Tradable Water Rights

Tradable water rights can function as a possible market-based solution for existing disagreement concerning the availability and allocation of water (see PDF1 and PDF2) (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).

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.

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).

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.

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).

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

• Secure property rights
• Water rights must be enforceable (see also strengthening enforcement bodies)
• Efficient administrative system to ensure market operation

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).