BIG PICTURE 1) About 75% of water used in California is used by agriculture. 2) The marginal value of most – though not all –water used in agriculture is quite low relative to the marginal value of water used for urban uses. 3) Urban use is growing with the growth in population. The need for water for environmental purposes instream is also growing. Agricultural water use is fairly stagnant, and likely to decline slowly with the conversion of agricultural land to urban use. 4) Many of the water rights in agriculture are now held by agricultural water districts rather than individual farmers. 5) Agricultural water districts distribute surface water to agricultural users, just like urban water agencies distribute water to urban residents.. ISSUES FOR ECONOMIC ANALYSIS 1. The economic theory of water rights. 2. The economic theory of water markets. 3. The divergence between theory and reality in the above. 4. The economic theory of agricultural water districts, and how they actually function. (Why do water agencies exist? How do they behave? Are they needed?)DISTINGUISH Individual water user (farmer) Retail water district Wholesale supplier (eg State Water Project, CVP) Ultimate surface water source Note: With groundwater, end users are typically self-supplied. DISTINGUISH Water rights – right to divert surface water, pump groundwater Water contracts between a retail supplier (water district) and a wholesale agency (CVP, SWP). Rights of individual member of a water district (end-user) to receive water from the district (retail supplier)WATER RIGHTS TO DIVERT WATER Distinguish between a right to own water and a right to USE (but not own) water. The latter is known as a usufructuary right.. It is like the right to take fruit from a tree, but not to own the tree. With land, the rights generally convey ownership. With water, typically, there is only a usufructuary right to water. In that case, who owns the water? Generally, the public per se owns the water, while individuals and groups have usufructuary rights to use the water Why is there such a difference between the legal status of land and water? A) There is often seen to be a public interest in protecting the continued existence of the body of water. Why? 1. Water-borne transportation as a public good 2. The aquatic ecosystem as a public good B) The highly uncertain and variable pattern of flow in arid and semi-arid areas creates an additional concern to protect the resource from being allowed to run dry. C) The episodic nature of agrarian use permits sharing, which can be achieved more conveniently through public rather than private ownership of the resource.APPROPRIATIVE WATER RIGHTS The key innovation in Western water law was the development of appropriative water rights. This makes it possible to irrigate non-riparian land. In the face of uncertain stream flow, it provides a mechanism for allocating risk. It also makes it possible, in theory, to transfer water from one place of use to another. Three Economic Issues 1. Risk sharing and the allocative effects of seniority. 2. Return flows and the externality that they create 3. Water marketing and impediments to the marketability of water rightsECONOMIC EFFECTS OF SENIORITY IN THE ABSENCE OF MARKETABLE RIGHTS With uncertainty in streamflow, the expected profit from irrigated agriculture is given by: E{Profit} = Farming Profit if get enough water to irrigate * Probability {get water} Therefore, the expected value of the marginal product of water, E{VMP}, is given by: E{VMP} = Probability {get water}*Value of Marginal Product if get water With riparian rights, Probability{get water} is the same for all riparians along a stream. With appropriative water rights, Probability{get water} varies with seniority: the more senior your right, the higher this is. Thus seniority affects the demand for water: at a given price of water, a senior rights holder demands a larger quantity than a junior rights holder, all else equal.The argument then goes that, since the allocation of seniority is likely to be random reflecting the vagaries of the history of settlement of an area, it will promote a variation in the demand for surface water that is arbitrary and has no good economic rationale. Everything else being equal, the unequal sharing of right to water (e.g., senior versus junior right) creates an inefficient allocation of water if: - There is no trading in water, and - Seniority is based on historical accident and does NOT correlate with increasing economic productivity of the land. BUT: The security of the right associate with seniority promotes investment in water development. This is a rationale. One can draw the analogy with a patent. Seniority is like an unlimited, perpetual patent. This may be too long a protection.RETURN FLOW Since a significant portion of water applied for irrigation use returns to the stream somewhere downstream, due to surface runoff and also groundwater percolation, the diversion of water from a stream creates an externality in the form of increased streamflow downstream. This raises the question: what is the extent of the usufructuary right? Does the right cover the gross amount diverted, or the next amount excluding return flow? In other words, who owns the return flow? The upstream diverter or the potential downstream user? In principle, what matters is just that this be resolved one way or the other, regardless of which way that is. Some states, eg Colorado, have created a right just to the net diversion. Others have created a right to the gross diversion. Unfortunately, California has no fixed rule; this is determined on a case-by-case basis. California, also adopted a law banning water transfers out of the hydrologic basin from which the water originated. This protects return flows only in a very general