Water Markets and Storage — Substitutes or Complements for Drought Risk Mitigation?

Abstract

Are water storage and water markets complements or substitutes? This paper examines the conditions under which water storage for drought risk mitigation augments or attenuates water market gains from trade, and conversely, the conditions under which water markets augment or attenuate the value of additional water storage. The analysis is performed in the context of the Prior Appropriations doctrine in a fully appropriated basin. Two stylized examples based on water use at the intensive and extensive margin are provided, along with simulation results for proposed water storage projects and market development in the Yakima Basin in South-central Washington State.

Benefit‐Cost Analysis of Integrated Water Resource Management: Accounting for Interdependence in the Yakima Basin Integrated Plan

“…This is a specific case of a more general treatment of the relationship between markets and storage presented in Yoder et al . ().…”

“…Obversely, additional water storage reduces the value of improving water markets. This is a specific case of a more general treatment of the relationship between markets and storage presented in Yoder et al (2016).…”

“…Depending on the trading regime, the IP as a whole provides average annual benefits to agriculture of $2.2-$6.3 million/yr, or about 0.4-1.3% of annual and present value of agricultural production. This illustrates that markets attenuate the value of additional water storage because they reduce the impact of curtailment, so that reducing curtailment with additional storage is less valuable (Yoder et al, 2016). Markets do not reduce overall curtailment (they do not produce more water), but they reduce the marginal loss from curtailment, and therefore reduce the benefit of reducing curtailment.…”

“…This is because effective trade alleviates the impacts of curtailment for any given water storage scenario, and therefore attenuates the benefits of adding storage. See Yoder et al (2016) for a more detailed theoretical examination of this economic relationship.…”

“…The value from water actually accrued through agricultural production depends on these inverse demand functions and on how the water is allocated, particularly during a drought. Because the allocation of water based on seniority during a drought will not in general coincide with the highest valued uses of water, the capacity of markets to transfer water across cropland area from initial appurtenant cropland to higher valued uses will affect the aggregate value of water and the costliness of drought (Yoder et al, 2016).…”