Understanding water rights demand and supply: Are non-market factors important?

December 2nd, 2014

Professor Guillermo Donoso, Water Law and Economics Center, Pontificia Universidad Católica de Chile

If markets are “perfect,” non-productivity-related factors ought not to enter price determination. However, several researchers have found that water rights (WR) are heterogeneous and their price varies according to their attributes1, geographic location2, and buyer and sellers’ characteristics3. With respect to the influence of the agent’s characteristics, researchers have found that buyers and sellers’ characteristics and their bargaining power significantly affect WR prices4.

Research on WR markets in Chile has emphasized intersectoral allocations5; however, WR demand and supply functions have not been estimated for the case of Chilean WR markets nor have the factors that influence WR demand and supply functions been studied or identified. This research estimates consumptive WR supply and demand functions for Chilean WR markets and identifies their determinants such as WR characteristics (e.g. geographic location) and agents’ attributes that influence the bargaining process (e.g. water market experience) as well as sectorial characteristics (agent’s economic sector and sectorial incomes).

The research is conducted in the WR market of the First Section of the Maipo river basin (1SMaipo), Metropolitan Region of Chile, where the average price of each traded WR is 90,160 Chilean pesos (approximately 150 US $); although WR market prices are subject to considerable variance, as evidenced by a coefficient of variation of 414%. The Maipo river is the main river that flows through Santiago de Chile. The Maipo River travels 250 km before reaching the Pacific Ocean near Llolleo, south of the port of San Antonio (see Figure 1). The Maipo river basin serves an irrigated area of around 127,000 ha out of a total catchment area of 15,380 km2 and supports rapidly growing industrial and urban sectors.

Chile’s Water Code of 1981 specifies permanent and contingent WR, as well as consumptive WR for both surface and groundwater, and non-consumptive WR for surface waters. Non-consumptive WR allow the owner to divert water from a river with the obligation to return the same water unaltered to its original channel. Consumptive water use rights do not require the water to be returned once it has been used. Consumptive and non-consumptive WR are specified by law as a volume per unit of time. However, given that river flows are highly variable in most basins, these WR are recognized in times of scarcity as shares of water flows.

The results indicate that the WR market within the 1SMaipo presents a great variability in prices and traded WR quantities. Results show that water rights prices have increased over the study period (July 1998-June 2003). Additionally, market prices present a high degree of variation, with a coefficient of variation of 414%. This price dispersion can be explained in part by differences due to geographic location, buying and selling agent’s attributes, such as agent type, previous WR market experience, and net income.

The main participants in the market are the agriculture and real estate sectors, with agriculture being the main buying and selling agent, accounting for 57% and 68% of total transactions respectively. Most water does not move away from the agricultural sector, but moves between agricultural users. This pattern reflects the high value of water to the agricultural fresh fruit and wine exporting sectors. Even so, there is an important amount of trading of water from agriculture to other socio-economic sectors, such as urban areas, which has allowed for the reallocation of water to satisfy growing water demands outside of agriculture.

The results indicate the importance of non-productivity factors such as an agent’s WR market experience: buyers (sellers) with previous WR market experience obtain lower (higher) WR prices due to their greater negotiating ability. There are also significant differences in WR prices at different water intakes. These significant differences are due to the uncertainty with respect to the feasibility of transferring rights. On the other hand, the results show that as water flow increases WR prices decrease. This result emphasizes the importance of providing adequate and timely information for potential water buyers and sellers of WR.

Additionally, estimates of market demand and supply functions of WR show that market forces do indeed drive market WR prices. Demand is inelastic to WR prices while supply is elastic to WR prices. Furthermore, supplied and demanded WR quantities are functions of the water right price as well as the type of buyer and seller agent, the agent’s profits, the geographic location of the water right, and the scarcity of water supply. Additionally, the agent’s previous WR market experience is an important determinant of WR demand and supply. This result supports the idea that prices are determined by a bargaining process. Additionally, our results support the hypothesis that buyer and seller’s characteristics are important determinants of WR demands and supplies.

References:

Bjornlund, H., 2002. Signs of Maturity in Australian Markets. New Zealand Property Journal July, 31-46. Hadjigeorgalis, E. and C. Riquelme, 2000. Análisis de los Precios de los Derechos de Aprovechamiento de Aguas En el Rio Cachapoal. Ciencia e Investigación Agraria 29 (2), 91-100. Wheeler, S.; Bjornlund, H.; Zuo, A.; Shanahan, M., 2010. The changing profile of water traders in the Goulburn-Murray Irrigation District, Australia between 1998-99 and 2003-06. Journal of Agricultural Water Management 97(9), 1333-43. Brookshire, D., B. Colby, M. Ewers, and T. Ganderton., 2004. Market prices for water in the semiarid West of the United States. Water Resources Research 40, W09S04, doi:10.1029/ 2003WR002846. Hearne, R. and G. Donoso., 2014. Water Markets in Chile: Are They Meeting Needs? Chapter 6: 103-126. In Easter, W. and Q. Qiuqiong (eds.) Water Markets. Springer-Verlag.

Guillermo Donoso obtained his PhD in Agricultural and Natural Resource Economics at the University of Maryland, College Park. His has carried out research on water economics, water allocation mechanisms, water markets, and user based water management. At present he is a Full Professor of Agricultural Economics Department of the Pontificia Universidad Católica de Chile. He has been Director of the National Agricultural Research Institute of Chile and held the position of Dean of the Facultad de Agronomía e Ingeniería Forestal of the Pontificia Universidad Católica de Chile from 1998 to 2007. Previously, Guillermo was Chair of the Agricultural Economics Department between 1995 and 1998.

The views expressed in this article belong to the individual authors and do not represent the views of the Global Water Forum, the UNESCO Chair in Water Economics and Transboundary Water Governance, UNESCO, the Australian National University, or any of the institutions to which the authors are associated. Please see the Global Water Forum terms and conditions here.