Water Markets, Water Courts, and Transaction Costs in Colorado

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.