Tradable Water Rights

Compiled by:
Aleix Ferrer Duch (seecon international gmbh), Corinne Waelti (seecon international gmbh)

Executive Summary

Tradable water rights are one of several market-based instruments used in water management and pollution control. In economic theory, they are increasingly seen as an efficient instrument for implementing environmental and natural resources management policies on national or supranational level, even though they are among the most challenging means in terms of both their design and implementation. As their main advantage, tradable rights set an overall quantitative goal and, at the same time, provide the flexibility required to achieve the best individual allocation of rights through decentralised transfers guided by market demand (OECD 2002).

Introduction

Tradable water rights can function as a possible market-based solution for existing disagreement concerning the availability and allocation of water (KRAEMER et al. 2004). Under this approach, a responsible authority establishes an overall level of allowable pollution or abstraction for a certain amount of time and allocates this in form of permits among its sources of consumption or pollution. Enterprises that keep their emissions/usage below the allotted level may sell or lease their surplus permits to firms that require additional permits or use them to offset excess emissions in other parts of their facilities (STAVINS & WHITEHEAD 1992).

The Economic Model

Economic instruments concerning scarce resources are based on the assumption that environmental degradation (such as soil degradation) and resource depletion occur because a substantial part of the costs of economic activities is not being paid by the actors responsible but by the general public in the form of environmental damage, security (see also water conflicts), health risks, or long-term climatic risks. The most frequently used economic measures to improve this situation are the establishment of tradable rights, the implementation of water charges, or subsidies.

Costs and value of water. Source: SAVENIJE & VAN DER ZAAG (2002).

In a system of tradable rights, a market for the trading of resource use permits (such as the permit to use or pollute a certain amount of water) needs to be created. Whoever wants to use environmental resources has to buy the respective permit on these markets (KAUFMANN-HAYOZ et al. 2001). The rationale behind water allocation through tradable rights is that in a perfectly competitive market, permits will flow towards their highest value user: Permit holders that gain a lower benefit from using their permits (for example due to higher costs) have an incentive to trade with someone who values them more. Such a sale of permissions will therefore result in a situation of mutual benefit (KRAEMER et al. 2003).

Types of Water Rights

Water rights can be distributed to water abstraction, the consumption of water-based resources (e.g. fish), and water pollution. The rights can further be differentiated according to their time scale (permanent, temporary or one-off rights) (KRAEMER et al. 2003).

Tradable water pollution rights face a much higher degree of complexity than water abstraction rights. Knowing the effect of a set level is difficult to assess, because there is a large array of different pollutants (see also pathogens and contaminants, which can in combination also potentiate each other (KRAEMER et al. 2003). It is therefore especially important to consider the interests of stakeholders when implementing such pollution rights (see also stakeholder analysis).

Secondly, water pollution is directly tied to both location and time of the year. Therefore, marketable permits may not always be as effective for controlling water pollution as other economic instruments (see also water charges and subsidies) (HELMER & HESPANHOL 1997).

Implementation

For a successful implementation of tradable water rights, three system requirements need to be fulfilled (KRAEMER et al. 2003): 

If these prerequisites are not adequately met, monopoly market power, the presence of high transaction costs as well as insufficient monitoring and enforcement are possible negative outcomes.

Several further requirements have to be taken into consideration and limit the applicability of tradable water abstraction and pollution rights (adapted from ANDERSON 2002):

  • Legal and regulatory framework (see also institutional framework and legal framework): Delineation of roles and responsibilities of the different parties.
  • Overall cap on emissions and sources to include.
  • Determination of emission quotas (when applying tradable water pollution rights).
  • Timing and spatial issues.
  • Mechanisms for measuring emissions.
  • Tracking and enforcement requirements.

Due to this list of necessities, successfully implementing tradable water rights is considerably more challenging than water charges.

A quantitative limit for tradable permits can be introduced either as a maximum ceiling for “cap and trade” schemes, or as a minimum performance commitment for “baseline and credit” schemes (JOHNSTONE & TIETENBERG 2004). These targets can be either in absolute or in relative terms. Many alternative baselines are possible for credits, allowing room for inventiveness on the part of policy-makers in designing a tradable permit scheme (OECD 2002).

Applicability

The implementation and enforcement of water rights can be troublesome in many respects (see also creating an enabling environment). Often, implementation places heavy demands on technical competence as well as on the amount of available human resources and financial assets to control the compliance with imposed restrictions (KAUFMANN-HAYOZ et al. 2001). In practice, the granting of exceptions recurrently compromises the implementation. In some cases, moreover, legal prescriptions (see also restrictions and standards) directed toward barely accessible target groups (such as “water consumers”) are very difficult to enforce, because control is almost impossible. Therefore the motive to avoid sanctions disappears (e.g. for illegal wastewater disposal). Tradable water rights could become increasingly relevant as the concept of virtual water is given more importance.

Advantages

  • Internalisation of negative externalities
  • Incentives for innovation
  • High degree of environmental certainty
  • Relatively low administrative costs
  • Flexibility to address distributional concerns
  • More cost-effective than traditional forms of regulation (ANDERSON 2002)
  • Can also address smaller sources such as households (ANDERSON 2002)

Disadvantages

  • Only effective if compliance controlled and non-compliance punished
  • Creating laws is time-consuming
  • Risk of guaranteeing too many exemptions
  • Danger of the formation of a monopoly
  • Allocation insecurities
  • Greater difficulties in designing tradable rights for water pollution

References Library

ANDERSON, R. (2002): Incentive-Based Policies for Environmental Management in Developing Countries. Issue Brief 02-07. Washington D.C.: Resources for the Future (RFF). URL [Accessed: 14.06.2012].

HELMER, R. (Editor); HESPANHOL, I. (Editor) (1997): Water Pollution Control - A Guide to the Use of Water Quality Management Principles. World Health Organization (WHO), Water Supply and Sanitation Collaborative Council (WSSCC) and United Nations Environment Programme (UNEP). URL [Accessed: 21.04.2010].

JOHNSTONE, N. ; TIETENBERG, T. (2004): ExPost Evaluation of Tradable Permits: Methodological Issues and Literature Review. (= Tradable Permits: Policy Evaluation, Design And Reform). OECD Publishing. URL [Accessed: 16.06.2012].

KAUFMANN-HAYOZ, R.; BAETTIG, C.; BRUPPACHER, S.; DEFILA, R.; DI GIULIO, A.; FLURY-KLEUBER, P.; FRIEDERICH, U.; GARBELY, M.; JAEGGI, C.; JEGEN, M.; MOSLER, H.J.; MUELLER, A.; NORTH, N.; ULLI-BEER, S.; WICHTERMANN, J. (2001): A Typology of Tools for Building Sustainability Strategies. In: KAUFMANN-HAYOZ, R. (Editor); GUTSCHER, H. (Editor) (2001): Changing Things – Moving People. Strategies for Promoting Sustainable Development at the Local Level. Basel, 33-108.

KRAEMER, R.; CASTRO, Z.; SEROA DA MOTTA, R.; RUSSEL, C. (2003): Environment Network: Economic Instruments for Water Management. Experiences from Europe and Implications for Latin America and the Caribbean. (= (=Proceedings of the 2nd meeting of the Environment Network of the Regional Policy Dialogue, 11th to 12th February 2003)). Washington D.C.: Inter-American Development Bank, Regional Policy Dialogue Series. URL [Accessed: 18.06.2012].

KRAEMER, R.; KAMPA, E.; INTERWIES, E. (2004): The Role of Tradable Permits in Water Pollution Control. Brussels: Ecologic, Institute for International and European Environmental Policy. URL [Accessed: 19.06.2012].

OECD (Editor) (2002): Implementing Domestic Tradable Permits. Recent Developments and Future Challenges. Paris: Organisation for Economic Co-operation and Development (OECD). URL [Accessed: 23.09.2010].

SAVENIJE, H.; ZAAG, P. van der (2002): Water as an Economic Good and Demand Management. Paradigms with Pitfalls. International Water Resources Association. In: Water International 27, 98–104. URL [Accessed: 22.04.2012].

STAVINS, R.; WHITEHEAD, B. (1992): Pollution Charges for Environmental Protection. A Policy Link Between Energy and Environment. In: Annual Reviews Energy Environment 17, 187-210. URL [Accessed: 14.06.2012].

Further Readings Library

Reference icon

PRI (Editor) (2005): Economic Instruments for Water Demand Management in an Integrated Water Resources Management Framework. (= (=Synthesis Report based in part on an Experts Symposium by the Policy Research Initiative, 14th to 15th June 2004)). Ottawa: Policy Research Initiative (PRI). URL [Accessed: 19.06.2012].

This report is a synthesis paper based in part on an Experts Symposium held in June 2004. It reviews the use of economic instruments for water demand management, such as pricing and markets. Available in English and French.


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ROSEGRANT, W.; GAZMURI, R. (1994): Reforming Water Allocation Policy through Markets in Tradable Water Rights. Lessons from Chile, Mexico, and California. Washington D.C.: International Food Policy Research Institute. URL [Accessed: 15.06.2012].

This paper extensively focuses on necessary policies for a successful implementation of tradable water rights. Lessons are drawn from case studies from Chile, Mexico, and California.


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SELMAN, M.; GREENHALGH, S.; BRANOSKY, E.; JONES, C.; GUILING, J. (2009): Water Quality Trading Programs. An International Overview. (= WRI Issue Brief, 1). Washington D.C.: World Resources Institute (WRI). URL [Accessed: 13.06.2012].

A worldwide look at the state of water quality trading: Based on a survey of stakeholders, an overview of the key factors necessary for a successful program implementation is compiled, resulting in recommendations for the development of water quality trading programs.


Reference icon

THOBANI, M. (1995): Tradable Property Rights to Water. How to Improve Water Use and Resolve Water Conflicts. In: Public Policy for the Private Sector (The World Bank) 34, 1-4. URL [Accessed: 15.06.2012].


Case Studies Library

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ARMITAGE, R.; NIEUWOUDT, W.; BACKEBERG, G. (1999): Establishing Tradable Water Rights. Case Studies of two Irrigation Districts in South Africa. In: Water SA 25, 301-310. URL [Accessed: 16.06.2012].

Comparison of two cases where tradable water rights were implemented in rural South Africa. In one case, the market for water rights bloomed, whereas in the other case transactions did not follow due to a lack of sellers


Reference icon

BAUER, C. (2003): Marketing Water, Marketing Reform. Lessons from the Chilean Experience. Washington D.C.: Resources for the Future (RFF). URL [Accessed: 19.06.2012].

Chile is known as the world’s leading example of the free-market approach to water law and economics. This publication summarises the Chilean experience, showing benefits and problems.


Training Material Library

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CAP-NET (2008): Economics in Sustainable Water Management. Training Manual and Facilitator's Guide. URL [Accessed: 18.06.2012].

Training guide, which delivers an overview on possible economic and financial tools for water management. The application ranges from water resources, through water supply and sanitation. Further training material as well as supporting PowerPoint’s are available on the website (in English, French, Spanish, and Portuguese).


Reference icon

KRAEMER, R. (2003): Tradable Permits for Water Management. Conceptual Framework. Berlin: Ecologic, Institute for International and European Environmental Policy. URL [Accessed: 18.06.2012].

A presentation giving an overview on the typologies of economic measures in water management with a focus on the role of tradable permits.


Important Weblinks

www.gwptoolbox.org [Accessed: 14.06.2012]

What are water markets and tradable permits and how can they be achieved? This page gives a short overview related to these questions. It further contains a list of documented related cases.

www.nationalwatermarket.gov.au [Accessed: 18.06.2012]

Website from the Australian Government concerning water rights in Australia. In Australia, an array of water rights is applied, including tradable water rights.

www.unescap.org [Accessed: 14.06.2012]

This website by the Economic and Social Commission for Asia and the Pacific (ESCAP) (division of the United Nations) offers an overview of market-based instruments for environment-related measures.