Emory Law Journal

Trading Water: Using Tradable Permits to Promote Conservation and Efficient Allocation of an Increasingly Scarce Resource
Paul W. Puckett J.D., Emory University School of Law, Atlanta, Georgia (2010); B.S., The University of Tennessee (2005). I would like to thank Professor Jonathan Nash for his helpful guidance and suggestions and the editors and staff of the Emory Law Journal for their assistance editing this Comment.

Abstract

Growing populations and changing climate patterns are causing water shortages in areas that have not previously experienced such water scarcity. Governments are forced to implement short-term ad hoc measures to address shortages because they have not implemented long-term conservation and efficient-use policies. Permanent policies that conserve and more efficiently allocate water resources should be implemented to prevent, or more effectively manage, water shortages.

This Comment argues that a free-market system for water-use rights should be implemented to address and prevent water shortages. A water market system would require that secure property rights be attached to water use and that those rights be freely tradable. Current water-rights regimes used in the United States are not sufficient to support such a market system because current regimes do not grant secure property rights in water use, and it is unclear to what extent water-use rights can be transferred. Therefore, a market system under the current water-rights regimes would not be able to maximize its potential to promote efficient allocation of water resources.

This Comment argues that tradable permits for water use should be used as the currency of a water market system. A water use permit would secure for its holder a right to a certain level of water use and would be freely tradable. The aggregate level of sustainable water withdrawal and consumption would be determined by the state, and the water-use permits would be distributed to current users at no cost. The amount of use allowed by the permit would be based on each user’s current and historical water use. The permits could then be traded in a market, encouraging efficient use, conservation, and the highest economic allocation of water resources.

Introduction

Due to growing demand from expanding populations and industry and an increasing frequency of drought conditions, water shortages in the United States have been increasing. 1 See Joseph W. Dellapenna, Interstate Struggles over Rivers: The Southeastern States and the Struggle over the ‘Hooch, 12 N.Y.U. Envtl. L.J. 828, 828 (2005) [hereinafter Dellapenna, Interstate Struggles] (noting that the southeastern U.S. region experienced the worst drought in its recorded history in the 1980s and still worse drought conditions at the beginning of the 21st century); Joseph W. Dellapenna, The Law of Water Allocation in the Southeastern States at the Opening of the Twenty-First Century, 25 U. Ark. Little Rock L. Rev. 9, 10 (2002) [hereinafter Dellapenna, Water Allocation] (stating that in the eastern half of the United States, growing demand and erratic climate patterns have caused more frequent shortages); Felicity Barringer, Signs of Another California Drought Year, N.Y. Times, Jan. 2, 2009, at A15 (“California, just finished with its second consecutive year of drought, might well be facing a third.”); see also Janet C. Neuman, Federal Water Policy: An Idea Whose Time Will (Finally) Come, 20 Va. Envtl. L.J. 107, 110–11 (2001) (noting that the problem is exacerbated by the fact that population is growing fastest in areas with less water). Some commentators believe that global warming has contributed to more frequent drought conditions, a trend they believe will continue to worsen. 2 E.g., Joseph W. Dellapenna, Regulated Riparianism, in 1 Waters and Water Rights § 9.01, at 9-10, 9-11 (Robert E. Beck & Amy K. Kelly eds., repl. vol. ed. 2007) [hereinafter Dellapenna, Regulated Riparianism] (noting that climate change is predicted to cause increasing frequency of both droughts and floods); Noah D. Hall, Bret B. Stuntz & Robert H. Abrams, Climate Change and Freshwater Resources, 22 Nat. Resources & Env’t 30 (2008) (noting that scientists predict climate change will have an adverse impact on water resources). To ensure water is available for basic needs, policy makers have implemented temporary conservation measures such as water rationing, 3 See, e.g., Barringer, supra note 1 (reporting that California may impose water rationing). and restrictions on watering lawns, filling swimming pools, and washing cars. 4 See, e.g., Stacy Shelton & John C. Perry, Only Toughest Ban Reduced Water Use, Atlanta J.- Const., Feb. 24, 2008, at D1 (reporting on water conservation measures implemented in Georgia during drought conditions).

In 2009 as California appeared to be facing its third drought year in a row, the state considered managing the shortage by implementing rationing policies that would reduce users’ water access by up to twenty percent. 5Ari B. Bloomekatz, U.S. Plans to Tighten Tap for Farmers, L.A. Times, Feb. 21, 2009, at B3. The U.S. Bureau of Reclamation, a water provider in California, 6The U.S. Bureau of Reclamation operates dams and reservoirs in the western United States and sells water in the wholesale market and to agricultural users. U.S. Bureau of Reclamation: About Us, http://www.usbr.gov/main/about/ (last visited Mar. 24, 2010). planned to cut off water for agricultural use in the Central Valley region of the state and cut the water allotment for municipalities and industrial users in half. 7Bloomekatz, supra note 5. One irrigation specialist at a commercial farm that also used its own wells and pipelines said that, under the drought conditions, he would be happy if the farm received one-sixth of the agricultural water it received under normal conditions. 8 Id.

It is apparent that in future times of drought and water shortage, temporary conservation measures will not be sufficient to preserve adequate water resources, particularly in areas of continuing population growth. 9 See Hall, Stuntz & Abrams, supra note 2, at 34 (“[W]e must reform water law and policy to emphasize conservation and efficient, environmentally sound allocation.”); Olen Paul Matthews & Michael Pease, The Commerce Clause, Interstate Compacts, and Marketing Water Across State Boundaries, 46 Nat. Resources J. 601, 603 (2006) (arguing that conservation and more efficient allocation are the solutions to inadequate water supply); see also Stacy Shelton, Atlanta Water Supply Precarious; Without Conservation, Future Looks Glum, Atlanta J.- Const., June 27, 2005, at E1 (citing district water plans, reporting that water shortages are projected in north Georgia, which includes Atlanta, unless there are “aggressive conservation measures and new lakes to store water”). Compounding the problem, population growth often takes place in areas that do not have adequate water resources to begin with. 10 See Stephen E. Draper, The Unintended Consequences of Tradable Property Rights to Water, 20 Nat. Resources & Env’t 49 (2005) (“Increasingly in the United States, commercial activities and growing population centers have developed in areas with scarce water resources.”); Neuman, supra note 1, at 110–11. Thus, more permanent measures will be required to solve the water shortage problem. 11 Supra note 9 and accompanying text. This Comment argues that a more effective and permanent water conservation strategy for state governments would be (1) to cap or limit water use at a predetermined sustainable level; (2) to allocate among existing users tradable or transferable withdrawal permits that grant property rights in water use and that collectively permit aggregate water use no greater than the predetermined cap; and (3) to facilitate a free market for the trading of such water-use permits. These permits would give their holders the right to use a certain amount of water by withdrawing it from a water source. 12The distinction should be made between the right to withdraw water, which would be attached to the permits this Comment proposes, and the possession or ownership rights of particular water from a particular source. This distinction is important because a withdrawal right can be transferred to a different location that has a different water source. See Tom Tietenberg, Tradable Permits in Principle and Practice, 14 Penn St. Envtl. L. Rev. 251, 266 (2006) (a tradable permit system does not “privatiz[e] the resource;” it “privatizes the right to access the resource”); see also James L. Huffman, Water Marketing in Western Prior Appropriation States: A Model for the East, 21 Ga. St. U. L. Rev. 429, 439 (2004) (explaining that water’s physical properties makes “it impossible, with some exceptions, to actually possess the same water for an extended period,” but that this “is not necessarily an insurmountable obstacle to water marketing”). For a further discussion of transferring a tradable permit for water use to a location other than where the permit was initially allocated, see infra Part II.A.2.

A cap on the total level of water use would enable policy makers to ensure that water resources are maintained at a sustainable level. 13 See Tietenberg, supra note 12, at 265 (describing the basic attributes of a cap-and-trade system). The initial allocation of water-use rights would be based on existing levels of actual use, not the level of use that would attach through current water-rights laws. 14See infra Part I for a discussion of current water-rights regimes. For a discussion of the system proposed by this Comment, see infra Part III. By then allowing water-use permits to be bought and sold in a market environment, water could be allocated more efficiently because the holder of a permit would have an incentive to sell it in the market to a user who values it more highly. 15 See generally Huffman, supra note 12, at 432 (“[A] well functioning market is the most effective and efficient institution to allocate scarce resources.”); Jonathan Remy Nash & Richard L. Revesz, Markets and Geography: Designing Marketable Permit Schemes to Control Local and Regional Pollutants, 28 Ecology L.Q. 569, 572 (2001) (describing emission permit trading systems as reducing “aggregate emissions to the chosen aggregate level for the least cost” when there is an active market); Janet C. Neuman, Have We Got a Deal for You: Can the East Borrow from the Western Water Marketing Experience?, 21 Ga. St. U. L. Rev. 449, 497 (2004) (“Subjecting water to market forces such as price signals can promote more efficient water use . . . .”); Richard B. Stewart, Panel I: Liberty, Property, and Environmental Ethics, 21 Ecology L.Q. 411, 414 (1994) (“The advantages of . . . tradable permits are quite clear in economic terms.”); Barton H. Thompson, Jr., What Good Is Economics?, 27 Environs Envtl. L. & Pol’y J. 175, 176–77 (2003) (arguing for and describing benefits of applying economic theory to environmental regulation). But see Draper, supra note 10, at 49 (noting that imposing economics on water allocation may have “unintended consequences that outweigh its benefits”).

Although there are economic benefits to a market system, there are also problems that may arise in such a system, particularly when applied to a precious resource such as water. Criticisms of water markets include concerns that states may be unable to prevent water from being transferred and used out-of-state, 16 See, e.g., Draper, supra note 10, at 53. that smaller agricultural users and consumers may not be able to afford to participate in the market, 17 See, e.g., Wilson Barmeyer, Note, The Problem of Reallocation in a Regulated Riparian System: Examining the Law in Georgia, 40 Ga. L. Rev. 207, 237–38 (2005) (noting the possibility of “inequitable allocation of water dependant on economic wealth”). and that transaction costs associated with implementing and facilitating the system will erode any gains that might have been attainable. 18 See, e.g., Draper, supra note 10, at 51–52 (discussing transaction costs and externalities). For a discussion of the criticisms of a market for water, see infra Part II.B.

Any change in water rights law would need to be implemented by the states. 19 See Huffman, supra note 12, at 442 (noting the possibility of a federal water rights law, but that “it would be very disruptive to shift from the well-established state water rights regimes”). The federal government has implemented legislation addressing specific issues related to water resources; 20 See Neuman, supra note 1, at 107–08, 113 (noting that federal legislation has addressed “water supply, pollution, dams, hydropower development, navigation, flood control, fisheries, and research” and that the federal government spends more than ten billion dollars annually on water programs). however, state law governs water rights. 21 See Zach Willey & Tom Graff, Federal Water Policy in the United States—An Agenda for Economic and Environmental Reform, 13 Colum. J. Envtl. L. 325, 347 (1988) (“State water laws have established rights to use water under appropriative, riparian, correlative, and other conditions.”). Although implementation of a tradable permit market for water at the federal level could impose a uniform system across all the states, such a change in the existing law would introduce issues of federalism that are beyond the scope of this Comment. 22 See Neuman, supra note 1, at 114–16 (arguing for a federal water-use policy but stating that a major political barrier preventing the development of a rational, federal water policy is the tension of federalism itself”). For a discussion of why a federal water use policy is a good idea, see Neuman, supra note 1. Instead, this Comment focuses on a structure of a market for tradable permits that could be implemented and tailored as needed by each state to conserve and efficiently allocate its water resources.

In addition to arguing that a cap-and-trade system for allocating water use should be implemented to address water shortages, this Comment demonstrates why the two current water-rights systems—riparian rights in the East and prior appropriation in the West—and their regulated variations cannot support such a system. 23 See infra Parts I.A.3 & I.B.2. Property rights in water use and the extent to which water-use rights can be transferred—characteristics that are essential for a robust and efficient permit trading market—are uncertain in both riparian rights and prior appropriation systems. 24 See, e.g., Huffman, supra note 12, at 443 (“One cannot overemphasize the importance of secure, well-defined, and enforceable property rights. The rights must be exclusive, universal, and transferable.”). For a discussion of the why both systems are inadequate for a water-market system, see infra Parts I.A.3 and I.B.2. Therefore, this Comment argues that a new water-rights system that provides for water-use permits that have vested property rights and that are freely tradable is necessary for a market system that maximizes its potential to conserve and efficiently allocate water resources.

Part I of this Comment discusses the water-rights regimes currently used in the United States. Part II discusses the various design considerations and structures of tradable permit systems, how tradable permit systems have been used in other contexts, 25Tradable permits have been used to limit pollution and regulate use of common resources such as habitats and fisheries. James Salzman & J.B. Ruhl, Currencies and the Commodification of Environmental Law, 53 Stan. L. Rev. 607, 616 (2000). and how they might be used in a water-market system. Part III proposes and describes a market system that uses as its currency tradable permits for water withdrawal and that attempts to minimize the risks associated with water markets, while maintaining the gains in conservation and economic efficiency promoted by such a system.

I. Current Water-Law Regimes and Why They Would Not Support a Water-Market System

This Part explores current water-law regimes used in the United States and explains why they would not adequately support a tradable permit water-market system. Section A discusses the historical common law riparian rights system generally used in the eastern states and explains how that system has been modified by state legislatures into its current form. Section B discusses the prior appropriation system generally used in the western states.

A. Riparian Systems and Their Regulated Progeny

This section discusses common law riparian rights and how those common law rights systems have been modified by state legislatures. It also discusses why neither common law riparian rights nor their legislatively-modified variations would adequately support a market for tradable water-use permits.

1. Common Law Riparian Rights

Common law riparian rights establish and govern the rights of water users to access and consume water resources. 26Dellapenna, Water Allocation, supra note 1, at 11. The riparian rights doctrine developed in the eastern part of the United States, and its application has generally been limited to that area. 27 See id. at 9 (noting that riparian rights developed east of Kansas City, where water was abundant, and appropriative rights were used west of Kansas City, where water was more scarce). Riparian rights are a common property system, which means that for the most part users are given discretion to decide how they use the resource. 28 Id. The doctrine is based on the theory that land appurtenant to a body of water has a “bundle of rights” associated with that physical proximity. 29Joseph W. Dellapenna, Introduction to Riparian Rights, in 1 Waters and Water Rights, supra note 2, § 6.01(a), at 6-7 [hereinafter Dellapenna, Introduction to Riparian Rights]; see also Restatement (Second) of Torts § 843 (1979) (“The term ‘riparian land’ . . . means a tract of land that borders on a watercourse or lake, whether or not it includes a part of the bed of the watercourse or lake.”). For purposes of this Comment, the most important of these is the right to use and consume water because it results in depletion of the resource. 30 See Dellapenna, Introduction to Riparian Rights, supra note 29, § 6.01(a)(4), at 6-70 (“Consumptive uses create interferences with competing uses that are permanent.”). The bundle of rights also includes, but is not necessarily limited to, the right to access the water, the right to build a pier, the right to accretions (sedimentary deposits), and the right to “own the subsoil of nonnavigable streams and other ‘private’ waters.” Id. § 6.01(a), at 6-8. Courts make a distinction between uses which are consumptive and those that are not consumptive. As Dellapenna notes that “[a]mong the most common non-consumptive uses recognized by the law have been navigation, fishing, hunting, and swimming.” Id. § 6.01(a)(3), at 6-60, 6-61. Common consumptive uses include irrigation, household distribution through public utilities, and industrial processing. 31 See id. § 6.01(a)(4), at 6-69, 6-70. Other consumptive uses include animal husbandry, mineral mining, and steam-generated power. Id.

When common law riparian rights developed in the early nineteenth century, 32 See Dellapenna, Water Allocation, supra note 1, at 11 n.12 (noting that Tyler v. Wilkinson, 24 F. Cas. 472 (C.C.D.R.I. 1827) (No. 14,312), is “often cited as the first true riparian rights case”). there was no apparent shortage of water in eastern states, and therefore no apparent need to restrict water use. 33 See id. at 9. Thus, under what is generally known as the reasonable use standard, a riparian land owner has the right to unlimited reasonable use of a water source, subject only to the reasonable use rights that other riparian users have to the same body of water. 34 See Restatement (Second) of Torts § 850 (1979) (“A riparian proprietor is subject to liability for making an unreasonable use of the water of a watercourse or lake that causes harm to another riparian proprietor’s reasonable use of water or his land.”); Joseph W. Dellapenna, The Right to Consume Water Under “Pure” Riparian Rights, in 1 Waters and Water Rights, supra note 2, § 7.02(d), at 7-48 [hereinafter Dellapenna, Right to Consume] (describing the reasonable-use theory of riparian rights). Under this rule, the only consideration is whether a use interferes with another riparian’s 35Riparian refers to an owner of riparian land. Black’s Law Dictionary 1352 (8th ed. 2004). right to reasonable use of the source; the effect that a use has on the body of water itself is not relevant. 36 See Dellapenna, Right to Consume, supra note 34, § 7.02(d), at 7-49 (noting that courts will find liability where another riparian suffers “unreasonable injury”). Under the rule adopted by the Restatement (Second) of Torts, the reasonableness of the use is determined by consideration of a number of factors including the purpose, social value, and economic value of the use. 37 Restatement (Second) of Torts § 850A (1979). In addition, the Restatement lists the following factors: level of harm caused by the use, the ability of one of the users to avoid the harm, the ability of each user to meet their needs using less water, the protection of existing economic value in the use, and the fairness of causing the harmful user to bear the loss from fewer use rights. Id.; cf. Dellapenna, Water Allocation, supra note 1, at 15 n.36 (explaining that many cases only consider economic factors: These [non-economic] principles figure prominently in the Restatement (Second) even if they do not figure prominently in the cases.”). Traditional reasonable-use common law holds that a non riparian use 38According the Restatement (Second) of Torts, “[n]onriparian uses are those made neither on nor in connection with the use of riparian land, and include irrigation of nonriparian land and use in manufacturing on nonriparian land, even though the land belongs to the owner of riparian land. They also include the diversion and sale of water for consumption by nonriparian customers of water companies and inhabitants of cities.” Restatement (Second) of Torts § 855 cmt. a (1979). of a water source that affects a riparian use in any way is per se unreasonable. 39Dellapenna, Right to Consume, supra note 34, § 7.02(d)(1), at 7-54. As will be discussed in Parts II and III of this Comment, a tradable permit water-market system is not viable unless nonriparian use is allowed to occur. See id. § 7.04, at 7-108 (“There is . . . no reason to believe that the economically most productive use of water from a particular waterbody will always lie on contiguous land.”). Courts in most riparian states still apply this strict common law rule to nonriparian use. 40 Id. § 7.02(d)(1), at 7-54, 7-55. The Restatement (Second) of Torts and courts in New Hampshire, Vermont, and Georgia have rejected the common law rule that nonriparian use is per se unreasonable. Id. Some states have passed legislation that may be interpreted to overrule the common law rule, but, as Professor Dellapenna concludes, the question is often not directly addressed and, therefore, the status of the common law rule is uncertain in many states. Dellapenna, Regulated Riparianism, supra note 2, § 9.03(a)(2), at 9-70 (discussing these legislative modifications in various states).

Since common law riparian rights accrue to the rights-holder through ownership of land that is appurtenant to the water source, 41 See Dellapenna, Right to Consume, supra note 34, § 7.01, at 7-2 (noting that the “basic concept of riparian rights” is that each land owner next to the water has equal rights to the other appurtenant land owners). in the early development of common law riparian rights, the rights were often transferable only as an attachment to the appurtenant land. 42 Id. § 7.04, at 7-107. Over time, however, exceptions to that common law rule developed. 43 See generally id. at 7-108 (explaining that every state has, to varying degrees, loosened the restriction on alienability of riparian rights). Some courts have allowed transfer of riparian rights to a nonriparian user apart from the appurtenant land, but the alienability of the rights often depends upon whether the contemplated use is consumptive or non-consumptive. 44 Id. § 7.04(a)(3), at 7-117. As Professor Dellapenna notes, grants by riparians allowed by a state would bind the grantor, but “the extent to which the grant conveys rights [to the grantee] against any riparians other than the grantor is far from clear.” 45 Id. This uncertainty demonstrates the difficulty in determining what standard of “reasonable use” should attach to a transfer of rights from a riparian user on appurtenant land to a nonriparian user. 46Dellapenna, Water Allocation, supra note 1, at 17–18 (noting the uncertainty as to whose level of “reasonable use” is acquired by a non-riparian user).

2. Regulated Riparianism

Legislative modifications of riparian rights are commonly referred to as regulated riparianism, 47 E.g., Dellapenna, Regulated Riparianism, supra note 2, § 9.01, at 9-17 & n.51. and they are generally intended to address water supply shortages. 48 See generally id. at 9-15 (discussing the conditions that led to development of regulated riparianism). Commentators have concluded that common law riparian rights without any legislative modification are not well suited to allocate water during water shortages because the system is limited in its ability to restrict use, and disputes among users require the expense, time, and uncertainty of litigation to resolve. 49 See id. § 9.01, at 9-12, 9-13, § 9.03, at 9-52 (summarizing criticisms of common law riparian rights as an allocation system during water shortages). Dellapenna has concluded that nineteen of thirty-one eastern states have implemented “comprehensive regulated riparian[ism].” 50 Id. § 9.03, at 9-54 (citing statutes in Alabama, Arkansas, Connecticut, Delaware, Florida, Georgia, Iowa, Kentucky, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, New Jersey, New York, North Carolina, Virginia, and Wisconsin).

The most common feature of regulated riparianism is a permit requirement for certain types and manners of use. 51 See id. § 9.03(a), at 9-62 (“Easily the most significant innovation under regulated riparianism, the feature that most sharply sets it apart from traditional riparian rights, is that direct users of water must have a permit from a state administrative agency in order to be entitled to use water.”). Common uses that trigger permit requirements are (1) withdrawals over a certain amount, 52 See, e.g., Ga. Code. Ann. § 12-5-96 (2009) (requiring permit for groundwater withdrawals greater than 100,000 gallons per day). (2) withdrawals from certain sources, 53 See Dellapenna, Regulated Riparianism, supra note 2, § 9.03, at 9-53 (citing 615 Ill. Comp. Stat. 50/1–50/14 (2009) (requiring permits for withdrawals from Lake Michigan)). and (3) inter-basin transfers of water. 54 See id. (citing S.C. Code Ann. 49-21-10 to -80 (2009)). It is not entirely clear whether regulated riparianism relaxes restrictions on water rights transfers to nonriparians because the statutes often do not directly address the issue. 55 Id. § 9.03(a)(2), at 9-70. Dellapenna has suggested that the best interpretation in such cases may be that the legislatures implicitly intended to leave the common law rule in place. 56 Id.

Regulated riparian statues also tend to exempt certain water users, often weakening the statute’s intended effect. 57 See id. § 9.03(a)(3) (discussing exemptions from permit requirement in regulated riparian systems). Common explicit permit exemptions in regulated riparian statutes include agricultural use, 58 See id., at 9-76, 9-77 (citing statues exempting agricultural use to varying extents in Kentucky, Maryland, Georgia, Michigan, Iowa, Maryland, and Minnesota). domestic use, 59 See id., at 9-75 (citing statutes explicitly exempting domestic use in Florida, Hawaii, Kentucky, Maryland, Minnesota, and Mississippi, and statutes that permit withdrawal amounts so large as to effectively exempt domestic use in Alabama, Connecticut, Delaware, Georgia, Iowa, Michigan, and Wisconsin). and uses that were already established when the permit system was implemented. 60 See id., at 9-77 (“Most of the statutes either exempt at least some uses established on the effective date of the statute from the permit requirement or guarantees an initial permit to established uses.”). Groundwater is often regulated within the same system as surface water, extending the reach of the regulations to more consumptive uses. 61 Id. § 9.03(a)(1), at 9-66 (noting that “fourteen of the nineteen regulated riparian states” have included ground water in their regulated riparianism laws). Most states, however, exclude from the permitting system “diffuse” 62Diffuse water can generally be described as surface water that is not part of a defined water body. See, e.g., Haw. Rev. Stat. § 174C-3 (2009) (describing diffused surface water as “water occurring upon the surface of the ground other than in contained water bodies”); Court Reports, 11 U. Denv. Water L. Rev. 445, 466 (2008) (describing diffuse surface waters as “waters from rain or melting snows flowing over land and not part of a defined watercourse”). water bodies by (1) expressly excluding them, (2) expressly applying the scheme to only certain water bodies, (3) exempting lakes and ponds, (4) exempting water bodies contained on the property of a single owner, or (5) exempting regulation of diffuse water bodies except in times of shortage. 63 See Dellapenna, Regulated Riparianism, supra note 2, § 9.03(a)(1), at 9-67 (describing various state laws with respect to diffuse surface waters). Dellapenna notes that these exemptions largely benefit agricultural uses and that “they obviously impair the administering agency’s ability to undertake effective management in the face of system-wide shortages.” 64 Id. at 9-69. Government subsidies, which can increase agricultural water use, exacerbate the problem. 65Willey & Graff, supra note 21, at 326. The permit exemptions mentioned above are often based more on political preferences than any societal benefits rationale, so they “undermine the entire scheme of regulating uses in the public interest.” 66Dellapenna, supra note 2, § 9.03(a)(3), at 9-80 (“To exempt such activities . . . serves little purpose other than capitulation to the political strength of the groups exempted.”).

Regulated riparian systems that exempt agricultural users adversely affect policy makers’ ability to effectively regulate water use in the aggregate because agricultural use comprises such a large portion of consumptive uses. 67 See Dellapenna, Interstate Struggles, supra note 1, at 838 (labeling irrigation as “generally the most heavily consumptive use of water”). One of the best examples of this problem is the set of exemptions for agricultural use in Georgia’s regulation system. 68 See Dellapenna, Water Allocation, supra note 1, at 72 (noting that agricultural exemptions in Georgia “go far beyond the exclusions of certain uses in other regulated riparian states”). The Ground-water Use Act of 1972 69Ga. Code Ann. §§ 12-5-90 to -107 (2009). As the name suggests, this law applies to use of ground water. and the Georgia Water Quality Control Act, 70Ga. Code Ann. §§ 12-5-20 to -53 (2009). This law applies to use of surface water. which was first passed in 1964, both require certain water users to obtain permits from the state before using water resources. The basic requirement of the two laws is that any user withdrawing more than 100,000 gallons per day of water from a ground or surface source must first obtain a permit. 71 Ga. Code Ann. §§ 12-5-31(a)(1)(A), 12-5-96(a)(1) (2009). See also Dellapenna, Water Allocation, supra note 1, at 68–70 (describing the provisions of each statute). Agricultural users face less stringent requirements under the statutes. 72 See Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(a) (2009). Both laws provide that a withdrawal permit up to the operating capacity of a farm shall be issued for any farm that used the water source prior to July 1, 1988, and applied for the permit prior to July 1, 1991. 73 Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(a) (2009). Under both statutes, farm-use permits applied for before April 20, 2006, or which are not within the Flint River basin, 74The Flint River flows through southwest Georgia. According to the River Basin Center at the University of Georgia, “[t]he Flint River is approximately 350 miles long and drains an area of 8,460 square miles.” Gretchen Loeffler & Judy L. Meyer, River Basin Ctr., Chattahoochee-Flint River Basin, http://www.rivercenter.uga.edu/education/k12resources/basinsofga2.htm. have no expiration; permits applied for on or after April 20, 2006, for a farm within the Flint River basin have a twenty-five-year term, but they are renewable at the original withdrawal capacity unless the “original capacity would have unreasonable adverse effects upon other water uses.” 75 Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(b)(1) (2009). The permits may be transferred to subsequent owners of the property, subject only to notification of the transfer to the state. Id. Changes in the use or withdrawal capacity of the water permit must be applied for and approved by the state. Id. Under this regulation scheme, policy makers in Georgia are limited in their ability to implement conservation measures targeted at agricultural use. 76 See Barmeyer, supra note 17, at 216 (“[The exemptions] impair the state’s ability to manage its water resources effectively.”). The permits that grant agricultural-use rights are not determined by actual use, and they have either no expiration dates or expiration dates that are long-term. 77 Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(b)(1) (2009). Thus, the policy makers have few options to regulate one of the largest categories of water use in the state. 78 See Julia L. Fanning, U.S. Geological Survey, Water Use in Georgia, 2000; and Trends, 1950-2000 (2003), available at http://cms.ce.gatech.edu/gwri/uploads/proceedings/2003/Fanning.pdf (noting that irrigation use accounts for almost seventeen percent of water use from all sources, and fifty-one percent of groundwater use in Georgia); Dellapenna, Water Allocation, supra note 1, at 72 (“Farm uses remain far and away the largest use of water in Georgia.”). This is particularly problematic in times of drought, during which the need to conserve water is the greatest and the relative level of agricultural use increases because of greater irrigation requirements. 79 See Fanning, supra note 78 (noting that more irrigation is required during droughts); Hall, Stuntz & Abrams, supra note 2, at 33 (noting that demand for irrigation water will increase in areas where drier conditions are expected).

3. Why Neither Riparianism nor Regulated Riparianism Can Support a Tradable Permit Market for Water

The most significant fundamental requirement for a successful and efficient water market is that water-use rights also be secure property rights. 80 See Barmeyer, supra note 17, at 230 (“Clearly defined property rights are a prerequisite to any system of water rights trading through a market.”); Joseph W. Dellapenna, The Importance of Getting Names Right: The Myth of Markets for Water, 25 Wm. & Mary Envtl. L. & Pol’y Rev. 317, 327 (2000) (“[M]ost fundamental to the functioning of markets are the laws that define the property rights that form the ‘objects’ of the market’s transactions . . . .”); Daniel C. Esty, Toward Optimal Environmental Governance, 74 N.Y.U. L. Rev. 1495, 1533–34 (1999) (discussing tradable permits in fisheries, stating that “governments must provide legal structures to ensure that those with property rights are able to vindicate them”); Huffman, supra note 12, at 443 (“One cannot overemphasize the importance of secure, well-defined, and enforceable property rights. The rights must be exclusive, universal, and transferable.”). It is unlikely that buyers would be willing to participate in a market for rights if those rights are not fully secure from forfeiture or interference by third parties. 81Barmeyer, supra note 17, at 230; Tietenberg, supra note 13, at 267 (“Confiscation of rights or simply insecure rights could undermine the entire [market trading] process.”). Because common law riparian rights and current regulated riparian systems have uncertain property rights, 82 See supra notes 45 & 46 and accompanying text. See also Barmeyer, supra note 17, at 231 (noting the lack of clear property rights in water withdrawal permits in Georgia). these systems cannot adequately support a market for tradable water permits. 83 See Hall, Stuntz & Abrams, supra note 2, at 35 (“[R]ights in water are less certain than in many other forms of property, making a true market difficult to achieve.”).

Common law riparian rights are not sufficiently clear to support a market system that uses tradable permits as its currency. 84 See Neuman, supra note 15, at 488 (stating riparian rights are “so poorly defined and open-ended as to discourage investment”); supra notes 45 & 46 and accompanying text. Because a riparian’s rights are based on the reasonable-use doctrine, 85 See supra notes 34–37 and accompanying text. those rights, in the amount and type of use allowed, may change and evolve over time if the needs and uses of other riparians change. 86 See Olivia S. Choe, Note, Appurtenancy Reconceptualized: Managing Water in an Era of Scarcity, 113 Yale L.J. 1909, 1911 (2004) (describing how this inherent uncertainty in riparian rights has prevented water markets); Hall, Stuntz & Abrams, supra note 2, at 35 (stating that litigation over water rights is inefficient because court “rulings may soon be mooted by changed conditions”). This unstable balance of reasonableness among users makes the riparian rights of competing users subject to change based on factors that are out of the user’s control. 87 See Dellapenna, Water Allocation, supra note 1, at 16 (“If either of the competing uses changes in physical or economic terms, the calculus of reasonableness will change . . . .”). This problem would likely be magnified in a market system because riparian users would want to sell as many of their riparian rights as possible, and it would be unclear how much of the shared water resource would be allocated to each user. In addition, disputes over common law riparian rights are settled in court based on a number of different factors. 88 See Restatement (Second) of Torts § 850A (1979) (listing nine factors to be considered to determine reasonableness of use). Because different factors may be considered or prioritized differently by different courts, riparian rights can be somewhat unpredictable. 89Dellapenna, Water Allocation, supra note 1, at 16 (“Courts, as well as scholars, have considered this [instability] a serious impediment to private investment in water development.”).

A second problem that makes common law riparian rights inadequate for a tradable permit market is that it is unclear whether common law riparian rights are transferable to nonriparian users, and if so, the extent of the rights that can be transferred. 90 See id. at 17–18, 67 (noting the uncertainty as to whose level of reasonable use is acquired by a non-riparian user); supra notes 45 & 46 and accompanying text. If a water market is to function as efficiently as possible, water-use rights must be transferable without regard to where the water will be used. 91 See Dellapenna, Right to Consume, supra note 34, § 7.04, at 7-108 (noting that the most efficient use will not always be on the riparian land). As Professor Dellapenna has noted, “[t]here is . . . no reason to believe that the economically most productive use of water from a particular waterbody will always lie on contiguous land. If riparian rights cannot be transferred, then some water must be used at less than its most efficient use.” 92 Id.

Regulated riparian systems are also imperfect for the implementation of markets for tradable water permits. The extent of the property right granted through a water-withdrawal permit is not always clear. For example, the administering state agency imposes a reasonable-use requirement on the permit when there are competing uses. 93 See, e.g., Ga. Code Ann. § 12-5-31(e), (g) (2009); see also Barmeyer, supra note 17, at 231 (noting that disputes have occurred when permit holders assert private property rights over groundwater); Neuman, supra note 15, at 488 (noting that the problems with common law reasonable use are still present in regulated riparianism; it is just administrative agencies, rather than courts, making the decision). It is also unclear in most regulated riparian systems whether permits can be transferred. 94Dellapenna, Water Allocation, supra note 1, at 38 (“Usually there is no express provision for the transfer of water rights or permits between potential users.”); Neuman, supra note 15, at 489. See supra notes 55 & 56 and accompanying text.

An equally significant problem with regulated riparian systems is certain users often are exempt from the permit system. 95 See generally Dellapenna, supra note 2, § 9.03(a)(3) (discussing statutory preferences for specific uses of water in various states); supra notes 57–66 and accompanying text. As discussed above, the exemption of agricultural use from the permit scheme in many states prevents policy makers from meaningfully regulating agricultural uses in states with large farming industries. 96 See, e.g., Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(a) (2009) (exempting farm uses from the statutory permit scheme for the withdrawal of surface or ground waters); supra notes 57–66 and accompanying text; see also Hall, Stuntz & Abrams, supra note 2, at 33 (“Irrigation accounts for 39 percent of all U.S. water withdrawals and 81 percent of consumptive water uses.”). Farm uses that are exempted from the permit schemes are still governed by common law riparian rights, which introduces the problems associated with that system, as discussed above. 97Dellapenna, Water Allocation, supra note 1, at 72–73 (noting this problem specifically in Georgia). For these reasons, riparianism and regulated riparianism can not adequately support a free-market tradable-permit system.

B. Prior Appropriation Systems

This section discusses prior appropriation regimes, including the standard features of common law prior appropriation systems and how the common law has been modified by state legislatures. It also discusses why prior appropriation systems would not adequately support a market for tradable water-use permits .

1. The Prior Appropriation System

The prior appropriation or appropriative rights system of water rights developed in the western states as an alternative to common law riparian rights. 98Owen L. Anderson et al., Introduction and Background, in 2 Waters and Water Rights, supra note 2, § 11.01, at 11-4 [hereinafter Anderson et al., Introduction]. The doctrine discussed in this subsection has been referred to as both “prior appropriation,” id., and “appropriative rights.” E.g., Dellapenna, Water Allocation, supra note 1, at 20. The basic principle of prior appropriation can be summarized as the “person who is first in time to appropriate water, is the first in right,” meaning the first user to establish a use gains priority to the water source over those who come later. 99Owen L. Anderson et al., Elements of Prior Appropriation, in 2 Waters and Water Rights, supra note 2, § 12.01, at 12-3 [hereinafter Anderson et al., Elements]. In Elements of Prior Appropriation, the authors note that the doctrine has five basic elements: “(1) person; (2) first in time; (3) to appropriate; (4) water; and (5) first in right.” Id.; see also A. Dan Tarlock, Prior Appropriation: Rule, Principle, or Rhetoric?, 76 N.D. L. Rev. 881, 881 (2000) (“Prior in time, prior in right is the central dogma of western water law.”). For a discussion of how the foundational principles of prior appropriation originated in the early days of the American West, see Dellapenna, Water Allocation, supra note 1, at 20–21. Under the common law rule, priority is established when a user takes a “first step” of appropriating the water by investing time and money towards its actual use. 100Anderson et al., Elements, supra note 99, § 12.02(b), at 12-8. Courts appear often to have decided disputes over establishment of priority by looking to custom. See id. (discussing cases in which first-in-time priority is disputed). When there is a shortage, the “oldest” appropriator has the highest priority use right and a user with junior priority has no right to use any of its allocation until there is enough water to fulfill the allocations of all users ahead of it in the priority line. 101Dellapenna, Water Allocation, supra note 1, at 24 (noting that this principle may result in complete forfeiture of junior rights in times of shortage). Some commentators have noted that allocation based on temporal priority, rather than a hierarchy of reasonable or necessary use, promotes waste because there is an incentive to withdraw the maximum amount of water as soon as possible to gain priority. 102 E.g., id. at 23–24 (“Appropriators thus live in an environment where it is smart to overirrigate.”); Tarlock, supra note 99, at 901 (“The strict enforcement of priorities tends to lead to inefficient use practices. The cushion of a senior right combined with the ‘use it or lose it’ rules, abandonment and forfeiture, create powerful incentives to use the maximum entitlement and to forego investments in water conservation infrastructure.”). Because junior use rights may be forfeited if there is only enough water to meet the allocation of more senior users, the system is not conducive to transferable rights. 103 See Dellapenna, Water Allocation, supra note 1, at 24–26 (“The recognition and protection of third-party rights precludes true market transactions.”). Unlike common law riparian rights, common law prior appropriation does not require that the water be used only on riparian land, which might actually facilitate the sale of use rights. 104Anderson et al., Elements, supra note 99, § 12.02(f), at 12-75. However, there are usually restrictions on where the water can be transported and used, 105 Id. Generally, there are four types of restrictions: (1) restrictions that limit transfer from the water’s area of origin; (2) restrictions on moving water out-of-state; (3) treatment of irrigation rights as running with the land; and (4) restrictions on a junior appropriator’s ability to change the place of use when the change improves the standing of the junior user. Id. which has resulted in a lack of water markets in prior appropriation states even if there may be the potential for them to exist. 106Dellapenna, Water Allocation, supra note 1, at 25 (“There never has been a market for appropriative rights to any significant extent.”); Amy Sinden, The Tragedy of the Commons and the Myth of a Private Property Solution, 78 U. Colo. L. Rev. 533, 577–78 (2007) (“These property rights did not historically lead to the creation of active markets, however. This was primarily because the rules surrounding transfer made trading so cumbersome that transfers rarely occurred.”).

Most western states have now codified prior appropriation into the law. 107 See Anderson et al., Introduction, supra note 98, § 11.01, at 11-4, 11-5 (discussing the historical evolution of the prior appropriation doctrine in the western states). See, e.g., Cal. Water Code § 1200 et seq. (West 1971). Generally, a permit process grants the use rights and establishes priority, with the first appropriator establishing his standing by registering his use first. 108Anderson et al., Elements, supra note 99, § 12.02(b), at 12-6. E.g., Cal. Water Code § 1450 (West 1971) (priority established as of the date of the application for appropriation permit). For an assertion that priorities are not actually enforced in prior appropriation states, see Tarlock, supra note 99. Most of these statutes require that an appropriator make “beneficial use” of the water to retain priority rights; the definition of beneficial use varies from state to state. 109Anderson et al., Elements, supra note 99, § 12.02(c)(2) (surveying beneficial-use statutes from various western states); Tarlock, supra note 99, at 882. For a use to be beneficial “the end use for the water must be a generally recognized and socially accepted use (abstract benefit) and the water must be put to that use and not ‘let run to waste.’” 110Anderson et al., Elements, supra note 99, § 12.02(c)(2), at 12-26. The beneficial use requirement is significant because it has been the basis for courts finding that an issued permit does not grant a vested property right to the water, but rather a right to the water insofar as it is put to a reasonable use. 111 See id. § 12.02(e), at 12-66, 12-67 (surveying case law addressing the issue and noting that “the most important restriction [on water rights] may be that an appropriator can only acquire the right to water for a beneficial/reasonable use”).

Finally, prior appropriation users are subject to the “no injury” rule, which holds that senior priority users cannot change the manner in which they use the water if the change will injure junior users. 112Eric L. Garner & Janice L. Weis, Coping with Shortages: Managing Water in the 1990s and Beyond, 5 Nat. Resources & Env’t 26, 29, 62 (1991); see also Owen L. Anderson et al., Reallocation, Transfers and Changes, in 2 Waters and Water Rights, supra note 2, § 14.04(c) [hereinafter Anderson et al., Reallocation] (discussing the no-injury rule). For example, if a junior user depends on the senior user returning water to the source, the junior user would be injured if the senior user allows the water to be used at another location that would not return it to the source. 113 See Garner & Weis, supra note 112, at 62. Thus, the no-injury rule would restrict the senior user’s ability to sell the rights to water that had previously been returned to its source after use, if the sale would result in the water being used in other locations that would no longer return it to the original source. 114 Id.

2. Why Prior Appropriation Will Not Support a Tradable Permit Market for Water

Common law prior appropriation cannot adequately support a market for tradable permits. First, any user who is not the first appropriator will frequently face some risk that his rights will be surpassed by a higher priority user, particularly in times of shortage. 115Dellapenna, Water Allocation, supra note 1, at 24. Second, some courts have placed restrictions on where and how water can be used, 116Anderson et al., Elements, supra note 99, § 12.02(f), at 12-75. See supra note 105 for specific examples of the types of restrictions that courts have imposed. which would lessen the efficiency gains of a market system by limiting the number and type of buyers. Third, the beneficial-use requirement, which is now codified in most prior appropriation states, presents a risk because it may result in the forfeiture of the right. 117 See id. § 12.02(e), at 12-66 (noting that the extent of property rights in the water is uncertain because of the beneficial-userule); supra notes 109–11 and accompanying text (discussing the beneficial-use requirement). Finally, prior appropriation users are subject to the “no injury” rule, which can limit the types and locations of use from a particular water source and therefore can limit the number of potential buyers of that source’s water in a market. 118 See Garner & Weis, supra note 112, at 62 (“The no-injury rule thus may prevent water transfers in some instances . . . .”); supra notes 112–14 (discussing the no injury rule).

Therefore, prior appropriation systems in their current forms are not adequate to support a market for tradable water-use permits because the rights they grant to users, and the transferability of those rights, are uncertain. As discussed above, riparianism and regulated riparianism are also inadequate water-rights systems to support a tradable-permit market. 119 See supra Part I.A.3. A system that more clearly defines property rights, allows for full alienability of water permits, and brings all water users within the permit system would be more suitable for a tradable water-permit market that more fully meets the goals of conservation and efficient allocation.

II. Markets for Tradable Water Permits

This Part will discuss how tradable-permit systems are structured. Specifically, it will discuss the various characteristics and design features of a tradable-permit system, and how the goals of the systems determine which features are chosen for implementation. It also will address some common criticisms of a free market, tradable-permit system for water.

A. Tradable Permits

This section discusses tradable permit systems. Subsection 1 discusses the typical objectives of a tradable permit system and how the structure of such a system works to achieve those objectives. Subsection 2 discusses the considerations that policy makers should take into account in designing an optimal system.

1. Goals and Structure of Tradable Permit Programs

Tradable permits can be used to allocate the amount of a given activity that each participant in that activity may undertake. 120 See Jonathan Remy Nash, Too Much Market? Conflict Between Tradable Pollution Allowances and the “Polluter Pays” Principle, 24 Harv. Envtl. L. Rev. 465, 483–84 (2000) (describing how governments can use tradable permits to achieve “the socially optimal level of pollution”); Tietenberg, supra note 12, at 251 (describing tradable permits as a way to ration “access to the commons”). They are often used either to limit the amount of a common resource that each participant can use or to limit the amount of pollutants that each polluter can emit. 121 See Salzman & Ruhl, supra note 25, at 616–17 (describing trading programs that manage pollution); Tietenberg, supra note 12, at 251 (describing tradable permits as a method of allocating common resources). Tradable permits have also been used to sustain fisheries 122Esty, supra note 80, at 1533–34 (describing tradable permit systems to regulate fisheries). and regulate land use. 123Salzman & Ruhl, supra note 25, at 616. The Environmental Protection Agency has regulated pollution by allowing tradable permits for fuel efficiency standards in vehicles and air pollution emissions, among other things. 124 Id. at 616 n.14. The legislation authorizing the trading of fuel-efficiency standards was later repealed. Id.

Tradable permit schemes have typically been implemented as either a credit-trading or a cap-and-trade system. 125Tietenberg, supra note 12, at 265. In a credit-trading program, each participant is allowed to engage in a standardized level of the activity, and if the participant uses or pollutes less than its allowed amount, it gains credit for that amount, which can then be traded with or transferred to a user who needs the surplus to exceed the allowable limit. 126 See id. at 265–66 (noting that activity below the limit “can be certified as surplus”). Tietenberg notes that regulators sometimes have difficulty setting the base level of activity at an appropriate level to avoid “unjustified credits.” Id. at 266. For example, in a program to reduce environmentally harmful emissions, a polluter who emits less than the limit gains an emission credit that can then be sold to a buyer who can then emit more than the limit. 127 See id. at 265 (citing emission-trading programs as an example of credit trading).

A cap-and-trade system sets an overall level of use for a society and allows participants to trade use rights. Its implementation involves three steps: (1) determining the total level of acceptable activity; (2) allocating rights among participants to engage in the activity; and (3) permitting and facilitating trading of use permits. 128Nash, supra note 120, at 483–85 (identifying and explaining the three steps in implementing a tradable permit system for pollution control). The primary goals of a cap-and-trade system are sustainability and achieving the most efficient allocation of the right to engage in the regulated activity. 129B. Timothy Heinmiller, The Politics of “Cap and Trade” Policies, 47 Nat. Resources J. 445, 445, 447 (2007). For example, in a cap-and-trade system to regulate pollution, the government would determine the acceptable level of total pollution for the society, and would then allocate the right to pollute among the participants in the polluting activity, with the aggregate of all the participants’ pollution rights being equal to the total level of acceptable pollution. 130Salzman & Ruhl, supra note 25, at 617 (using the regulation of pollutants as an example of a cap-and-trade program with tradable permits). A participant in the activity is then given the choice to use its allotted amount, reduce use and sell its unused right, or buy additional rights to increase use. 131Sinden, supra note 106, at 568 (describing the options of polluters in a cap-and-trade pollution control system).

A primary distinction between the two systems is that one is able to limit total activity, while the other is not. 132Heinmiller, supra note 129, at 447. Credit trading does not limit the aggregate amount of the activity because new participants can enter the process and increase the overall level of activity. 133 Id. In a pollution-regulation system, for example, new users can gain tradable credits simply by emitting less of the pollutant than the allowable limit; these new participants and the new credits that they generate would increase the aggregate level of activity. 134 See id. (noting that this assumes no additional regulatory action is taken to counteract the additional activity). Conversely, in a cap-and-trade program the aggregate level of the activity is defined without regard to the number of participants. 135 Id. As the author notes, this difference between the two systems has social implications because in a cap-and-trade system every gain of a right by a participant means that another participant must lose that right. Id. As discussed below, this element of the cap-and-trade system has led some critics to argue that poorer and more rural water users would be harmed in a water market because they will be economically outmatched by wealthier users. See supra Part II.B. New participants must purchase permits from existing users to have the right to engage in the activity, so the overall societal activity level or consumption does not change. 136Heinmiller, supra note 129, at 447. (explaining that new users in a cap-and-trade system cause “some or all users [to get] a smaller slice of the resource pie”).

Through the market process, cap-and-trade programs using tradable permits as currency aim to allocate resources to their best use. 137 See id. at 445–48 (“In their ideal conception, cap and trade policies combine the policy goals of sustainability and economic efficiency and offer the potential to achieve both simultaneously.”); Jonathan Remy Nash, Trading Species: A New Direction for Habitat Trading Programs, 32 Colum. J. Envtl. L. 1, 12–13 (2007) (describing the two most significant benefits of tradable permit programs as (1) economically viable promotion of environmental sustainability and (2) highest economic allocation of scarce resources). Indeed, in addition to allowing control over the level of an activity for purposes of conservation or environmental protection, tradable permit systems tend to increase economic efficiency. 138Heinmiller, supra note 129, at 447 (noting that in a cap-and-trade system, the “cap” achieves conservation, while the “trade” promotes economic efficiency); Salzman & Ruhl, supra note 25, at 620 (“If the cap is set appropriately, marketable permits achieve the same level of protection as command-and-control alternatives at a lower cost.”). Cap-and-trade systems and credit trading both provide an incentive for participants in the regulated activity to increase their efficiency because doing so will allow them to sell their rights to use or emit for a profit. 139 See Salzman & Ruhl, supra note 25, at 620 (using the air pollution permit system as an example of encouraging efficiency because more efficient users profit from being able to sell their excess use rights); Tietenberg, supra note 12, at 256 (“One of the most desirable aspects of tradable permits for resource users is the ability to raise income levels for participants.”). Those efficiency gains may come from advances in technology and processes that decrease use or allow for more production without increasing resource use. 140Barton H. Thompson, Jr., Conservative Environmental Thought: The Bush Administration and Environmental Policy, 32 Ecology L.Q. 307, 340 (2005) (“[P]ermit programs may encourage the development of new environmental technology and processes that can achieve better results at lower cost. Because individuals or companies can trade any reductions that they make in their regulated activities, the regulated community has an incentive to develop less expensive, more effective means of making those reductions.”). One example of how economic incentives can encourage users to be more efficient is the EPA’s acid rain reduction program, which has resulted in an overall level of actual sulfur dioxide emissions that is less than the total allowable amount. Salzman & Ruhl, supra note 25, at 621 (noting that actual emissions in 1995 were forty percent less than the allowed amount). Salzman and Ruhl also note that the costs of the reductions in the program were estimated to be forty percent lower than they would have been in a command-and-control system. Id. Tradable permit systems should also tend to increase the economic value of the right to engage in the activity. 141Tietenberg, supra note 12, at 260 (noting that tradable permit systems tend to increase the value of the traded resource or lower the cost of pollution control, as the case may be).

However, the influence of stakeholders in the system’s structure and implementation has the potential to create inefficiencies that negate the benefits of a market system. 142 Id. at 272–73. One commentator cites inefficient alterations to market transfer rules that are implemented to assuage concerns with the initial allocation as an example of such influence. 143 Id. Another commentator argues that politics influences the design, implementation, and ultimately the success of tradable permit programs. 144 See Heinmiller, supra note 129, at 445–46 (noting that because of political influence many cap-and-trade programs are not as economically beneficial as they might be). For example, Heinmiller notes that the 1997 emissions caps in the Kyoto Protocol are the result of a negotiated middle point between the interests of environmental and emitters and do not represent a scientifically optimal level. Id. at 455. Influential groups with valuable interests at stake may be able to use the public’s lack of understanding of the issues to influence the policy decisions related to a water market system. 145Esty, supra note 80, at 1548–49 (“[T]he complexity and opacity of many environmental issues and the public’s difficulty in perceiving its own interest make the risk of special interest manipulation much more severe in the environmental realm than in other fields of regulation or government activity.”). Stakeholders whose interests are not aligned with a water market may also try to prevent such a system from being implemented at all. 146 See Huffman, supra note 12, at 436 (“Any interest believing that it can serve its interest through the political process is likely to oppose markets since the state will provide the resource to them for free.”).

2. Considerations in the Design of Tradable Permit Programs

Policy makers considering a tradable permit system must carefully consider how the system will be designed. Each aspect of the program can be tailored to accomplish specific goals. 147 See Nash, supra note 120, at 483–85 (describing in the context of pollution-control systems, the decisions policy makers must make, including the geographic area of coverage, the nature and scope of the permit rights, and the method of initial allocation). The design choices, discussed in detail below, include (1) how the permits will be initially allocated among users, (2) whether the initial users will be given the permits for free, (3) how trading can be structured to encourage participation by all users, and (4) how to remedy problems arising from permits being used in circumstances different from those for which they were allocated.

First, when implementing a tradable permit system, policy makers must determine how the use permits initially will be allocated; this is one of the most difficult issues that must be resolved at the outset of a tradable permits system because of the established interests of existing participants. 148Tietenberg, supra note 12, at 269; see also Heinmiller, supra note 129, at 449 (“[C]ap and trade policies are most needed and most likely to be introduced in situations of resource scarcity and overexploitation where vested interests are already well established and cannot be ignored.”). Common initial allocation schemes include those based on the use of each user when the system is implemented, auctions, 149 See Nash & Revesz, supra note 15, at 575–76 (describing allocation systems for tradable emissions permit regimes, including an auction system and “grandfathering” in existing users). a lottery, and a first-come-first-serve program. 150Tietenberg, supra note 12, at 269–70.

Some commentators have noted that the initial allocation scheme is sometimes dictated by politics rather than considerations of public good, and one has stated that a free initial allocation based on existing use is “a necessary ingredient” to implementing a tradable permit system. 151 Id. at 254. The initial allocation is extremely important to the stakeholders because it provides access to an economically valuable resource at potentially no cost, which could lead to a “windfall” for the recipients of initial permits. 152Heinmiller, supra note 129, at 450. The potential for a windfall has been cited as one reason water-market systems should not be implemented. See, e.g., John L. Fortuna, Note, Water Rights, Public Resources, and Private Commodities: Examining the Current and Future Law Governing the Allocation of Georgia Water, 38 Ga. L. Rev. 1009, 1060 (2004). For environmentalists or conservationists wishing to hold emission or consumption permits, the initial allocation may provide the most economically feasible way to do so; if the initial allocation in a water market were free, environmental groups could “retire” the permits without having to pay for them, assuming they were allowed to take part in the initial allocation. 153 See Heinmiller, supra note 129, at 450, 461. Environmentalists could hold the permit, thereby actively conserving the resource by leaving fewer water-use rights available for consumption. Id. at 461. Environmentalists in western states have already used this method of preservation by purchasing water rights and “retiring” them to protect downstream flow. 154Thompson, supra note 140, at 340–41 (describing the increasing activity of “water trusts” in purchasing and “retiring” water rights). It should be noted that environmental groups that engage in “retiring” water-use rights in western prior appropriation regimes might face opposition because change-of-use rules are applied more rigorously to them than traditional users. Tarlock, supra note 99, at 902 (noting that this has been the case in Oregon as applied to the Oregon Water Trust). In a cap-and-trade system, the fact that the permit allocation is a “zero-sum” game—i.e., a system in which every permit obtained by a given party is one less permit available for all other parties—makes the initial allocation even more important. 155Heinmiller, supra note 129, at 450 (noting that because of the nature of the process and the economic value at stake, “this process is quite clearly political”).

Likely because of the political influence of the existing users, most tradable permit programs use initial allocations that favor existing users. 156Tietenberg, supra note 12, at 270 (stating that in “virtually all implemented tradable permit programs discussed in this article” existing users get free permits). One drawback of giving free permits to existing users in the initial allocation is that it will be more expensive for new users to access the system. 157 See id. at 271 (arguing that free initial allocations disadvantage new users). Another is that if users know the initial allocation is based on existing use, they may inefficiently increase their use to increase their initial permit allocation. 158 Id. The inefficient depletion problem could be mitigated by using historical data going back beyond the time that users knew their level of use would determine their initial permit allocation. 159 Cf. id. (noting the problem exists when users know their allocation will be based on historical use).

Some commentators suggest that political and social influence in the trading of permits is a significant reason that tradable permit programs are not as successful in practice as they are in theory. 160 See, e.g., Heinmiller, supra note 129, at 461 (describing how political and social pressure may prevent lower value water users from participating in the market). For example, in a tradable water permit system, agricultural water users in smaller communities may resist selling their water withdrawal rights because of sentimental feelings about the significance of the resource to their communities and families, even when those users could expect to receive an economic benefit from selling their withdrawal rights. 161 See id. (noting that these are typically low value users who could expect a financial gain from selling their rights). Heinmiller discusses water trading in Australia and explains that tensions that have developed between “buyers,” states with low-value irrigators, and “sellers,” states with higher value users. Id. at 463. But see Fortuna, supra note 152, at 1061 (noting the possibility of the opposite problem occurring—that a water market could entice farmers in smaller communities to sell their use rights because the rights will be more valuable to heavily populated areas). Because agricultural use is often such a large potion of water consumption, 162Dellapenna, Interstate Struggles, supra note 1, at 838. policy makers must consider ways to encourage agricultural and other low-value users to participate in the market when it is economically beneficial for them to do so. 163 See Heinmiller, supra note 129, at 461–64 (noting the economic benefits of an open market, but observing that some users’ reluctance to participate for social or political reasons can negate those benefits).

On the other hand, some reluctance to trade by smaller users may be useful to the system by preventing a concentration of rights in too few users, which may create too much market power for the concentrated holder and reduce the efficiency of the market. 164 See Tietenberg, supra note 12, at 273 (describing how concentration in fishery permits has resulted in the decline of smaller fishing operations because they are being bought out by larger operations). More proactive methods of dealing with the concentration problem have also been used, including placing limits on the percentage of rights any one user may hold, government restriction of trades that violate public policy, retaining a reserve to dilute the market if needed, and requiring an annual auction in which each user must put up a percentage of their rights for the auction. 165 Id. at 273–74. The first two methods have been used in tradable permit markets for fisheries; the latter two methods have been used in the United States’ sulfur pollution allowance program. Id.

Finally, some commentators suggest that a tradable permit system must be designed to address issues arising when a permit is used in circumstances other than those under which it was initially allocated. 166 See, e.g., Salzman & Ruhl, supra note 25, at 625 (noting that the currency of a tradable permit market needs to be designed to address this issue). These issues are often referred to as “nonfungibilities,” 167Fungible is defined as “being of such a nature that one part or quantity may be replaced by another equal part or quantity in the satisfaction of an obligation.” Merriam-Webster’s Collegiate Dictionary 507 (11th ed. 2004). Further, “oil, wheat, and lumber are fungible commodities.” Id. (emphasis added). and they arise in “environmental trading markets” in three different ways: space, type, and time. 168Salzman & Ruhl, supra note 25, at 611, 625 (explaining fungibility as when “the things exchanged are sufficiently similar in ways important to the goals of environmental protection”); see also Tietenberg, supra note 12, at 280 (discussing breakdowns in theory when systems are implemented and noting as an example that tradable permits are not always homogenous because time and place of use matters). The most prevalent of the three is nonfungibility of space. 169Salzman & Ruhl, supra note 25, at 628. Nonfungibility of space can occur when, as a result of the trade, the right to use or emit is exercised in a different location than it would have been if it had not been traded, so the external effect of exercising the right on the environment and third parties changes. 170 See Nash, supra note 137, at 14 (describing “spatial differentiation” in the context of pollution control programs and habitat trading programs). Nonfungibility of space can result in “hot spots,” which can occur when there is a concentration of an activity in one place. 171 See Salzman & Ruhl, supra note 25, at 627–28. The authors cite as an example a hot spot resulting from a Los Angeles program that allowed industrial polluters to gain pollution credits by destroying older, heavily polluting cars. Id. at 628. But critics pointed out that the refineries were closely concentrated; thus, after the trades, the reduced emissions from the cars affected a 12,000-square-mile area, while the increased emissions from the industrial polluters were now concentrated in a twenty-square-mile area. Id.; see also Nash & Revesz, supra note 15, at 580–81 (discussing hot spots). When this happens, the same level of activity may have a greater marginal impact within the hot spot than it would outside of it because there are fewer units of space to absorb the activity. 172 See Salzman & Ruhl, supra note 25, at 628 n.42 (“‘[I]t is immediately pointed out that a ton of any particular kind of waste will do much more damage in some places than in others . . . .’” (quoting J.H. Dales, Pollution, Property & Prices 79 (1968) (alteration in original))). Commentators have noted that nonfungibility of space can disrupt the economic efficiency of the market by introducing externalities and have suggested that one way to address this problem is to restrict the geographic area of trading. 173 E.g., Tietenberg, supra note 12, at 275 (discussing lack of homogeneity in transfers and geographic restrictions on trades). Another, less restrictive, potential remedy is to require regulatory approval of trades to allow for assessment of nonfungibility. 174 See Nash & Revesz, supra note 15, at 573 (proposing a system that requires regulatory pre-approval to address nonfungibility in emission trading programs); see also Tietenberg, supra note 12, at 275 (noting that the U.S. Wetlands program deals with “harmful spatial aspects” by requiring regulatory approval of trades). However, both of these methods would likely decrease the economic efficiency benefits of the market by disallowing some trades. 175Tietenberg, supra note 12, at 275 (discussing geographic restrictions on trades and concluding that “[s]patial issues can be dealt with within the tradable permit scheme, but those choices typically make transfers more difficult”). Requiring regulatory approval in a water market may also implicitly discourage trading because of increased bureaucracy, particularly for smaller users.

One commentator has explained fungibility of type as simply “[a]pples are traded for apples, not oranges.” 176Salzman & Ruhl, supra note 25, at 629. Fungibility of type is most difficult to assess when the object of the tradable permit, such as a parcel of land in habitat trading, is not homogenous—i.e., no two parcels of land are exactly the same. 177 Id. The authors also cite emission programs that bundle different types of polluting gases into one category as an example of nonfungibility of type. Id. Finally, nonfungibility of time arises when a trade results in the activity occurring at a different time than that contemplated by the permit, causing the marginal effect to be different than the effect intended by the permit. 178 Id. at 630; see also Nash, supra note 137, at 17–19 (discussing “temporal differentiation” in environmental programs); Tietenberg, supra note 12, at 276 (discussing the “temporal flexibility”).

Of the three nonfungibilities, nonfungibility of space is likely to pose the biggest problem in a tradable permit water market. Within the context of tradable emission permits, water use may be analogous to what have been termed “regional” pollutants—those that may travel many miles—”but the affected region is defined by reference to where the emissions come from.” 179Nash & Revesz, supra note 15, at 576. Perhaps analogously, water can travel over a broad area, but water shortages experienced by downstream users may be related to upstream users’ consumption, potentially depriving downstream users of adequate resources to fulfill their water-use rights. 180 See Tietenberg, supra note 12, at 277 (discussing issues that can affect the success of tradable permit programs and noting that water regulators “must cope with the consequences of trades on downstream users”).

In addition, environmentalists believe that tradable permits increase the potential for hot spots 181For a discussion of hot spots, see supra notes 171–72 and accompanying text. because existing users tend to be concentrated, which will likely result in the initial allocation of permits being concentrated. 182Nash & Revesz, supra note 15, at 580–81. Nash and Revesz note that this problem also may stem from older polluters being less likely to convert to better pollution control technologies, forcing them to buy additional permits and worsening the hot spot. Id. This phenomenon may also occur in a tradable water permit system if large industrial users concentrated in cities purchase withdrawal permits from agricultural users. The marginal effect of those withdrawals in areas of concentration or water shortage would be greater than the effect of the same withdrawal in an area without a concentration or shortage. 183 See Barmeyer, supra note 17, at 237 (discussing interbasin transfers and their potential negative impact on “hydrologic capacity” in areas of shortage).

The easiest way to address spatial fungibility issues is to restrict trading within certain geographic zones. 184Salzman & Ruhl, supra note 25, at 638. In a water market system, geographic trading restrictions could prevent withdrawal permits that originate in rural areas from concentrating in cities, where the resources would be unable to fulfill the withdrawals that the permits prescribe. 185 See Nash & Revesz, supra note 15, at 573 (proposing a system that requires regulatory pre-approval to address nonfungibility in emission trading programs); Salzman & Ruhl, supra note 25, at 638–39 (discussing geographic trading restrictions). However, these types of trading restrictions can undercut the economic efficiency gains of a market system. 186Salzman & Ruhl, supra note 25, at 636 (discussing transaction costs and their negative effect on economic efficiency); see also supra notes 173–75 and accompanying text.

Nonfungibility of time may occur in a tradable permit system for water if, for example, many users purchased withdrawal permits when there was no shortage but did not use them until a shortage occurred, causing a greater impact at the time of use than would have occurred at the time of issuance. 187 See supra note 178 and accompanying text. Restrictions that tie the time of the withdrawal to the time of the sale would be one way to address nonfungibility-of -time issues in a water market. 188 See Salzman & Ruhl, supra note 25, at 642 (“Temporal nonfungibilities may be neutralized by restricting trades to narrow time periods.”).

Of the three nonfungibilites, type is of the least concern in a water market. Nonfungibility of type could conceivably occur because of hydrological differences between groundwater and surface water; however, it is unclear whether this distinction would have real implications for a water market because there seems to be little practical difference between the two. 189 See Carol M. Rose, From H2O to CO2: Lessons of Water Rights for Carbon Trading, 50 Ariz. L. Rev. 91, 99 (2008) (“It has long been known that groundwater and surface water are hydrologically related, and there have long been calls to link their legal treatment.”). Thus, nonfungibility of type is of less concern than nonfungibility of space or time in water permit trading, but if it were determined to be a legitimate concern, it could be addressed by having a permit specific to each source. 190 See Salzman & Ruhl, supra note 25, at 640 (noting that in emissions-trading schemes, trades are restricted to the same pollutant and mixing of pollutants does not occur).

B. Criticisms of Water Market Proposals

Commentators have noted more potential negative consequences of water markets than this Comment is able to address. However, it will discuss how a tradable permit system might be structured to address the following concerns: that (1) the states will be unable to control the sale of water resources to out-of-state buyers because of the dormant Commerce Clause; 191 See Barmeyer, supra note 17, at 234 (“[T]he dormant commerce clause . . . could limit the power of the state to prevent the export of its water resources to other states or countries . . . .”); Draper, supra note 10, at 53 (discussing the Commerce Clause’s effect on tradable property rights for water); Fortuna, supra note 152, at 1051 (describing the “substantial constitutional implications” that a market for water-withdrawal permits would create). (2) the agricultural industry may be damaged because it will become more lucrative to sell water rights than to use them for irrigation to harvest crops; 192 E.g., Fortuna, supra note 152, at 1061. (3) the permits would increase water use as current users sell their excess rights; 193 E.g., id. and (4) transaction costs will negate economic gains from the system. 194 See, e.g., Draper, supra note 10, at 51–52 (discussing transaction costs and “externalities”). This section will discuss some ways a tradable permit system might be designed to address these concerns.

Commentators have noted that the Dormant Commerce Clause doctrine could prevent states that adopt a free market for water rights from transferring their water rights to out-of-state users. 195 See supra note 191. The Dormant Commerce Clause doctrine holds that states may not enact policies that are economically protectionist or that discriminate against interstate trade in favor of intrastate trade. 196 See, e.g., Philadelphia v. New Jersey, 437 U.S. 617, 623–24 (1978) (“The crucial inquiry, therefore, must be directed to determining whether [the statute] is basically a protectionist measure, or whether it can fairly be viewed as a law directed to legitimate local concerns, with effects upon interstate commerce that are only incidental.”). The critics of the water market describe a scenario in which a private holder of a large water use permit sells its rights to use water within the state to the highest bidder, who happens to be out of state and plans to transfer the water out of state; they contend that the state would be powerless, with narrow exceptions, to stop such an interstate transfer. 197Draper, supra note 10, at 53. The seminal case on the application of the Commerce Clause to water resources is Sporhase v. Nebraska. 198458 U.S. 941 (1982), see also Draper, supra note 10, at 53. In Sporhase, the Court held that groundwater is an article of commerce subject to Dormant Commerce Clause analysis 199 Sporhase, 458 U.S. at 953–54. and struck down a Nebraska law restricting interstate transfers of Nebraska groundwater as unconstitutional. 200 Id. at 960. The Nebraska law required any person or entity that wanting to transport water from Nebraska for use in another state to apply for a permit, which would only be granted if the state to which the water was being transported granted reciprocal rights to transfer water to Nebraska. Id. at 944.

The Sporhase holding has several potential loopholes that might be used by states to restrict out-of-state transfers. The Court acknowledges that a state has a legitimate interest in conservation and preservation of its water resources “in times of severe shortage”: A “State’s power to regulate the use of water in times and places of shortage for the purpose of protecting the health of its citizens—and not simply the health of its economy—is at the core of its police power.” 201 Id. at 956. The law in Sporhase was constitutionally flawed because its reciprocity requirement did not further a legitimate interest—it would restrict the transfer of water to its most beneficial use if that use was out of state and would do so even when water was abundant at the point of withdrawal. 202 Id. at 958. Thus, the Court noted that a “demonstrably arid State conceivably might be able to marshal evidence to establish a close means–end relationship between even a total ban on the exportation of water and a purpose to conserve and preserve water.” 203 Id. This statement from the Court seems to indicate that a state facing a severe shortage that threatens the health of its citizens could make a compelling case to strictly protect its resources from out-of-state transfers.

Some commentators have noted states might also restrict out-of-state transfers without running afoul of the Dormant Commerce Clause analysis by using a “basis of origin” rule, 204 E.g., Matthews & Pease, supra note 9, at 619. which would restrict transfers out of the water’s geological base or “watershed.” 205Barmeyer, supra note 17, at 235–36 (proposing that Georgia could impose transfer restrictions based on watersheds for the purpose of protecting “hydrologic integrity”). Such a rule would seem to apply equally to anyone out of the basis, whether they were in or out of state. 206 See Matthews & Pease, supra note 9, at 619 (“Proponents argue that there is no discrimination because all potential users outside the boundaries of the watershed are treated alike . . . .”). Analysis of the constitutionality of such a rule is beyond the scope of this Comment, but commentators have noted that it is unlikely that the rule would be upheld under a Dormant Commerce Clause analysis because protectionist policies within subdivisions in a state are no more constitutional than if they were implemented by the state. 207 Id. at 619–20 (discussing Fort Gratiot Sanitary Landfill, Inc. v. Michigan Department of Natural Resources, 504 U.S. 353 (1992), which invalidated a state law that isolated its counties from solid waste produced outside of the county). And a basis-of-origin restriction may also lessen the viability of a water market if transfers could not be made from areas with excess water resources to areas with shortages. 208 Cf. Barmeyer, supra note 17, at 236 (noting that in Georgia permit transfers from agricultural areas to Atlanta could violate a prohibition against interbasin transfers).

Even if Sporhase leaves states completely unable to prevent out-of-state transfers of their water resources, interstate transfers would help promote the highest economic use of water resources by expanding the potential market and providing an economic benefit to the selling permit holder. 209 See Nash, supra note 120, at 484–85 (noting that geographic restrictions reduce the potential number of participants, thus increasing the cost of finding trading partners). For a discussion of the economic benefits of a market system, see supra note 15 and accompanying text. If each state participating in the market were to allow tradable permits for water use, each would stand to benefit from the economic efficiency promoted by a free-market system, even if those tradable permits flow across state lines. 210 See Matthews & Pease, supra note 9, at 607 (“Reducing the size of a market area by limiting water exports constrains the ability to move water from inefficient uses to more efficient ones.”). The economic efficiency that is realized by free trade across state borders is the basis underlying the Commerce Clause’s invalidation of protectionist state policies. 211 See Philadelphia v. New Jersey, 437 U.S. 617, 623 (1978) (“‘This principle that our economic unit is the Nation . . . has as its corollary that the states are not separable economic units. . . . [W]hat is ultimate is the principle that one state in its dealings with another may not place itself in a position of economic isolation.’” (quoting H.P. Hood & Sons, Inc. v. Du Mond, 336 U.S. 525, 537–38 (1949)). Under the proposed system, a state would at the very least be able to regulate the total depletion of its resources through management of the allowable withdrawal attached to each permit, while still gaining the economic benefit from maximizing the efficient use of its resources. 212 See Matthews & Pease, supra note 9, at 604 (arguing that limiting a market geographically sacrifices possible gains from efficient allocation).

Next, some commentators argue that the force of supply and demand, which could drive prices for water in the market higher, would harm the ability of individual households and agricultural users to obtain, or retain, water-use rights, and further, that, aside from the basic human need for water, this could lead to destruction of smaller communities that rely on small agricultural operations. 213 E.g., Fortuna, supra note 152, at 1058, 1061; Neuman, supra note 15, at 463 (noting that water markets can lead to a concentration of rights in the wealthy). But see Huffman, supra note 12, at 435–36 (noting this argument from critics, but dismissing it as an “[un]persuasive reason to oppose the creation of water markets”). For a discussion of how this issue has been addressed in tradable permits for fisheries, see Tietenberg, supra note 12, at 274. For a discussion and examples of how a price or value can be determined for water in a market, see Willey & Graf, supra note 65, at 331–34. However, each municipality would receive an initial allocation of withdrawal permits sufficient to supply its citizens with water for domestic use under the proposed system. In times of severe shortage, sufficient water to meet basic human needs would take precedent. In Sporhase, the Court indicates that state governments have wide latitude to ensure the availability of water for its citizens. 214Sporhase v. Nebraska, 458 U.S. 941, 956 (1982) (“[A] State’s power to regulate the use of water in times and places of shortage for the purpose of protecting the health of its citizens . . . is at the core of its police power.”). If a water provider were forced to pay high prices to increase its supply and were forced to pass those increases to domestic consumers, water subsidies could be implemented to ensure that those who may not be able to afford higher prices have access to water. 215 See Huffman, supra note 12, at 436 (“If society cares about fairness, it is possible to create needs-tested subsidy programs to assure that the poor get the water they need for basic human survival.”). Such policies recognize the conflict between ultimate economic efficiency and the desire for all users to have an equal ability to utilize the market for their benefit. Policy makers are allowed to make judgments that strike the appropriate balance between those goals. 216 See Esty, supra note 80, at 1572 (“[E]ffective environmental procedures may not take full cognizance of other social values such as justice or equity. If all the [resources] are owned by the rich, a property rights-based allocation system may be efficient, but it will not be just. Optimal environmental governance must therefore be understood to be both relative and contextual. A theory of optimal governance defines a theoretical goal and a process, but does not offer a definitive answer to every policy question.”).

A related argument against tradable permits is that because agricultural users typically do not use their full allocation of water rights under current laws, overall use would increase if they were allowed to sell excess use rights on an open market and the shortage problems would be exacerbated. 217Fortuna, supra note 152, at 1061. However, in a system where the initial allocation is not based on the current withdrawal rights, but rather on a reasonable amount actually needed to sustain current operations, the overall withdrawal amount would not increase by a large margin. 218The initial allocation cap based on current use would also alleviate concerns that tradable permits based on current rights, which often allow withdrawal amounts much greater than those actually used, would provide a “windfall” to current users. See id. at 1060 (arguing that a windfall would result for current permit holders). Profit for permit holders would come from efficiency gains in their operations or reduced use—not from selling excess use initially allocated to them. For additional discussion of why the “windfall” criticism of water markets is unfounded, see Huffman, supra note 12, at 435. Agricultural users would then be encouraged to increase the efficiency of their water use 219Inefficient agricultural uses may include irrigation that produces relatively low-value crops, unlined ditches used for water diversion and low-technology flood irrigation. See Matthews & Pease, supra note 9, at 603 n.5. so that they could sell the remaining withdrawal rights for a profit to users with increasing demand, such as growing population centers. 220Barton H. Thompson, Jr., Markets for Nature, 25 Wm. & Mary Envtl. L. & Pol’y Rev. 261, 263–64 (2000) (“The government can allocate reductions based on historical use or seniority and rely on the market for meeting economic needs and changing demands.”). Professor Thompson notes that in western states, “the transfer of merely a tenth of current agricultural water can more than double the water available for growing metropolitan areas.” Id. at 264; see also Thompson, Jr., supra note 15, at 195 (“Tradable permits . . . encourage entities to find ways of further improving their performance since the entities can then sell their unneeded permits . . . .”); supra notes 138–40 and accompanying text. Because agriculture is such a large portion of consumptive uses of water, 221Dellapenna, Interstate Struggles, supra note 1, at 838 (stating that irrigation is “generally the most heavily consumptive use of water”); Thompson, Jr., supra note 220, at 264 (stating that agricultural use composes eighty percent of water use in the western part of country). the improvements in efficiency that would be promoted by a cap on withdrawal would free up water for other uses. 222 See Neuman, supra note 15, at 468 (stating that smaller agricultural users, who are often the most inefficient, currently do not have an economic incentive to improve). One commentator argues that this excess water would allow agricultural businesses at once to continue their operations and sell remaining water rights. 223 Id. at 473 (“[I]nsisting that urban or conservation-driven water demands are a threat to the agriculture industry’s viability ignores the tremendous potential for conserving water in the agricultural sector.”). Further, these gains in conservation through more efficient use may outweigh the potential threat to the agricultural industry. 224 Id.

As with any market system, there is a risk that transaction costs may erode any economic gains. 225 See Draper, supra note 10, at 51–52 (discussing potential transactions costs in a water market and stating that “[t]he most serious direct economic consequence of for-profit water trading is the inability of bilateral water transactions between sellers and buyers to consider the effects of the transaction on third parties”); Nash, supra note 120, at 485 (“[G]overnment must be careful that the transaction costs do not become so high that they preclude the establishment and maintenance of a viable market.”). Generally, transaction costs include not only the transacting parties’ costs, but also costs to third parties that are not reflected in the price of the transaction. 226Draper, supra note 10, at 51; Willey & Graff, supra note 21, at 335. The more that the system and permits are tailored to address nonfungibilities, 227See Part II.A.2 for a discussion of nonfungibilities. are restricted by geographic area, 228Nash, supra note 120, at 484–85 (noting that geographic restrictions reduce the potential number of participants, thus increasing the cost of finding trading partners). or are regulated to protect certain users, 229 See supra Part II.A.2. For example, constructing regulatory barriers to trade that are designed to protect agricultural communities from loss of resources. the more economic efficiency is lost to transaction costs because increased regulation increases the costs of the trade. 230Salzman & Ruhl, supra note 25, at 636 (explaining that increased cost in design and management of the system may lessen participation in trading); Tietenberg, supra note 12, at 273 (“[A]dditional restrictions tend to raise transaction costs and to limit the cost-effectiveness of the program.”). Transaction costs occurring outside of the trade noted by commentators include depleted resources for downstream users caused by upstream use 231 See, e.g., Sinden, supra note 106, at 579 (“One right holder’s diversion of surface water can have important impacts on downstream users.”). and the potential damage to the agricultural industries and the small communities they support because those users may find it more profitable to sell water rights than to use them for irrigation. 232 See, e.g., Draper, supra note 10, at 51; Sinden supra note 106, at 581. Because of this tradeoff between economic efficiency on the one hand and an optimal system design to protect against nonfungibility and harm to third-parties on the other, “the policy instrument’s viability rests on a balance.” 233Salzman & Ruhl, supra note 25, at 636. Salzman and Ruhl note that some level of nonfungibility is desirable, if not critical, to a functioning market; otherwise there would be no need for the participants to trade. Id. at 645. The more nonfungible the currency (the permit), the more active the market will be. Id. at 645–46; see also Draper, supra note 10, at 51 (“[I]f the rights and costs of third parties are included in the water rights transfer, transaction costs rapidly become exorbitant.”). In a tradable permit water market, policy makers would have to determine the point at which the non-economic and third-party costs of the market are outweighed by the benefits of water conservation and efficient allocation, a determination that might itself be deemed a transaction cost. 234 See Draper, supra note 10, at 51 (“In any large and complex hydrologic system, the difficulty and expense of structuring the necessary third-party transaction costs frustrates the development of markets unless the law chooses to disregard the externalities.”); Salzman & Ruhl, supra note 25, at 637 (noting that “aggressive market construction” aimed at reducing external effects is dangerous because it can cause even more problematic flaws in the ability of the market to function); Sinden, supra note 106, at 582 (“[W]hen ecological and community impacts are added to the mix, the government’s role in approving trades must necessarily shift from one of simply facilitating bargaining among affected parties to making substantive judgments about the level of impact that is acceptable or desirable.”).

III. What Would a Market for Tradable Water Permits Look Like?

As described in Part II, tradable permit systems are typically structured in one of two forms: credit trading and cap and trade. 235 See supra notes 125–27.This Comment argues that water markets are needed to conserve and efficiently allocate a scarce resource through a market system that caps aggregate use and that tradable permits should be the currency of such a system because they can be structured as secure property rights that are freely tradable. This system would allow policy makers to determine and impose a sustainable level of use and, through the use of the market, would encourage users to consume the resource more efficiently. 236 See supra notes 15 & 220 and accompanying text.

Both cap and trade and credit trading tend to promote economic efficiency, 237Credit trading promotes more efficient use of resources because users can sell credits they have accumulated by becoming more efficient. See Tietenberg, supra note 12, at 265. but credit trading does not cap use. 238 See generally Heinmiller, supra note 129, at 445–48. In areas with rapidly growing populations and industry, 239For example, it has been estimated that metro-Atlanta’s population will double over the next twenty-five years. Shelton, supra note 9. the inability of regulators to cap the aggregate level of consumption would decrease their ability to maintain the desired level of conservation as new users are added to the system. 240 See Heinmiller, supra note 129, at 447 (“[I]f the number of users in a credit program increases, aggregate resource use will also increase . . . .”). Therefore, credit trading is not as effective as a cap-and-trade system for maintaining sustainable levels of water use. Under this proposed system, policy makers would determine an annual level of sustainable use and then divide the use rights, which would automatically renew each year among the users. 241 Cf. Nash, supra note 137, at 14 (noting that in pollution programs, the level is usually set on an annual basis).

For a cap-and-trade system to effectively regulate aggregate use, all water users must be accounted for within the system. 242For a discussion of how exempting certain users from the permit system impairs the ability of the system to effectively conserve water, see supra notes 57–66 and accompanying text. Therefore, current permit systems under regulated riparian 243 See supra Part I.A.2. and prior appropriation 244 See supra Part I.B.1. systems, which exempt some large-scale users from permit requirements, must be expanded and modified to eliminate wide-ranging exemptions. In many states, this would require currently exempted users—often agricultural users—to be brought into the permit system. 245 See supra Part I.A.2. There may be a level of use at which it is no longer productive to regulate the consumption by a user. For example, the cost of regulating a rural household withdrawing water from a ground well might be greater than the benefit. However, this Comment takes the position that such decisions should be made on the basis of value added to the goals of the system—not on the basis of political influence. See supra notes 142–46. Continuing to allow a large portion of water use to be largely unregulated cripples the ability of the system to conserve resources because often the largest categories of use are the ones out of the reach of regulators. 246 See Dellapenna, Interstate Struggles, supra note 1, at 838 (noting that irrigation use is generally one of the most consumptive uses). The system proposed by this Comment would bring most users 247 See supra note 245. within the permit system so that all water use would be regulated.

Water rights that are traded in an active market must be secure property rights so that participants can be certain of what rights they are buying and selling, and they must be transferable. 248 See supra notes 80 & 81 and accompanying text. As described in Part I, water rights under current laws are often uncertain, as is their transferability. 249 See supra Part I.A.3 & Part I.B.2. Under the proposed system, a use permit would specify how much water the owner is entitled to withdraw within a given time period, and it would not be subject to the rights of any other users or permits. The permit would automatically renew annually. 250 See supra note 241 and accompanying text. Thus, once a permit is obtained, the user would be certain that his property right in the permit’s allowable use would remain secure. 251 See Salzman & Ruhl, supra note 25, at 617 (discussing environmental trading markets and stating that the rights attached to the tradable permit compel “the government [to] create[] a new form of property,” which can be characterized as the right to engage in a certain activity or use a common resource).

Under the proposed system, permits initially would be allocated through a free distribution to existing users based on existing and historical use. 252 See supra notes 218–20 and accompanying text for a discussion of why the initial allocation is based on historical use. As noted in Part II.B, one criticism of water markets has been that overall consumption would actually increase because users who do not currently use all the water to which they have a common law right would sell their excess use rights once a market is available to do so. 253Fortuna, supra note 152, at 1061. However, if the initial allocation of use permits were based on existing or historical use, rather than on available common law or current permit use rights, overall water consumption would not increase. 254 See supra note 218 and accompanying text. Basing allocation on actual use also alleviates the problem of giving existing users a windfall because they will not have an initial excess of rights available for sale; rather, they will have to reduce use or become more efficient in their use to realize profits from selling permits. 255 See supra notes 217–20 and accompanying text.

A water market should be structured to attempt to alleviate any nonfungibilities that exist. As discussed in Part II.A.2, nonfungibility of space is most likely to present a problem in water markets, although nonfungibility of time and type may also be issues, but to a lesser extent. 256 See supra Part II.A.2. Nonfungibility of space should be prevented to the extent that it creates harmful hot spots that occur when permits are concentrated in an area where the marginal effect of use in the hot spot is greater than it would be if the use were to occur where the permit originated. 257 See Salzman & Ruhl, supra note 25, at 628 n.42. For a discussion of hot spots, see supra notes 171–72 & 181–82 and accompanying text.

In the proposed system, nonfungibility-of-space issues could be managed by monitoring all trades. 258 Cf. Nash & Revesz, supra note 15, at 573 (proposing an emission-trading system that requires pre-approval of trades based on a model that assesses the marginal effect of the trade). Geographic zones would be delineated by matching levels of use with available resources, and trades would be tracked to determine the concentration of permits in each area. For example, permits flowing from rural agricultural areas to cities would be monitored because they would be moving to an area of greater consumption. 259For a discussion of the possible effects of transfers from agricultural areas to cities, see Fortuna supra note 152, at 1062–63. Regulators would then be able to block trading activity if it appeared that hot spots were going to strain the water resources in the concentrated area or if overuse in the concentrated area would deprive downstream users of their use rights. 260For a discussion of hot spots, see supra notes 171–72 & 181–82 and accompanying text. However, the level at which trades would be blocked must be carefully considered so as not to prevent the market from functioning inefficiently and imposing burdensome transactions costs that negate the efficiency gains; this calls for a balance that policy makers ultimately will have to determine—a task that admittedly is a difficult one. 261For a discussion of transaction costs, see supra notes 225–34.

Nonfungibility of time seems to be most troublesome in times of severe water shortage. For example, adequate resources may not be available to fulfill a withdrawal permit during a severe water shortage even though there may have been adequate resources at the time of the trade. Nonfungibility of time has been addressed in other tradable permit systems by imposing time limits on tradable permits. 262For example, in emissions-trading programs, an emission permit may have a time limit attached within which the allowable emission must occur. See, e.g., Salzman and Ruhl, supra note 25, at 642 (describing temporal limits in trading programs). However, in the proposed water market, imposing time limits would be impractical because withdrawal rights would be measured by the amounts withdrawable within each year, and the right to would renew annually. 263 See supra note 241 and accompanying text.

One possible solution would be to review the problem arising from nonfungibility of time before each renewal period begins, allowing for an adjustment in use amounts if, at that time, resources were inadequate for the amount of existing permitted use. However, as noted above, the tradable permit grants a right to water withdrawal that must be secure and certain; it must continue to renew at the same amount in each new period. 264 Supra notes 250 & 251 and accompanying text. Thus, it may not be possible to impose time limits on the use of water permits while still maintaining their value to market participants. A perfect solution to this difficult issue may not exist; regulators will need to have an accurate forecast of resources at the program’s outset to avoid permitting too much use in the market during times of shortage. But the value of having use rights attached to the permit that are certain outweigh the risks of nonfungibility of time.

This proposed system allows regulators and policy makers to achieve a sustainable level of overall water use by placing a cap on total use. It also provides incentive for water resources to be used more efficiently because users who use less water can benefit economically by selling their unused rights. Rights to use water resources, and the ability to transfer those rights, will be secure and free from the vagaries of riparian rights and prior appropriation regimes, allowing participants in the market to buy and sell a secure asset freely.

Conclusion

This Comment has argued that a market system for water-withdrawal rights, using tradable permits as its currency, should be implemented by states to address water shortages. A cap-and-trade structure would allow policy makers to determine a sustainable level of water use and to impose that sustainable limit by requiring all water use to be accounted for within the permit system. Implementing a cap-and-trade permit system would allow regulators to set conservation goals and implement long-term strategies rather than the short-term measures that traditionally have been used during shortages. 265 See supra notes 3 & 4 and accompanying text. This system also would promote efficient allocation of water resources through the market structure.

This Comment has argued that current water-rights regimes do not provide adequate property rights or alienability of those rights to support a market for tradable water permits. Therefore, a tradable-permit system for water use would have to be implemented within a new water-rights system that would ensure secure property rights and full transferability among users. These permits would be issued to current users at no charge and would be based on the user’s current and historical use level. By capping aggregate water use and promoting more efficient use of water resources through a market structure, water shortages can be addressed with long-term planning and conservation through permanent systems, rather than with inadequate short-term measures.

Footnotes

1 See Joseph W. Dellapenna, Interstate Struggles over Rivers: The Southeastern States and the Struggle over the ‘Hooch, 12 N.Y.U. Envtl. L.J. 828, 828 (2005) [hereinafter Dellapenna, Interstate Struggles] (noting that the southeastern U.S. region experienced the worst drought in its recorded history in the 1980s and still worse drought conditions at the beginning of the 21st century); Joseph W. Dellapenna, The Law of Water Allocation in the Southeastern States at the Opening of the Twenty-First Century, 25 U. Ark. Little Rock L. Rev. 9, 10 (2002) [hereinafter Dellapenna, Water Allocation] (stating that in the eastern half of the United States, growing demand and erratic climate patterns have caused more frequent shortages); Felicity Barringer, Signs of Another California Drought Year, N.Y. Times, Jan. 2, 2009, at A15 (“California, just finished with its second consecutive year of drought, might well be facing a third.”); see also Janet C. Neuman, Federal Water Policy: An Idea Whose Time Will (Finally) Come, 20 Va. Envtl. L.J. 107, 110–11 (2001) (noting that the problem is exacerbated by the fact that population is growing fastest in areas with less water).

2 E.g., Joseph W. Dellapenna, Regulated Riparianism, in 1 Waters and Water Rights § 9.01, at 9-10, 9-11 (Robert E. Beck & Amy K. Kelly eds., repl. vol. ed. 2007) [hereinafter Dellapenna, Regulated Riparianism] (noting that climate change is predicted to cause increasing frequency of both droughts and floods); Noah D. Hall, Bret B. Stuntz & Robert H. Abrams, Climate Change and Freshwater Resources, 22 Nat. Resources & Env’t 30 (2008) (noting that scientists predict climate change will have an adverse impact on water resources).

3 See, e.g., Barringer, supra note 1 (reporting that California may impose water rationing).

4 See, e.g., Stacy Shelton & John C. Perry, Only Toughest Ban Reduced Water Use, Atlanta J.- Const., Feb. 24, 2008, at D1 (reporting on water conservation measures implemented in Georgia during drought conditions).

5Ari B. Bloomekatz, U.S. Plans to Tighten Tap for Farmers, L.A. Times, Feb. 21, 2009, at B3.

6The U.S. Bureau of Reclamation operates dams and reservoirs in the western United States and sells water in the wholesale market and to agricultural users. U.S. Bureau of Reclamation: About Us, http://www.usbr.gov/main/about/ (last visited Mar. 24, 2010).

7Bloomekatz, supra note 5.

8 Id.

9 See Hall, Stuntz & Abrams, supra note 2, at 34 (“[W]e must reform water law and policy to emphasize conservation and efficient, environmentally sound allocation.”); Olen Paul Matthews & Michael Pease, The Commerce Clause, Interstate Compacts, and Marketing Water Across State Boundaries, 46 Nat. Resources J. 601, 603 (2006) (arguing that conservation and more efficient allocation are the solutions to inadequate water supply); see also Stacy Shelton, Atlanta Water Supply Precarious; Without Conservation, Future Looks Glum, Atlanta J.- Const., June 27, 2005, at E1 (citing district water plans, reporting that water shortages are projected in north Georgia, which includes Atlanta, unless there are “aggressive conservation measures and new lakes to store water”).

10 See Stephen E. Draper, The Unintended Consequences of Tradable Property Rights to Water, 20 Nat. Resources & Env’t 49 (2005) (“Increasingly in the United States, commercial activities and growing population centers have developed in areas with scarce water resources.”); Neuman, supra note 1, at 110–11.

11 Supra note 9 and accompanying text.

12The distinction should be made between the right to withdraw water, which would be attached to the permits this Comment proposes, and the possession or ownership rights of particular water from a particular source. This distinction is important because a withdrawal right can be transferred to a different location that has a different water source. See Tom Tietenberg, Tradable Permits in Principle and Practice, 14 Penn St. Envtl. L. Rev. 251, 266 (2006) (a tradable permit system does not “privatiz[e] the resource;” it “privatizes the right to access the resource”); see also James L. Huffman, Water Marketing in Western Prior Appropriation States: A Model for the East, 21 Ga. St. U. L. Rev. 429, 439 (2004) (explaining that water’s physical properties makes “it impossible, with some exceptions, to actually possess the same water for an extended period,” but that this “is not necessarily an insurmountable obstacle to water marketing”). For a further discussion of transferring a tradable permit for water use to a location other than where the permit was initially allocated, see infra Part II.A.2.

13 See Tietenberg, supra note 12, at 265 (describing the basic attributes of a cap-and-trade system).

14See infra Part I for a discussion of current water-rights regimes. For a discussion of the system proposed by this Comment, see infra Part III.

15 See generally Huffman, supra note 12, at 432 (“[A] well functioning market is the most effective and efficient institution to allocate scarce resources.”); Jonathan Remy Nash & Richard L. Revesz, Markets and Geography: Designing Marketable Permit Schemes to Control Local and Regional Pollutants, 28 Ecology L.Q. 569, 572 (2001) (describing emission permit trading systems as reducing “aggregate emissions to the chosen aggregate level for the least cost” when there is an active market); Janet C. Neuman, Have We Got a Deal for You: Can the East Borrow from the Western Water Marketing Experience?, 21 Ga. St. U. L. Rev. 449, 497 (2004) (“Subjecting water to market forces such as price signals can promote more efficient water use . . . .”); Richard B. Stewart, Panel I: Liberty, Property, and Environmental Ethics, 21 Ecology L.Q. 411, 414 (1994) (“The advantages of . . . tradable permits are quite clear in economic terms.”); Barton H. Thompson, Jr., What Good Is Economics?, 27 Environs Envtl. L. & Pol’y J. 175, 176–77 (2003) (arguing for and describing benefits of applying economic theory to environmental regulation). But see Draper, supra note 10, at 49 (noting that imposing economics on water allocation may have “unintended consequences that outweigh its benefits”).

16 See, e.g., Draper, supra note 10, at 53.

17 See, e.g., Wilson Barmeyer, Note, The Problem of Reallocation in a Regulated Riparian System: Examining the Law in Georgia, 40 Ga. L. Rev. 207, 237–38 (2005) (noting the possibility of “inequitable allocation of water dependant on economic wealth”).

18 See, e.g., Draper, supra note 10, at 51–52 (discussing transaction costs and externalities). For a discussion of the criticisms of a market for water, see infra Part II.B.

19 See Huffman, supra note 12, at 442 (noting the possibility of a federal water rights law, but that “it would be very disruptive to shift from the well-established state water rights regimes”).

20 See Neuman, supra note 1, at 107–08, 113 (noting that federal legislation has addressed “water supply, pollution, dams, hydropower development, navigation, flood control, fisheries, and research” and that the federal government spends more than ten billion dollars annually on water programs).

21 See Zach Willey & Tom Graff, Federal Water Policy in the United States—An Agenda for Economic and Environmental Reform, 13 Colum. J. Envtl. L. 325, 347 (1988) (“State water laws have established rights to use water under appropriative, riparian, correlative, and other conditions.”).

22 See Neuman, supra note 1, at 114–16 (arguing for a federal water-use policy but stating that a major political barrier preventing the development of a rational, federal water policy is the tension of federalism itself”). For a discussion of why a federal water use policy is a good idea, see Neuman, supra note 1.

23 See infra Parts I.A.3 & I.B.2.

24 See, e.g., Huffman, supra note 12, at 443 (“One cannot overemphasize the importance of secure, well-defined, and enforceable property rights. The rights must be exclusive, universal, and transferable.”). For a discussion of the why both systems are inadequate for a water-market system, see infra Parts I.A.3 and I.B.2.

25Tradable permits have been used to limit pollution and regulate use of common resources such as habitats and fisheries. James Salzman & J.B. Ruhl, Currencies and the Commodification of Environmental Law, 53 Stan. L. Rev. 607, 616 (2000).

26Dellapenna, Water Allocation, supra note 1, at 11.

27 See id. at 9 (noting that riparian rights developed east of Kansas City, where water was abundant, and appropriative rights were used west of Kansas City, where water was more scarce).

28 Id.

29Joseph W. Dellapenna, Introduction to Riparian Rights, in 1 Waters and Water Rights, supra note 2, § 6.01(a), at 6-7 [hereinafter Dellapenna, Introduction to Riparian Rights]; see also Restatement (Second) of Torts § 843 (1979) (“The term ‘riparian land’ . . . means a tract of land that borders on a watercourse or lake, whether or not it includes a part of the bed of the watercourse or lake.”).

30 See Dellapenna, Introduction to Riparian Rights, supra note 29, § 6.01(a)(4), at 6-70 (“Consumptive uses create interferences with competing uses that are permanent.”). The bundle of rights also includes, but is not necessarily limited to, the right to access the water, the right to build a pier, the right to accretions (sedimentary deposits), and the right to “own the subsoil of nonnavigable streams and other ‘private’ waters.” Id. § 6.01(a), at 6-8. Courts make a distinction between uses which are consumptive and those that are not consumptive. As Dellapenna notes that “[a]mong the most common non-consumptive uses recognized by the law have been navigation, fishing, hunting, and swimming.” Id. § 6.01(a)(3), at 6-60, 6-61.

31 See id. § 6.01(a)(4), at 6-69, 6-70. Other consumptive uses include animal husbandry, mineral mining, and steam-generated power. Id.

32 See Dellapenna, Water Allocation, supra note 1, at 11 n.12 (noting that Tyler v. Wilkinson, 24 F. Cas. 472 (C.C.D.R.I. 1827) (No. 14,312), is “often cited as the first true riparian rights case”).

33 See id. at 9.

34 See Restatement (Second) of Torts § 850 (1979) (“A riparian proprietor is subject to liability for making an unreasonable use of the water of a watercourse or lake that causes harm to another riparian proprietor’s reasonable use of water or his land.”); Joseph W. Dellapenna, The Right to Consume Water Under “Pure” Riparian Rights, in 1 Waters and Water Rights, supra note 2, § 7.02(d), at 7-48 [hereinafter Dellapenna, Right to Consume] (describing the reasonable-use theory of riparian rights).

35Riparian refers to an owner of riparian land. Black’s Law Dictionary 1352 (8th ed. 2004).

36 See Dellapenna, Right to Consume, supra note 34, § 7.02(d), at 7-49 (noting that courts will find liability where another riparian suffers “unreasonable injury”).

37 Restatement (Second) of Torts § 850A (1979). In addition, the Restatement lists the following factors: level of harm caused by the use, the ability of one of the users to avoid the harm, the ability of each user to meet their needs using less water, the protection of existing economic value in the use, and the fairness of causing the harmful user to bear the loss from fewer use rights. Id.; cf. Dellapenna, Water Allocation, supra note 1, at 15 n.36 (explaining that many cases only consider economic factors: These [non-economic] principles figure prominently in the Restatement (Second) even if they do not figure prominently in the cases.”).

38According the Restatement (Second) of Torts, “[n]onriparian uses are those made neither on nor in connection with the use of riparian land, and include irrigation of nonriparian land and use in manufacturing on nonriparian land, even though the land belongs to the owner of riparian land. They also include the diversion and sale of water for consumption by nonriparian customers of water companies and inhabitants of cities.” Restatement (Second) of Torts § 855 cmt. a (1979).

39Dellapenna, Right to Consume, supra note 34, § 7.02(d)(1), at 7-54. As will be discussed in Parts II and III of this Comment, a tradable permit water-market system is not viable unless nonriparian use is allowed to occur. See id. § 7.04, at 7-108 (“There is . . . no reason to believe that the economically most productive use of water from a particular waterbody will always lie on contiguous land.”).

40 Id. § 7.02(d)(1), at 7-54, 7-55. The Restatement (Second) of Torts and courts in New Hampshire, Vermont, and Georgia have rejected the common law rule that nonriparian use is per se unreasonable. Id. Some states have passed legislation that may be interpreted to overrule the common law rule, but, as Professor Dellapenna concludes, the question is often not directly addressed and, therefore, the status of the common law rule is uncertain in many states. Dellapenna, Regulated Riparianism, supra note 2, § 9.03(a)(2), at 9-70 (discussing these legislative modifications in various states).

41 See Dellapenna, Right to Consume, supra note 34, § 7.01, at 7-2 (noting that the “basic concept of riparian rights” is that each land owner next to the water has equal rights to the other appurtenant land owners).

42 Id. § 7.04, at 7-107.

43 See generally id. at 7-108 (explaining that every state has, to varying degrees, loosened the restriction on alienability of riparian rights).

44 Id. § 7.04(a)(3), at 7-117.

45 Id.

46Dellapenna, Water Allocation, supra note 1, at 17–18 (noting the uncertainty as to whose level of “reasonable use” is acquired by a non-riparian user).

47 E.g., Dellapenna, Regulated Riparianism, supra note 2, § 9.01, at 9-17 & n.51.

48 See generally id. at 9-15 (discussing the conditions that led to development of regulated riparianism).

49 See id. § 9.01, at 9-12, 9-13, § 9.03, at 9-52 (summarizing criticisms of common law riparian rights as an allocation system during water shortages).

50 Id. § 9.03, at 9-54 (citing statutes in Alabama, Arkansas, Connecticut, Delaware, Florida, Georgia, Iowa, Kentucky, Maryland, Massachusetts, Michigan, Minnesota, Mississippi, New Jersey, New York, North Carolina, Virginia, and Wisconsin).

51 See id. § 9.03(a), at 9-62 (“Easily the most significant innovation under regulated riparianism, the feature that most sharply sets it apart from traditional riparian rights, is that direct users of water must have a permit from a state administrative agency in order to be entitled to use water.”).

52 See, e.g., Ga. Code. Ann. § 12-5-96 (2009) (requiring permit for groundwater withdrawals greater than 100,000 gallons per day).

53 See Dellapenna, Regulated Riparianism, supra note 2, § 9.03, at 9-53 (citing 615 Ill. Comp. Stat. 50/1–50/14 (2009) (requiring permits for withdrawals from Lake Michigan)).

54 See id. (citing S.C. Code Ann. 49-21-10 to -80 (2009)).

55 Id. § 9.03(a)(2), at 9-70.

56 Id.

57 See id. § 9.03(a)(3) (discussing exemptions from permit requirement in regulated riparian systems).

58 See id., at 9-76, 9-77 (citing statues exempting agricultural use to varying extents in Kentucky, Maryland, Georgia, Michigan, Iowa, Maryland, and Minnesota).

59 See id., at 9-75 (citing statutes explicitly exempting domestic use in Florida, Hawaii, Kentucky, Maryland, Minnesota, and Mississippi, and statutes that permit withdrawal amounts so large as to effectively exempt domestic use in Alabama, Connecticut, Delaware, Georgia, Iowa, Michigan, and Wisconsin).

60 See id., at 9-77 (“Most of the statutes either exempt at least some uses established on the effective date of the statute from the permit requirement or guarantees an initial permit to established uses.”).

61 Id. § 9.03(a)(1), at 9-66 (noting that “fourteen of the nineteen regulated riparian states” have included ground water in their regulated riparianism laws).

62Diffuse water can generally be described as surface water that is not part of a defined water body. See, e.g., Haw. Rev. Stat. § 174C-3 (2009) (describing diffused surface water as “water occurring upon the surface of the ground other than in contained water bodies”); Court Reports, 11 U. Denv. Water L. Rev. 445, 466 (2008) (describing diffuse surface waters as “waters from rain or melting snows flowing over land and not part of a defined watercourse”).

63 See Dellapenna, Regulated Riparianism, supra note 2, § 9.03(a)(1), at 9-67 (describing various state laws with respect to diffuse surface waters).

64 Id. at 9-69.

65Willey & Graff, supra note 21, at 326.

66Dellapenna, supra note 2, § 9.03(a)(3), at 9-80 (“To exempt such activities . . . serves little purpose other than capitulation to the political strength of the groups exempted.”).

67 See Dellapenna, Interstate Struggles, supra note 1, at 838 (labeling irrigation as “generally the most heavily consumptive use of water”).

68 See Dellapenna, Water Allocation, supra note 1, at 72 (noting that agricultural exemptions in Georgia “go far beyond the exclusions of certain uses in other regulated riparian states”).

69Ga. Code Ann. §§ 12-5-90 to -107 (2009). As the name suggests, this law applies to use of ground water.

70Ga. Code Ann. §§ 12-5-20 to -53 (2009). This law applies to use of surface water.

71 Ga. Code Ann. §§ 12-5-31(a)(1)(A), 12-5-96(a)(1) (2009). See also Dellapenna, Water Allocation, supra note 1, at 68–70 (describing the provisions of each statute).

72 See Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(a) (2009).

73 Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(a) (2009).

74The Flint River flows through southwest Georgia. According to the River Basin Center at the University of Georgia, “[t]he Flint River is approximately 350 miles long and drains an area of 8,460 square miles.” Gretchen Loeffler & Judy L. Meyer, River Basin Ctr., Chattahoochee-Flint River Basin, http://www.rivercenter.uga.edu/education/k12resources/basinsofga2.htm.

75 Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(b)(1) (2009). The permits may be transferred to subsequent owners of the property, subject only to notification of the transfer to the state. Id. Changes in the use or withdrawal capacity of the water permit must be applied for and approved by the state. Id.

76 See Barmeyer, supra note 17, at 216 (“[The exemptions] impair the state’s ability to manage its water resources effectively.”).

77 Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(b)(1) (2009).

78 See Julia L. Fanning, U.S. Geological Survey, Water Use in Georgia, 2000; and Trends, 1950-2000 (2003), available at http://cms.ce.gatech.edu/gwri/uploads/proceedings/2003/Fanning.pdf (noting that irrigation use accounts for almost seventeen percent of water use from all sources, and fifty-one percent of groundwater use in Georgia); Dellapenna, Water Allocation, supra note 1, at 72 (“Farm uses remain far and away the largest use of water in Georgia.”).

79 See Fanning, supra note 78 (noting that more irrigation is required during droughts); Hall, Stuntz & Abrams, supra note 2, at 33 (noting that demand for irrigation water will increase in areas where drier conditions are expected).

80 See Barmeyer, supra note 17, at 230 (“Clearly defined property rights are a prerequisite to any system of water rights trading through a market.”); Joseph W. Dellapenna, The Importance of Getting Names Right: The Myth of Markets for Water, 25 Wm. & Mary Envtl. L. & Pol’y Rev. 317, 327 (2000) (“[M]ost fundamental to the functioning of markets are the laws that define the property rights that form the ‘objects’ of the market’s transactions . . . .”); Daniel C. Esty, Toward Optimal Environmental Governance, 74 N.Y.U. L. Rev. 1495, 1533–34 (1999) (discussing tradable permits in fisheries, stating that “governments must provide legal structures to ensure that those with property rights are able to vindicate them”); Huffman, supra note 12, at 443 (“One cannot overemphasize the importance of secure, well-defined, and enforceable property rights. The rights must be exclusive, universal, and transferable.”).

81Barmeyer, supra note 17, at 230; Tietenberg, supra note 13, at 267 (“Confiscation of rights or simply insecure rights could undermine the entire [market trading] process.”).

82 See supra notes 45 & 46 and accompanying text. See also Barmeyer, supra note 17, at 231 (noting the lack of clear property rights in water withdrawal permits in Georgia).

83 See Hall, Stuntz & Abrams, supra note 2, at 35 (“[R]ights in water are less certain than in many other forms of property, making a true market difficult to achieve.”).

84 See Neuman, supra note 15, at 488 (stating riparian rights are “so poorly defined and open-ended as to discourage investment”); supra notes 45 & 46 and accompanying text.

85 See supra notes 34–37 and accompanying text.

86 See Olivia S. Choe, Note, Appurtenancy Reconceptualized: Managing Water in an Era of Scarcity, 113 Yale L.J. 1909, 1911 (2004) (describing how this inherent uncertainty in riparian rights has prevented water markets); Hall, Stuntz & Abrams, supra note 2, at 35 (stating that litigation over water rights is inefficient because court “rulings may soon be mooted by changed conditions”).

87 See Dellapenna, Water Allocation, supra note 1, at 16 (“If either of the competing uses changes in physical or economic terms, the calculus of reasonableness will change . . . .”).

88 See Restatement (Second) of Torts § 850A (1979) (listing nine factors to be considered to determine reasonableness of use).

89Dellapenna, Water Allocation, supra note 1, at 16 (“Courts, as well as scholars, have considered this [instability] a serious impediment to private investment in water development.”).

90 See id. at 17–18, 67 (noting the uncertainty as to whose level of reasonable use is acquired by a non-riparian user); supra notes 45 & 46 and accompanying text.

91 See Dellapenna, Right to Consume, supra note 34, § 7.04, at 7-108 (noting that the most efficient use will not always be on the riparian land).

92 Id.

93 See, e.g., Ga. Code Ann. § 12-5-31(e), (g) (2009); see also Barmeyer, supra note 17, at 231 (noting that disputes have occurred when permit holders assert private property rights over groundwater); Neuman, supra note 15, at 488 (noting that the problems with common law reasonable use are still present in regulated riparianism; it is just administrative agencies, rather than courts, making the decision).

94Dellapenna, Water Allocation, supra note 1, at 38 (“Usually there is no express provision for the transfer of water rights or permits between potential users.”); Neuman, supra note 15, at 489. See supra notes 55 & 56 and accompanying text.

95 See generally Dellapenna, supra note 2, § 9.03(a)(3) (discussing statutory preferences for specific uses of water in various states); supra notes 57–66 and accompanying text.

96 See, e.g., Ga. Code Ann. §§ 12-5-31(a)(3), 12-5-105(a) (2009) (exempting farm uses from the statutory permit scheme for the withdrawal of surface or ground waters); supra notes 57–66 and accompanying text; see also Hall, Stuntz & Abrams, supra note 2, at 33 (“Irrigation accounts for 39 percent of all U.S. water withdrawals and 81 percent of consumptive water uses.”).

97Dellapenna, Water Allocation, supra note 1, at 72–73 (noting this problem specifically in Georgia).

98Owen L. Anderson et al., Introduction and Background, in 2 Waters and Water Rights, supra note 2, § 11.01, at 11-4 [hereinafter Anderson et al., Introduction]. The doctrine discussed in this subsection has been referred to as both “prior appropriation,” id., and “appropriative rights.” E.g., Dellapenna, Water Allocation, supra note 1, at 20.

99Owen L. Anderson et al., Elements of Prior Appropriation, in 2 Waters and Water Rights, supra note 2, § 12.01, at 12-3 [hereinafter Anderson et al., Elements]. In Elements of Prior Appropriation, the authors note that the doctrine has five basic elements: “(1) person; (2) first in time; (3) to appropriate; (4) water; and (5) first in right.” Id.; see also A. Dan Tarlock, Prior Appropriation: Rule, Principle, or Rhetoric?, 76 N.D. L. Rev. 881, 881 (2000) (“Prior in time, prior in right is the central dogma of western water law.”). For a discussion of how the foundational principles of prior appropriation originated in the early days of the American West, see Dellapenna, Water Allocation, supra note 1, at 20–21.

100Anderson et al., Elements, supra note 99, § 12.02(b), at 12-8. Courts appear often to have decided disputes over establishment of priority by looking to custom. See id. (discussing cases in which first-in-time priority is disputed).

101Dellapenna, Water Allocation, supra note 1, at 24 (noting that this principle may result in complete forfeiture of junior rights in times of shortage).

102 E.g., id. at 23–24 (“Appropriators thus live in an environment where it is smart to overirrigate.”); Tarlock, supra note 99, at 901 (“The strict enforcement of priorities tends to lead to inefficient use practices. The cushion of a senior right combined with the ‘use it or lose it’ rules, abandonment and forfeiture, create powerful incentives to use the maximum entitlement and to forego investments in water conservation infrastructure.”).

103 See Dellapenna, Water Allocation, supra note 1, at 24–26 (“The recognition and protection of third-party rights precludes true market transactions.”).

104Anderson et al., Elements, supra note 99, § 12.02(f), at 12-75.

105 Id. Generally, there are four types of restrictions: (1) restrictions that limit transfer from the water’s area of origin; (2) restrictions on moving water out-of-state; (3) treatment of irrigation rights as running with the land; and (4) restrictions on a junior appropriator’s ability to change the place of use when the change improves the standing of the junior user. Id.

106Dellapenna, Water Allocation, supra note 1, at 25 (“There never has been a market for appropriative rights to any significant extent.”); Amy Sinden, The Tragedy of the Commons and the Myth of a Private Property Solution, 78 U. Colo. L. Rev. 533, 577–78 (2007) (“These property rights did not historically lead to the creation of active markets, however. This was primarily because the rules surrounding transfer made trading so cumbersome that transfers rarely occurred.”).

107 See Anderson et al., Introduction, supra note 98, § 11.01, at 11-4, 11-5 (discussing the historical evolution of the prior appropriation doctrine in the western states). See, e.g., Cal. Water Code § 1200 et seq. (West 1971).

108Anderson et al., Elements, supra note 99, § 12.02(b), at 12-6. E.g., Cal. Water Code § 1450 (West 1971) (priority established as of the date of the application for appropriation permit). For an assertion that priorities are not actually enforced in prior appropriation states, see Tarlock, supra note 99.

109Anderson et al., Elements, supra note 99, § 12.02(c)(2) (surveying beneficial-use statutes from various western states); Tarlock, supra note 99, at 882.

110Anderson et al., Elements, supra note 99, § 12.02(c)(2), at 12-26.

111 See id. § 12.02(e), at 12-66, 12-67 (surveying case law addressing the issue and noting that “the most important restriction [on water rights] may be that an appropriator can only acquire the right to water for a beneficial/reasonable use”).

112Eric L. Garner & Janice L. Weis, Coping with Shortages: Managing Water in the 1990s and Beyond, 5 Nat. Resources & Env’t 26, 29, 62 (1991); see also Owen L. Anderson et al., Reallocation, Transfers and Changes, in 2 Waters and Water Rights, supra note 2, § 14.04(c) [hereinafter Anderson et al., Reallocation] (discussing the no-injury rule).

113 See Garner & Weis, supra note 112, at 62.

114 Id.

115Dellapenna, Water Allocation, supra note 1, at 24.

116Anderson et al., Elements, supra note 99, § 12.02(f), at 12-75. See supra note 105 for specific examples of the types of restrictions that courts have imposed.

117 See id. § 12.02(e), at 12-66 (noting that the extent of property rights in the water is uncertain because of the beneficial-userule); supra notes 109–11 and accompanying text (discussing the beneficial-use requirement).

118 See Garner & Weis, supra note 112, at 62 (“The no-injury rule thus may prevent water transfers in some instances . . . .”); supra notes 112–14 (discussing the no injury rule).

119 See supra Part I.A.3.

120 See Jonathan Remy Nash, Too Much Market? Conflict Between Tradable Pollution Allowances and the “Polluter Pays” Principle, 24 Harv. Envtl. L. Rev. 465, 483–84 (2000) (describing how governments can use tradable permits to achieve “the socially optimal level of pollution”); Tietenberg, supra note 12, at 251 (describing tradable permits as a way to ration “access to the commons”).

121 See Salzman & Ruhl, supra note 25, at 616–17 (describing trading programs that manage pollution); Tietenberg, supra note 12, at 251 (describing tradable permits as a method of allocating common resources).

122Esty, supra note 80, at 1533–34 (describing tradable permit systems to regulate fisheries).

123Salzman & Ruhl, supra note 25, at 616.

124 Id. at 616 n.14. The legislation authorizing the trading of fuel-efficiency standards was later repealed. Id.

125Tietenberg, supra note 12, at 265.

126 See id. at 265–66 (noting that activity below the limit “can be certified as surplus”). Tietenberg notes that regulators sometimes have difficulty setting the base level of activity at an appropriate level to avoid “unjustified credits.” Id. at 266.

127 See id. at 265 (citing emission-trading programs as an example of credit trading).

128Nash, supra note 120, at 483–85 (identifying and explaining the three steps in implementing a tradable permit system for pollution control).

129B. Timothy Heinmiller, The Politics of “Cap and Trade” Policies, 47 Nat. Resources J. 445, 445, 447 (2007).

130Salzman & Ruhl, supra note 25, at 617 (using the regulation of pollutants as an example of a cap-and-trade program with tradable permits).

131Sinden, supra note 106, at 568 (describing the options of polluters in a cap-and-trade pollution control system).

132Heinmiller, supra note 129, at 447.

133 Id.

134 See id. (noting that this assumes no additional regulatory action is taken to counteract the additional activity).

135 Id. As the author notes, this difference between the two systems has social implications because in a cap-and-trade system every gain of a right by a participant means that another participant must lose that right. Id. As discussed below, this element of the cap-and-trade system has led some critics to argue that poorer and more rural water users would be harmed in a water market because they will be economically outmatched by wealthier users. See supra Part II.B.

136Heinmiller, supra note 129, at 447. (explaining that new users in a cap-and-trade system cause “some or all users [to get] a smaller slice of the resource pie”).

137 See id. at 445–48 (“In their ideal conception, cap and trade policies combine the policy goals of sustainability and economic efficiency and offer the potential to achieve both simultaneously.”); Jonathan Remy Nash, Trading Species: A New Direction for Habitat Trading Programs, 32 Colum. J. Envtl. L. 1, 12–13 (2007) (describing the two most significant benefits of tradable permit programs as (1) economically viable promotion of environmental sustainability and (2) highest economic allocation of scarce resources).

138Heinmiller, supra note 129, at 447 (noting that in a cap-and-trade system, the “cap” achieves conservation, while the “trade” promotes economic efficiency); Salzman & Ruhl, supra note 25, at 620 (“If the cap is set appropriately, marketable permits achieve the same level of protection as command-and-control alternatives at a lower cost.”).

139 See Salzman & Ruhl, supra note 25, at 620 (using the air pollution permit system as an example of encouraging efficiency because more efficient users profit from being able to sell their excess use rights); Tietenberg, supra note 12, at 256 (“One of the most desirable aspects of tradable permits for resource users is the ability to raise income levels for participants.”).

140Barton H. Thompson, Jr., Conservative Environmental Thought: The Bush Administration and Environmental Policy, 32 Ecology L.Q. 307, 340 (2005) (“[P]ermit programs may encourage the development of new environmental technology and processes that can achieve better results at lower cost. Because individuals or companies can trade any reductions that they make in their regulated activities, the regulated community has an incentive to develop less expensive, more effective means of making those reductions.”). One example of how economic incentives can encourage users to be more efficient is the EPA’s acid rain reduction program, which has resulted in an overall level of actual sulfur dioxide emissions that is less than the total allowable amount. Salzman & Ruhl, supra note 25, at 621 (noting that actual emissions in 1995 were forty percent less than the allowed amount). Salzman and Ruhl also note that the costs of the reductions in the program were estimated to be forty percent lower than they would have been in a command-and-control system. Id.

141Tietenberg, supra note 12, at 260 (noting that tradable permit systems tend to increase the value of the traded resource or lower the cost of pollution control, as the case may be).

142 Id. at 272–73.

143 Id.

144 See Heinmiller, supra note 129, at 445–46 (noting that because of political influence many cap-and-trade programs are not as economically beneficial as they might be). For example, Heinmiller notes that the 1997 emissions caps in the Kyoto Protocol are the result of a negotiated middle point between the interests of environmental and emitters and do not represent a scientifically optimal level. Id. at 455.

145Esty, supra note 80, at 1548–49 (“[T]he complexity and opacity of many environmental issues and the public’s difficulty in perceiving its own interest make the risk of special interest manipulation much more severe in the environmental realm than in other fields of regulation or government activity.”).

146 See Huffman, supra note 12, at 436 (“Any interest believing that it can serve its interest through the political process is likely to oppose markets since the state will provide the resource to them for free.”).

147 See Nash, supra note 120, at 483–85 (describing in the context of pollution-control systems, the decisions policy makers must make, including the geographic area of coverage, the nature and scope of the permit rights, and the method of initial allocation).

148Tietenberg, supra note 12, at 269; see also Heinmiller, supra note 129, at 449 (“[C]ap and trade policies are most needed and most likely to be introduced in situations of resource scarcity and overexploitation where vested interests are already well established and cannot be ignored.”).

149 See Nash & Revesz, supra note 15, at 575–76 (describing allocation systems for tradable emissions permit regimes, including an auction system and “grandfathering” in existing users).

150Tietenberg, supra note 12, at 269–70.

151 Id. at 254.

152Heinmiller, supra note 129, at 450. The potential for a windfall has been cited as one reason water-market systems should not be implemented. See, e.g., John L. Fortuna, Note, Water Rights, Public Resources, and Private Commodities: Examining the Current and Future Law Governing the Allocation of Georgia Water, 38 Ga. L. Rev. 1009, 1060 (2004).

153 See Heinmiller, supra note 129, at 450, 461. Environmentalists could hold the permit, thereby actively conserving the resource by leaving fewer water-use rights available for consumption. Id. at 461.

154Thompson, supra note 140, at 340–41 (describing the increasing activity of “water trusts” in purchasing and “retiring” water rights). It should be noted that environmental groups that engage in “retiring” water-use rights in western prior appropriation regimes might face opposition because change-of-use rules are applied more rigorously to them than traditional users. Tarlock, supra note 99, at 902 (noting that this has been the case in Oregon as applied to the Oregon Water Trust).

155Heinmiller, supra note 129, at 450 (noting that because of the nature of the process and the economic value at stake, “this process is quite clearly political”).

156Tietenberg, supra note 12, at 270 (stating that in “virtually all implemented tradable permit programs discussed in this article” existing users get free permits).

157 See id. at 271 (arguing that free initial allocations disadvantage new users).

158 Id.

159 Cf. id. (noting the problem exists when users know their allocation will be based on historical use).

160 See, e.g., Heinmiller, supra note 129, at 461 (describing how political and social pressure may prevent lower value water users from participating in the market).

161 See id. (noting that these are typically low value users who could expect a financial gain from selling their rights). Heinmiller discusses water trading in Australia and explains that tensions that have developed between “buyers,” states with low-value irrigators, and “sellers,” states with higher value users. Id. at 463. But see Fortuna, supra note 152, at 1061 (noting the possibility of the opposite problem occurring—that a water market could entice farmers in smaller communities to sell their use rights because the rights will be more valuable to heavily populated areas).

162Dellapenna, Interstate Struggles, supra note 1, at 838.

163 See Heinmiller, supra note 129, at 461–64 (noting the economic benefits of an open market, but observing that some users’ reluctance to participate for social or political reasons can negate those benefits).

164 See Tietenberg, supra note 12, at 273 (describing how concentration in fishery permits has resulted in the decline of smaller fishing operations because they are being bought out by larger operations).

165 Id. at 273–74. The first two methods have been used in tradable permit markets for fisheries; the latter two methods have been used in the United States’ sulfur pollution allowance program. Id.

166 See, e.g., Salzman & Ruhl, supra note 25, at 625 (noting that the currency of a tradable permit market needs to be designed to address this issue).

167Fungible is defined as “being of such a nature that one part or quantity may be replaced by another equal part or quantity in the satisfaction of an obligation.” Merriam-Webster’s Collegiate Dictionary 507 (11th ed. 2004). Further, “oil, wheat, and lumber are fungible commodities.” Id. (emphasis added).

168Salzman & Ruhl, supra note 25, at 611, 625 (explaining fungibility as when “the things exchanged are sufficiently similar in ways important to the goals of environmental protection”); see also Tietenberg, supra note 12, at 280 (discussing breakdowns in theory when systems are implemented and noting as an example that tradable permits are not always homogenous because time and place of use matters).

169Salzman & Ruhl, supra note 25, at 628.

170 See Nash, supra note 137, at 14 (describing “spatial differentiation” in the context of pollution control programs and habitat trading programs).

171 See Salzman & Ruhl, supra note 25, at 627–28. The authors cite as an example a hot spot resulting from a Los Angeles program that allowed industrial polluters to gain pollution credits by destroying older, heavily polluting cars. Id. at 628. But critics pointed out that the refineries were closely concentrated; thus, after the trades, the reduced emissions from the cars affected a 12,000-square-mile area, while the increased emissions from the industrial polluters were now concentrated in a twenty-square-mile area. Id.; see also Nash & Revesz, supra note 15, at 580–81 (discussing hot spots).

172 See Salzman & Ruhl, supra note 25, at 628 n.42 (“‘[I]t is immediately pointed out that a ton of any particular kind of waste will do much more damage in some places than in others . . . .’” (quoting J.H. Dales, Pollution, Property & Prices 79 (1968) (alteration in original))).

173 E.g., Tietenberg, supra note 12, at 275 (discussing lack of homogeneity in transfers and geographic restrictions on trades).

174 See Nash & Revesz, supra note 15, at 573 (proposing a system that requires regulatory pre-approval to address nonfungibility in emission trading programs); see also Tietenberg, supra note 12, at 275 (noting that the U.S. Wetlands program deals with “harmful spatial aspects” by requiring regulatory approval of trades).

175Tietenberg, supra note 12, at 275 (discussing geographic restrictions on trades and concluding that “[s]patial issues can be dealt with within the tradable permit scheme, but those choices typically make transfers more difficult”).

176Salzman & Ruhl, supra note 25, at 629.

177 Id. The authors also cite emission programs that bundle different types of polluting gases into one category as an example of nonfungibility of type. Id.

178 Id. at 630; see also Nash, supra note 137, at 17–19 (discussing “temporal differentiation” in environmental programs); Tietenberg, supra note 12, at 276 (discussing the “temporal flexibility”).

179Nash & Revesz, supra note 15, at 576.

180 See Tietenberg, supra note 12, at 277 (discussing issues that can affect the success of tradable permit programs and noting that water regulators “must cope with the consequences of trades on downstream users”).

181For a discussion of hot spots, see supra notes 171–72 and accompanying text.

182Nash & Revesz, supra note 15, at 580–81. Nash and Revesz note that this problem also may stem from older polluters being less likely to convert to better pollution control technologies, forcing them to buy additional permits and worsening the hot spot. Id.

183 See Barmeyer, supra note 17, at 237 (discussing interbasin transfers and their potential negative impact on “hydrologic capacity” in areas of shortage).

184Salzman & Ruhl, supra note 25, at 638.

185 See Nash & Revesz, supra note 15, at 573 (proposing a system that requires regulatory pre-approval to address nonfungibility in emission trading programs); Salzman & Ruhl, supra note 25, at 638–39 (discussing geographic trading restrictions).

186Salzman & Ruhl, supra note 25, at 636 (discussing transaction costs and their negative effect on economic efficiency); see also supra notes 173–75 and accompanying text.

187 See supra note 178 and accompanying text.

188 See Salzman & Ruhl, supra note 25, at 642 (“Temporal nonfungibilities may be neutralized by restricting trades to narrow time periods.”).

189 See Carol M. Rose, From H2O to CO2: Lessons of Water Rights for Carbon Trading, 50 Ariz. L. Rev. 91, 99 (2008) (“It has long been known that groundwater and surface water are hydrologically related, and there have long been calls to link their legal treatment.”).

190 See Salzman & Ruhl, supra note 25, at 640 (noting that in emissions-trading schemes, trades are restricted to the same pollutant and mixing of pollutants does not occur).

191 See Barmeyer, supra note 17, at 234 (“[T]he dormant commerce clause . . . could limit the power of the state to prevent the export of its water resources to other states or countries . . . .”); Draper, supra note 10, at 53 (discussing the Commerce Clause’s effect on tradable property rights for water); Fortuna, supra note 152, at 1051 (describing the “substantial constitutional implications” that a market for water-withdrawal permits would create).

192 E.g., Fortuna, supra note 152, at 1061.

193 E.g., id.

194 See, e.g., Draper, supra note 10, at 51–52 (discussing transaction costs and “externalities”).

195 See supra note 191.

196 See, e.g., Philadelphia v. New Jersey, 437 U.S. 617, 623–24 (1978) (“The crucial inquiry, therefore, must be directed to determining whether [the statute] is basically a protectionist measure, or whether it can fairly be viewed as a law directed to legitimate local concerns, with effects upon interstate commerce that are only incidental.”).

197Draper, supra note 10, at 53.

198458 U.S. 941 (1982), see also Draper, supra note 10, at 53.

199 Sporhase, 458 U.S. at 953–54.

200 Id. at 960. The Nebraska law required any person or entity that wanting to transport water from Nebraska for use in another state to apply for a permit, which would only be granted if the state to which the water was being transported granted reciprocal rights to transfer water to Nebraska. Id. at 944.

201 Id. at 956.

202 Id. at 958.

203 Id.

204 E.g., Matthews & Pease, supra note 9, at 619.

205Barmeyer, supra note 17, at 235–36 (proposing that Georgia could impose transfer restrictions based on watersheds for the purpose of protecting “hydrologic integrity”).

206 See Matthews & Pease, supra note 9, at 619 (“Proponents argue that there is no discrimination because all potential users outside the boundaries of the watershed are treated alike . . . .”).

207 Id. at 619–20 (discussing Fort Gratiot Sanitary Landfill, Inc. v. Michigan Department of Natural Resources, 504 U.S. 353 (1992), which invalidated a state law that isolated its counties from solid waste produced outside of the county).

208 Cf. Barmeyer, supra note 17, at 236 (noting that in Georgia permit transfers from agricultural areas to Atlanta could violate a prohibition against interbasin transfers).

209 See Nash, supra note 120, at 484–85 (noting that geographic restrictions reduce the potential number of participants, thus increasing the cost of finding trading partners). For a discussion of the economic benefits of a market system, see supra note 15 and accompanying text.

210 See Matthews & Pease, supra note 9, at 607 (“Reducing the size of a market area by limiting water exports constrains the ability to move water from inefficient uses to more efficient ones.”).

211 See Philadelphia v. New Jersey, 437 U.S. 617, 623 (1978) (“‘This principle that our economic unit is the Nation . . . has as its corollary that the states are not separable economic units. . . . [W]hat is ultimate is the principle that one state in its dealings with another may not place itself in a position of economic isolation.’” (quoting H.P. Hood & Sons, Inc. v. Du Mond, 336 U.S. 525, 537–38 (1949)).

212 See Matthews & Pease, supra note 9, at 604 (arguing that limiting a market geographically sacrifices possible gains from efficient allocation).

213 E.g., Fortuna, supra note 152, at 1058, 1061; Neuman, supra note 15, at 463 (noting that water markets can lead to a concentration of rights in the wealthy). But see Huffman, supra note 12, at 435–36 (noting this argument from critics, but dismissing it as an “[un]persuasive reason to oppose the creation of water markets”). For a discussion of how this issue has been addressed in tradable permits for fisheries, see Tietenberg, supra note 12, at 274. For a discussion and examples of how a price or value can be determined for water in a market, see Willey & Graf, supra note 65, at 331–34.

214Sporhase v. Nebraska, 458 U.S. 941, 956 (1982) (“[A] State’s power to regulate the use of water in times and places of shortage for the purpose of protecting the health of its citizens . . . is at the core of its police power.”).

215 See Huffman, supra note 12, at 436 (“If society cares about fairness, it is possible to create needs-tested subsidy programs to assure that the poor get the water they need for basic human survival.”).

216 See Esty, supra note 80, at 1572 (“[E]ffective environmental procedures may not take full cognizance of other social values such as justice or equity. If all the [resources] are owned by the rich, a property rights-based allocation system may be efficient, but it will not be just. Optimal environmental governance must therefore be understood to be both relative and contextual. A theory of optimal governance defines a theoretical goal and a process, but does not offer a definitive answer to every policy question.”).

217Fortuna, supra note 152, at 1061.

218The initial allocation cap based on current use would also alleviate concerns that tradable permits based on current rights, which often allow withdrawal amounts much greater than those actually used, would provide a “windfall” to current users. See id. at 1060 (arguing that a windfall would result for current permit holders). Profit for permit holders would come from efficiency gains in their operations or reduced use—not from selling excess use initially allocated to them. For additional discussion of why the “windfall” criticism of water markets is unfounded, see Huffman, supra note 12, at 435.

219Inefficient agricultural uses may include irrigation that produces relatively low-value crops, unlined ditches used for water diversion and low-technology flood irrigation. See Matthews & Pease, supra note 9, at 603 n.5.

220Barton H. Thompson, Jr., Markets for Nature, 25 Wm. & Mary Envtl. L. & Pol’y Rev. 261, 263–64 (2000) (“The government can allocate reductions based on historical use or seniority and rely on the market for meeting economic needs and changing demands.”). Professor Thompson notes that in western states, “the transfer of merely a tenth of current agricultural water can more than double the water available for growing metropolitan areas.” Id. at 264; see also Thompson, Jr., supra note 15, at 195 (“Tradable permits . . . encourage entities to find ways of further improving their performance since the entities can then sell their unneeded permits . . . .”); supra notes 138–40 and accompanying text.

221Dellapenna, Interstate Struggles, supra note 1, at 838 (stating that irrigation is “generally the most heavily consumptive use of water”); Thompson, Jr., supra note 220, at 264 (stating that agricultural use composes eighty percent of water use in the western part of country).

222 See Neuman, supra note 15, at 468 (stating that smaller agricultural users, who are often the most inefficient, currently do not have an economic incentive to improve).

223 Id. at 473 (“[I]nsisting that urban or conservation-driven water demands are a threat to the agriculture industry’s viability ignores the tremendous potential for conserving water in the agricultural sector.”).

224 Id.

225 See Draper, supra note 10, at 51–52 (discussing potential transactions costs in a water market and stating that “[t]he most serious direct economic consequence of for-profit water trading is the inability of bilateral water transactions between sellers and buyers to consider the effects of the transaction on third parties”); Nash, supra note 120, at 485 (“[G]overnment must be careful that the transaction costs do not become so high that they preclude the establishment and maintenance of a viable market.”).

226Draper, supra note 10, at 51; Willey & Graff, supra note 21, at 335.

227See Part II.A.2 for a discussion of nonfungibilities.

228Nash, supra note 120, at 484–85 (noting that geographic restrictions reduce the potential number of participants, thus increasing the cost of finding trading partners).

229 See supra Part II.A.2. For example, constructing regulatory barriers to trade that are designed to protect agricultural communities from loss of resources.

230Salzman & Ruhl, supra note 25, at 636 (explaining that increased cost in design and management of the system may lessen participation in trading); Tietenberg, supra note 12, at 273 (“[A]dditional restrictions tend to raise transaction costs and to limit the cost-effectiveness of the program.”).

231 See, e.g., Sinden, supra note 106, at 579 (“One right holder’s diversion of surface water can have important impacts on downstream users.”).

232 See, e.g., Draper, supra note 10, at 51; Sinden supra note 106, at 581.

233Salzman & Ruhl, supra note 25, at 636. Salzman and Ruhl note that some level of nonfungibility is desirable, if not critical, to a functioning market; otherwise there would be no need for the participants to trade. Id. at 645. The more nonfungible the currency (the permit), the more active the market will be. Id. at 645–46; see also Draper, supra note 10, at 51 (“[I]f the rights and costs of third parties are included in the water rights transfer, transaction costs rapidly become exorbitant.”).

234 See Draper, supra note 10, at 51 (“In any large and complex hydrologic system, the difficulty and expense of structuring the necessary third-party transaction costs frustrates the development of markets unless the law chooses to disregard the externalities.”); Salzman & Ruhl, supra note 25, at 637 (noting that “aggressive market construction” aimed at reducing external effects is dangerous because it can cause even more problematic flaws in the ability of the market to function); Sinden, supra note 106, at 582 (“[W]hen ecological and community impacts are added to the mix, the government’s role in approving trades must necessarily shift from one of simply facilitating bargaining among affected parties to making substantive judgments about the level of impact that is acceptable or desirable.”).

235 See supra notes 125–27.

236 See supra notes 15 & 220 and accompanying text.

237Credit trading promotes more efficient use of resources because users can sell credits they have accumulated by becoming more efficient. See Tietenberg, supra note 12, at 265.

238 See generally Heinmiller, supra note 129, at 445–48.

239For example, it has been estimated that metro-Atlanta’s population will double over the next twenty-five years. Shelton, supra note 9.

240 See Heinmiller, supra note 129, at 447 (“[I]f the number of users in a credit program increases, aggregate resource use will also increase . . . .”).

241 Cf. Nash, supra note 137, at 14 (noting that in pollution programs, the level is usually set on an annual basis).

242For a discussion of how exempting certain users from the permit system impairs the ability of the system to effectively conserve water, see supra notes 57–66 and accompanying text.

243 See supra Part I.A.2.

244 See supra Part I.B.1.

245 See supra Part I.A.2. There may be a level of use at which it is no longer productive to regulate the consumption by a user. For example, the cost of regulating a rural household withdrawing water from a ground well might be greater than the benefit. However, this Comment takes the position that such decisions should be made on the basis of value added to the goals of the system—not on the basis of political influence. See supra notes 142–46.

246 See Dellapenna, Interstate Struggles, supra note 1, at 838 (noting that irrigation use is generally one of the most consumptive uses).

247 See supra note 245.

248 See supra notes 80 & 81 and accompanying text.

249 See supra Part I.A.3 & Part I.B.2.

250 See supra note 241 and accompanying text.

251 See Salzman & Ruhl, supra note 25, at 617 (discussing environmental trading markets and stating that the rights attached to the tradable permit compel “the government [to] create[] a new form of property,” which can be characterized as the right to engage in a certain activity or use a common resource).

252 See supra notes 218–20 and accompanying text for a discussion of why the initial allocation is based on historical use.

253Fortuna, supra note 152, at 1061.

254 See supra note 218 and accompanying text.

255 See supra notes 217–20 and accompanying text.

256 See supra Part II.A.2.

257 See Salzman & Ruhl, supra note 25, at 628 n.42. For a discussion of hot spots, see supra notes 171–72 & 181–82 and accompanying text.

258 Cf. Nash & Revesz, supra note 15, at 573 (proposing an emission-trading system that requires pre-approval of trades based on a model that assesses the marginal effect of the trade).

259For a discussion of the possible effects of transfers from agricultural areas to cities, see Fortuna supra note 152, at 1062–63.

260For a discussion of hot spots, see supra notes 171–72 & 181–82 and accompanying text.

261For a discussion of transaction costs, see supra notes 225–34.

262For example, in emissions-trading programs, an emission permit may have a time limit attached within which the allowable emission must occur. See, e.g., Salzman and Ruhl, supra note 25, at 642 (describing temporal limits in trading programs).

263 See supra note 241 and accompanying text.

264 Supra notes 250 & 251 and accompanying text.

265 See supra notes 3 & 4 and accompanying text.

J.D., Emory University School of Law, Atlanta, Georgia (2010); B.S., The University of Tennessee (2005). I would like to thank Professor Jonathan Nash for his helpful guidance and suggestions and the editors and staff of the Emory Law Journal for their assistance editing this Comment.