Modelling Spot Water Markets Under Uncertain Water Supply

Water availability in semiarid regions usually exhibits patterns of extreme variability. Even in intensively controlled basins, some users are subject to low levels of water reliability, and more vulnerable to periods of extreme scarcity. To reduce their risk exposure more flexible instruments, such as voluntary exchanges of water among users, are required. Recent changes in the Spanish water Law have given an initial impulse to allow for leases of water use rights. Properly designed and monitored, this instrument provides some flexibility to water management, and may increase the economic use efficiency as well as mitigate the adverse economic effects of droughts. This paper looks at the risks and uncertainty dimensions of water markets, which have not been paid much attention in the literature. It analyses, from theoretical and empirical standpoints, the role that uncertainty plays in market participants' decisions and its impact on gains from trade. Two models have been developed to carry out the empirical application. One is a stochastic and two-stage discreet programming model which simulates irrigators behaviour and the other is a spatial equilibrium model to compute market exchange and equilibrium. Water market price endogeneity is solved by an iterative process, which characterise price uncertainty from the results obtained from the spatial equilibrium model. Hydrological risk is characterised at the irrigation farm level through the variation of the water allowances served for irrigation. The application is performed on eleven irrigated farms in a district of the Guadalquivir Valley (Southern Spain. It is shown how water availability uncertainty reduces farmers' benefits because of the fact that they must take ex-ante decisions. However, if market participation is allowed once water allowances become known, even at an uncertain price, the benefit losses are partly mitigated. From a methodological standpoint, these results suggest that the agricultural water market benefits estimates found in the literature may be undervalued as a result of omitting the option to participate in the market in the mix of possible strategies. Exchanging water in annual spot markets allows for the reduction of farmers' economic vulnerability caused by the variability and uncertainty of water supply within an irrigation season.