Transaction costs and third-party impacts with and without proposed legal changes in Colorado's prior appropriation water markets

Water markets are frequently proposed as mechanisms for water reallocation, adaptive water management, and demand-side management. Decades of academic literature has identified transaction costs present under prior appropriation water law, the prevailing water allocation system in the western U.S., as a barrier to efficient, adaptive water markets. These transaction costs, however, limit third-party impacts to other water users. Few studies have estimated these costs, and no studies have estimated them from an ex ante decision-making perspective or under proposed changes to western U.S. water law.

We estimated ex ante transaction costs and approval times to trade water rights with and without legal changes that were suggested by practitioners using an economic stated preference survey of 100 repeat participants (water attorneys and hydrologic consultants) in Colorado's water markets. The stated preference survey also explored which legal changes present the highest potential for third-party impacts to other water rights holders. Under current law, transaction costs are significantly higher in more contentious regions and for more senior water rights, and transaction costs and approval times are significantly higher for more contentious procedural outcomes and exhibit large economies of scale. We project significant decreases in applicants' transaction costs under three legal change scenarios. One legal change, abolishing or limiting historical use analysis, also presents lower potential for third-party impacts. Our two-step statistical framework for calculating the expected value of transaction costs first estimates the likelihood of procedural outcomes (e.g., settlement, court trial) and then estimates transaction costs with those outcomes. This work develops a replicable approach for measuring water market transaction costs.