California's Future Is in Australia

No new rust, at least.

Photographer: Justin Sullivan/Getty Images

California's worst-in-a-century drought is forcing the state to impose strict limits on water use and to consider increasingly elaborate and expensive proposals to move water from here to there. Those steps may be necessary, but they should be accompanied by something more rational and efficient. 

That mechanism, of course, is the market. When it comes to California's water, however -- especially the 80 percent of it used in agriculture -- the market is woefully inefficient. And making it work is no easy process. But the sooner California can work this out, the easier it will be for the state to adapt to a world of scarce supply. California can also show the way for other drought-endangered states in the Southwest to do the same.

Like many other places, California has traditionally insulated its water from market forces -- by preventing its sale outright or by imposing steep transaction costs and other barriers. Its underused water market operates without transparent pricing or simple and consistent rules.

This market could be made more efficient, though. That's the lesson from Australia, which started using water markets in the 1980s and has since become a model for other countries. The system sets an annual cap on the amount of water that can be used without threatening future supply, then breaks that amount into entitlements for different users, which they can trade, temporarily or permanently.

When droughts hit, the volume of water that's trading in Australia increases, as farmers who grow water-intensive crops such as rice or cotton sell their rights to farmers who grow crops that can't be fallowed because they grow on vines or trees, such as grapes or almonds. Australia's system aims to make those transfers as smooth as possible; you can view real-time prices or trade water rights online. What's more, all the other data needed to set rational prices -- including up-to-the-minute water usage and records of water rights -- are publicly at hand.

The system has been a success: During droughts, water trading has helped agricultural production stay mostly constant and helped individual farmers survive financially.

California, like most other U.S. states, also lets farmers buy and sell their water rights, to each other or to cities. But the transactions are not supported by a transparent online marketplace (though laws passed last year will help track water use). And they're bogged down by red tape and other costs. The volume of trading shows it. From 2006 to 2010, agricultural districts or urban water utilities bought only about 3 percent of the water used in California's San Joaquin Valley, according to the Public Policy Institute of California. In Australia's prime agricultural zone, more than 30 percent of available water is traded.

Transaction costs on the water market aren't always monetary. In Nevada, for example, a farmer who wants to sell his or her water rights must go through so many reviews and approvals that the process lasts years. Even a one-year transfer can take months.

Sweeping away such obstacles is best done at the state level, because communities too often oppose water markets as economically harmful. After all, even if the farmers who sell their water rights get compensated, other businesses that depend on farming do not. In California, communities have used local ordinances and other steps to block sales in order to protect the local economy and their own water supply. A more efficient market needs standardized rules -- statewide and from state to state -- that encourage water trading.

Building efficient water markets takes time, and communities will still need to keep some control over their supplies. But making it easier to buy and sell water is the best way to adapt to living with less of it. 

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.