How water markets would make America’s Western cities sustainable

In the seven states dependent on the Colorado River watershed – Arizona, California, Colorado, Nevada, New Mexico, Utah, and Wyoming – users draw 15% to 20% more water than the river can support in a typical year. The results are visible in the dwindling water levels of Lake Mead and Lake Powell, the two main human-made reservoirs along the Colorado River. Overuse in the Rio Grande watershed and on the western slope of Utah’s Wasatch Mountains has similarly caused drastic declines in the water levels of the Elephant Butte Reservoir and the Great Salt Lake.

The problem will almost surely get worse in coming years, for three reasons:

1. Climate change will generally cause dry places to get drier. Climatologists predict that rain and snowfall in the Rocky Mountains will reduce the Colorado River’s flow by 10% to 20% by late in this century.

2. The West’s reservoirs are silting up, just as human-made reservoirs have done throughout history, reducing the capacity of the system to hold water

3. Population continues to grow rapidly in most leading Western and Southwestern cities outside Southern California. Total population in the major metropolitan areas of Texas, Oklahoma, Colorado, New Mexico, Arizona, Utah, and Nevada has increased more than 20% since 2010. The West is also adding enormous industrial facilities that will consume vast amounts of water, such as Taiwan Semiconductor’s new Phoenix area fabs.

None of the fixes proposed over the last 50 years will solve the problem. Building more dams won’t work. The Colorado River hydraulic system already captures all the water flowing through the river and its tributaries, so no water escapes to the Gulf of California at the river’s mouth. Federal water engineers had dreams in the 1960s of diverting water from further away – for instance, from the Mississippi, Columbia, or even Yukon rivers. But they have long since abandoned those proposals in the face of unmanageable price tags and opposition from environmentally minded voters.

A more practical fix is to reduce the farm sector’s water consumption, which takes up about 80% of diverted water in America’s Western states. Agronomists – including visitors from dry but water-efficient places like Israel – have long marveled at the wasteful practices of much Western agriculture and urged improvements like drip rather than flood irrigation. While some crop producers are working to adopt more water-efficient methods, the Western agriculture sector remains prodigiously wasteful of water resources.

Another way federal authorities have reduced the farming sector’s water use is by paying growers not to produce. Between 2022 and 2024, the federal government saved a significant amount of water by paying farmers in the driest growing areas of Arizona and California to leave some fields fallow.

However, agricultural landowners have little incentive to invest in water-saving technology when public-sector authorities give them abundant water at rock-bottom prices. Landowners in California’s Imperial Valley, moreover, made clear that they view recent deals to fallow fields in exchange for federal payments as strictly temporary. Fallowing remains an “evil F-word” in the Imperial Valley, a Los Angeles Times article reported.

Agricultural interests typically have senior claim on water resources under the doctrine of prior appropriation, the heart of Western water law. Prior appropriation, which awards water rights in perpetuity based on who started using it first, means municipal and industrial users would lose all access to water in a sufficiently bad drought before long-time agricultural landowners lost a single drop. Prior appropriation also applies to whole states under the seven-state Colorado River Compact of 1922. Since California’s population grew large before that of other Western states, water authorities would, in principle, shut off water supply to metropolitan Phoenix altogether before reducing flows to either Los Angeles or the Imperial Valley.

Falling supply, increasing use, and prior appropriation together present an existential threat to Western cities. If precipitation declines 20%, water use falls to match reduced supply, and courts enforce prior appropriation, Phoenix and other Western cities will not only stop growing but will also face drastic population shrinkage – and America’s metropolitan experiment in the arid West will effectively come to an end.

The simple case for allocating essential commodities like water through market mechanisms is that freely fluctuating prices bring supply and demand into equilibrium. If the amount of a commodity demanded by users exceeds the available supply, higher prices signal to suppliers that they should bring more supply online and to users that they should conserve.

In the case of Western water, wider reliance on markets would raise prices for many users, who would use less water. Higher prices would incentivize players with excess supply to sell to the highest bidder. Fort Worth, Texas, billionaires Edward and Lee Bass demonstrated how powerful this incentive can be when they invested $60 million to become large Imperial Valley landowners in the 1990s, struck a deal to sell some of their water rights to the city of San Diego, California, and ultimately sold the whole investment to a public corporation for $250 million several years later.

The Bass episode also illustrates just how underpriced the Imperial Valley’s water is. Federal authorities in those years sold water to the valley’s landowners at prices less than 5% of what San Diego was willing to pay.

The case for bureaucratic fiat, by contrast, is that vital resources like water should be under democratic rather than private control. Critics of water markets argue, as one activist organization put it, that water “should not be commodified, privatized, or traded for commercial purposes.” From this standpoint, central planners should allocate water based on what they view as the public desirability of different uses, rather than allowing bidders willing and able to pay the highest price to get first in line.

Elwood Mead, a leading 19th century water engineer who devised Wyoming’s strict system of prior appropriation – and for whom Congress named Lake Mead – vehemently opposed private markets for water. Citing the example of then-dominant copper and oil producers, he warned that deep-pocketed firms would monopolize water supplies.

Water markets do pose additional theoretical challenges. It’s hard to standardize contracts, making every specific package of water rights different. Information asymmetries are likely across market participants, which could cause harm to small players. And if some private landowners cash in by selling rights to users outside their region, declining agricultural activity could have detrimental spillover effects for others in the community, like seed vendors and day laborers.

Water market proposals also raise the thorny question of who should reap the windfall profits if market prices are higher than government-administered prices. If policymakers were to deregulate water markets but maintain prior appropriation, then large landowners with senior claims would be able to sell part or all their water entitlements for large gains.

One solution would be for federal and state policymakers to throw out the doctrine of prior appropriation. It exists only in statutory and case law, so lawmakers are free to override it. Then they could auction off water rights over time. Taxpayers would receive any profits from selling water for more than the cost of storing and delivering it.

But overriding prior appropriation rights risks undermining markets, since governments create significant uncertainty when they threaten to revoke or dilute the value of tradeable privileges bestowed in the past. Economists sometimes call this the “taxi medallion” problem, named for New York medallions that give owners the valuable right to operate a yellow cab. Current rights holders, moreover, would likely sue public authorities for engaging in inappropriate “taking” – a legal gray area that could slow the emergence of well-functioning water markets.

Still, none of these concerns is sufficiently compelling to disallow water markets. Americans are accustomed to “commodified” markets for basic necessities like food and, indeed, bottled water. The government has more tools to prevent monopoly abuses or subsidize water supply for low-income people than it had in Mead’s time. Full standardization of water contracts isn’t necessary, since transactions would be between large, sophisticated businesses.

Economic distress in nonviable agricultural communities would be tough for people living there, but there’s no other industry where the government tries to freeze existing towns in place by prohibiting companies from moving assets elsewhere. And if the government revokes prior appropriation privileges gradually rather than all at once, participants would have time to adjust – even if current rights holders wouldn’t like it.

America’s experience allocating water by fiat is in actuality a far cry from the egalitarian model that central planning advocates have in mind. When Congress entered the dam-building business with the Reclamation Act of 1902, sponsors imagined a future in which federal water initiatives would support the westward spread of small yeoman farmers, who would pay the full cost of dam building through water prices.

Almost from the start, the reality ran counter to this vision. The Bureau of Reclamation, charged with building and operating the West’s water system, sold water to early appropriators – or to powerful interests able to accumulate prior appropriation rights from others – at prices far too low to recoup capital expenditures. Crop growing also turned out to be much less economically viable than expected without massive subsidies. Within several decades, costs per irrigated acre were more than 15 times higher than the bureau had projected, as Marc Reisner recounts in his book Cadillac Desert: The American West and Its Disappearing Water. Eastern politicians noted throughout the 20th century that Congress subsidized Western farmers to grow crops they were paying eastern farmers not to grow.

Bureaucratic water allocation also gave rise to a long history of injustices. An early example was the Los Angeles water authority’s infamous grab of the Owens River Valley’s water rights – a fraud that became the basis for the classic film Chinatown. In New Mexico, state and local authorities for decades conspired to expropriate Hispanic farmers and turn their water rights over to wealthy White landowners at ultra-cheap prices, also the basis for a hit movie, The Milagro Beanfield War.

Massive subsidies have yet to make a success of desert agriculture in the West. The six Colorado River Compact states other than California account for just 4.6% of U.S. agriculture output and 4% of farm employment, according to the U.S. Department of Agriculture. California’s share of output – larger than that of the other states at 11% thanks to immense subsidies – has been declining for decades.

The principal effects of centrally planned water allocation in the West have been to make certain crops – notably alfalfa, used primarily as cattle feed – are cheaper than they would otherwise be and to enrich a small number of large landowners. In Southern California, the leading beneficiaries have, at times, included Chevron and Prudential Insurance, which diversified into agricultural land because water subsidies were so attractive.

In the Imperial Valley, a desert area that receives only 3 inches of rain per year, 20 families receive half the water flowing to the area, amounting to about 10% of all Colorado River water. Federal authorities allow Imperial Valley landowners to buy water even more cheaply than other farmers. Not surprisingly, they use copious volumes of water – more than three times as much per acre as the average Western farmer, according to Stanford University legal scholar Barton Thompson.

Water markets have taken root in the United States and elsewhere, but only to a limited extent. Western states, which largely banned appropriators from selling water rights separately from underlying land in the 20th century, now mostly permit water rights transactions under some circumstances.

Regions that have seen the most trading activity include Southern California, Arizona, Colorado’s northern Front Range, and the San Antonio, Texas, area, according to WestWater Research. Australia has led the world in adopting water markets, with one-tenth of the water in the nation’s southeastern Murray-Darling Basin trading each year.

In Arizona, water markets have played a pivotal role in the growth of the Phoenix metro area. In one transaction that proved controversial with agricultural interests, the booming suburb of Queen Creek acquired water rights from several private landowners in the farming town of Cibola on the main stem of the Colorado River.

New companies are emerging like New York-based Water Asset Management, which buys agricultural land, shifts to water-efficient crops like baby lettuce, and sells excess water rights. One of Water Asset Management’s senior executives comes from a leading Imperial Valley family, suggesting a growing acceptance of water markets even in places that have most bitterly resisted them.

Wider adoption will require states and localities to make several policy changes, according to experts like Barton Thompson and Arizona State University law professor Rhett Larson:

• Create consistent processes to define specific water rights. For instance, define how a buyer can use tradeable credits that arise under the legal arrangements of Arizona and a few other states when a water rights-holder recharges an aquifer by releasing some of their water into the ground.

• Define permissible uses for certain kinds of water, like “produced water” recovered from oil or gas wells.

• Make water rights secure and enforceable. Allow owners to unbundle water rights from ownership of specific land parcels.

• Regulate surface and groundwater withdrawals to promote conservation and make water rights valuable. Legal credits for refilling an aquifer have no value in places like California that mostly don’t regulate groundwater withdrawal.

• Repeal or loosen antispeculation laws that prohibit investors from buying water rights for investment purposes. Market makers play a vital role in creating well-functioning markets.

• Prohibit local authorities from intervening arbitrarily to block specific water rights transactions.

Widespread adoption of water markets would likely result in significant transfers of water from agricultural to municipal and industrial uses and from water-inefficient to water-efficient crops. Total water use would decline, partly because water would be more expensive for agricultural landowners. Farmers would more aggressively pursue drip irrigation. Additionally, residential neighborhoods use much less water than farms use on an equivalent quantity of land.

Some agricultural commodities – especially beef – would become more expensive, since the amount of heavily subsidized alfalfa growing land would decline. True, recent inflation has raised concerns about high and rising food prices. But water-efficient crops would become more abundant and thus cheaper, offsetting higher beef prices.

Living in Western metropolitan areas might become more expensive. Developers in places like Queen Creek would have to outbid other potential users for water rights, so home prices might increase. On the other hand, more land would become available for residential development, which might mitigate these effects.

Most significantly, America’s fragile Western “oasis civilization,” as author Wallace Stegner called it, would become more sustainable in the long run. (Some cities, like Phoenix, would still be extremely hot in the summer, so sustainability would remain uncertain.) Western cities that perform better than most other U.S. cities for offering people economic opportunity and affordable quality of life would be positioned to keep growing.

We should hope they succeed. As the writer Joan Didion famously wrote about the American West, “Things had better work better here, because here, beneath that immense bleached sky, is where we run out of continent.”

About the series

Waters of the West is a special report from the George W. Bush Institute. This four-part series aims to answer key questions surrounding urban development: Will water availability hinder growth in Western U.S. cities? What can be done to ensure that these high-opportunity places are sustainable?

To answer these questions, we spent months speaking with policy experts and stakeholders. We also looked at water usage data and state water plans where available.

Read the full series