Issues With Water Markets | The Water Page

* This report is an updated version of an article published in Eclac Magazine No 59. It has specific groundwater references not included in the first version of the report. SUMMARY Modern water legislation is concerned with improved water allocation. Water marketing is an important tool for obtaining such improvement. There are examples in Latin America of economic rigidity and non-efficient water allocations resulting from legal provisions not allowing markets to play a role in the allocation of water resources. However, some authorities have indicated that marketing may need regulations to control -to the extent possible- undesirable environmental and social effects. Consequently, “mature” water marketing systems have developed sets of rules and regulations with a view to strike a balance between market forces-and social and environmental concerns. Main and foremost among these rules is the conditioning of the existence and valid transfer of water rights to the rule of effective and beneficial use of the waters to be transferred. The purpose of this condition -sine qua non for the existence of a valid water right, and therefore of public interest- is to prevent Monopolies and speculation sustained on the hoarding and accumulation of non-used water entitlements. This rule is often summarized as the “use or lose principle”. With the privatisation of large scale public services, the importance of the rule becomes immediately apparent: without the condition of effective and beneficial use water rights can be used to block entry into service markets, restricting competition and allowing purveyors to obtain monopolistic rents. Water, and attached rights on it, may then become part of the market power policies and strategies of individual firms. The paper brings about specific examples in this regard. Other conditionalities and regulations applying to water marketing intend to prevent the causation of negative transactional impacts on other users, special groups, communities, society at large, and the environment. Thus, mature water marketing systems have developed rules on the amounts of water to be transferred, protection of area of origin, environmental impacts, community interests, priorities and preferences, water rights of aboriginal citizens, and other concerns. Water rights marketing is also affected by other legal, administrative, economic, and investment related factors. They include, inter alia, the quality of the right to be marketed, the size of the transaction, the profile of the parties, the reliability of records and registries, the availability of appropriate infrastructure, location, and other relevant elements. Thus, while water markets improve the efficiency of water allocation, water legislation must allow water reallocations, considering the existence of environmental and social frameworks where market failures are common. The paper deals with legal systems allowing water marketing and provides examples of regulations intended to cope with externalities and other concerns specific to particular societies. INTRODUCTION  Modern legislation has considerably broadened the type and scope of issues to be considered in the regulation of water resources. There is concern with improved water allocation through water marketing. However, some authorities have indicated that marketing must be regulated to prevent unwanted environmental and social effects. It has also been noticed that the performance of water markets is contingent to the situation of each particular place. While water legislation and water management are influenced by the need to improve the economic efficiency of water allocation and use, the processes for improved allocation take place within environmental and social frameworks where market failures and externalities are common. This is best exemplified by two contemporary trends in water management: development of water markets on the one hand, and need for water planning and control of externalities on the other. Both are needed. Thus, economic flexibility may require accommodation with the environmental requirements and social concerns posed by sustainable development. A. STRUCTURAL AND REGULATORY NORMS IN WATER LEGISLATION Because water is a flow resource, a scarce one, and also prone to negative externalities proper management of water-and of water related activities- are crucial to the implementation of successful and sustainable processes of water development and conservation. However, the role of institutional and legal arrangements is not limited to water management and regulation of water related activities. The legal-institutional design determines the framework within which the private sector is prompted to invest in water development and conservation, therefore performing a structural function of socio-economic engineering, determining the manners in which economic agents relate to economic resources. This function of the law has tremendous relevance to conservation and development goals, since consequent on its operation economic agents are prompted to invest, if economically beneficial, in water development and conservation, of their own free will and on regular basis. Security and flexibility of rights are two main structural features of legislation in general and water law in particular. A. Main Structural Elements Structural elements primarily relate to ownership of water resources, legal nature and stability of rights on water, effective and beneficial use; transferability of water rights and acknowledgment and respect of uses and customary entitlements at times of incepting formal water legislation or causing other legal changes to take place. a) Ownership of Water Resources Most systems of water law explicitly include water within the public domain of the state, the people or the nation. This concept has traditionally being expressed by legislation stating that water belongs to the public domain, a terminology resulting from the notion that the particularities of water resources and their importance to economy and life do not allow private ownership of water as a resource. There are, however, exceptions to the terminology. A draft water law for Perú replaces the traditional terminology of public domain for the terms “national patrimony”. On the meaning of this latter terminology, within the context of the French water law of 1992, Jazzing states that the use of the term “national common patrimony” did not effectively change the legal regime of the water resources of the country. Peruvian authorities argue that the draft law proposed for Perú would in fact disaffect water from the public domain. It is apparent that the term “national patrimony” does not have the same precise legal meaning as “public domain”. If the intent is to include water within the public domain of any given country it is advisable to use the traditional terminology. Otherwise, an element of uncertainty would be introduced in new legislation. The evolution of groundwater law regarding ownership of this particular manifestation of water resources has been somehow slower than the evolution of surface water law. For centuries groundwater was owned according to the Roman principle that the owner of surface land was also the owner of the water under the ground, or percolating in the ground. This rule, also known as the “Roman Rule” and the “English Rule” did not generally survive the threats to sustainability and the externalities associated to massive groundwater development made possible by modern technology. In many countries groundwater is presently regulated, managed and controlled as public property, or invoking the police power of States. In the American system, several doctrines, such as prior appropriation, reasonable use, and correlative rights have been used to improve groundwater management, with a view to ensure sustainability, curb external effects and, on a more proactive vein, optimise output. Yet, the Texas system still adheres to the English rule of absolute ownership, affording limited room for legal control and as a result highly limiting liability for damages resulting from groundwater development. The result has been a system where there are serious problems, including drawdown, mining, salination, baseflow reduction and subsidence. b) Water Rights The issue of uncertainty raised in the previous section becomes particularly relevant when creating a system of rights on water. While in most countries water, or at least the most important water sources, belongs to the public domain, water rights granted to private individuals or corporations are protected under the property provisions of national and, in the case of federal countries, state or provincial constitutions. Thus, stability of water rights is an important principle in water law, which some authorities have traced back to roman law. A system of stable water rights is an incentive to invest in the development and conservation of water resources. Stable water rights are useful collaterals, assets, or appurtenances for credit purposes, and also important assets when assessing properties for taxation. Additionally, the stability and certainty of water rights and appurtenant uses provide recognition to existing economies and prevent the social unrest that would result from ignoring uses existing at times of changes in water legislation. An accepted tenet of the requirements of successful water markets is that they do not operate without stable, clearly defined, and enforceable water rights. A water right usually is a right to use, and ownership of a water right does normally means a usufructuary power, and not ownership of the corpus of water itself. However, in some legislation the usufructuary power can be traded. c) Effective and Beneficial Use The relevance of water rights as property assets is related to the availability of the resource. The scarcer resource is the most valuable. Therefore, most water laws have provisions that require the effective use of water entitlements, either for a right to be born and kept, or for the maintenance of a valid water right. The principle of effective and beneficial use is widespread. While the terminology is not uniform the notion that water rights risk forfeiture if not used, or if not used according to the terms of a license or permit, is found in the German law, as amended on 23rd September 1986, the Spanish law of 1985, the new Mexican water law, the legislation of most Argentinean provinces, and the laws of the states of the American West. The rationale behind the principle has been precisely and clearly constructed by the authorities, judges, and legislation of the United States. A typical statement of the rule of beneficial use is: “Beneficial use is the basis, the measure, and the limit of all rights to the use of water in this state”…”consistent with the interest of the public in the best utilization of water supplies”. The tenets of the doctrine of effective and beneficial use are: a) water is not to be obtained for speculation or let run to waste (reality of use); b) the end use must be a generally recognized and socially acceptable use; c) water is not to misused (reasonable efficiency); d) the use must be reasonable as compared against other uses; A common idea was that the quantity of water was to be no more than needed, the concern being with the possibility of “vesting an absolute monopoly on a single individual”. This antimonopoly- antispeculation concern where claimants do not have an specific use in mind continues today. For a long time it was difficult to assess what happens in practice when water legislation does not have a requirement of use. The reason being that national systems of water legislation did not normally grant exclusive-non riparian-based water rights, without adding the requirement of effective and beneficial use. At present, the state of flux of water legislation in general, and legislation related to water-based public services in particular, has prompted specific research on the subject of water rights and on the consequences of creating water rights severed from the requirement of effective and beneficial use. It has helped that assessments of the Chilean experience (where water rights are not conditioned to effective and beneficial use) are becoming widely available. Natural resources economists argue that non-use, if not penalized with forfeiture may result in “sleeper rights” which increase uncertainty on the quantities of available waters. The Chilean experience on the issuance of non-conditioned water rights is an apparent validation of the forebodings behind the requirement of effective and beneficial use. A study on the impact of the legal system for water allocation in Chile has found that: “It is also common a state-owned Monopolies that benefited from exclusive rights be privatised with them, creating legal barriers to entry that maintain the monopolistic characteristics of the sector”… “As mentioned above the regulatory framework [for electricity] is based on the existence of competition in the generation of electricity”…”However, competition practically does not exist in Chile”… “The water rights of the main hydroelectrical projects belong mainly to…[a single corporation]… “The implication of this is that the largest generator has an incentive to appraise projects considering the effects that they will have on the profitability of its intramarginal capacity. It can obtain the monopoly equilibrium overtime by postponing investments. New entrepreneurs will be unable to enter [into the generation market] because they do not have the water rights to undertake the more efficient projects”….”Water rights should have been returned to the state prior to privatisation, which in turn could have granted them subject to the conditionality of their timely development …[through new projects] by existing producers or new comers”. Thus, the actual operation of the Chilean system appears to confirm the rational behind the requirement of effective and beneficial use. Monopolization through the creation of barriers to entry resulting from the control of essential production inputs and natural resources, are standard fare in economics literature. The existence of water markets does not alleviate the situation since in fact “crucial inputs of this kind are not usually traded on competitive markets”. Furthermore, for large institutional users the incentives to sell water rights, absent the penalty of forfeiture for non-use, are minor, if compared against the strategic advantages that control of a key production input represents within the market power policies of corporative practices. Hence, it appears that the absence of a requirement of effective and beneficial use does have a negative effect on water transactions, on water markets, and on efficient water allocations. In mature water marketing systems, such as the American West, beneficial use and forfeiture of rights for non-use have been deemed to be inventives to transfer water rights. Empirical evidence on the actual working of water markets in Chile shows that with a few local exceptions market transactions of water rights in Chile have been limited. In the single known case of non-existence of this provision, Chile, the system has resulted in speculation, hoarding, and impaired water management, to the detriment of water sources. Proposals to amend the system are presently before Congress. However, the manner in which the rights were granted may make legal change extremely laborious. Proposals to tax water rights in order to promote their more efficient and equitable use by holders, have been attacked on Constitutional grounds. The now-private electrical utilities argue that since original water rights were not conditioned to effective and beneficial use, the use of taxes to induce behaviour other than the one unilaterally fitting the company would be an infringement of its property rights, which are constitutionally protected as granted. In association with the principle of beneficial use, there are proposals to charge for water according to its opportunity cost. Examples of this approach are not abundant. However there are examples of charges intended to recover costs, pay for treatment of wastes, cover administrative expenses and induce environmentally sound behaviour. Mexico and Spain. However, more analytical work seems to be required in order to refine criteria for inception, procedures for application, and consideration of issues of opportunity and equity. In Chile, water allocation is not related to any specific use or price. If water is available the Government can not, according to the water law, reject an application. After allocation the only possible regulation is given by the water market. A recent report states that the results of the system include: a) a free transfer of wealth; b) present applications for water amount to 50.000 m3/s, four times the total exploitable volumes available in the country and without any relation with reasonable foreseen national development during the next 50 years; c) the situation distorts the operation of water trade, and other markets, since water rights can be used as a deterrent to entry into some industries; d) the results can include underinvestment and increases in prices of products such as electricity; e) in addition, the individualistic structure of the water rights system leaves no room for planning for the medium and long term; f) long-term externalities are difficult if not impossible to control; g) integrated basin management is limited since rivers are divided, for administrative purposes, into sections that do not represent hydrological units; h) ground and surface water are independently managed; i) quality and quantity are not integrated and water development is not planned according to multiple use objectives, but sectorally. d) Water transfers A corollary of the economic character of water is the existence of water markets. They are a useful tool to economically optimise the use of water. However, since the many roles of water and its peculiar features, make it a very special commodity, mature systems of water marketing regulate its performance in light of social, economic, and environmental considerations. Water rights transfers are increasingly being considered as a policy alternative to encourage the optimal use of scarce water resources, through private reallocation . They are also means to postpone the development of costly new supplies. Water markets are a distinctive characteristic of water use in the American Western States. In other areas water markets are a relatively new experience. e) Recognition of existing uses Legislative change creates stress for existing uses and water rights. Most legislation provide for the recognition of uses and rights already existing at the time of changes in the legal framework for water allocation and management. These provisions recognize “existing economies” and prevent opposition to legal change. The procedural aspects of the process to acknowledge and recognize existing uses should be particularly careful not to affect, through difficult formalities and short forfeiture periods, the entitlements of rural and native populations. 2. Main Regulatory Elements Water legislation includes a good amount of regulatory norms. They do usually address issues of water conservation, protection of water supplies, establishment of preferences and priorities, protection of water quality, technological and efficiency requirements, inception of management areas, basin management principles, monitoring of use, requirement of information, administrative rights of entry and inspection, creation and enforcement of public rights, emergency measures, registration and recording of uses and supplies and other regulatory measures. Groundwater poses special regulatory problems, including not only the technical content of regulation but also the appropriate regulatory level.. Regarding the appropriate regulatory level, (national, provincial, or local-municipal), and somehow contradicting current predicated wisdom, the experience in the US is that allowing local management of state resources results on ad hoc approaches to groundwater issues and incoherent policy which can only be remedied by greater state direction and control over local management efforts. Local control results in overdraft, drawdown, mining, and restrictions on water exports. Management is impaired. Since aquifers are not restricted to local boundaries the lack of a unified administrative system undermines the ability to establish safe yields. The experience seems to be common to California and Texas, where state legislatures appear to have given authority to institutions and groups which are not largely willing or empowered to accept responsibility for ground water management. According to some authorities, barring exceptions, Texan local groundwater districts have not been very successful. Special interests, limited territorial jurisdiction vis-à-vis aquifer extension, limited powers, and ignorance of technical questions by users and stakeholders are often mentioned as causes for the relative lack of success of local arrangements and special interests representations. Experiences in Asia confirm the importance of choosing an appropriate jurisdictional level for the implementation of groundwater management measures. Tushaar Shah notes that, absent mechanisms for collective restraint on pumping, users fail to internalise externalities affecting groundwater and are driven into socio-ecological crisis. He also refers to the intractability of some of the context problems associated to local use and control of groundwater: on the one hand local enforcement is difficult, and on the other, when successful, it may end up strengthening the monopolies enjoyed by local water sellers. The vulnerability of local level arrangements in terms of regulatory capture, or overriding predominance of privileged social groups and special interests, has been documented not only in water management literature, but also in public utilities literature. This is why World Bank publications on water supply and sanitation recommend that the jurisdictional level of the regulator be high enough to prevent regulatory capture . B. WATER MARKETS Marketing of water rights is being paid increased attention as a useful, and economically efficient, alternative for the improvement of water allocations. As supplies diminish relative to demand they become not only an efficient alternative, but also a necessary solution to problems of water scarcity. 1. The American Experience Water markets are an important feature of the legal system of the states of the American West. A review of their experience is important to the understanding of the subject and its complexities. In Colorado, Nevada and Utah water rights can be sold and bought separately from land. In other states, like Arizona, water is acquired as an appurtenance to land. Reallocation of water rights may be “with the possible exception of water quality…the most pressing matter facing the arid West”. For a reallocation to be legally valid some requirements must be fulfilled: . water must have been beneficially used, and must continue to be beneficially used after the reallocation; . such reallocation must not affect other users and must be in the public interest. . in many jurisdictions, interbasin transfers or transfer outside the area-of-origin can only take place with due consideration to local interests. . in some jurisdictions appurtenance statutes prevent water reallocation. Marketing of water rights is a complex process, which is affected and influenced by several factors, including: . the priority of the transacted right; . the profile of the parties; . geographic flexibility; . size and economic value of the transaction; . reliability of the marketed water right; . buyer characteristics; . volume of water transferred; . changes in regional economies; . system for water administration; . availability of infrastructure to effect a change; . environmental impacts; While water rights markets are strongly advocated by reputable experts, there are also reservations. Conflicts over water transfers occur in the American West as large metropolitan areas look for the water supplies of rural areas. The public values at stake include the economic development of urban areas, culture, way of life, environment and the future of rural communities built around agricultural uses. “It is becoming increasingly apparent that current water law and water market oriented behaviour are incapable of solving this conflict in an equitable manner”. Therefore, according to some authorities, oversight and regulatory approval for water transfers and markets is required. 2. Regulation of Water Markets in the American System A result of the complexities of water marketing is that the activity has been subjected to regulations in the interest of third parties and the public. Broadly stated, regulations impinging on the marketing process include: . the appurtenancy principle, which prohibits the transfer of water rights if not as an appurtenance to the land where they are used. Its purpose was to prevent land speculation; . transfers to be approved by judicial, legislative or administrative authorities (the approving authority varies according to the law of each state); . public notice of the intent to transfer, with the possibility of filing protests granted to either any interested person or only to holders of water rights (again standing to oppose varies according to the legislation of each state); . administrative recording of the transfer and filling with the authority for water management; . issuance of permits to reallocate and use subject to existing or new conditionalities, including proof of completion of work and beneficial use; . forfeiture of water right, (and in some states charges for misdemeanour), if prior approval is not obtained; . limitation of transferable entitlement to historic consumptive use; . requirement that transfer does not injure other appropriators who, even if juniors, have a right to the substantial maintenance of the stream conditions existing at the time of their appropriations. Injury might result from changes in volumes, timing, storage, means of diversion, quality, deprivation of return flows, point of diversion, or a combination thereof; . accommodation of uses through conditions intended to mitigate or prevent injury; . compensation and payment of expenses; In addition to the above mentioned regulatory examples, there are also considerations of public interest which apply to the review of applications to transfer water rights. They apply to the review of public value externalities. They might include: . considering the benefit to the applicant; . effects of the economic activity resulting from the application; . effects on fish and game resources and on public recreation; . effects on public health; . opportunity cost of the use; . harms to other persons; . intent and ability to use; . effects on access to public and navigable waters; . needs for water conservation; . factors of local relevance; Accordingly, a reallocation would not be allowed if it results in the violation of minimum health, environmental, or safety standards. However, the public interest element can be accommodated by conditioning a requirement for reallocation to measures to mitigate public interest concerns. While there are no questions on the substantive legitimacy of public interest concerns questions on the appropriate forums and means for their consideration have been raised. While there is always an administrative and judicial role, for Dumars such means and forums should include water planning and public participation. Additional considerations might include the assessment of the impacts that a transfer may have on the environment, the tax base or the local economy of the area of origin of the water allocation to be transferred. 3. South America: Chile and the 1995 Draft Water Law for Perú Water marketing in South American countries is still incipient. In many cases there is still adherence to the appurtenance principle inherited from Spanish law and from a strong tradition of strict administrative controls. In some areas, such as the provinces of western Argentina, the appurtenancy principle has sensibly contributed, in association with other factors, (such as subsidies unrelated to effective demand for produce, and pre-emption of some activities from the private sector), to the stagnation, and even regression, of regional economies. However, there are some regional experiences of water marketing worth to be brought to the discussion. There are laws, like the Chilean law of 1981, which authorize water transfers and marketing of water rights (arts. 6 and 21). Marketing of water rights is also endorsed by a draft water law prepared for Peru (arts 26 to 29). Neither the water law of Chile, nor the draft water law for Peru reflect the public interest considerations or the detailed elaboration of rules to prevent injury to third parties which characterized American water law. It has already been discussed that none of them require the effective and beneficial use of waters, a fact that in Chile has favoured the formation of Monopolies of water rights and hydroelectric generation. In addition, some concepts, like historical consumptive use, have not been elaborated, either by the law of Chile or by the draft proposal for Peru, since consumptive water rights allow the diversion, and eventual transfer of the full nominal entitlement of a water right and not only of the amount historically consumed, as in the American system. There is already a Chilean case where water rights originally used for agriculture have been transferred to mining. The transfer has sensibly increased the stress on the water source. Mining is a permanent activity, while agriculture is mostly seasonal. Therefore, water abstractions have increased, without the change in use and ownership having been considered a relevant factor in order to prohibit, limit, or condition the water transfer. Both, in Chilean law and in the Peruvian draft, the role of water administration and planning in assessing public interest elements, when dealing with water transfers have been severely limited. The assumption is that market forces will deal with externalities and issues of public interest better than government organizations, whose role should be as limited as possible. The Chilean water market system has been promoted by experts, who advocated the merits of the Chilean system when compared to the American system. Some of the large scale water conflicts of the country seem to confirm the view that contractual solutions (like marketing) do not work entirely well when many parties, large scale water units, and important water-based public services are involved. Water transactions other than those involved in large scale conflict-solving have also been limited. The lack of effective operation of market mechanisms has been attributed to constraints or transaction costs. In addition, the market and the legal system do not have penalties for inefficient, inadequate, or non-effective use of water rights: water rights are free of charges and there are no sanctions for lack of use (In the Western United States there is a requirement for effective and beneficial use of water. The requirement is the cornerstone of the system). Accordingly, market incentives for water transactions may not have in fact encouraged efficiency in the use of water. The investments that have taken place may have been prompted by expected gains resulting from the yields of water use. It has been noted that increased investments in irrigation might be due to the creation of subsidies for irrigation development thorough law 18. 450/1985. The law authorized subsidies for up to 75% of investments, for a period of eight (8) years (art.1). There have also been considerations on the equity aspects of the system. It has been found that the impact might have been negative, since small and medium size farmers did not have adequate information or enough