values and any higher value uses, their wealth position will be improved by placing greater reliance on markets.

Water as an Item of Commerce

The High Plains (Ogallala Aquifer) studies have been completed and their findings are being reviewed.^[18] In this context, the Bureau of Reclamation is assessing technical assistance to the states that might be made on integrated ground- and surface water utilization. Determining the extent of market opportunities is an important part of this review. Also, state and interstate concerns relating to potential market solutions are already being addressed in the courts. The recent Sporhase decision of the U.S. Supreme Court, along with follow-up actions, will clarify the potential for marketing water across state boundaries. In this case, an individual's farm straddles the border of Nebraska and Colorado. The farmer's right to pump water from an aquifer in Nebraska to provide a water supply to the portion of his land in Colorado was at issue, since Nebraska law prohibits out-of-state transfers to states that do not have reciprocal agreements. Colorado did not have such an agreement. In this litigative process, one question became that of determining whether groundwater was an article of interstate commerce which should not be restricted by another state. The Court ruled that groundwater was an item of commerce, but still allowed that a state may ban water exports if the ban is "narrowly tailored" to the goal of conserving water.^[19]

Joint Ventures for the Development of New Water Supplies

In addition to facilitation of voluntary exchange of water supplies, the federal government will continue to have a role in new water augmentation plans. However, this role should be limited to joint federal/nonfederal partnerships where nonfederal entities (project beneficiaries and state and local governments) validate feasibility determinations by making a financial commitment to the project, thus diminishing the responsibility of the federal sector both as financier (lien holder) and as developer.^[20] Given a feasible project plan that includes related economic, social, and environmental costs, a willingness on the part of nonfederal entities to participate in financing provides ultimate project validation. This is commonly referred to as cost sharing.

These joint venture agreements should contain clear statements of ownership rights which make provision for transfer of water, repayment, and O&M responsibilities. The underlying assumption is if a potential project water user really believes he needs and can profit from the new water to be developed, he will pay for it either up front or over time or in some combination.

Looking into the future, new water development will likely emphasize catalytic projects, such as those which provide interconnections between existing units or support the optimization of conjunctive use of ground- and surface water systems. Furthermore, these projects will be modest in scale and of an intrastate scope. Therefore, nonfederal entities could more easily play the role of senior partner in a great number of such ventures, or better yet, the sole partner where no significant federal interests are identified.

Joint ventures would be equally appropriate for investments involving the rehabilitation costs on existing water facilities. The long-term assignment of responsibility for these costs is not entirely clear and should be established. As a minimum, rehabilitation of all or parts of older multipurpose facilities should be addressed in the same way as new augmentation projects, because they require expenditure of new money and should be subjected to feasibility tests and cost sharing guidelines. Joint ventures impose a market test of economic feasibility. By extending greater responsibility for finance and repayment to states, the source of repayment beyond that provided by direct beneficiaries must be addressed by the state. Thus, the state becomes an active participant in determining if beneficiary repayment will be sufficient to support the investment. As such, state decision makers must assess the market for vendibles and impute a value for nonvendibles.

Conclusions

It is the policy of this administration that control of this nation's water resources is a state's right. Primacy in water allocation and management decisions will continue to rest with the states. It is the thesis of this chapter that some aspects of both state and federal water policy have resulted in market distortions and reduced use efficiency and value of water resources. The conclusion is that allocation of water resources, both new and those already developed, is best handled by markets which function without unnecessary interference from the public sector. To the extent possible, market distortions which are the responsibility of the federal sector should be identified and removed.

Future water development should fully reflect state leadership in which the federal role is one of cost sharing in those cases where significant federal interests are present. In the absence of state leadership and nonfederal cost sharing, new multiobjective water projects will be limited and increasingly difficult to justify. Initiatives in nontraditional technologies for increasing water supply will also look toward state leadership and joint ventures for research and development.

If water markets operate effectively, the agricultural sector in the semiarid West will continue to be strong and viable. Price incentives and increases in water resource values will encourage individual adjustments in water resource use, with net movement toward high value uses both in agriculture and in the nonagricultural sector. In the longer term, higher water resource values in agriculture should provide an adequate asset base and appropriate incentive to employ the more efficient technologies, improved genetic materials, and a more efficient management which are most essential to the continued viability of the industry.

Discussion on Part IV
Discussion:
Henry P. Caulfield, Jr.

The assumptions on which public policy strategies are based need to be examined, not taken for granted. I, along with others, took for granted certain assumptions in the 1960s and before, which time and experience have proven to be largely false. These false assumptions were: that there were many potential nationally justifiable and publicly salient water resource development projects beyond the substantial developments that had already been built or authorized, or were near authorization; that comprehensive river basin planning and authorizations were the best political means of realizing these potentials; and that water resource development would continue to be strong politically at the national level, through the efforts of key Congressional coalition leaders supported by active and strong interest groups. Other political factors were involved, but without validity of the foregoing assumptions some of the strategies embodied and implied in the Water Resources Planning Act of 1965 were doomed to failure.

A major assumption of this volume seems to be that a western water crisis can be avoided if water transfers to municipal and industrial use are widely permitted, without substantial harm to agriculture, urban and rural social life, and the environment. By implication, a contrary assumption should be false: that the total

- 461 -

sector-by-sector projections of physical water requirements, compared to total supplies, as set forth in national water assessments for the semiarid West, make water crises inevitable. There appears to be some consensus among the participants in this volume that water use transfers are occurring, and that they will increasingly occur in the future constrained only by respect for third party private interests and necessary and/or desirable public interests. A water crisis, therefore, except in the context of severe drought, need not occur.

Miller and Cardon's analysis of "What Farmers Can Do for Themselves" clearly indicates that farmers have substantial means to avoid harm as water increases in value through market transfers to higher valued uses. Other chapters prepared from different perspectives generally support this conclusion. Also supportive is a fact widely understood that present agricultural use is so large in the semiarid West, compared to quantities likely to be demanded for urban and industrial growth, that such growth will not impinge greatly on agriculture, except in particular areas (e.g., in the Upper Colorado River Basin in Colorado and Utah if and when oil shale and coal production are greatly expanded). Likewise, urban and rural life, except in particular areas, will not be substantially affected. But lack of harm to instream environmental values, as offstream consumptive use of water is intensified, is not so clear. The implications of greatly intensified competitive use of water in the West need more thorough examination, in my opinion, as to the adequacy of existing environmental federal, state and local public policies.

The major thrust of the policy chapter from the federal perspective by Carruthers et al. is that the control of the nation's water resources should largely be in the states and that "the long-run ability of irrigated agriculture to remain economically viable . . . will be enhanced by placing greater reliance on [economic] markets to guide water allocation and investment decisions." The authors appear to assume that the western states will increasingly want to exercise their water management responsibilities by fostering economic market transfers in water use, largely unconstrained except by third party and other equitable interests. Thus federal policy should be directed toward removal of restrictions in reclamation law and other regulations and contracts which inhibit market transfers, while, at the same time, making certain that nonfederal financial obligations to the federal government for reclamation projects continue to be met. No doubt much needs to be done to implement this policy, with which I fully agree.

- 462 -

"Unnecessary restrictions on water transfer (market distortions) inhibit economic growth, reduce economic efficiency, and reduce the value of the nation's water resources," Carruthers et al. declare, and by implication they assert an appropriate realm of necessary restrictions. However, they don't develop this implication that economic market failures can exist. In other words, political market places may be necessary to allocate values that are not, and cannot be, adequately represented in economic markets. Thus political instrumentalities of law, regulation, and public funds may be required to constrain economic markets in the interest of these values.

More particularly, Carruthers et al. don't recognize present federal and state laws that now constrain economic markets in water rights. What I have in mind generally are environmental laws, including those that provide for wild and scenic rivers, maintenance of low river flow, reservoir recreation pools, protection of endangered and threatened species of fish and wildlife, preservation of wetlands, etc. Within the context of these and other constraints the domain of appropriate federal policy and action is much larger than recognized by the authors. The assertion that "control of this nation's water resources is a state's right" calls for an enlargement of the administration's concept of federal-state water resources partnership.

Governor Schwinden's remarks on state and local public water policy pertain directly only to Montana. At least two major points, however, are of widespread western concern. The first is his reference to "use it or lose it." Montana seems particularly concerned at this time that downstream out-of-state use of water is going to preclude future consumptive use in Montana of that water, unless definite legal and developmental steps are taken now to preclude downstream claims. This is a widespread problem which, in many interstate river basins, has been settled by interstate water allocation compacts and judicial decrees.

"Use it or lose it," however, represents a widespread intrastate problem in the semiarid West, which affects water conservation opportunities and the ability to make economic market transfers of conserved water and consequent economic gains. The problem is caused by the fact that water rights are most often expressed in cubic feet per second for a prescribed period of time-a flow right. The consumptively used part of that flow right, at least in Colorado, can be rented or sold. Thus a farmer attempts to own and keep flow rights equal to his maximum plant needs at particular times in the growing season; he tends to over-appropriate

- 463 -

and over-use early season water. If his water right were stated in terms of acre-feet per year and deliverable in specified quantities upon demand he could control his conserved water to the amount actually needed, and thus minimize his demands upon the system.^[1] He could then transfer to others, with financial benefit to himself, the water he did not really need. Such a change, however, could affect present return flows upon which downstream junior rights are based and would be opposed by those otherwise adversely affected. Also, such a change could require increased water storage capacity to provide intrayear water releases upon demand, not to exceed the acre-foot right.

The second major point in Governor Schwinden's remarks is further development of state water resources. In addition to Montana, several states have recently taken action to participate financially in proposed federal projects, or to develop further their water resources through state cooperation with local public bodies and private enterprise without federal financial involvement. Among states taking such action are Wyoming and Colorado. California and Texas, of course, have long had such programs.

At the National Water Resources Conference, Washington, D.C., in April 1975, I asserted that "the federal water development program (both in the East and in the West) is politically dying, if not already dead," and went on to explain why.^[2] Several factors are involved in this decline, including what proved to be the invalid assumptions that I and others had made earlier. More generally, it can reasonably be asserted that the rationale for federal water resource development is no longer as convincing in Washington, D.C., as it was previously for over a hundred years. There is no longer a sufficient constituency for its support in a nation that is increasingly urban.

The Carter Administration's well-known dissatisfaction with federal water projects became manifest through its "hit list," calls for reduced use to solve water supply problems, and "principles, standards and procedures" which very few, if any, proposed water projects could satisfy. President Reagan in his 1980 campaign strongly favored federal water projects, particularly in the West. His Administration has appeared to loosen "principles, standards and procedures" and has taken some steps to authorize projects, but very reluctantly in the face of federal budget problems. Both the Carter and Reagan Administrations have assumed that the key to new water projects is up-front cost sharing with states, local governments, and private interests. Both

- 464 -

have ignored the fact that the old political epithet of "pork barrel" now appears to signify widely to the public, particularly in the East, that no federal water project is ever valid. Both have ignored the more fundamental national political factors which are important regardless of reform in cost sharing policies.

Instead of the type of technical and financial partnership set forth in the paper by Carruthers et al., why does the Reagan Administration not jettison much of the federal water resources development program as a manifestation of its New Federalism, and take widespread political credit for abolishing "pork barrel?" Its 1980 campaign commitment in the West to favor federal water projects could be one reason; but with skillful preparatory work and leadership, this hurdle surely could be overcome.

Federal block grants could effectively aid water supply and water quality investments made by state and local governments. This financial aid could take the place of some nonreimbursable investment in federal water projects. It could also take the place of federal grants in connection with public sewage treatment projects; could be used in rehabilitation of urban and rural water supply systems, and rehabilitation of old, or investment in new, irrigation projects; and could be used to meet present standards of dam safety and to interconnect water systems to facilitate transfers of water rights.^[3] No doubt it would be a difficult problem to devise a formula for allocation of block grants among the states, but this problem, in principle, is no more difficult of solution than it has already been for the highway program, community development, social services, and others.

States and local governments, with staff supplemented by private engineering organizations, are certainly technically capable of replacing staff of the Bureau of Reclamation and the Corps of Engineers. Also, state and local governments generally have authority (but differ somewhat among them) to finance investment costs by revenue and general obligation bonds, particularly where repayments can be met efficiently by user changes and property taxes. Financial aid via the federal block grant is often needed where investment costs cannot be so met (e.g., recreation and enhancement of fish and wildlife).

This concept of partnership between federal, state, and local governments appears to me to be more politically feasible than the partnership proposal apparently now being developed within the Reagan Administration. Certainly it would implement more fully the Administration's philosophy of New Federalism. In any case, I hope that the assumptions underlying future federal

- 465 -

water policy will be thoroughly examined and prove to be more valid than those upon which most water policies were based at mid-century.

Discussion:
Carole R. Cristiano

I am pleased to provide some congressional perspective on this most important issue. In the past, the "congressional perspective" has consisted of an upbeat projection, promising increased availability of federal money to construct new projects and an optimistic estimate of project appropriations. This presentation is not in that grand old tradition. To understand why, it is important to first discuss the problems we confront with our national budget, especially the magnitude of the budget deficits. A few facts are very revealing.

1) In FY 1983, our budget deficit could be close to $180 million. That number is higher than the entire FY 1968 budget of Lyndon Johnson, reputed to be one of the biggest spenders in recent history.

2) The FY 1983 budget includes a line item for interest on the national debt. This payment alone will be higher than Johnson's entire FY 1965 budget.

3) The budgetary problems will be compounded in the coming years. By FY 1986, if we pay only for defense, entitlement programs, and interest on the national debt (in effect eliminating all other government expenditures), we will still have a deficit.

- 466 -

Clearly, Congress cannot eliminate all nondefense discretionary expenditures. But just as clearly, it cannot continue to budget such record deficits. To reduce the projected deficits, the administration and the Congress are confronted with three politically very distasteful options. They can: (1) reduce increases in entitlement programs, including price supports for agricultural commodities; (2) reduce projected increases in defense spending; or (3) increase taxes. Probably they will choose to do a little of each. But each of these decisions is going to take a great deal of time, political capital, and emotional energy. With fiscal problems of this magnitude, Congress will not collectively be predisposed to deal with many other issues, including water development.

One can discuss this political reality in different ways. The chapter by Carruthers et al. took the subtle approach; the authors spoke in terms of new federal-state partnerships, increased cost sharing, and leaner, meaner, smaller, more cost-effective projects. Another, perhaps more western approach is somewhat more direct: blunt honesty. The federal money just isn't there. Maybe it should be, and maybe sometime in the distant future it will be again, but right now it is virtually nonexistent.

Politicians are not generally known for their blunt honesty, so it is unlikely that there will be an official announcement of this new reality. Instead, there will be a stalemate in policy. Those who support a continued strong federal role in project development will block any programmatic legislation which seeks to reduce or eliminate the federal financial role. While there will continue to be laws on the books which require a strong federal presence, each year there will be less money available. Slowly, individual project sponsors willing to be substantially involved in planning and financing projects will obtain authorizations and construct those projects. But all other new projects will be placed on indefinite hold.

The national economy's response to decreased availability of water will not be all that severe. It is not even apparent that the response will be negative. This is also true of decreased federal funding for project development. However, it would be shortsighted to be concerned only with the national economic response. The impacts on regions, on specific areas, and most certainly, on specific individuals, could be very negative and quite severe. We should remember this when we discuss public policy options.

- 467 -

There is another, less definable, but just as important impact. Agriculture is a significant environmental component of all western life. I myself was raised in Denver and lived a typically urban life, yet the attitudes and values I absorbed were much more typical of a rural agricultural environment than of the urban settings of the East. The ambiance of the West is important, and should be maintained. This may not be a federal goal, but state governments may appropriately consider it a high priority.

The viewpoints in this volume are encouraging. They indicate that state and local governments, farmers, and financial institutions are taking more initiative and responsibility in resolving their problems. Some states have made basic changes in their water laws. Several authors describe a number of technological innovations in farming. Banks will be more aggressive and more responsive to the needs of agricultural borrowers. This kind of self-help will mitigate the negative impacts of declining water availability.

Two areas of thought and activity are worth emphasizing:

1) It must be decided whether it is important to maintain agriculture at its current level. Clearly, in the past we as a nation made a conscious decision to subsidize western agricultural development. It is evident that it is no longer in the national interest to increase or maintain these subsidies. I would not be surprised if such subsidies were gradually decreased in coming years.

In the future, the states will have to determine whether it is in their interest to continue these subsidies. If subsidy is deemed to be appropriate, the level must be decided, and how it should be administered. In Montana's case, severance tax revenues are used for water financing-a very appropriate response to the problem. There may be other available financing possibilities to consider.

2) Although the federal role will clearly decrease in the future, it will not be eliminated. While many legislators are concerned about the problems we have discussed, they are frustrated by their inability to determine which programs should have the highest priority. Deliberation should be given to programs of top priority. Research may be one. The Senate recently passed S. 2494, which provides funds for water research institutes and other water research. We are hopeful that it will also pass the House. Research is important, yet the top priority may be something else, perhaps limited impact assistance. Whatever it is,

- 468 -

those concerned must decide what the program should accomplish, what a reasonable funding level is, and then work with Congress and the administration to address the legislation. The federal government is unlikely to determine which are the top priorities, or even how the program should work-congressmen are too worried about the impact of voting for decreases in Social Security programs.

Finally, I would encourage the reader to be heartened. Our nation is going through rough times as we withdraw from our addiction to federal funds. But no other group will be better able to cope with changing times and opportunities than residents of the West. Our heritage of independence and frontier spirit has served us well in the past. It will continue to do so in the future.

Discussion:
W. Don Maughan

The country and the West will be best served if irrigated agriculture is maintained at a reasonable level. Expansion will be limited to a few places; there is no major dispute that, from a westwide perspective, water for agriculture is a diminishing resource. Groundwater supplies are being overdrafted, undeveloped surface water supplies are being reserved for environmental purposes, and developed surface and groundwater supplies are being syphoned off for urban and industrial growth. Since the West is blessed with ample good land, good climate, and good markets for irrigated agricultural products, the need for the best possible public policy for irrigated land cannot be overstressed. It must be updated periodically due to changing conditions.

Nevertheless, public irrigation policy has floundered over the past thirty years. I have had firsthand participation in (a) commissions, councils, and interagency committees; (b) the development of multipurpose and multiobjective principles and standards; and (c) the execution of national, regional, and river basin planning. All these have contributed far too little towards adequate solutions to the vital western water need. They have filled books, reports, and auditoriums, have provided a livelihood for many planners and researchers, and have garnered the support of grassroot organizations and associations. But all together they have weighed but lightly upon decision making in both the public and private sectors. That has to change. We must have policies with substance, that decision makers will use.

- 469 -

We have reached the time when we should candidly categorize what won't work so that we avoid wasting future efforts. It is human nature to seek the easy or well-traveled road. Too many hold out hope for just one more spectacular irrigated agricultural triumph. However, meeting the near and mid-distance water needs of irrigated agriculture will not accommodate those desires, and we should admit it. I would like to review some of these "dead ends."

There is no room for waste of our best talents, energy, and money on promoting large scale interbasin transfer projects for irrigated agriculture. Even after three decades of strenuous efforts, all we have to show are plans for projects that would be too costly, impossible politically, and have major adverse impacts upon the environment. Because such schemes have unusual publicity value, many still insist that massive projects will be the solution for western agriculture. No way! At least not for several generations. Failures of post-World War II attempts to advance long distance importation projects for irrigated agriculture should be clear to all who seek the truth.

There is no room for those who yearn for a return of water successes of the past. It is unfortunate, but nearly all the good dam sites, hydroelectric power sites, and man-made water recreation sites have been utilized. The availability of untapped groundwater resources has all but disappeared.

There is little room for optimism about weather modification, watershed management, or desalination. Taxpayers have contributed hundreds of millions of dollars to basic and applied research and to a few prototype projects with only marginal success. Even those that have survived appear to be of limited value to the future of irrigated agriculture.

Finally, there is no room for regrets. We must take what is available and make the most of it-reuse our treated wastewaters, artificially recharge our groundwater aquifers, conserve, build small- and medium-scale water regulation projects, transfer water supplies to accommodate higher and better uses.

There is room to improve efforts to get the most effective persons elected and appointed to public office, to make and execute public water decisions over the next two decades. Water problems are incredibly complex. If those who decide upon public funding and governmental controls have only superficial understanding of the problems and potential solutions, it will not bode well for their decisions. Professional water people must try harder to speak an understandable, practical language of water needs and programs to those officials.

- 470 -

The realization has to sink in that we cannot afford to take any aspect of water management for granted. We must be able to improve our use of available water supplies by considering basic changes in water allocations and rights. That is a challenging objective. Arizona's 1980 Groundwater Management Act is an outstanding example of a new, innovative direction, but it requires steps that are not easy to take. We have two years of experience since enactment and there are things yet to be learned. Even so, the legislation may be a bellwether for the ways in which agriculture in an extremely dry state can realistically prepare for its long-range future. In Arizona that will mean less acreage in irrigated agriculture, but the reduction will be on an orderly basis.

There is room to concentrate more attention on the underlying forces for public funding and regulation. These forces determine whether there will be lasting water resources available for western agriculture. Let us brush away myths. We should not be persuaded that national economic development drives the Congress to provide money; national attention to social and environmental issues has been much more persuasive in the recent past. Local and regional economies are extremely important, however, and straightforward approaches to Congress are much more effective than seeking to put proposals in a so-called national perspective. Past water resources appropriations by the Congress demonstrate this fact.

Regulation and management depend upon physical, political, and economic forces. Governmental control has to be based on those facts, and inflexible or impractical regional or river basin policies avoided. Many federal regulations have proven unacceptable over time. State officials must also fulfill their proper roles; federal intervention will not correct weaknesses found in state or local programs. At the same time all states and locals need not carry the same burdens. There is no need for federal involvement in water marketing and transfers.

There is room to demand more useful results, not just promises, from investigations, research, data collection, etc. Planners, researchers, and data collectors jealously guard their domains, but their efforts should be graded by others in their fields, as well as decision makers and managers.

There is room to borrow, adapt, and use successful water ideas originated by others, though there is sometimes great reluctance to do so. We can take lessons in this regard from Japan and other nations.

- 471 -

These ideas are based on experience and observation, not upon wishful thinking. People engaged in irrigated agriculture need to discern the truth about public water policy; it is important to their future.