Water markets increasingly facilitate adaptation to water scarcity, but transaction costs can be barriers to expanded water marketing, particularly under water rights law in the western United States. However, transaction costs are rarely measured, and existing research commonly overlooks how transaction costs differ across individual water transfers and uncertainty in those costs. We collected hundreds of estimates of procedural transaction costs-costs incurred by transfer proponents for legal and hydrologic experts-by surveying 100 water professionals in the state of Colorado. There, water markets are among the most active in the United States, convey perhaps the most clearly defined private property rights of any state, and, unique to Colorado, require approval from specialized water courts. We elicited costs for water transfers with differing physical and legal characteristics, and we elicited separate assessments of (i) probabilities of legal outcomes for water transfers and (ii) transaction costs conditional on those outcomes. Then, we estimated expected transaction costs with a statistical model that combines (i) with (ii). The model reveals systematic differences in transaction costs, with scale economies and higher transaction costs for water-scarce regions, senior water rights, and higher-conflict legal outcomes. It also shows substantial transaction cost uncertainty, which itself can discourage trading. Our novel survey and estimation procedure develops a replicable approach for measuring transaction cost heterogeneity and uncertainty. Additionally, qualitative survey data we collected indicate transaction costs have increased over time due to growing competition for scarce water and that, despite high transaction costs, specialized water courts offer unique benefits. Key Points:• Water market transaction costs are uncertain, and this uncertainty depends upon legal procedures for water rights transfers • Transaction costs are higher in water-scarce regions, for higher-conflict transfers, and for senior water rights, and show scale economies • Transaction costs have grown over time due to increased competition for scarce water and more complex water rights operations Supporting Information:• Supporting Information S1

Water markets are commonly described as failing to achieve efficient water management because of transaction cost barriers to trade. In the western United States, two sources of legal conflict frequently drive transaction costs: (1) negative externalities of trading and (2) uncertain property rights. Conflicts arise because water law applies a no-injury rule that prevents water transfers from modifying water available to third-party water rights and defines water rights by historical water use, among other reasons. Existing literature suggests many legal changes to reduce transaction costs, but no studies in the western United States quantify transaction costs under proposed future changes. Here we developed statistical models of transaction costs for water transfer proponents under four specific legal changes in the state of Colorado. Two legal changes would modify the no-injury rule, and two aim to clarify property rights. Colorado hosts active markets and has recently experienced debate over such legal changes. By surveying 100 legal and hydrologic experts, we elicited transaction cost estimates and rankings of which legal changes were most likely to increase third-party injury. The legal changes that aim to clarify property rights had significantly lower likelihoods of increasing injury. One of these legal changes, which would not limit transferable water to historical use in certain circumstances, also had the greatest reductions in proponents' transaction costs. Meanwhile, the legal changes that directly modify the no-injury rule project substantial transaction cost savings but much higher likelihoods of increased injury. The results demonstrate trade-offs between reducing transaction costs and increasing third-party effects.

A U.S. court decision unlocks vast potential to improve sustainable freshwater management

Environmental water markets have emerged as a tool for restoring flows in rivers across the world. Prior literature suggests that certain legal conditions are necessary for these markets to function. However, we find substantial market activity has occurred without these legal conditions through market and legal data collected in five core U.S. Colorado River basin states (Arizona, Colorado, New Mexico, Utah, and Wyoming) from 2014 to 2020. Ninety-five percent of the 446 water transactions sidestepped formal legal processes to transfer water rights to the environment. We also find that government regulatory and conservation programs, not private-sector investment, have driven most environmental water market activity. Government spending is the dominant funding source, with 90% of the $53 million spent coming from governments and 68% from the U.S. federal government alone. Finally, our analysis finds that current market activity would be insufficient to stave off future curtailment of critical water users under the Colorado River Compact and that $86–89 million annually in new investment is required to do so. In a basin experiencing a historic megadrought, our analysis suggests prioritizing such new investments over legal reform. Global implications are that such flow restoration is possible where legal regimes for environmental water markets do not already exist.