10

California's Central Valley: Fear and Loathing in Potential Water Markets

California faces ever-increasing prospects of water scarcity and thus needs to find new ways to meet a wide range of demands. Both strong public preference for the environmental amenities associated with free-flowing water and the escalating financial costs of developing new water supplies have made it increasingly difficult for the state to pursue its past policy of building large dams and canals to meet new needs. At the same time, population growth in California is approximately 750,000 per year, and projections indicate that this growth will continue beyond the turn of the century (California Department of Water Resources, 1987a).

Since it appears unlikely that the state will embark on major new water development schemes, some reallocation of existing supplies is inevitable. One major reallocation is already under way as the Metropolitan Water District salvages approximately 100,000 acre-feet (123,350 megaliters (ML)) annually from the Imperial Irrigation District (see Chapter 11). Other reallocation schemes include court-ordered reductions in diversions by the city of Los Angeles from the Mono Basin and a major administrative reallocation that could result from a court-mandated review of water allocations in the Sacramento/San Joaquin delta.

Virtually all segments of the California water industry concede that water transfers are a desirable way to reallocate water, and the state legislature has passed laws intended to facilitate such transfers. Despite this fact, transfers have not occurred on a major scale and



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Water Transfers in the West: Efficiency, Equity, and the Environment 10 California's Central Valley: Fear and Loathing in Potential Water Markets California faces ever-increasing prospects of water scarcity and thus needs to find new ways to meet a wide range of demands. Both strong public preference for the environmental amenities associated with free-flowing water and the escalating financial costs of developing new water supplies have made it increasingly difficult for the state to pursue its past policy of building large dams and canals to meet new needs. At the same time, population growth in California is approximately 750,000 per year, and projections indicate that this growth will continue beyond the turn of the century (California Department of Water Resources, 1987a). Since it appears unlikely that the state will embark on major new water development schemes, some reallocation of existing supplies is inevitable. One major reallocation is already under way as the Metropolitan Water District salvages approximately 100,000 acre-feet (123,350 megaliters (ML)) annually from the Imperial Irrigation District (see Chapter 11). Other reallocation schemes include court-ordered reductions in diversions by the city of Los Angeles from the Mono Basin and a major administrative reallocation that could result from a court-mandated review of water allocations in the Sacramento/San Joaquin delta. Virtually all segments of the California water industry concede that water transfers are a desirable way to reallocate water, and the state legislature has passed laws intended to facilitate such transfers. Despite this fact, transfers have not occurred on a major scale and

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Water Transfers in the West: Efficiency, Equity, and the Environment have made only marginal contributions to the solution of the state 's water problems. In fact, there is less transfer activity in California than in most other western states. The reasons behind this hesitancy are primarily institutional—existing water institutions tend to protect existing uses. Transfers of riparian and appropriative water rights held by individuals are constrained because many of these rights are tied to land or are unrecorded (or only partially recorded) as to quantity. Large blocks of appropriative rights are held by the Bureau of Reclamation and the California Department of Water Resources and allocated under contract to cooperatives of water users. The transfer of these contractual entitlements has been discouraged, in part because these agencies have not had strong affirmative policies supporting transfer and reallocation. The southern portion of California's Central Valley, the San Joaquin Valley, is a particularly important and relevant target for transfer activity. The vast majority of developed water supplies in the valley are used to support agriculture. Urban water users in southern California recognize that some of the valley 's agricultural supply represents a potentially inexpensive source of water to augment domestic supplies in the face of rapid population growth. At the same time, persistent ground water overdraft in some parts of the valley and sharp population increases projected for the valley's urban areas suggest that the valley economy itself will require additional water to maintain existing levels of economic activity and to support growth. THE SETTING California's great Central Valley occupies much of the northern and central heartland of the state. As shown in Figure 10.1, the valley extends more than 400 mi (640 km) from Redding in the north to Bakersfield in the south. The valley is bordered by the Coast Range and the Sierra Nevada mountains on the west and east, respectively; by the Klamath and Trinity mountains in the north; and by the Tehachapi mountains in the south. The valley's climate is characterized by dry, hot summers and mild, rainy winters. Average annual precipitation ranges from 38 in. (92.7 cm) in the north to 6 in. (14.6 cm) in the south. The alluvial soils have helped to make the valley one of the most productive agricultural regions in the world. The valley is divided into three hydrologic basins, each of which drains roughly one-third of the area. The northern third drains to the Sacramento River, and the middle third drains to the San Joaquin River. The southern third, the Tulare Lake hydrologic basin, flowed to the San Joaquin River centuries ago but is today a closed basin except in extremely wet years. This case study focuses on the San Joaquin and Tulare Lake basins, which are frequently combined and characterized as the San Joaquin Valley. The Sacramento Valley poses some different and more localized transfer issues, which have been discussed elsewhere (Gray, 1990).

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Water Transfers in the West: Efficiency, Equity, and the Environment FIGURE 10.1 Main waterways and features, Central Valley of California.

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Water Transfers in the West: Efficiency, Equity, and the Environment Irrigated agriculture is the dominant economic activity in the eight counties of the San Joaquin Valley. Approximately 4.7 million acres of land in these counties has been developed for irrigation (California Department of Water Resources, 1987b). In 1987 the value of agricultural production in the San Joaquin Valley totaled approximately $9 billion. The leading agricultural commodities include cotton, grapes, citrus, almonds, stone fruit, and dairy and livestock, each valued well in excess of $100 million in 1987 (American Farmland Trust, 1989). In an average year, approximately 14.5 million acre-feet (17.9 million ML) of water is consumed to support irrigated agriculture in the San Joaquin Valley (California Department of Water Resources, 1987b). This is a little more than half of the water used by agriculture state-wide and nearly 41 percent of the state's total net water use (California Department of Water Resources, 1987b). The valley's water comes from four sources: (1) locally developed surface supplies, (2) ground water, (3) the federal Central Valley Project (CVP), and (4) the State Water Project (SWP). Local surface supplies, which account for approximately 36 percent of the net use in the San Joaquin Valley, arise predominantly in the Sierra Nevada. In the early years of irrigation, settlers built simple facilities that permitted them to divert water directly from streams to their fields. Subsequently, the substantial seasonal and annual variability of streamflows led irrigation districts to build sophisticated facilities to capture wet season and wet year flows for use during dry seasons and dry years. The San Joaquin Valley overlies a substantial ground water resource, and ground water extractions account for about 20 percent of the valley's net water use. Overdrafting is a persistent problem, and the California Department of Water Resources (1987a) estimates that it amounts to 1.4 million acre-feet (1.7 million ML) in an average year and perhaps four times that amount in periods of severe drought. Despite the unattenuated overdrafting, many irrigation districts in the central and eastern portions of the valley have devised effective conjunctive use programs in which wet season and wet year flows are stored in underlying aquifers for use during dry periods. Imported surface water supplies, which account for about 22 percent of net water use, were first made available through the Central

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Water Transfers in the West: Efficiency, Equity, and the Environment Valley Project, built by the Bureau of Reclamation during the 1940s and 1950s. The southern portion of the CVP, which is relevant here, includes two divisions. The Friant Division's dominant features are the Friant Dam on the San Joaquin River and the Friant-Kern Canal, which runs 150 mi (240 km) south to a point near Bakersfield. This division delivers an average of 1.5 million acre-feet (1.8 million ML) annually to approximately 15,000 farms on the east side of the San Joaquin Valley. The San Luis Division includes the San Luis Reservoir and a portion of the California Aqueduct, both of which are jointly used by the CVP and the state of California. This division services an area on the western side of the San Joaquin Valley, delivering approximately 1.2 million acre-feet (1.4 million ML) annually. Surface waters are also imported to the San Joaquin Valley from the Sacramento basin by the State Water Project; this water is delivered to the western side of the San Joaquin Valley from the delta of the Sacramento and San Joaquin rivers via the California Aqueduct. The aqueduct, which lies on the western side of the valley, ultimately traverses the Tehachapi Mountains and enters the Los Angeles basin. The water supply facilities of the San Joaquin Valley, as well as those of the state as a whole, are interconnected in a variety of ways. The Cross Valley Canal connects the California Aqueduct with the Friant-Kern Canal and allows water to be delivered from the Sacramento-San Joaquin delta to users in the Friant Division. The Kern River-California Aqueduct Intertie allows water flowing in the lower reaches of the Kern River to be put into the California Aqueduct and made available to users along the aqueduct. Ground water recharge basins are operated throughout the eastern and southern portions of the San Joaquin Valley and permit surface and ground water supplies to be managed conjunctively. These facilities, together with numerous smaller, more localized interconnections, provide a physical infrastructure that allows the water delivery systems of the valley to be managed in a highly integrated fashion. The existence of physically integrated water delivery systems and the ability of different irrigation districts to exchange water from different sources mean that water can be moved between virtually any two points in the valley. In addition, water can be obtained from or transferred to most locations in the state with the exception of the North Coast basin and some central coast areas. Thus, except in very rare cases, water transfers in California need not be constrained by the absence of transport facilities. This contrasts with circumstances in other states, such as Arizona, where the potential for water transfers is crucially conditioned by the availability of conveyance facilities.

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Water Transfers in the West: Efficiency, Equity, and the Environment WATER INSTITUTIONS California has a bewildering array of water institutions that shape the allocation of water and affect the capacity of water users to transfer, exchange, or lease water and water rights. The net effect is that water is allocated in large blocks controlled by strong local districts. The institutions that most critically affect the allocation of water are the water agencies and the system of water rights. Strong federal, state, and local agencies influence the water agenda for the state. The primary federal agency is the Bureau of Reclamation, which operates the Central Valley Project. The major state agencies are the California Department of Water Resources, which is primarily responsible for water supply facilities in California, and the State Water Resources Control Board, a regulatory agency responsible for the administration of water rights and water quality programs. Because of the state's historical role as a primary provider, the regulatory role is less well developed than in other states. California is unique in that much of its irrigable land, including more than 90 percent of such land in the San Joaquin Valley, falls within the boundaries of special purpose agencies—mostly water and irrigation districts—that have been formed to acquire and purvey water to local users. Statutorily, these districts function as special-purpose local governments, having been established under a variety of provisions in the California Water Code for the general purpose of acquiring, storing, and conserving water. The districts function much like “user cooperatives.” Some have developed their own surface water supplies, whereas others contract for surface supplies with either the state of California or the Bureau of Reclamation. It is not uncommon for districts to have a combination of locally developed supplies and supplies delivered under contract with either the state or the federal government. These districts influence the terms under which virtually all of the irrigation water in the valley is used. Their financial and political powers give them key roles in facilitating or inhibiting transfers. California's system of water rights also has a major effect on the extent to which transfers occur. In no other part of the West has so much development taken place in the face of so much theoretical confusion and uncertainty about entitlements. The legal system has survived because of the endless promise of aqueducts from distant places—the mountains, the Colorado River, the North Coast, the Columbia River. The state is unique in its dual system of water rights, in which both riparian and appropriative rights exist side by side, largely unintegrated with ground water rights (Governor's Commis-

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Water Transfers in the West: Efficiency, Equity, and the Environment sion to Review California Water Rights Law, 1978; Hutchins, 1956). Riparian rights to surface water are attached to any tract of land adjoining a stream or lake. A riparian right is limited to the quantity of water that can be put to “reasonable and beneficial” use on the land in question. The right cannot be expanded by adding dry land to the tract but can be diminished if the tract is subdivided and the size of the parcel that abuts the stream or lake is reduced. Where the sum of riparian rights exceeds the common water supply, rights holders are obliged to share the water equitably. Riparian rights are held almost exclusively by private individuals, because public agencies and private companies cannot acquire them except for use on lands that they own. Two features of riparian rights are especially significant. First, in virtually all instances, riparian rights take precedence over appropriative rights. That is, a typical appropriative right can be exercised only on water that is surplus to water subject to riparian rights. In time of shortfall, riparian rights are superior to all appropriative rights except for the very few that were established prior to the riparian rights (Bowden et al., 1982). However, the California Supreme Court has held that unexercised riparian rights may be subordinated to appropriative rights in an adjudication. Second, riparian rights typically may not be transferred independently of the land to which they attach. The water may be captured through adverse possession, but in such instances the riparian right is not transferred; instead, a prescriptive right, similar to an appropriative right, is established in its place. It is thus clear that under the prevailing legal doctrine in California a riparian right cannot be traded except in association with the land. Appropriative rights to surface waters are obtained by using the water continuously and for a reasonable, beneficial purpose. Failure to use the water for a period of 5 years results in loss of the right. Appropriative rights can be established only for water that is “ surplus” to the reasonable and beneficial requirement for both riparian and senior appropriative rights established in the water source. Seniority in appropriative rights is established by the first date of appropriation, with an early right being senior to a later one. Today, appropriative rights are licensed by filing with the State Water Resources Control Board, which then holds hearings and presents findings with respect to the availability of surplus water, the absence of injury to third parties with standing, and the “reasonableness” of the appropriation. The licensing process has been in effect only since 1914, and rights established prior to that date have not been recorded. Thus the ownership and quantity of such rights are subject to dispute, making them potentially difficult to transfer.

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Water Transfers in the West: Efficiency, Equity, and the Environment Appropriative rights may be established by private users or by intermediaries such as local public agencies or private water companies. In the latter case, the members of the intermediary are viewed as having a beneficial interest in the water. Thus appropriative rights to surface water tend to reside ultimately in the users of the water (Bain et al., 1966). The appropriative right is not inherently tied to the land, and the site of use or point of diversion may be changed subject to the approval of the State Water Resources Control Board. However, there is a tendency for appropriative rights to become in fact appurtenant to the land on which they are used, which is specified on the license issued by the state. Although it may be a simple matter to change the kind of use—from irrigation to municipal and industrial use, for example—changing the location of use is more problematic. The law recognizes the interrelatedness of uses, and changes in the site of use or point of diversion cannot occur without approval from the State Water Resources Control Board. This approval is not granted if unreasonable injury will result to third party users. Ground water is also subject to a separate system of water rights. The correlative right entitles holders to use ground water on overlying lands and requires that shortfalls be shared equitably. Correlative rights cannot be established for lands not overlying the aquifer. For nonoverlying lands, appropriative rights to ground water—similar in most respects to appropriative rights to surface water—may be established. Appropriative rights to ground water are inferior to correlative rights. A critical difference between ground and surface water rights is that there is no requirement for filing and licensing to establish a ground water right; it is necessary only to initiate use and ensure that it is continuous. The result is that ground water rights are not recorded or quantified except in a few urban basins in southern California where there has been extensive litigation. In the San Joaquin Valley, as in most other agricultural areas of California, the permissiveness of ground water law has fostered a situation in which there are virtually no restrictions on ground water pumping other than the economic restrictions imposed by cost. Permits for a significant portion of the appropriated surface water in the San Joaquin Valley have been acquired from the State Water Resources Control Board by the Bureau of Reclamation (for the Central Valley Project) and the Department of Water Resources (for the State Water Project). This water is not used directly by the appropriating agencies but is almost entirely sold under contract to water districts and water agencies. As a consequence, water users in

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Water Transfers in the West: Efficiency, Equity, and the Environment the San Joaquin Valley who receive water from the Department of Water Resources or the Bureau of Reclamation hold contractual rights with those agencies rather than water rights per se. Contract holders clearly have equitable entitlements to water deliveries, but the existence of a contractual relationship with a government entity obligated to repay the costs of the project complicates attempted transfers. The permits for the Central Valley Project define the place of use as the entire service area of the CVP and allow the water to be used for many purposes (Kahrl, 1979). Under the terms of the permit, one CVP contractor can transfer water to another CVP contractor within a service area without securing the approval of the State Water Resources Control Board to change the place of use, the purpose of use, or the point of diversion. As a matter of bureau policy, such transfers are generally limited to a one-year period (Gray, 1990). These rules provide water users in individual service areas with flexibility to respond to changing water conditions. Transfers between CVP contractors within the same division are quite common. However, current bureau policies (somewhat modified by the 1991 drought) do not encourage transfers between divisions. By limiting permissible transfers to intradivisional exchanges among contractors, the bureau, in effect, restricts exchanges that involve changes of use because virtually all CVP users are engaged in irrigation. Transfers of CVP water to users outside the CVP service area have not occurred so far. This limitation, apparently based largely on concerns about potential third party effects, creates a substantial barrier to transfers between agricultural and urban users. No CVP water has yet been transferred to municipal and industrial users in the southern California urban areas, nor has any been transferred to urban users in the San Francisco Bay area who are not themselves bureau customers. The State Water Project contractors have not established a routine water transfer system. Although there are several long-term (50 years) exchange arrangements that permit districts remote from the SWP aqueduct to receive other water in exchange for their SWP entitlement, there have been virtually no other transfers, short or long term, among SWP contractors (Gray, 1990). This is attributable to the considerable uncertainty surrounding the rules, processes, and policies governing water transfers. Ironically, California has perhaps the most supportive water laws related to transfers. These laws, most of which were enacted during the 1980s, manifest the legislature's conclusion that water reallocation through private transactions is one significant, low-cost means by which the state can respond to its intensifying water scarcity. Yet

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Water Transfers in the West: Efficiency, Equity, and the Environment despite the presence of detailed water transfer law, California has had less water transfer activity than most of the other states examined by this committee. Only 24 petitions to transfer water were submitted to the State Water Resources Control Board between 1981 and 1989 (Gray, 1990). Of these, 19 were approved. By contrast, during the same period, approximately 1,200 transfers between CVP contractors occurred. None of these transfers required the approval of the board, and virtually all were for periods of less than a year. Transfers among CVP users appear to be an accepted means of dealing with variations in the demands of individual irrigators from year to year. It is important to recognize, however, that all of these exchanges were limited to transfers of water—there were no transfers of water rights (MacDonnell, 1990). The fact that transfer activity in California seems confined to short-term exchanges within project service areas cannot be attributed to the lack of profitable opportunities for trade. Several studies demonstrate that significant opportunities for profitable water transfers between the agricultural regions and urban areas exist. For example, Vaux and Howitt (1984) showed that in 1980 some 2 million acre-feet (2.5 million ML) could have been profitably traded from agricultural regions to the state's major urban areas. These quantities were projected to grow to more than 2.5 million acre-feet (3.1 million ML) by 1995. This study showed that buyers and sellers would have jointly benefited by $66 million in 1980, with benefits growing to $156 million by 1995. Other studies document the existence of profitable trading opportunities within agricultural regions such as the San Joaquin Valley (California Assembly Office of Research, 1985; Vaux, 1986). The explanation for the lack of transfer activity appears to lie instead with water institutions and a reluctance to change those institutions. Although a number of factors can inhibit transfers, three stand out. First, the lack of a coherent transfer policy for the CVP and legal uncertainties associated with policies governing transfers of SWP water have dampened transfers between the service areas of these projects and effectively prohibited transfers to users outside the institutional and geographic realms of the projects. These restrictions and uncertainties are grounded in concerns about the need to protect existing uses of water, possible adverse third party effects, and resistance to change in water management and allocative institutions. Second, the profitability of many potential trades is eroded by the expectation of high transaction costs. As noted earlier, many appropriative rights in California have not been clearly quantified, and costly adjudications may be prerequisite to exchange of these

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Water Transfers in the West: Efficiency, Equity, and the Environment rights or waters. Moreover, there is so much uncertainty surrounding the process through which transfers can be consummated—uncertainty over who has standing to intervene and uncertainty over when interveners are entitled to block a transfer and when compensation should be paid—that the transfer process suffers. Much of this uncertainty is rooted in the lack of clear rules and procedures for dealing with third party effects. Third, perhaps the most pervasive explanation for the lack of transfer activity is the failure of water institutions to evolve in ways that facilitate transfers. California's water institutions traditionally have dealt with water scarcity through the construction of dams and canals. Historically, the Department of Water Resources and the Bureau of Reclamation have performed an entrepreneurial role in developing and marketing water supplies. Neither agency has ever attempted to promote and facilitate a broadly based system of water transfers or administrative reallocation. The State Water Resources Control Board, although possessing broad authority to restrict and reallocate both surface and ground water, has not exercised that authority in the way that state engineers in other western states have typically exercised it (Gray, 1989). In the rare instances where the board has addressed allocative issues (see Chapter 11), it has relied on the threat of using the authority rather than wielding it directly. (The efforts of the board to reallocate water in the Sacramento/San Joaquin delta, in response to a court mandate, could be the beginning of a substantial departure from its historical reluctance to be involved in water reallocation issues.) The fact that California's State Water Project remains uncompleted means that many of its contracting districts receive less water than the formal entitlements established by the contracts. Moreover, in the absence of additional water project construction, the difference between what the districts actually receive and the contracted quantities will grow. These contractors are shareholders in a pool of water, and as long as there is more demand than the pool can supply, the contractors will resist any effort to transfer water (Miller, 1990). It is not clear whether claims based on this argument are legally enforceable (Gray et al., 1990), but the consequent uncertainty creates a substantial impediment to transfers outside the SWP service area. The failure to resolve the third party standing of other state contractors means that any external trade could be subject to costly litigation, and few buyers are willing to risk incurring those costs. Local water districts have both the capability and the incentive to preserve the historical allocation of water through a variety of legis-

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Water Transfers in the West: Efficiency, Equity, and the Environment lative and legal means. This contributes to the persistence of institutions that resist efforts to deal with water scarcity through reallocation. Given current institutions and the absence of clear procedures governing water transfers, transfers can be accomplished now only when there is complete consensus that a transfer is beneficial to some parties and harmless to all other parties. The emergence of the consensus process stems from the widely held perception that any party to a transfer, no matter how remote, can effectively veto the transfer by demonstrating some adverse impact. To exercise such a veto, an individual or group need not resort directly to courts or administrative agencies. Rather, the mere threat of prolonged and costly litigation is usually enough to prevent agreements. Although the “complete consensus ” process may work in the short run for a few trades, it is not a recipe for success in the long run. Apart from the fact that change is rarely without cost, there is the larger issue of self-interest. Paralysis can result when a polity dominated by special interest groups seeks to redistribute or reallocate wealth (Thurow, 1980). In short, it is in the self-interest of any group that is adversely affected by a public policy or action to resist and block that action. Thus, with the exception of a few transfers that are broadly profitable, a consensus process in which there are no mechanisms for resolving disputes is a major institutional impediment to water trading. Existing institutional arrangements are not immutable, but they are not likely to cede the power associated with the control of large blocks of water without considerable external pressure. However, the fact that California's major water agencies have not actively encouraged transfers as one means of alleviating water scarcity has dampened the impetus for institutional change. The failure of all but a few political leaders to advocate water transfers explains, at least in part, the absence of a proactive approach to transfers by the major water agencies. Representatives of the Bureau of Reclamation indicate that the U.S. Department of the Interior's 1988 transfer policy has placed the bureau in a largely passive position. The California Department of Water Resources has not actively supported long-term transfers, perhaps out of concern about becoming embroiled in legal conflicts. And the major urban water agencies, which are potentially the largest buyers of agricultural water supplies, also have been quite cautious in their approach to transfers. This is due, at least in part, to fears of resurrecting the “Owens Valley syndrome”—the perception that large urban water agencies are “stealing” water from rural citizens. In the absence of political leadership, the institutional changes

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Water Transfers in the West: Efficiency, Equity, and the Environment required to facilitate water transfer are unlikely to happen soon. The major water purveyors in the state appear reluctant to encourage institutional change without such leadership. Thus, as current institutional arrangements persist, it will be difficult for California to realize the full potential of water transfers as a strategy to cope with water scarcity. THIRD PARTY IMPACTS In a state as vast and diverse as California, examples of almost every type of third party effect can be identified from among the array of potential transfers. Some of these effects are more important and pervasive than others, however. For example, adverse cultural impacts on minority groups and effects arising from undefined or poorly defined Indian water rights are likely to be far less significant in the San Joaquin Valley than elsewhere in the West. Issues relating to the impact of water transfers on minorities exist, but the impacts are not as well identified as they are in places such as New Mexico and the case for giving them substantial weight is not as great. By contrast, the two most prominent classes of third party effects involve areas of origin and the environment. Areas of Origin Several impacts on areas of origin are illustrated in the case involving the Berrenda Mesa Water District and its parent institution, the Kern County Water Agency. The Berrenda Mesa Water District lies in Kern County in the southwestern region of the San Joaquin Valley, and it depends on the SWP for its entire water supply. The Kern County Water Agency is a distinct type of special district that overlies all of Kern County but whose member districts, including Berrenda Mesa, are only those with entitlements to state water. The Kern County Water Agency was formed for the purpose of contracting with the state of California for water from the SWP and has access to the entire tax base of Kern County in financing its operations. Its primary function is to sell water from the SWP to member districts. Together, the individual member districts and the Kern County Water Agency determine the allocation of all waters imported to Kern County via the SWP (Vaux, 1986). In 1986 the Berrenda Mesa Water District foreclosed on the owners of approximately 6,500 acres of land because of their continuing inability to meet the payments required by the water service agreements with the district. In the aftermath of the foreclosure, Berrenda

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Water Transfers in the West: Efficiency, Equity, and the Environment Mesa's remaining water users were then faced with the possibility of having to assume the portion of the district's fixed costs previously borne by the foreclosed users. Berrenda Mesa estimated that operations covering an additional 6,000 acres might be financially threatened if this occurred. The district thus attempted to market the water released via the foreclosure and thus help to defray the fixed costs. The Kern County Water Agency and other state water contractors opposed the sale of Berrenda Mesa's water, arguing that they were entitled to any water that was surplus to the demands of an existing contractor. The argument of the Kern County Water Agency differed in some important respects from arguments mounted by other water districts. The Kern County Water Agency assesses all taxpayers in Kern County about 15 percent of the cost of delivering water to districts where agricultural uses predominate. The rationale for this assessment is based on the proposition that most agricultural lands will be irrigated in perpetuity and thus current landowners should not be obligated to pay the full cost of the water. Rather, all citizens of Kern County have an interest in ensuring that water currently allocated to Kern County remains there, both to preserve the important economic base provided by irrigated agriculture and to support further urban growth in Kern County. This case illustrates at least three types of third party effects, two of which are related to areas of origin. First, when a water user (or users) within a district proposes to transfer water to users outside the district, real financial costs can accrue to other users within the district if nothing is done to defray the capital costs of facilities and other fixed costs previously borne by the transferor. In the extreme, this increased burden could harm the economic viability of district operations and, perhaps, bankrupt the entire district. From an economic perspective, it can be argued that each grower who joins a district or collective binds himself, to some extent, to the welfare of the collective. If the collective as a whole is not economically viable, efficiency considerations dictate that it should fail unless some subset of the collective is profitable enough to defray all fixed costs. Although the efficiency implications of such situations seem quite straightforward, there are substantial issues of equity. The crucial issues turn on the circumstances under which the individual is bound to the collective. Normally, such questions would be addressed in the collective's charter. However, most water districts in the West were organized before water marketing was viewed as a practical option, and their charters may thus be silent on the rights of members to transfer water to remote buyers. (It should be

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Water Transfers in the West: Efficiency, Equity, and the Environment noted that the Department of Water Resources would be unlikely to approve any trade that threatens the financial viability of the SWP itself, but this protection would not necessarily extend to the financial viability of individual districts, particularly when a buyer is willing to defray the selling district's contractual obligations to the state.) Some western water districts (e.g., the Northern Colorado Water Conservancy District) prohibit members from selling or leasing water to buyers outside the district. This type of prohibition protects the interests of district members but may create significant allocative inefficiencies by barring transfers that are otherwise profitable. When sellers insist that any external buyer retire the costs of conveyance capacity or facilities idled by the transfer, allocative distortions are introduced, because buyers are required to defray the costs of the seller. That is, if the buyer is required to pay for some of the prior financial obligations of the seller, which are unrelated to the value of the water, less water would be transferred than would be economically optimal. A second concern related to areas of origin is the indirect impact of water transfers on firms and industries linked to irrigated agriculture and the impacts on agricultural communities. For example, in an area where agricultural production is reduced because of transfers of water to other regions, the remaining production may prove insufficient to support some or all of the local packinghouses or seed, fertilizer, and machinery distributors. Similarly, as irrigated agriculture declines, the community becomes less prosperous, and its economic and social infrastructure may decline. Banks, pharmacies, and other essential firms close. The social structure provided by churches, civic groups, and political organizations weakens just when community members most need such support. Area-of-origin concerns often focus on the multiplier effects of disinvestment in irrigated agriculture. Just as investments in irrigated agriculture bring “linked industries” to an area, disinvestment causes them to leave. The disinvestment, then, leads to other adverse consequences for the social and political structure of the community as the tax base shrinks, community services diminish, and unemployment rises. The prospect of this chain of impacts raises fears of impoverishment and fears that traditional agricultural lifestyles may vanish. The Kern County Water Agency was in a unique position in regard to this latter type of concern because taxes that it had collected were used to defray about 15 percent of the costs of the water that Berrenda Mesa wished to sell. Therefore the agency could argue that it had recognized indirect benefits stemming from irrigated agricul-

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Water Transfers in the West: Efficiency, Equity, and the Environment ture in Berrenda Mesa and had borne a portion of the water supply costs as a consequence. (The question of whether the level of the Kern County Water Agency's financial contribution appropriately reflected the magnitude of the indirect benefits is a separate issue.) In most cases, local (or regional) taxpayers do not participate in the financing of water supplies, although some or all of them may reap indirect benefits from irrigated agriculture. Nevertheless, in many instances, local firms and communities would suffer both economic and social costs as a consequence of water transfers. A third issue raised by the Berrenda Mesa/Kern County Water Agency example relates to the lack of clear rules and procedures governing the transfer of water. The Berrenda Mesa water sale was opposed by other SWP contractors who argued that they had first call on any surplus SWP supplies. The contractors argued, in effect, that the terms of SWP contracts would make them third parties to any transfer of water outside the SWP service area. This position was never tested in the courts, presumably because potential buyers feared the high costs of litigation. However, if the contractors had prevailed in such a court test, Berrenda Mesa could have lost the water and received no compensation. Ultimately, Berrenda Mesa was unable to sell its water because the terms under which water from the SWP could be sold or exchanged were never clearly specified and the district was unwilling to risk a test case in the courts. Subsequently, the Kern County Water Agency implemented a procedure under which it guarantees a sale price for the surplus water to Berrenda Mesa during hydrologically “normal” years. Berrenda Mesa uses the water in “dry” years and is essentially stuck with it in hydrologically “wet” years. Thus Berrenda Mesa has been effectively barred from selling at least a portion of its surplus water by the actions of the Kern County Water Agency and the threats of other SWP contractors. This case emphasizes how the lack of clear, legally tested rules and procedures can inhibit water trading and illustrates the need to specify precisely, perhaps as a matter of law, the groups and individuals who are entitled to third party standing in any water transfer. Kern County residents aside, there is no a priori reason why other state water contractors should be accorded third party status in this situation. Environment Water transfers in the Central Valley could have a broad range of environmental impacts. On the one hand, some environmental groups

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Water Transfers in the West: Efficiency, Equity, and the Environment have supported transfers as a means of avoiding the adverse environmental impacts associated with the construction of new storage facilities. On the other hand, an unfettered market-like system of water transfers could bring environmental damages. Unless transfers are restricted to water that is used consumptively or otherwise becomes unusable, runoff that flows back to watercourses could be diminished, and instream flow problems would follow. Downstream rights holders might also be harmed. In California, rights to instream flows are not vested in any specific individual, group, or state agency. Unlike many other states, there are no exclusive property rights to instream flows. They are simply common property rights, which may be diminished by private uses. Although groups wishing to purchase water to augment instream flows could, in theory, acquire water for those purposes, it is not clear how they could protect that water from downstream appropriation. Since most instream uses of water are public goods, it is fair to conclude that a market system without some form of public intervention would underallocate water for instream flows. Instream flow protection has always been ad hoc in California. During the last decade the California Supreme Court has employed the public trust doctrine to protect environmental uses (see, for example, National Audubon Society v. Superior Court, 1983). Just as the doctrine was used to limit appropriations in Mono Lake basin for export to Los Angeles, it could be invoked either administratively or through the courts to bar or modify proposed transfers from one basin to another to maintain desired flows within the basin of origin or current use. The legal procedures involved would be both costly and time-consuming, and the threat of such proceedings might be sufficient to block transfers, even those with relatively benign environmental effects. The fact that the implications of the public trust doctrine have not been fully elaborated by either the courts or the State Water Resources Control Board contributes to the uncertainty surrounding proposed water transfers. If transfers are to be facilitated, clear rules and procedures governing environmental impacts will need to be developed. Such rules and procedures should recognize explicitly that water transfers in certain local situations may represent both an efficient and an equitable way of resolving an environmental problem. The appearance of toxic concentrations of selenium in drainage waters pooled at Kesterson Reservoir in the northwestern San Joaquin Valley has been carefully documented elsewhere (National Research Council, 1989). That situation illustrates how irrigation drainage waters can degrade ground and surface water quality and harm fish and wild-

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Water Transfers in the West: Efficiency, Equity, and the Environment life. Part of the solution to problems posed by drainage waters involves more careful management of irrigation water to reduce the volume of drainage produced (Letey et al., 1986). The existence of well-functioning water markets could help facilitate the management of drainage waters. Overirrigation in a number of water districts on the west side of the San Joaquin Valley contributes to the drainage problem (University of California Committee of Consultants on Drainage Water Reduction, 1988). This overirrigation can be explained in part by the lack of incentives to manage irrigation water more intensively and in part by the inability of some growers to finance the capital and labor necessary for more intensive management. The Reclamation Reform Act of 1982 requires all districts receiving water from the Bureau of Reclamation to develop water conservation plans but makes no provision for recovering the costs expended. The establishment of water markets might help address both problems, first, by providing an incentive to sell or lease water saved as a consequence of more intensive management and, second, by providing a source of revenue to finance water-saving technology and management. There may also be opportunities for buyers to participate directly in the financing of drainage-reducing measures in a fashion similar to those discussed in the Imperial Valley case study. Although transfers can facilitate reductions in the volume of drainage waters, they do not offer a complete solution to the drainage problem. Means will still have to be found to maintain salt balances by either exporting salt from the basin or sequestering it in some harmless way. By generating funds to finance salt management activities, transfers could be helpful in supporting solutions to the problem of where to dispose of salts. CONCLUSIONS The lack of clear rules and procedures pervades the water transfer process in California. Although the legislature has passed a number of laws designed to facilitate water transfers and the Department of Water Resources, particularly in its recent creation of a drought-induced water bank, has made efforts to implement those laws, legal and procedural uncertainties constrain transfers. Uncertainties with respect to possible third party effects are particularly significant, since it is unclear which third parties would have to be accommodated in connection with transfers. For example, the ability of State Water Project contractors to veto transfers to noncontractors has not been resolved completely and the resulting possibilities for litigation will

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Water Transfers in the West: Efficiency, Equity, and the Environment impede trade. The California situation illustrates the extent to which failure to distinguish between those third party impacts that must be accounted for in a transfer and those that may safely be ignored can impede water reallocation through transfers. Institutions with a stake in developing new water supplies tend to resist efforts to reallocate water, which also impedes development of the transfer process. Water users and their cooperatives can be especially effective in blocking transfers by identifying all manner of potentially adverse third party impacts. The lack of clear policy governing which third party impacts should be considered means that all such impacts tend to be given weight in a transfer proceeding, irrespective of their merits. Under California water law, riparian rights and pre-1914 appropriative rights are particularly difficult to transfer either because they are appurtenant to the land or because they have not been quantified. The apparent restrictions placed on transfers by the Bureau of Reclamation and the lack of clear policy governing external exchanges by SWP contractors also tend to restrict transfers of contract rights or entitlements outside or even within their respective project service areas. Several types of potentially adverse impacts on areas of origin are illustrated by the Berrenda Mesa case. To what extent should the financial viability of an irrigation district be protected in the transfer process? To what extent should local economies be protected? On efficiency grounds alone the answers are relatively clear. The equity impacts are more difficult to assess but will clearly be important. Areas-of-origin effects are probably dealt with most effectively through broad state policies that articulate the extent to which water-dependent rural economies should be preserved. Such policies should be developed with a clear understanding of the costs involved. Thus, for example, a policy that tends to impede the reallocation of water from areas of origin may require the construction of new facilities to supply the water necessary to support new growth. In formulating such policies, it will also be important to recognize that disinvestment in unprofitable industries is one of the ways by which mixed free market economies maintain their vitality. If the economy of the West is to remain vibrant, and if national and world demands for food and fiber produced in the West do not grow substantially in coming decades, disinvestment in irrigated agriculture is probably inevitable and efforts to forestall it are likely to be counterproductive in the long run. Similarly, political judgments will have to be made about equity effects that arise when a sale by several water users in a cooperative

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Water Transfers in the West: Efficiency, Equity, and the Environment imposes increased costs of indebtedness on the remaining water users. From a strict efficiency standpoint, there is no reason why the financial integrity of such a cooperative should be protected. However, issues of equity and financial integrity are real and must be addressed. They are probably best addressed by the user cooperatives themselves. The environmental impacts of water transfers are varied. Policies that give standing to instream uses and provide for the public purchase and protection of water for environmental uses are needed. The fact that water transfers provide a means for alleviating some environmental problems, as illustrated by the potential of market-like transfers to help resolve the San Joaquin Valley drainage problem, suggests that policies should be crafted to provide balance between environmental and consumptive uses. REFERENCES American Farmland Trust. 1989. Eroding Choices—Emerging Issues: The Condition of California's Agricultural Land Resources. San Francisco, Calif. Bain, J. S., R. E. Caves, and J. Margolis. 1966. Northern California's Water Industry. Baltimore, Md.: The Johns Hopkins Press. Bowden, G. D., S. W. Edmunds, and N. C. Hundley. 1982. Institutions: Customs, laws and organizations. In Ernest A. Engelbert and Ann Foley Scheuring, eds., Competition for California Water. Berkeley: University of California Press. California Assembly Office of Research. 1985. Water Trading: Free Market Benefits for Exporters and Importers. Report 058-A. Sacramento. California Department of Water Resources. 1987a. California Water: Looking to the Future. Bulletin 160-87. Sacramento. California Department of Water Resources. 1987b. California Water: Looking to the Future. Statistical Appendix. Bulletin 160-87. Sacramento. Governor's Commission to Review California Water Rights Law. 1978. Final Report. Sacramento, Calif. Gray, B. E. 1989. A primer on California water transfer law. Arizona Law Review 31:745. Gray, B. E. 1990. Water transfers in California: 1981-1990. Unpublished report. Hastings College of Law, San Francisco, Calif. Gray, B. E., B. C. Driver, and R. Wahl. 1990. The transferability of water provided by the State Water Project and the Central Valley Project: A report to the San Joaquin Valley Drainage Program. Unpublished manuscript. Hastings College of Law, San Francisco, Calif. Hutchins, W. A. 1956. The California Law of Water Rights. Sacramento Office of the California State Engineer. Kahrl, W. L. 1979. The California Water Atlas. Sacramento Office of Planning and Research. Letey, J., C. Roberts, M. Penbreth, and C. Vasek. 1986. An Agricultural Dilemma: Drainage Water and Toxic Disposal in the San Joaquin Valley. Special Publication 3319. Oakland: University of California, Division of Agriculture and Natural Resources .

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Water Transfers in the West: Efficiency, Equity, and the Environment MacDonnell, L. J. 1990. The Water Transfer Process as a Management Option for Meeting Changing Water Demands. Vol. 1. Report submitted to the U.S. Geological Survey. Miller, B. J. 1990. Water transfers in California: Problems and solutions. Unpublished manuscript. B. J. Miller Associates, Berkeley, Calif. National Audubon Society v. Superior Court, 658 P.2d 709 Cal. ( 1983). National Research Council (NRC). 1989. Irrigation-Induced Water Quality Problems: What Can Be Learned From the San Joaquin Valley Experience? Washington, D.C.: National Academy Press. Thurow, L. C. 1980. The Zero-Sum Society: Distribution and the Possibility for Economic Change. New York: Basic Books. University of California Committee of Consultants on Drainage Water Reduction. 1988. Opportunities for Drainage Water Reduction. Riverside: University of California Water Resources Center, Salinity/Drainage Task Force. Vaux, H. J., Jr. 1986. Water Scarcity and Gains from Trade in Kern County, California. Pp. 67-101 in Kenneth D. Frederick, ed., Scarce Water and Institutional Change. Washington, D.C.: Resources for the Future. Vaux, H. J., Jr., and R. E. Howitt. 1984. Managing water scarcity: An evaluation of interregional transfers . Water Resources Research (20):785-792.