Would water rights trading work for Saudi Arabia?

There is an argument that there would be less need for desalination or water reuse in Saudi Arabia if only there was a developed market for water rights. The problem with water is not that it is running out, but that too much of it is being used in the wrong places. If there was a market mechanism to transfer water from low-value agricultural uses to high-value urban uses, which adequately compensated farmers, then it would not be necessary to invest so much in developing new supplies.

The country with the most developed water rights market is Australia. In 2007/8, the total value of trades was A$1.6 billion (US$1.4 billion). In the 2008/9 water year, the total value of trades was A$2.8 billion (US$2.5 billion). The 2009/10 water year (which ended in June) is expected to show continued growth in the market. The real driver there is not so much demand for water (which has slackened off a bit as a result of wet weather), but the development of water exchanges with a reasonable degree of liquidity. Probably the most sophisticated of these is Waterfind (see www.waterfind.com.au). This is an electronic trading platform which automates 19,000 irrigation district water trading rules to simplify the trading process. It brings together the widest possible range of buyers and sellers to create a liquid market with transparent pricing and fast trading 24/7. Tom Rooney, the CEO of Waterfind, has been able to create a virtuous circle in which increased market liquidity has served to attract more market participants, which in turn has led to increased market liquidity. Besides enabling farmers to manage and maximise the value of their irrigation portfolios, the market has also attracted serious financial investors. In this month’s GWI we report on a new A$100 million (US$90 million) fund dedicated to the Australian water rights market, and plans by Summit Water Asset Management to develop storage capacity so that it can hold water as well as trade it. The arrival of financial buyers has also served to increase the liquidity of the market, enabling irrigators to sell surplus water (either annual “allocations” or permanent “entitlements”) even when there are no agricultural buyers. Similarly, when there are more buyers than sellers, financial owners of water can help out.
Besides financial buyers, the government has also become involved in the water market, buying entitlements to reduce the water overdraft in the Murray-Darling Basin.

The Waterfind system could probably be adapted for certain markets in the Western US. An effective trading platform would undoubtedly help increase liquidity in a market which is largely conducted through brokers and offers no transparent spot prices. However, the real challenge is establishing a new system of tradeable water rights in a country where there is currently no such system, and where there is a large water overdraft, such as Saudi Arabia. In that country, an estimated 84% of the water supply comes from non-renewable groundwater, the availability of which is declining every year. Desalination provides only 5.5% of the supply, while 88% of water usage is in agriculture.

The phasing out of wheat subsidies in Saudi Arabia should suppress agricultural water demand, but as long as farmers treat groundwater as a free asset, there is going to be a significant implied subsidy in the opportunity cost of using groundwater in agriculture rather than in industry or for domestic use. The cost of distilling seawater at the coast and pumping it across to Riyadh may be as much as $6/m3. Agricultural production represents 3.2% of the Kingdom’s GDP, which amounts to $23 billion. The Saudi agricultural sector consumes 21 billion m3 of water per year, so the average value of the agricultural produce generated by a cubic metre of water in Saudi Arabia is $1.10 (including government subsidies). There is certainly a trade to be made.

The problem is how to introduce it. The reality of water use for agriculture has been the law of the biggest pump. This is the way water rights are determined in most water-scarce countries, and it is very difficult to pedal back from. Giving people rights based on what they have been pumping historically, then buying them back, would be a horrible thing to do economically, but the alternative – not creating a system of rights – is worse because it simply perpetuates over-pumping and wastage. Without putting a value on water rights, there is no financial interest in monitoring their exploitation successfully.

What is needed for large water overdraft countries such as Saudi Arabia is some sort of tapering water right, which takes the status quo as the base, then reduces entitlements by a fixed percentage each year until a sustainable level of water withdrawal is reached. For example, the title to 15 billion m3 of groundwater per year could be issued to farmers today, on the condition that that entitlement were diminished over a period of five years to 5 billion m3.

The best thing about this arrangement would be that although farmers would have the entitlement to just one third of the water they started with, the rights that they owned could well be worth three times as much. This is partly the result of the law of supply and demand, and partly because the development of the water rights market over that period would ensure other higher-value buyers of water entered the market. With a water grid based on the Saline Water Conversion Corporation’s long-distance pipelines, it might be possible to reach an equilibrium in the country where the value of groundwater was bid up closer to the cost of desalinated water. Higher prices would help suppress demand, although if in the longer term, population and economic growth continued to push demand up beyond what could be drawn in from the agricultural sector, entrepreneurs could build desalination and storage facilities to fill the gap.

At the moment, only Australia and the Western US have a system of tradeable water rights. Europe and the Eastern US have riparian systems of water rights which are not tradeable. Israel has a closely monitored system of annual allocations, and the rest of the world essentially relies on the law of the biggest pump. This cannot continue forever. With increasing claims on a limited amount of water, tradeable rights seem to be the only way to allocate water around an economy so that it is used most efficiently, and so that those surrendering their right to water are adequately compensated.