Tuesday, 21 June 2016

Why we need tradeable fresh water useage rights

I've been asked by a couple of students this semester about what I thought about water allocation or a market for fresh water. Interestingly, Basil Sharp (Professor of Energy and Resource Economics at the University of Auckland) wrote a good piece in the New Zealand Herald on that topic today. Sharp wrote:
Creating a market for water use rights would be good for the environment and the economy. It's true to say New Zealand has no overall water shortage. True, but meaningless in practice.
Yes, we are blessed with six times the water per person compared to Australia and 16 times that compared to the US. But rainfall varies geographically and seasonally. Droughts are expected to get longer and more frequent. Ask farmers in Canterbury and Otago, and increasingly in Waikato, if water is scarce.
If water is scarce then it has value. Yet, here's the paradox: water is one of our most valuable natural assets but we don't know its economic value. Successive governments have failed to provide a workable framework that reveals value and enables the exchange necessary for efficient use...
The current system works like this: farmers hold a permit to irrigate their land and can exercise this use right for the duration of the permit. They also have to follow usage rules. Councils can and should monitor use rights and recover compliance costs.
If farmers and other users could transfer their use rights - trade them for money - then the price of water would be revealed. It's already common for water permits to be transferred when land is traded. But what if the opportunity to transfer was freed up? Farmers within a catchment could trade their use rights and trades could occur across industries. They could occur for the duration of the permit, or be leased. This would all take place within sustainability limits.
Essentially, we have a fresh water allocation problem. The problem is that water has traditionally been allocated on a first-come-first-served basis. So, whoever applied for consent to use water first gets to use the water. They cannot transfer that right to others, who may be able to make better (i.e. more value-creating) use of the water. So not only do we have valuable water being used for low-value activities (hands up if you use drinking-quality water to wash your car), but we have no idea how to price water to extract its value (leading to situations like this).

An efficient water rights system (e.g. permits that allow the permit-holder to extract and use a stated quantity of water per year) would need to have a few key properties. The water permits should be: (1) universal; (2) exclusive; (3) transferable; and (4) enforceable.

Universality means that all fresh water use would need to be included in the system (so municipal water supply, irrigation schemes, industrial use, etc. would all have to have permits to extract and use water). There can be few exceptions to this - although hydro power (where the water is not used up or degraded - that is, its use is not rival, as it doesn't deprive others of also using the same water) may be one.

Exclusivity means that all of the benefits and costs associated with extracting and using the water must accrue to the permit-holder. This essentially means that there can be no free riders - no one benefiting from water who does not have a permit to extract and use that water.

Transferability means that the permits can be freely traded voluntarily. So, if you have a permit to extract and use water from a given river, and you find someone else who is willing to pay more for that permit than whatever you value it at (presumably, whatever value it provides to you), then you should be able to sell (or lease out) your permit. This ensures that water will be used in the highest value activities, and means that water has a price (representing by the price of the permits). Failing to sell (or lease out) a permit entails an opportunity cost (foregone income for the permit holder), so selling (or leasing out) a permit to someone else might actually be the best use of the permit.

Potentially, a system like this provides not only for improvements in water allocation, but also improvements in water quality. If your actions are degrading the water quality for permit-holders, you are reducing the value they can extract from the water source, and presumably that loss in value for the permit-holders would be actionable through the courts. So, as well as government-mandated water quality standards, the market could start to provide its own (potentially higher) standards, with failing to meet those standards leading to compensation for other users of the water (which raises the costs of polluting waterways).

However, setting up a system of water use rights or permits does not come without significant challenges. One major issue is how should we decide how many permits to allocate? Do you allocate a number of permits based on the average river flows or aquifer replenishment (of course allowing for the fact that it's unrealistic to take 100% of water)? What happens if flows are below average? Which permit holders will miss out? Do you create some prioritised system of permits, where permits with higher priority can be fulfilled first? However, if you instead take a more conservative approach to permit allocation (based on some lower level of flows), then potentially lots of valuable water simply flows out to sea. Do you instead allocate some additional time-limited permits in years with substantially higher-than-permitted flows?

A second major issue to overcome is how to allocate the initial set of rights. Municipal water supply and other existing users should probably be allocated rights first. But what about other users? What about tangata whenua? Do the remaining rights get auctioned? Who receives the proceeds from the auction (local government, central government, iwi, some other group, or some combination)?

It is clearly time to have a serious conversation about water allocation in New Zealand, because we can do much better. As Sharp concludes:
We have lost 30 years of opportunity. The cost is obvious: water is over-allocated in numerous catchments, patterns of use can't readily adapt to changing economic conditions, and water quality has deteriorated. We can do better for the generation that follows.

No comments:

Post a Comment