Law and the New Institutional Economics: Water Markets and Legal Change in California, 1987-2005

Título: Law and the New Institutional Economics: Water Markets and Legal Change in California, 1987-2005

Autor: Jedidiah Brewer, Michael A. Fleishman, Robert Glennon, Alan Ker, Gary Libecap

Año: 2007

Fuente: Social Science Research Network


This paper can be downloaded without charge from the
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Arizona Legal Studies
Discussion Paper No. 07-35
Law and the New Institutional Economics: Water Markets and Legal Change in California, 1987-2005
Jedidiah Brewer, Department of Economics The University of Arizona
Michael A. Fleishman, Butler & Assocs., P.L.C. Tucson, Arizona
Robert Glennon, James E. Rogers College of Law The University of Arizona
Alan Ker, Department of Agricultural and Resource Economics The University of Arizona
Gary Libecap, Bren School of Environmental Science and Management and Economics Department, University of California, Santa Barbara
December 2007
Law and the New Institutional Economics: Water Markets and Legal Change in California, 1987-2005
Jedidiah Brewer∗
Michael A. Fleishman∗∗
Robert Glennon∗∗∗
Alan Ker∗∗∗∗
Gary Libecap∗∗∗∗∗
New Institutional Economics (NIE) focuses on the interaction between legal (formal and informal) institutions and economic behavior.1 Both directions of causality concern researchers in the field: how institutions influence economic behavior and how economic factors affect institutional change. As such, the NIE abandons standard neoclassical economics assumptions that individuals have perfect information about the market and important current or future events, as well as the assumption that transaction costs of exchange are zero. As a result, NIE introduces observed organization and information costs to neoclassical analysis, thereby providing more analytical richness and power for examining empirical activities. Institutions, such as written contracts, charters, constitutions, laws, and even unwritten norms and codes of behavior are devised to reduce information uncertainty and transaction costs. If effective, these institutions can promote efficiency by encouraging investment, production, and trade.
∗ Department of Economics University of Arizona, Tucson.
∗∗ Butler & Assocs. P.L.C., Tucson, Arizona.
∗∗∗ Rogers College of Law University of Arizona, Tucson.
∗∗∗∗ Department of Agricultural and Resource Economics, University of Arizona, Tucson.
∗∗∗∗∗ Bren School of Environmental Science and Management and Economics Department, University of California, Santa Barbara National Bureau of Economic Research Hoover Institution October 1, 2007.
Support for this research was provided by National Science Foundation Grant 0317375; the Robert Wesson Fellowship at the Hoover Institution, Stanford; the Julian Simon Fellowship at the Property and Environment Research Center (PERC), Bozeman, Montana; the Earhart Foundation; the International Center for Economic Research (ICER), Turin, Italy; the Rogers College of Law, and the Department of Agricultural and Resource Economics, University of Arizona.
Institutions, especially laws and regulatory arrangements, may also be used to redistribute income, or be part of rent-seeking activities. If ineffective, these institutions may result in inefficiencies and reduced investment, production, and trade.2 At the same time, individuals engage in collective action as a response to exogenous changes in relative prices to make institutions more effective in promoting economical activities.3
In the spirit of the NIE, we examine the interactions among regulation, property rights, and water markets in California from 1987-2005. We are interested in whether and how the definition of water rights and the regulation of water transfers has affected observed market activity in: the extent and pattern of water trades, their duration, and the nature of the contracts used (short-term leases, long-term leases, and sales).
There is growing pressure to re-allocate fresh water from historical uses in agriculture, where as much as eighty percent of water has been used, to meet greater water demands in urban areas, recreation (i.e. fishing and boating), and environmental requirements (i.e. protect endangered species and repairing aquatic and riparian habitats). Fresh water supplies are limited with little or no new sources, so meeting new demands necessarily requires re-allocation.
Markets are institutional options for achieving such re-allocation. Land markets, for example, fairly smoothly and routinely shift land resources from one use (farming) to another (housing). But water is a more complicated resource than land. Due to its physical mobility, water cannot be easily bounded or partitioned across claimants and uses, making it more difficult to define and enforce property boundaries and rights. As a result, exclusion is extremely difficult and numerous parties typically access the same water either simultaneously or sequentially. Because it is difficult to segment water into its various concurrent or chronological uses, there is often a
1. For a discussion of New Institutional Economics, see HANDBOOK OF THE NEW INSTITUTIONAL ECONOMICS, (Claude Menard & Mary M. Shirley eds., Springer 2005).
2. This does not mean that all redistribution is inefficient. Some redistribution can provide more social and political stability for property rights and the overall economy by being perceived as more “fair” or “just.” For a discussion of fairness issues, see Alberto Alesina & George-Marios Angeletos: Fairness and Redistribution, 95 AM. ECON. REV. 960 (2005); Gary D. Libecap, Distributional Issues in Contracting for Property Rights, 145 J. INSTITUTIONAL & THEORETICAL ECON. 1, 6-24 (1989).
3. Not all institutional change, of course, is aimed at efficiency. For example, some change is designed to facilitate rent seeking or redistribution as a resource’s value rises. For a discussion of the various motives for institutional change in response to price change, see GARY D. LIBECAP, CONTRACTING FOR PROPERTY RIGHTS 16-19 (1989).
high degree of interaction among water claimants and applicants. For these reasons, water trading among some parties can have important and negative effects on others.
For instance, consider an upstream irrigator who diverts water for farming purposes. Only part of the water will be used, with the remainder percolating back through the ground to aquifers, streams, or to ditches for repeated access by other parties in the same watershed or basin. If the first farmer were to sell some or all of her water and ship it out of the basin for urban use, the unconsumed residual or tail water would no longer be available for use by subsequent claimants or environmental uses. They would lose access to water and be harmed by the trading process.
Accordingly, any trades that change the location of water diversion, nature of use, and timing, especially if they are large relative to the stream flow, are restricted by state law and regulated by state agencies. Because of the potential for harm, transfers of surface water rights in western states are predicated on there being “no harm or injury” to downstream rights holders. State water agencies, such as the California State Water Resources Control Agency, typically allow trades that involve changes in diversion and location only for historical consumptive uses (water that would not be available to subsequent users in any event) in order to minimize these negative third-party effects.4 In contrast, local, short-term water transfers among neighboring users, such as irrigators, typically do not require state approval because the water stays nearby and any changes are of limited duration.
California laws and regulations, as defined by the state legislature, courts, and administrative agencies, may promote water market transactions if they: (1) clarify the definition and enforcement of private water rights so that ownership is obvious; (2) streamline and make transparent the regulatory process; and (3) limit third-party protests to well-defined criteria and short time periods. Alternatively, California law may retard or change the duration and type of transactions if water rights are weakened and/or the regulatory process is made more complicated. For instance, California law could affect the relative costs and benefits of using particular contracts (leases relative to sales), and the length of transactions (short term versus long term or permanent) by the nature of the regulatory process.
4. Ronald N. Johnson et al., The Definition of a Surface Water Right and Transferability, 24 J.L. & ECON. 273 (1981). The authors describe how specifying a property right in water in terms of consumptive use with options for third party grievances can be an effective method for promoting transfers.
In this Article, we examine the water market activities in California between 1987 and 2005 and analyze how the changes in the definition of water rights and regulation have influenced the extent and nature of water trading.
California is one of the most important states in the West with respect to water transfers, along with Arizona, Colorado, and Texas.5 California was not only one of the earliest states to adopt the prior appropriation doctrine, it was also the first state to recognize that water rights could be transferred independently of land.6 In turn, Federal and state water projects have given California large-scale storage facilities and the infrastructure to move water from one part of the state to another.
For example, the State Water Project (SWP) captures water in the Oroville Reservoir, located on the Feather River in Northern California, and exports water from the Sacramento-San Joaquin Delta to areas both west and south of the delta.7 Two-thirds of the people in California receive some portion of their water supply from the SWP, including the southern San Francisco Bay area, southern California, and over 700,000 acres of farmland in the Tulare Lake Basin of the San Joaquin Valley.8
Additionally, the United States Bureau of Reclamation (USBR) operates the Central Valley Project (CVP), which is perhaps the nation’s largest water project. CVP stretches almost 500 miles from north of Sacramento down to the Kern River in the south.9 The CVP consists of 20 dams and reservoirs, 11 power plants, and 500 miles of major canals.10 Despite these immense water projects, in the 1970s an ever-expanding population required California to come
5. See Jedidiah Brewer et al., Water Markets in the West: Prices, Trading, and Contractual Forms, (Nat’l Bureau of Econ. Research, Working Paper No. 13002, 2007), for a discussion of water transfers by state in the west.
6. See Brian E. Gray, The Shape of Transfers to Come: A Model Water Transfer Act for California, 4 HASTINGS W-NW. J. ENVTL. L. & POL’Y 23 (1996); see also Duckworth v. Watsonville Water & Light Co., 150 Cal. 520, 530-31 (1907); CAL. CODE REGS., tit. 23, § 775 (2005).
7. States Water Project.
8. See Gerald E. Johns, Making Water Transfers Work in California, in 2005 A.B.A. SEC. OF ENV’T, ENERGY, AND RESOURCES, 23RD ANN. WATER CONF. 31, 32.
9. See Central Valley Project, General Overview, (last visited Nov. 6, 2007).
10. Id.
to terms with the reality that it had not only one of the biggest agricultural economies in the world, but also a population of thirty-five million people.
It was within this context that the idea of water marketing seemed like a sensible way of making more efficient use of existing water resources.11 In 1978, a specially appointed Governor’s Commission recommended statutory changes to create greater incentives for more efficient use of water, and to clarify water rights in order to encourage voluntary water transfers.12 The California legislature enacted these recommendations into law in 1980.13 The legislature mandated that “The growing water needs of the state require the use of water in an efficient manner and that the efficient use of water requires certainty in the definition of property rights to the use of water and transferability of such rights.”14
In 1982, the legislature directed the California Department of Water Resources (DWR), the State Water Resources Control Board (SWRCB), and other state agencies to “encourage voluntary transfers of water and water rights.”15 One impediment to water transfers in the West has been the law in some states that provides that conserved water goes to the next junior in the priority system rather than to the person who undertook the conservation effort for either additional irrigation or for sale or lease to a third party.16 To try to eliminate this disincentive for conservation, the California legislature enacted a series of laws that allowed the transfer of conserved and surplus water to be consistent with beneficial use.17
11. For a recent analysis of water marketing in California, see generally Barton H. Thompson, Jr., Institutional Perspectives on Water Policies and Markets, 81 CAL. L. REV. 673 (1993); Ellen Hanak, Counties Wresting Control: Local Responses to California’s State Wide Water Market, 6 U. DENV. WATER L. REV. 490 (2003); Ellen Hanak, Stopping the Drain: Third Party Responses to California’s Water Market (Public Policy Inst. of California, Working Paper No. 2004.11, [YEAR]); ELLEN HANAK, WHO SHOULD BE ALLOWED TO SELL WATER IN CALIFORNIA? THIRD PARTY ISSUES AND THE WATER MARKET (Public Policy Inst. of California 2003); ELLEN HANAK, CALIFORNIA’S WATER MARKET, BY THE NUMBERS (Public Policy Inst. of California 2002); Kevin N. O’Brien & Robert R. Gunning, Water Marketing in California Revisited: The Legacy of the 1987-1992 Drought, 25 PAC. L.J. 1053 (1994).
12. See Primer, supra note 6.
13. See CAL. WATER CODE §§ 109(b), 475, 1010, 1011, 1244 (West 1971 & Supp. 2007); see also CAL. CODE REGS. tit. 23, ch. 3 (2007). All the administrative regulations noted throughout the matrix are covered by California Code of Regulations, which outlines many of the procedures of the State Water Resources Control Board. The Board’s authority is derived from CAL. WATER CODE § 1058 (West 1971 & Supp. 2007).
14. Id. § 109(a).
15. Id. § 109(b).
16. Se. Colo. Water Conservancy Dist. v. Shelton Farms, 529 P.2d 1321 (Colo. 1974).
17. CAL. WATER CODE §§ 380-87, 1010-11, 1240, 1244; cf. City of Los Angeles v. City of Glendale, 142 P.2d 289 (1943); see also Lindblom v. Round Val. Water Co., 173 P. 994 (1918) (discussing difference between 5
In 1982, in an attempt to decentralize the water transfer process, the California legislature recognized that “[m]any water management decisions can best be made at a local level . . . [where] flexibility will maximize efficient state wide use of water supplies.”18 The legislature allowed local water agencies to sell water outside their boundaries, serve as water brokers, and control the transfer of surplus water.19 These provisions greatly enhanced the authority of irrigation districts and other water providers to control the transfer of water outside their boundaries. Notwithstanding this authority delegated to local agencies, all transfers in California are still subject to the overarching no-injury provision of the water code.20 The legislature also created rules that govern water transfers that distinguish between short-term and long-term transfers. It created three categories of short-term transfers: (1) temporary urgency changes,21 which applies during droughts and emergencies; (2) temporary changes,22 which occur for up to
abandonment and forfeiture). These code sections are important in understanding the seemingly conflicting provisions of the California Constitution and the Water Code. The natural question of how can surplus water be transferred, yet also be protected from forfeiture or waste is still debatable. Sections 1010-1011 provide for the sale, lease, exchange, or transfer of reclaimed water, polluted water, and conserved water, but by themselves provide no protection against claims of waste or forfeiture. Section 1244 specifically states that “[t]he sale, lease, exchange, or transfer of water or water rights, in itself, shall not constitute evidence of waste or unreasonable use.” Professor Brian Gray has argued that there is still sufficient uncertainty in this area, which has prevented wider participation in the water market. See Gray, supra note 6, at 30.
18. CAL. WATER CODE § 380(c) (West 1971 & Supp. 2007).
19. Id. § 382-383. Section 383 gives the local water agency a great deal of power over its local members’ ability to transfer water. The consent of the agency is required before an individual will be able to transfer her water rights.
20. Id. § 386. California also distinguishes surface water rights by whether they were commenced before or after 1914. If after 194, the water users must obtain a permit from the SWRC. The pre-1914 rights are not subject to a permitting process. Even though the initial appropriation of these early rights is not subject to SWRCB oversight, the transfers of such rights are still subject to the no-injury rules.
21. Id. § 1435. Section 1435 provides that a permittee or licensee that has “an urgent need to change a point of diversion, place of use, or purpose of use . . . may petition for . . . a conditional, temporary change order without complying with other procedures or provisions . . .” A temporary urgency change may last for no more than 180 days, but may be renewed by the Board. The Board has oversight of these petitions and approval of a temporary urgency change does not create a vesting of water rights.
22. Id. at §§ 1725-1732. Section 1728 defines a temporary change as “any change of point of diversion, place of use, or purpose of use involving a transfer or exchange of water or water rights for a period of one year or less.” Section 1725 restricts the transfer of water to that which the transferor would have “consumptively used or stored” prior to the transfer. The 1988 amendments to section 1726 removed a provision that previously allowed a transferor to simply notify the Board that it was planning a temporary change. The Board must now be notified and has oversight power as well. Temporary changes may still be seen as beneficial to the transferor because of the potential allowance for expedited approval by the Board (see Matrix Factor 60, which was given a “1,” because of the expedited system for water leases and temporary changes). The burden is on the transferor to show that the proposed transfer will meet the traditional no-injury rule.
a year; and (3) trial transfers,23 which allow for experimental transfers.24 Long-term transfers occur when the period exceeds one year.25
In 1986, the Legislature further clarified the voluntary conservation of water; allowing the transfer of conserved and surplus water. It also allows for the transfer of non-surplus water made available by land fallowing.26 The Legislature also put water rights on a more secure basis by recognizing that water transfers are beneficial uses and are not subject to the forfeiture rules.27 Because California has the riparian rights doctrine in addition to the prior appropriation rule, the question arose as to whether riparian rights could be transferred. The California Legislature attempted to resolve this issue in 1988 by providing that decreed riparian rights may be transferred.28
In 1991, the California Legislature took a significant step when it created the Emergency Drought Water Bank.29 The Bank served to alleviate many drought related problems at the time by allowing for the prompt but temporary transfer of water from one user to another.30 The agricultural community bought into the water bank idea because their rights were protected, the program involved only short-term transfers, and there were substantial financial rewards to those who participated.31 The water bank was particularly active during a five-year drought cycle in the late 1980s and early 1990s.32 It can be seen as a necessary catalyst for a sustainable long-term market, in part because the bank was so successful as revealed in the transfer data described below. In 1991 it acquired 820,665 acre-feet of water.33 The major purchasers were the
23. 1980 Cal. Stat. 2956-58.
24. 1980 Cal. Stat. 3676.
25. CAL. WATER CODE §§ 1735-1737 (West 1971 & Supp. 2007).
26. See id. §§ 382, 475, 480, 1011, 1745.02, 1745.05.
27. See id. §§ 1024(C), 1244, 1745.05.
28. See id. § 1740.
31. David J. Guy, A Model Water Transfer Act for California: An Agricultural Perspective, 4 HASTINGS W. –N.W. J. ENVTL. L. & POL’Y 75, 77 (1996). Water rights holders were paid $125 per acre-foot in 1991 and $50 per acre-foot in 1992.
33. Morris Israel & Jay R. Lund, Recent California Water Transfers: Implications for Water Management, 35 NAT. RESOURCES J. 1, 7 (1995).
Metropolitan Water District of Southern California, the Kern County Water Agency, and the San Francisco Water District.34 Notably, as we show below, most of the water moved from agricultural to municipal and industrial uses. In 1992, the water bank remained active, though with a smaller number of participants and less water. The primary purchasers that year were farmers, as there was sufficient rainfall for industrial and domestic uses.35
Also in 1992, the California legislature allowed water providers to transfer conserved water by members of water agencies.36 In 1999, the legislature further refined the water transfer process and more securely established property rights through the Water Rights Protection and Expedited Short-Term Water Transfer Act, which provided that a transfer or an offer to transfer water would not be a basis for forfeiture, abandonment, or modification of the water right.37 This Act helped allay the fears of many water rights holders who had not entered the market for fear of losing their water rights.38 The Act also protected rights holders from the actions of a transferee. If a transferee should violate any of the numerous reasonable use provisions in the Water Code, the Act provides for an automatic reversion of the water rights back to the transferor.39 The Act sped up the transfer review proceedings by providing that the board must reach a decision within forty-five days.40
The 1999 Act also attempted to confront third-party issues that arise from water transfers. Prior to the Act, agricultural water rights holders could fallow or retire farmland and then transfer the water at will.41 But the Act distinguished between temporary land fallowing and
34. Id. at 11.
35. Id. at 15.
36. See CAL. WATER CODE §§ 1745-1745.11.
37. CAL. WATER CODE §§ 1014 (West 1971 & Supp. 2007); see also Wood v. Etiwanda Co., 81 P. 512, 514 (Cal. 1905).
38. See Guy, supra note 31, at 77. Many of the provisions of the 1999 Act incorporated many of the concerns raised by Guy in the above piece. Securing water rights has long been a major concern of agriculturalists. The ability to participate in short-term transfers that will not jeopardize water rights, it is argued, should bring a number of new rights holders to the market.
39. See CAL. WATER CODE § 1015 (West 1971 & Supp. 2007).
40. Id. § 1726(e), (g)(1)-(2). Id. § 1726(e), (g)(1)-(2).
41. See 1996 Cal. Legis. Serv. ch. 408, § 1, at 96 (West) (amending CAL. WATER CODE § 1011(b)).
permanent land fallowing.42 Now, only water conserved from temporary fallowing may be transferred.
In California, most water users do not hold the water rights; instead, they have water contracts with supply agencies such as the State Water Project or the U.S. Bureau of Reclamation.43 The complicated nature of water rights in California has meant that there is no single entity with jurisdiction to oversee the process. The SWRCB has general authority over surface water rights in California but, because much of California’s water is regulated under contract either with the Bureau of Reclamation or with the Department of Water Resources through the State Water Project, many transfers escape the scrutiny of SWRCB. Indeed most transfers in California have been within the Central Valley Project or the State Water Project. Between 1981 and 1989, some 1,200 informal transfers involving more than three million acre-feet took place just within the CVP.44
The relationship between irrigation districts and their members also complicates the water transfer process in California.45 Because most surface water used in California comes from either the Central Valley Project, administered by the U.S. Bureau of Reclamation, or the State Water Project, administered by the Department of Water Resources, there are contractual rights between the state or federal agency and institutions, such as an irrigation district or a conservancy district. Even though an irrigation district typically has a contract with the state or federal agency, its property right is generally considered to be minimal.46 At the same time, the ability of the actual water users to dispose of “their” water is severely restricted. First, there may be conditions imposed by USBR or DWR in the contract with the irrigation district. Second, the nature of the property right held by the ultimate water user is quite ambiguous, ultimately turning on the relationship between the district and the water users.47 Third, state law may place
42. Id. §§ 1732, 1745.10, 1745.11.
43. See CAL. WATER CODE §§1745-1745.11 (West 1971 & Supp. 2007)); Primer, supra note 6, at 779.
44. See Thompson, Institutional Perspectives on Water Policy and Markets, 81 CAL. L. REV. 671, 719 (1993).
45. See Brian E. Gray, The Modern Era in California Water Law, 45 HASTINGS L.J. 249 (1994) [hereinafter Gray, Modern Era]; Reed D. Benson, Whose Water Is It? Private Rights and Public Authority Over Reclamation Project Water, 16 VA. ENVTL. L.J. 363 (1997).
46. See Truckee-Carson Irrigation District, D. Sec’y of the Dept. of Interior, 742 F.2d 527, 530-31 (9th Cir. 1984).
47. See Richard Roos-Collins, Voluntary Conveyance of the Right to Receive a Water Supply from the United States Bureau of Reclamation, 13 ECOLOGY L.Q. 773, 847 (1987). 9
additional restrictions on transfers outside of irrigation districts or even within the district itself.48 Fourth, the internal regulations of various irrigation districts may demand that the proposed transfer receive the approval of the board of directors of the district.49
Even though the California Water Code allows an irrigation district, if it determines that entering into a contract for the sale or lease of any surplus water50 is in the best interest of the district, it is unclear whether individual water users in the district have a right to transfer even water that they have “conserved.”51 This uncertainty of water rights and individual user authority is a substantial constraint in water transfers.52
In 1992, Congress passed the Central Valley Project Improvement Act (CVPIA), which reallocates Central Valley Project water directly to the environment.53 CVPIA allocates 800,000 acre-feet to meeting the needs of fish and wildlife in the Sacramento River and the Sacramento/San Joaquin River delta.54 The CVPIA also allocates another 400,000 acre-feet for wildlife reserves in the Central Valley.55 The CVPIA uses water transfers to generate the water for these environmental objectives. The CVPIA basically allows existing contractors to benefit from selling heavily subsidized USBR water at contemporary market rates.56 The Secretary of the Interior must approve all transfers in order to protect the area of origin and to ensure that fish and wildlife habitat are protected.57 But, in a sharp departure from conventional practice, CVPIA authorizes individual farmers, rather than irrigation districts, to engage in water transfers.58 If
48. See Gray, Modern Era, supra note 45, at 279-80.
49. See, e.g., Westlands Water District, Regulations—Article 2, (last visited Nov. 6, 2007); see also Gray, Modern Era, supra note 45, at 280.
50. CAL. WATER CODE § 22259 (West 1971 & Supp. 2007).
51. CAL. WATER CODE § 1011(a) (West 1971 & Supp. 2007).
52. Paul R. Williams & Steven J. McHugh, Water Marketing and Instream Flows, 9 STAN. ENVTL. L.J. 132 (1990).
54. JOSEPH L. SAX, BARTON H. THOMPSON, JR., JOHN D. LEISHY, & ROBERT H. ABRAMS, LEGAL CONTROL OF WATER RESOURCES, 778 (4th ed. 2006). For additional information about CVPIA, see Harrison Dunning, Confronting the Environmental Legacy of Irrigated Agriculture in the West: The Case of the Central Valley Project, 23 ENVTL. L. 943 (1993).
55. See SAX ET AL., supra note 54, at 778.
56. See id. 778.
58. 10
individual farmers propose to transfer less than 20% of the CVPIA water received by the district, the district cannot prohibit the transfers.59
Another environmental program is the Calfed Environmental Water Account (EWA), which is a collaboration between federal and state agencies to provide protection to at-risk fish species in the Bay/Delta system.60 Begun in 2001, the EWA program typically purchases in excess of 200,000 acre-feet of water each year, and uses this water to protect at-risk fish species in the Bay/Delta system.61
Judicial decisions have also played a major role in affecting the incentives for water transfers in California. For example, in Imperial Irrigation District v. State Water Resources Control Board62 the court held that the state retained the power “to prescribe water use practices, to limit waste, and to sanction water transfers.” This ruling created tremendous incentive for the Imperial Irrigation District to modernize its infrastructure to avoid forfeiture of some of its water rights.
Administrative rulings by the SWRCB may impact water transfers under application of the discretionary “public interest” criteria.63 The SWRCB has authority to deny outright any application on “public interest” grounds or to approve the transfer subject to various terms and conditions that the board sees fit to employ. The process can be unpredictable and time consuming.64 The legislature embellished the common law prohibitions on the no-injury rule to include protection for fish, wildlife, and other instream beneficial uses, as well as protection for third parties from unreasonable harm caused by water transfers.65 The SWRCB often has used
59. See SAX ET AL., supra note 54, at 778.
62. Imperial Irrigation Dist. v. State Water Res. Control Bd., 225 Cal. App. 3d 548, 573 (1990) (citing Freyfogle, Context and Accommodation in Modern Property Law, 41 STAN. L. REV. 1529, 1546-47 (1989)).
63. See Gray, supra note 6; see also McDonald & Blackburn v. Bear River & Auburn Water & Mining Co., 13 Cal. 220, 233 (Cal. 1859) (stating that “the ownership of water, as a substantive and valuable property right . . . may be transferred like other property.”).
64. See generally Consuelo Bokum, Implementing the Public Welfare Requirement in New Mexico’s Water Code, 36 NAT. RESOURCES J. 681, 706 (1996). Bokum notes that fourteen of eighteen western states have adopted public welfare/interest lists of uses. Six of the fourteen states explicitly list uses in their statutes, including California.
65. Gray, supra note 6; see also CAL. WATER CODE §§ 1702, 1706, 1028, 1435(b), 1725, 1736, 1745.10, 1745.11 (West 1971 & Supp. 2007).
these provisions to justify additional terms and conditions to water transfer permits in order to protect instream stream flows and other instream uses.66
To analyze the interaction between water markets and the law, we collected data on California water transfers from the major water trading journal, the monthly publication Water Strategist, from 1987-2005, the period for which such data are available.67 In Brewer, Glennon, Ker and Libecap we describe the data collection methodology in detail so only a brief summary is provided here.68 The Water Strategist is self-advertised as “the only source of published information on water transactions in the West.”69 Each month, the journal publishes a “Transactions” section that lists, by state, each water transfer that occurred.70 It typically lists: the year of the transfer; the acquirer of the water; the supplier; the amount of water transferred; the proposed use of the water; the price; and the type of contract.71 Uses of water include agriculture, urban (municipal & industrial), and environmental.72 Accordingly, there are nine possible trades: agriculture to agriculture, agriculture to urban, agriculture to environmental, urban to agriculture, urban to urban, urban to environmental, environmental to agriculture, environmental to urban, and environmental to environmental.73 This data is one of the bases for our analysis of water transactions.
This section provides a brief discussion of the trends in the California water market. On the whole, California has an active water market compared to other states in the West and thus is an important market to analyze. This is true for both the number of transfers that have taken place and the amount of water that has been traded. Over the 19 year period (1987-2005) in our sample, 493 transfers took place in California which transferred over 11.3 million acre-feet of
66. Gray, supra note 6.
67. Water Strategist, (last visited Nov. 16, 2007).
68. See Brewer et al., supra note 5; Brewer et. al, Transferring Water in the American West: 1987-2005 40 U. MICH J. L. REFORM 1021, 1034-37 (2007) [hereinafter Transferring Water in the American West].
69. Water Strategist, supra note 67, at homepage.
70. Id.
71. Id.
72. Transferring Water in the American West, supra note 68, at 1035.
73. Id. at 1035 n.86.
water.74 In comparison, in ten of the other eleven states in the West75 (excluding Colorado76) there were 1,047 water transfers totaling about 19.1 million acre-feet.77 These numbers indicate that California accounts for almost half of the number of transfers and sixty-percent of the amount of water transferred in the West. Therefore, understanding how the legal process affects water markets in California is an important first step to understanding how the legal process may affect water markets more generally in the West.
1. Total California Water Transfers
Figure 1 illustrates water trading in California over the 19 year period. The left axis represents the volume of water transferred as measured by annual flow whereas the right axis represents the number of transfers. We graphed them together to show how the two data series correspond to each other. The correlation coefficient between the number and volume of transfers is 0.76 indicating the two series tend to move together.
As shown, there is no clear trend in the number of water transfers. The greatest activity occurred in California in 1991 and the least in 1996. The data reveals a general increase in the amount traded, with the greatest amounts involved in 1991 and 2003 and the least in 1996.
75. In addition to California our dataset includes water transfer information from eleven other states in the West: Arizona, Colorado, Idaho, Montana, New Mexico, Nevada, Oregon, Texas, Utah, Washington, and Wyoming. Brewer et al., supra note 5, at 15.
76. The state of Colorado has a unique water market system where numerous small transfers occur each year. Over the sample period there were 1,777 transfers in the state with a total of 1,265,560 acre-feet transferred. Thus, each transfer is an average of approximately 700 acre-feet. California’s transfers were less in number (493), but much larger (23,000 acre-feet on average), for a total amount of 11,395,892 acre-feet transferred—almost ten times what was transferred in Colorado.
77. 13
FIGURE 1 19861988199019921994199619982000200220042006024681012x 105YearVolume of Transfers (
acre feet)105198619881990199219941996199820002002200420060102030405060Total Transfers in California 1987-2005: Volume and Number Number of TransfersVolume of Transfers Number of Transfers
In our empirical analysis in section V, we model both the volume and number of transfers because while related, they represent different metrics of market activity. For example, if the transaction costs for a transfer are primarily fixed, that is that the costs are similar whether 100 or 10,000 acre-feet are being transferred, the volume of water exchanged would be a poor metric for identifying factors that promote or hinder market activity. In that situation, modeling the number of transfers rather than the volume of transfers would better identify which factors promote or hinder market activity. If, on the other hand, the transaction costs for a transfer are primarily variable, that is that the costs increase with the volume of water transferred, then the volume rather than the number of transfers would be the appropriate metric to identify which factors promote or hinder market activity. With respect to water transfers in California, transaction costs are comprised of both fixed and variable costs, so we have modeled both.
2. California Water Market Contracts
Figure 2 describes the contract type used in California water markets. The data in the figure demonstrates the dominance of short term (1 year) leases in California. As figure 2 shows,
there is no clear trend in either short or long term leasing, but sales of water rights are increasing. The predominate use of short term sales in California is of special note in comparison with other states in the West. In total, 62% (305 out of 493) of all transfers in California were short term leases for one year or less. This sharply contrasts to the rest of the West where only 39% of all transfers (excluding Colorado) were short term leases.78
FIGURE 2 Contract Type05101520253035401987198919911993199519971999200120032005YearNumberSalesShort-Term Leases Long-Term Leases
3. Water Market Transaction Types
Figure 3 outlines the number of transactions by major categories of trading in California: agriculture-to-agriculture, agriculture-to-urban, and agriculture-to-environmental. As shown, there was a spike in agriculture-to-agriculture and agriculture-to-urban trading in 1991. There is a slight declining trend in agriculture-to-agriculture trades; no clear trend in agriculture-to-urban; and a slight increase in agriculture-to-environmental trades over the 19 year period.
78. Including Colorado only magnifies the difference. If Colorado is included only 17% of all transfers were short-term leases in the rest of the West.
FIGURE 3 Number of Trades by Major Category0510152025301987198919911993199519971999200120032005YearNumberAg to AgAg to EnvirAg to Urban
4. Quantities Traded
Figure 4 examines quantities traded for the same categories. The quantity patterns tend to mirror those shown in Figure 4, with spikes for agriculture-to-agriculture and agriculture-to-urban trades in the early 1990s and increases in agriculture-to-environmental trades by 2003. Moreover, slight increases also were seen in amounts traded from agriculture-to-urban.
FIGURE 4 Quantities Traded by Category0100,000200,000300,000400,000500,000600,0001987198919911993199519971999200120032005YearAcre FeetAg to AgAg to EnvirAg to Urban
Table 1 illustrates trades within California, and compares market activities within the state with other states in the West in terms of the number of transfers and the amount of water
exchanged. The table shows that California is fairly balanced between agriculture-to-agriculture, agriculture-to-urban, and agriculture-to-environmental transfers. “Agriculture to Agriculture” trades account for twenty-two percent of the number of water transfers, but only fourteen percent of the total volume of transfers. Agriculture-to-urban transactions reveal a similar pattern, but agriculture-to-environmental transfers are larger on average, involving fifteen percent of the trades, but twenty-four percent of the volume.
Most notably though, the table displays key comparisons with other states. For one, California tends to engage in more agriculture-to-agriculture transfers than most other states, but the average size of each exchange is smaller. The opposite is true for agriculture-to-urban transfers. California engages in relatively fewer agriculture-to-urban transfers (as a percent of total transfers), but moves more water from agriculture to urban uses. This means that agriculture-to-urban transfers in California are generally larger than elsewhere. Additionally, agriculture-to-environmental transfers are more important in California than in other western states.
Percent of Transfers (Number)
Other Western States
Other Western States (Excluding Colorado)
Percent of Water Transferred (Acre-feet)
Other Western States
Other Western States (Excluding Colorado)
In sum, the data in the above figures and table reveal a steady number of trades, and an increase in amounts involved over nineteen years in California. Within those aggregates, agriculture-to-urban and environmental transactions are increasing, and the importance of water sales is rising relative to short term and long term leases, even though short term leasing remains the dominant type of transaction. California differs distinctly from other states in the West as it relies more heavily on short term transactions. California also transfers less water within agriculture and more water out of agriculture (relative to all water transferred within the state) than other western states. The issues to be explored throughout the rest of the Article include: (a) the nature of water transactions in California; (b) the patterns of legal change involving statutes, court rulings, and administrative agency decisions; and (c) the role of changes in legal property rights and regulatory systems in California for explaining changes in the annual number of water transfers and amounts transacted in the state, when controlling for other factors.
1. Methodology
The manner in which the law defines water rights and the operation of the regulatory process can importantly affect water transfers. In order to more precisely examine the impact of legal changes on water marketing, we coded water law in California between 1980 and 2005 with respect to twenty-one legal variables that might encourage or retard the transfer of water from agriculture to municipal and environmental uses. We partitioned the twenty-one legal variables into those that strengthened water rights and promoted water transfers, and those that weakened water rights and limited or raised the transaction costs of water trades. The breakdown of variables is provided below in Table 2.
Factors that Strengthened Property Rights and Lowered the Transaction Costs of Trading
Factor Number*
– Does the law make water right more definite or precise?
– Does the law specifically define what uses qualify as beneficial uses?
– Does the law allow for the sale of the land without the water right or the water right without the land?
– Does the law allow someone to profit from the sale, transfer, or exchange of his water right to another?
– Does the law allow someone to transfer ownership of his water right?
– Does the law allow someone to lease his water right to someone else?
– Does the law allow temporary transfer of water rights on an emergency basis, in times of need?
– Does the law allow someone to exchange his water right?
– Does the law add a mechanism for enforcing water rights?
– Does the law require or encourage water conservation?
– Does the law encourage water conservation and then allow the owner of the right to sell or transfer some or all of that conserved water?
– Does the law provide for water banking mechanisms?
– Does the law provide an expedited process for short term transfers or transfer of water rights during times of great need, like droughts?
– Does the law allow the use of canals, reservoirs, water support facilities, or streambeds to transport water as part of a water transfer?
Factors that Weaken Property Rights and Raise the Transaction Costs of Trading
– Does the law authorize water districts, irrigation districts, or other member institutions to regulate use and transfer of water by their members?
– Does the law limit water use based on environmental concerns or restrictions?
– Does the law limit the transfer of water rights to protect the rights of other water users?
– Does the law restrict the transfer of water rights to protect the environment?
– Does the law require a third party to be compensated for damage to his water right or when he sells or transfers his water right?
– Does the law provide for or require notice of proposed water transfers?
– Are third parties allowed to protest water transfers, and what is the mechanism for those protests?
* These factor numbers are used to identify the changes in the law illustrated in Figures 6 and 7.
We analyzed each state’s law across the twenty-one water rights variables with respect to three types of legal rules: judicial case law, legislative or statutory law, and administrative regulations. The research involved examining all statutes and cases using Westlaw and Lexis Nexis legal databases and search engines, using keywords and tables of content for each state’s statutes. We accessed administrative regulations separately through legal databases for each state. Treatises, law review articles, and other periodicals also guided the analysis.79 The analysis began with 1980 in order to have a full understanding of the process of legal change, even though our statistical analysis begins in 1987, due to data limitations.
The coding proceeded in two stages. The first stage recorded if any one of the twenty-one factors was present in a state in the year 1980. The presence of the factor would result in that factor being coded “1”, and the absence would result in the factor being coded “0.” We coded a variable as a “1” if it involved a “significant” change in the law, that is, a substantive or procedural change in the law that had a marked alteration in how the law operated. For example, considering the factor whether the law makes the water right more definite or precise, a change in law that shifted a state’s groundwater law from the reasonable use doctrine to an allocation of three acre-feet per-acre per-year was coded as a “1”, while a change that renamed the state’s water agency from the Department of Water Resources to the Department of Ecology was coded as a “0”. In other words, purely formal or stylistic changes were coded “0”, but significant substantive or procedural changes were coded as “1.”80 Court decisions often refer to a statute or an earlier judicial precedent, but merely referring to a precedent may not change the law. Cases or statutes referred to in this way are known to lawyers as “dicta” that is, a discussion that is not germane to the holding of a case. We codified dicta as “0.” Finally, students researched administrative regulations in each state.
79. Research was undertaken by a team of eight law students, with a senior law student supervisor and Robert Glennon as the ultimate supervisor and arbiter.
80. The first step in the coding process required the law students to examine the entire statutory code of each state. Depending on the state and the complexities of its water code, this task may have entailed reading several hundred statutes. This process was necessary in order to establish a base line for the year 1980. After that, web-based research engines became very helpful and efficient because, once a statute was identified, the annotations would lead the researcher to the associated case law. The primary technique used to identify case law was to search using either a known statute or key words that related to each of the factors being researched. Even then, the inexact functionality of search engines sometimes required the law students to read through many cases in order to determine whether the holding of the case actually changed or supplemented the law in any way.
In a year when a particular legal variable was significantly changed, a “1” was assigned and it remained in subsequent years. Significant changes in the same law during another year would also be coded a “1” and thereafter.81 Given the number of legal variables across the three categories, many are perfectly correlated. In our empirical analysis we cannot differentiate between those variables in terms of their impact on water transfers, as discussed below. However, the summary of changes in the legal environment in California provides insights for explaining the results of the statistical analysis.
2. Trends in Legal Change in California
Figure 5 plots legal change across time in California with respect to the twenty-one legal variables divided into those that promoted water transfer relative to those that restricted water transfers. As indicated, the greatest activity for legal change to support water markets were in the years 1987, 1988, 1991, 1993, 1999, and 2003, whereas changes that limited water markets occurred in 1988, 1999, and 2001. Most changes occurred through legislation and those that promoted trading tended to cluster during the time periods described above.
81. For the coding to be meaningful, it was imperative that the law students be consistent in determining whether a factor was present or not. This was not a particularly challenging task for the factors that were precise and concrete, but more difficult when the factors were phrased in general terms. If the case law made the water rights more complicated or nuanced, the water right would not substantively be more definite or precise. Law students only coded a case as making a right more definite or precise if the holding of the decision in fact did so. The statutory and administrative coding presented some of the same challenges but it was not as difficult a process for two reasons. First, state statutes and administrative regulations typically address one specific area of law or policy. It generally is clear what a statute or administrative regulation is attempting to achieve. To the extent that any ambiguity remained after the student had read the statute, there was often legislative history that was helpful in determining a statute’s meaning. To resolve ambiguous issues, the team of law students worked closely together with the supervising senior student and the law professor to resolve how to handle ambiguities. As a final check on objectivity, all of the states were coded separately by at least two law students, and a final review was performed by a third law student.
FIGURE 5 Comparison of Legal Changes that Promote and Restrict Water Transfers over Time02468101214161987199019931996199920022005Number of ChangesPromoteRestrict
Figures 6 and 7 break out the pattern of change by variable. The most active factors in support of markets were making the water right more precise such as defining beneficial use to include trading activities, allowing for the transfer of water rights, separating water from the land for trading, and defining conservation and the trading of conserved water. The most active factors limiting water markets were restrictions on transfers to protect other water users, restrictions to protect the environment, requiring third-party compensation, requiring notice of transfers, and allowing for third-parties to protest and challenge proposed transfers. In the following section we statistically analyze how these legal changes may have affected observed water transfers by identifying when they took place and thereby changed the legal environment in which water transactions took place.
FIGURE 6 Changes in Legal Variables that Promote Transfers024681012141618201234567891011121314Factor Number (Table 2)Number of Changes
FIGURE 7 Changes in Legal Variables that Limit Trading01234567891015161718192021Factor Number (Table 2)Number of Changes
In this section, we empirically model the water transfer process—both the annual number and volume of transfers—as a function of economic and legal institutional variables. As discussed in the previous section, we reviewed the legal institutions that govern water transfers
in the California. This appraisal resulted in a number of legal variables that were perfectly collinear in that they changed in the same year. For example, with respect to legislative or statutory law there were changes in 1988 with respect to the following three factors: whether the law allows an individual to lease his water right to another; whether the law allows temporary transfer of water rights on an emergency basis or in times of need; and whether the law restricts the transfer of water rights to protect the environment. As a result, the three dummy variables representing these three factors were identical because they had the value of ‘0’ in 1987 and a ‘1’ thereafter and thus were empirically indistinguishable from each other. There were many instances of this. Accordingly, we were forced to undertake the modeling process using yearly dummy variables rather than institutional-specific dummy variables.
These yearly dummies are such that once they change from a zero to a one, they remain a one, representing a permanent change in the legal institutional environment. Specifically, dummy variable 1991 is a zero from 1987-1990 and a one from 1991-2005 and by necessity, encapsulates the effect of the institutional (legal) variables that changed significantly in 1990 and 1991. We say both 1990 and 1991 because legislation may have been passed in the latter part of 1990 that could have begun affecting water transfers only in 1991. Similarly, legislation may have been passed in the early part of 1991 that could have affected water transfers in the same year.
In addition to the institutional variables, a number of economic variables representing supply and demand factors likely influencing water transfers were also included as control variables. These included precipitation measures, drought indexes, electricity rates (water pumping and transport costs), gross state product (economic activity and growth), annual state population measures, per capita income, percent in poverty, agricultural gross state product measures (agricultural water supply), lands in farms, planted acres, harvested acres, farm cash receipts, and government agricultural payments.
Table 3 below summarizes our statistical analysis of the yearly number of water transfers in California from 1987 to 2005 using the annual legal change dummies and control variables. Because the dependent variable is a count, the number of water transfers, we use a Poisson model and likelihood methods rather than ordinary least squares (OLS). The Poisson distribution is generally used to model numerical data of this form and is defined as Pr(Y=y|)=(e-y)/y!.
Hence the corresponding log likelihood function for the regression model is
Log L(yilog(i)- i}
where log(i)=Xi
The dependent variable was the number of water transfers, the independent variables were the annual dummies representing legal change, and the controlled variable was the supply and demand for water transfer. We report only the coefficients that were statistically significant.
Lagged Population Change
Dummy 1989
Dummy 1991
Dummy 2000
Dummy 2003
The statistical analysis is quite revealing. On the demand side, we find that among the control variables, increases in California’s population (lagged to control for potential endogeneity) resulted in an increased number of water transfers, all else being equal. This is as predicted. On the supply side, we find that decreases in precipitation led to an increased number of water transfers.82 This result is also consistent with predicted effects. In terms of institutional
82. Precipitation data was provided on an annualized basis from Michael Anderson, State Climatologist, California Department of Water Resources Division of Flood Management. We also collected other climate related supply variables. One was the Sacramento River 40-30-30 Index (SIR) from the California Department of Water Resources. It measures the amount of water-year flow in the Sacramento River. We used the precipitation data as opposed to the SIR for two primary reasons. First, the SIR is calculated as a weighted-moving-average of the current year’s water flow and the past year’s water flow. However, the current year’s water flow is based on a water-year (October-September), while our water transfer data we are predicting is based on a calendar-year (January-December). Both the weighted-moving average and the water-year aspect of the SIR make it a more difficult variable to predict water transfers. Secondly, the SIR measures the water flow only in the Sacramento River. In our
effects, we find the dummy variables associated with legal changes 1989, 1991, and 2000 had a significant impact on the number of water transfers. We include the dummy for 2003 to be consistent with the regression for the volume of water transferred. The dummy for 1989 reflects the effects of 1988 legislation providing that decreed riparian rights may be transferred, and as such, it had a positive effect on the number of water transfers once the law was operational. The dummy for 1991 reflects two things. First, the important effect of the creation of the Emergency Drought Water Bank by the state legislature in 1991, which promoted short term exchanges from agriculture to urban uses. Second, the likely effects of 1992 changes in legislation that allowed water providers to transfer water conserved by their members. Also in 1992, the Federal Central Valley Project Improvement Act was enacted and smoothed the process for the transfer of water provided by the Bureau of Reclamation, a major water supply institution in California, by individual farmers. The discussion in Section II provides more detail as to why these institutional changes should have a positive effect on the number of water transfers in California. Finally, we find that the dummy for 2000 is both significant and negative. In 2000 and 2001 there were judicial rulings that limited water transactions if there were potential environmental damages, and in 2001, the California Legislature approved statutes that required increased third-party notice of proposed transfers and facilitated third-party protests of such actions. All else being equal, these legal changes appear to have reduced the number of transfers.
We also empirically modeled the quantity of water transferred as measured by annual flow. Specifically, we estimate the linear model: Y=X.
In this model, X represents the vector of economic and institutional variables discussed above. Table 4 presents the results of our statistical analysis of the determinants of the annual quantity of water transferred, as measured by the annual flow of water among the parties as stipulated by the contract. This is the standard way of reporting water transactions as reported in the Water Strategist.
data set, water transfers occur throughout the state of California and we needed a more comprehensive measure. A second climate related supply variable that we collected was the Palmer Drought Severity Index (PDSI) for the state of California. The drought measure did not perform as well in predicting water transfers as did the precipitation variable.
Standard Error
Lagged Population Change
Dummy 1989
Dummy 1991
Dummy 2000
Dummy 2003
As shown, the coefficient signs are the same as reported for the analysis of water transfers, but the statistical significance has changed in some cases. This is not surprising in that the two dependent variables, although similar, do differ importantly in some years.83 We find that the population change coefficient remains positive and the precipitation coefficient remains negative, although the statistical significance for both variables has been reduced. We also find that the 1989 dummy and 2003 dummy are statistically significant and positive. Again, the dummy for 1989 likely represents the 1988 legislation providing that decreed riparian rights may be transferred, and as such, it continues to have a positive effect on the volume of water transfers. The positive coefficient for the 2003 dummy reflects the effects of important 2003 legislation that strengthened water rights in California by defining them more clearly, including what constituted beneficial use and allowing for sale or lease of conserved water. A 2003 court ruling also strengthened water rights.84 Although, as shown in Table 3, the 2003 dummy is not significant for the number of transfers, it does have a statistically significant effect on the volume traded. Accordingly, the 2003 legislative changes may have facilitated larger water transactions.
83. See supra Figure 1.
84. 27
Scholars such as Ronald Coase, Douglass North, and Oliver Williamson have emphasized the importance of institutions, institutional change, and transaction costs in molding economic behavior.85 Legal institutions, especially as they relate to property rights and regulation of markets, critically influence trading activity. At the same time, the need to facilitate trade provides political and economic pressure for the modification of existing or the introduction of new laws and regulations to support market exchange. How completely the institutional environment responds will determine how quickly and effectively market activity can respond to exogenous changes in prices.
In this Article we examined the interaction between legal change and market activity regarding water in California in the spirit of the New Institutional Economics. Our approach suggests that quantifying otherwise qualitative measures of legal change and statistically analyzing their impact on observed market behavior can be a useful mechanism for analysis within the New Institutional Economics to better understand the interplay between economic factors and the law.
With a rapidly growing population, increased demand for recreation and environmental quality, and a semi-arid climate, more and more water must be transferred from historical uses in agriculture, where eighty percent of it has been devoted, to urban and environmental uses. The development of water markets for voluntary exchange of water through leases of water and sales of water rights are an important institutional reaction. Water market institutions require changes in water rights and regulations to allow for increased water transfers from traditional uses and originating watersheds. These legal changes take place in legislatures, courts, and administrative agencies, and we have chronicled those changes from 1980 through 2005. Many of these changes are spurred by drought, which has often stretched California’s already tight water supply and demand conditions. At the same time, the institutional structure of California water rights and water supply organizations determine that much more water trading occurs through one-year leases in the state than elsewhere in the West, where water rights sales and long-term leases are more prevalent. As climate change occurs and precipitation patterns become even more variable, and as California’s urban population continues to grow with an increased demand for recreation
85. 28
and environmental water uses, there will be additional pressure for legal changes on how to reallocate water in a smooth and cost-efficient manner.



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