Water trading is easier said in theory than done in practice

Water trading allows a valuable resource to be reallocated to the highest value user. But putting it into practice turns out to be easier said than done, as professor Keith Weatherhead explains.

Worldwide, growth in populations, living standards and changing diets are increasing demand for fresh water, while in the UK and elsewhere, there is pressure to improve the environmental protection for our water bodies and reduce a historical over-allocation of water.

Climate change adds to this mesh of challenges. It is pushing up the need for water, particularly for farming, and reducing the available resource. Drier summers and more frequent droughts spell serious problems – even for the UK’s apparently verdant environment. It is therefore unsurprising that the UK government is looking for ways to use our remaining water resources more effectively.

Defra’s ongoing review of the water abstraction licensing system has highlighted water trading as one option to reduce water scarcity. From the economic viewpoint, the advantage is clear – trading allows water to be reallocated to the highest value user. But putting this into practice is complex.

First, we must be clear about what we are trading. Trading water as water is of course what water supply companies do: abstracting it from a source and selling it to customers, usually (but not necessarily) after treatment. Most farmers receive some or all of their treated water via the public water supply.

However, this is not the interpretation of water trading Defra is concerned with. In this context, we are talking about trading abstractions and abstraction licences along streams and rivers, in the short or long term.

Some licences are used only for irrigating low-value crops, while neighbours are unable to obtain water for higher value uses – trading would unlock the additional value. Even in dry years, most abstraction licences are not fully used. Some licences are never used and a risk of introducing more trading mechanisms might be an awakening of these “sleeper licences”, leading to more abstraction.  

Trading licences is already possible, by joint application to the Environment Agency, although there are few recorded examples.  

But this lack of evidence may be misleading. There is probably a great deal of “hidden” water trading within the agricultural sector, for example. Many irrigated crops are grown by contractors who move their crops between farms in a rotation to minimise disease; the farmer rents out the land and in effect sells the water to the grower for that year. Long-term trading is achieved by buying the land or the point of abstraction.  

Could a more active market be achieved, based, say, on a fortnightly auction? Farmers might buy and sell their allocated volumes to neighbours and water companies as the year progresses. Various research groups have tried modelling what might happen if this was rolled out. Cranfield University’s Engineering and Physical Sciences Research Council-funded Transforming Water Scarcity Through Trading project is modelling the potential gains if farmers optimised their abstractions under different trading rules. Meanwhile, Defra-funded researchers are using agent-based modelling to study what farmers, water companies and power generators might do. Neither turns out to be simple.

Unlike normal markets, where anyone can trade with anyone, a water market has to be hedged with restrictions. The regulator wants water traded only downstream along a river, to maintain stream flows and ensure there is no increase in overall abstraction when flows are low.

The original hands-off constraints must be passed on to the purchaser, but may be inappropriate at the new abstraction point. Prohibiting trading of sleeper licences would be relatively easy, but controlling increased use of partially used licences poses bigger problems, given the large normal variations in annual abstractions for irrigation.

With every abstractor having a different use profile, trading will probably change the timing of when water is abstracted – could that create a problem? Can anyone guarantee the water will reach the purchaser? Some of the water will be lost to evaporation, and another abstractor between the traders might legally abstract it under his own licence.  

Trading abstraction licences from groundwater raises further issues. Flow limits and hands-off water levels are set for every borehole to avoid derogation of neighbouring boreholes and environmental sites. Trading that involves moving the point of abstraction may require extensive studies and test pumping; potential trades may therefore need to be pre-approved, which hardly helps towards a dynamic short-term market.

Trading around ponded systems, such as the polders in the Fens, avoids many of these issues: water can be put into the drainage dykes and taken out anywhere, so it is perhaps there that we will first see effective trading.

Should we be looking for more sophisticated answers, such as piped systems for untreated water backed up by storage reservoirs? These networks are starting to appear between groups of farmers in the east of England. In Italy, some farmers obtain their allocated volumes from their water user associations using credit card-type controls (see photo); these could be adapted for trading water allocations and smart tariffs. Water companies could have an important role in promoting and operating such systems.

Are we likely to see more trading in the UK? Almost certainly, as the rising scarcity and value of water forces users to overcome the hurdles. Whether government can lower the barriers sufficiently to create active short-term markets along UK rivers is questionable. If trading does occur, how long before neighbours and environmental bodies start blaming the traders for any deterioration?   

Water trading promises much, but if we don’t get it right, it could be the lawyers who stand to gain the most.