Water Banks: What Have We Learnt from the International Experience?
2. Water Banks: Concept and Types
2.1. Water Banks as a Type of Water Market
2.2. Water Bank Typology
- Public water banks are organized and managed by a public administration, typically one with expertise in the field of water.
- Private water banks are organized and managed by means of a private initiative, generally run by non-profit organizations, such as NGOs dedicated to environmental conservation.
- Permanent water banks. Rights-holders permanently transfer their water entitlements to the water bank. The rights acquired by the bank can subsequently be reassigned, partly or wholly, to other users (current rights-holders or new users), either by means of acquisition or via a system of free public concession. These banks can be aimed at solving problems associated with structural water scarcity, both economic and environmental in nature [16,17,18], as is discussed below.
- Spot or temporary water banks. These banks act in same way as permanent water banks but with the difference that they deal with temporary transfers of water use rights (usually for an irrigation season) or specific quantities of water (spot). In both cases, the activity is concentrated in periods of drought, and the aim is to mitigate the effects of cyclical shortages [19,20].
- Option contract banks. This type of water bank facilitates the exchange of contracts that provide buyers with the option (but not the obligation) to buy water from the seller (the holder of the water rights), in exchange for a certain price or “premium” [21,22]. If the aforementioned option is eventually exercised, the buyer pays additional compensation to the seller, called the “strike price”. These contracts allow the buyer to hedge against the risk of not having enough water for their activity, while simultaneously ensuring that the seller does not forfeit the water entitlement (the right to use the water) [23,24].
- Water banks for the reallocation of resources as a production input. Exchanges of rights that enable water banks to reallocate the resource (temporarily or permanently) depending on current and potential suppliers and demanders according to market forces, fostering the transfer of water from lower-value to higher-value uses. These transfers, in the absence of negative externalities, help to make water use more economically efficient [25,26].
- Water banks for environmental purposes. These banks work by purchasing rights without subsequently reallocating them . This type of bank, thus, provides a solution to environmental problems stemming from both structural water shortages (addressing overallocation of basin resources by purchasing permanent rights) and cyclical shortages (tackling low water flows in the dry season by purchasing temporary rights).
- Water banks for managing risk related to water availability. Climate and hydrological uncertainty inherent to water management causes interannual variability of resource provision. This exposes users to significant risk, and as a result they do not make economically-efficient decisions . In order to minimize sub-optimal decisions and improve water-use efficiency, these banks work by negotiating water options contracts. This helps to improve supply security for the buyers of water options contracts (by reducing supply security for the sellers of such contracts), thereby enabling an effective transfer of risk between users with different levels of risk aversion [23,24].
- Active water banks. Those where the managers of the bank adopt a proactive strategy as “market makers”, buying water rights out of the bank’s own budget, and subsequently attempting to sell them to potentially interested users. In this regard, the aim of the water bank management is to achieve a balanced market, by trying to ensure that the sum of purchases and sales does not yield a net cost (the amount spent on purchases should equal revenue from sales), or that said cost does not exceed a maximum budgeted for this purpose. It should be noted that, in these cases, the bank administrator is the one who sets the conditions for the purchase and sale of rights (or options), and these banks, thus, become a type of monopolistic market with a one-way trading system . As such, the bank first acts as the sole buyer of water rights or options (monopsony through public purchase tenders) and then, in turn, becomes the sole vendor of such rights or options (monopoly through public sale offerings). The purchasing system can vary depending on the nature of the public offerings. The bank may: (i) establish the maximum amount of net purchases (maximum spending budget), whether by means of a fixed price or via auction (successive increments in the purchase price until the total allocated budget has been spent); (ii) fix a maximum volume of water to be acquired, also by means of either budget limits or auction; or (iii) establish a fixed market price for acquisitions, without budgetary constraints or limits on the volumes of water to be purchased. These public offerings may also be differentiated according to whether they are open or restricted; whereas all rights-holders in the territory under the bank’s jurisdiction (e.g., a river basin district or users of an aquifer) can voluntarily attend the former, the latter is only for certain types of specifically-authorized users. Similarly, public sale offerings can be differentiated in terms of both price conditions and contract amount, as well as with respect to their open/restricted nature. Active water banks are a useful way of boosting market activity (improving economic efficiency) and exercising more effective control over market operations (reducing externalities and minimizing asymmetrical information about water prices).
- Passive water banks limit themselves to facilitating contact between buyers and sellers so that operations can be carried out according to the supply and demand at any particular moment. In these cases, the role of the manager of the bank is simply to act as an intermediary for purchases and sales (broker), either as a clearinghouse or through sealed bid double auctions. In thinner water markets, water banks usually adopt the first approach (clearinghouses), where buyers and sellers reveal their intent to buy and sell, usually posted on bulletin boards, and trades are executed when matching offers and bids are found in terms of quantity and price . Sealed bid double-auctions only take place in more liquid water markets. The offers to buy and sell rights are based on a system similar to the stock market, where the bank provides up-to-date and transparent information (positions or offers to buy and sell). Thus, by matching existing purchase and sales offers, a market clearing price is achieved—the price at which the exchange of all the rights of all those wishing to accept/pay the equilibrium price are cleared .
3. International Experiences
3.1. Water Banks in California
3.2. Water Banks in Other Western US States
3.3. Water Banks in Australia
3.4. Water Banks in Spain
3.5. Water Banks in Chile
4. Water Banks as an Instrument for Managing Water Scarcity
4.1. Advantages of Water Banks
- They increase utility (income in the case of private, profit-maximizing agents) for all market agents (buyers and sellers of water). The participation of water users in the market is always voluntary, which ensures that all operations are beneficial (raised utility or income) to both parties.
- They improve resource-allocation efficiency, encouraging water transfers from activities of lower value of marginal utility (value of marginal productivity in the case of productive economic uses) towards activities with higher value of marginal utility, thereby maximizing the total utility (production value in the case of productive economic uses) generated by all agents participating in the market. As a result, in those cases where externalities are minimized, water banks usually lead to improved social welfare (net benefits from a public perspective).
- Market prices provide a proxy of the true opportunity cost of water, encouraging more rational use of the resource.
- They can ensure better supply security to the users that are most averse to the risk of hydrological uncertainty, since they provide the possibility of water exchange in times of water shortage.
- They rationalize the construction of new infrastructure projects aimed at increasing water supply, as the markets provide an alternative to building expensive water works (when market prices are lower than the marginal cost of new resources).
- Water banks centralize purchases and sales of water rights (or options), reducing operational or static transaction costs for both the agents involved in the market and the institution managing the bank. Transaction costs are a key issue in environmental policy , and are also a key factor determining the performance of water institutions (e.g., water banks) . For a recent review of transaction costs in environmental policy, interested readers can consult [60,61]. With a more specific focus on water markets, Bjornlund et al. [54,62] are also worth referring to. Following recent debate, transaction costs can be divided into two categories: the first refers to the costs of designing and setting up the instrument under analysis (namely institutional transaction costs), while the second are associated with the operational costs of the instrument (namely static transaction costs). These static costs include: (i) support and administration costs; (ii) contracting costs; (iii) monitoring and detection costs; and (iv) prosecution and enforcement costs. Water banks are particularly effective at reducing contracting costs. This advantage is the most important one for market agents, since it involves the costs of finding parties interested in participating, bargaining costs, and decision costs associated with transactions. The reduction of all these static transaction costs boosts water trade by making operations more profitable (or ensuring they generate more utility in the case of public or non-profit organizations) for buyers and sellers.
- Water banks encourage governmental oversight of environmental and social externalities arising from water transactions. They also allow operations with environmental purposes (public offers to purchase rights without subsequent reallocation), in order to increase river flows, restore overexploited groundwater bodies, etc.
- They make the market more transparent by releasing purchase/sale prices and making them publicly available to all users.
- Public initiative water banks, since they are managed by the government, provide greater security and reassure buyers as to the actual availability of negotiated water resources.
- The implementation of water banks during the early stages of drought periods should more effectively raise all users’ awareness of the need for efforts to reduce demand in order to mitigate the negative effects of drought.
4.2. Disadvantages of Water Banks
- They could generate negative environmental externalities, especially by altering water flows in natural watercourses. This occurs firstly through changes in the location of uses, which can reduce flows (sale of water from the lower to the upper part of the basin) or increase flows (sales in the opposite direction). Secondly, it occurs through the overall decline in returns when transfers are made from areas of low-efficiency water use to areas of higher-efficiency water use, resulting in an increase in water depletion (reduction of natural flows) at the basin level.
- They could generate social externalities in the areas of origin, due to the loss of employment caused by abandoning productive activity, which can in turn cause depopulation and territorial imbalances. Such issues could then present a political problem (e.g., rural stakeholders in areas of origin lobbying to maintain irrigated agriculture).
- The activation of “sleeper rights” or “paper rights”. The presence of the market encourages the activation of these rights, resulting in an increase in the water abstraction from the system, a situation that exacerbates water shortages.
- Existence of other market imperfections, resulting from the small number of buyers and/or sellers, the variety of water rights exchanged and/or the lack of transparency in the information on volumes transferred and prices negotiated. A further consequence of all this is that the balance achieved by the markets is sub-optimal from an economic efficiency perspective. In this regard, it is worth noting the impact on the market of cultural barriers (unwillingness to use water markets as water is not considered a tradable commodity), physical barriers (lack of appropriate infrastructure for completing transactions) and legal barriers, which limit the number of agents that can operate in it.
4.3. Critical Features: Defining Successful Water Banks
- As with any water market, water banks can generate two main kinds of environmental externalities. The first is the change in water flow regimes, which could be harmful for aquatic ecosystems. In order to address this potential externality, operational rules of water banks need to include criteria for approving transfers, which guarantee that they are compatible with maintaining minimum environmental flows in all natural water courses affected. The other environmental externality is the likely increase in overall water consumption at the basin level because more efficient irrigation practices lead to less water flowing back to water bodies . In order to reduce this negative environmental externality, operating rules of water banks must ensure that the total water rights transferred tally with the volume of water actually consumed (water extracted from the source that does not return to water bodies) in previous years. This is the only way of verifying that water bank operations do not increase water depletion, which would increase the quantitative pressure on water bodies and reduce water flows in natural watercourses. In this regard, a two-step approach is proposed. First, appropriate mechanisms are required to prevent the transfer of water rights that are not being used (sleeper rights), a situation that leads to an increase in total abstractions. Second, rules must be put in place to limit the amount of water transferred to the amount actually ‘consumed’ by the rights-holders (only the water evapotranspired by crops, in the case of irrigators), rather than the amount ‘used’ (total water abstracted from the source). In other words, water banks should avoid transferring the fraction of water corresponding to return flows. This is the only way to make sure that the water bodies in the areas of origin maintain the levels of water extraction that predate the banks' operations . To that end, both the volume of water effectively used in previous years and the technical efficiency in water use would have to be determined in order to calculate the volume of return flows. Consequently, the volume of transferable water should be limited to the water abstracted from the water bodies minus the returns that would have originally occurred.
- Transaction costs are also a relevant issue when designing and implementing water banks. As McCann  shows, a monopsony structure, as the one provided by water banks, may facilitate bargaining, easing contact between users and a central operator instead of between users, thus reducing static transaction costs. In any case, an efficient initial design of these banks is required in order to minimize institutional transaction costs. Before creating this kind of centralized market, bank developers should be encouraged to examine the current water market framework: agents, ‘market training’ (experience in water markets), number of agents previously operating in the market and volume of water or rights traded, the role of private brokers, etc. This analysis should help inform decisions regarding the timing (when to create the water bank) and structure (market infrastructures and the design of operational rules) of the bank to be created. It is also worth mentioning that static transaction costs should also be minimized by setting up appropriate operating protocols and boosting the use of information and communication technologies (integrating operations applications with public water records databases), geographic information systems (GIS), and remote sensing techniques. This would allow the following procedures to be streamlined: (i) the presentation of offers/demands by stakeholders; (ii) verification of the information they provide (e.g., water rights held, location of abstraction, consumption and effective use of the rights in recent years); (iii) approval of operations and the execution of the corresponding financial transfers; and (iv) compliance (e.g., ensuring that users who transfer their rights do not subsequently use them).
- Well-designed water banks, as well as any other water policy, must improve transparency by making all market information available to the public . Such information includes the parties involved, prices and trading volumes agreed, terms of the offer, etc. This information should be made public in real-time through the websites of the basin authorities. In addition, the managing organizations of these banks should publish an annual report of activities which details the effective contribution they make to water governance as, in fact, some of them already do.
- All water banks should be self-financing as promoted by some water legislations, such as the EU’s Water Framework Directive , where the principle of full cost recovery is a key issue. This means that the prices paid by buyers must cover not only the compensation required by the seller, but all operational and management costs relating to transactions, including water conveyance costs if transportation is needed. In this way, even public initiative water banks can avoid any possible hidden subsidies to water users (e.g., irrigators).
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|Type||California (Federal and State)||California (Federal)||Idaho (State)||Montana (NGO)||Colorado (State)||Colorado (NGO)||New Mexico (State)||New Mexico (Private)||Texas (State)||Texas (NGO)||Oregon (State and NGO)||Washington (State)||Washington (NGO)||Australia (Private)||Australia (State)||Spain (State)||Chile (State) a|
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Montilla-López, N.M.; Gutiérrez-Martín, C.; Gómez-Limón, J.A. Water Banks: What Have We Learnt from the International Experience? Water 2016, 8, 466. https://doi.org/10.3390/w8100466
Montilla-López NM, Gutiérrez-Martín C, Gómez-Limón JA. Water Banks: What Have We Learnt from the International Experience? Water. 2016; 8(10):466. https://doi.org/10.3390/w8100466Chicago/Turabian Style
Montilla-López, Nazaret M., Carlos Gutiérrez-Martín, and José A. Gómez-Limón. 2016. "Water Banks: What Have We Learnt from the International Experience?" Water 8, no. 10: 466. https://doi.org/10.3390/w8100466