Two innovative water management tools – water marketing and groundwater banking – can help California manage its scarce water resources more flexibly and sustainably. California's experience with them shows both their promise and what remains to be done to ensure their success.

Water marketing involves the temporary, long-term or permanent transfer of water rights in exchange for compensation. Such transfers can lessen the economic and environmental costs of drought and also help accommodate longer-term shifts in the patterns of water demand. Groundwater banking is another cost-effective tool: it involves the deliberate storage of surface water in aquifers during relatively wet years, for retrieval in dry years.

During the late 2000s, California experienced a multiyear drought – the perfect opportunity to see whether the past few decades of state and federal encouragement of these tools has paid off. In our new study, "California's Water Market, By the Numbers: Update 2012," we find some progress – but also some backsliding since the drought of the late 1980s and early 1990s.

That earlier drought jump-started California's water market, thanks in large part to direct state actions. In the late 1980s, the Department of Water Resources began purchasing water from a few irrigation districts to make it available to wildlife refuges and State Water Project contractors. By 1991, when faced with the prospect of draconian across-the-board rationing, DWR officials launched the state's first drought water bank, a large-scale brokering program that acquired water from numerous willing sellers and resold it to those facing high costs from shortages. When the rains returned, the water market continued to grow, as many local districts got comfortable trading with each other.

Today, about 2 million acre-feet of water is traded annually – roughly 5 percent of all water used by the state's businesses and residents. Water agencies in most counties participate in this market. Farmers – the largest water-using sector – continue to be the primary providers. Recipients include other farmers, cities and environmental programs supporting wildlife reserves and river flows for fish. Long-term and permanent trades – especially valuable for supporting shifts in patterns of water demand – now make up well over half of the market.

However, the market did not perform so well during the latest drought. Our study estimates that transfers provided 500,000 to 600,000 acre-feet in drought-oriented supplies between 2007 and 2010, above and beyond transfers that would likely have occurred anyway. The market slowdown began in the early 2000s. This slowdown reflects a variety of infrastructure and institutional constraints, including more complicated approval procedures and pumping restrictions introduced in 2007 to protect endangered native fish in the Sacramento-San Joaquin Delta.

Groundwater banking did a better job mitigating the drought. Our study focused on a new form of banking in which local groundwater managers store water for parties located elsewhere in the same county or in other regions. From the mid-1990s to 2006, these water banks – located in Kern County and Southern California – had built up reserves of nearly 3.4 million acre-feet. Between 2007 and 2010, they returned nearly 1.9 million acre-feet to their depositors, considerably more than the drought-related water market sales.

What lessons can be drawn from this experience? Despite its good showing, groundwater banking still faces obstacles. More comprehensive local basin management – a common practice in Southern California and Silicon Valley – would prevent unsustainable pumping and long-term declines in groundwater levels. Outside pressure – with a credible threat that the state would step in if local agencies fail to do so – might be the best way to proceed, ideally accompanied by positive financial incentives.

To strengthen the water market, the state needs to clarify and simplify the institutional review process, while continuing to ensure that transfers do not harm the environment or water users. Both marketing and banking depend on addressing infrastructure weaknesses in the Delta, which have already limited the market's ability to furnish water supplies in dry years and the availability of supplies to replenish groundwater banks in wet years. Because routinizing marketing and banking transactions will require risk-taking, high-level state and federal officials should be involved, perhaps through a coordinating committee to facilitate decisions.

Attending to these and other priorities will help ensure the success of two of the state's most critical strategies for efficiently managing its water resources.

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