It has become popular to lament how slowly California is embracing water markets. Proponents’ rhetoric can paint markets as an unambiguously better, or even as the only, solution to California’s water challenges. But faith in market efficiency needs to be tempered with a firm grasp of the greater physical and institutional context for water. Markets may be part of the solution, but only where implemented carefully.

Take groundwater. In many areas, decades of unfettered pumping have depleted aquifers, resulting in dry wells, deteriorating water quality, depleted streams, and infrastructure damage. The situation was so dire during the recent drought that the Legislature passed the Sustainable Groundwater Management Act (SGMA), the first statewide mandate for managing groundwater resources.

SGMA opens the door for groundwater markets. It gives local groundwater agencies responsibility for managing priority groundwater basins and an array of tools to work with, including the ability to authorize transfers of groundwater pumping allocations within their jurisdictions. Groundwater markets based on these transfers could help water users adapt to pumping restrictions needed to achieve sustainability.

But markets are not a panacea. They can be remarkable engines for efficiently enabling the reallocation of limited resources, sometimes in ways that benefit society and the environment. However, they can also generate harmful unintended consequences. For groundwater, missteps could reverberate far into the future.

Just as air pollution markets can create pollution “hotspots,” groundwater markets can concentrate pumping, causing harm to communities and ecosystems that depend on groundwater. As a cautionary example, groundwater trading in Australia’s North Adelaide Plains region quickly concentrated pumping, causing a precipitous drop in local groundwater levels. Special trading rules were needed to mitigate the problem, and are now commonly applied in Australian water markets.

Those with an interest in the sustainability of California’s water future, should think carefully about the risks, as well as the benefits, of groundwater markets. Groundwater agencies in particular must consider not only how markets might generate efficiency and create wealth but also how to ensure they further sustainability and avoid harmful side effects.

For example, groundwater agencies will need to require pumpers to report their groundwater extractions. That can be controversial, but it provides essential context for market trades and for establishing and enforcing the overall pumping limits and individual pumping allocations that make trading possible.

In addition, every groundwater agency will need a clear picture of the likely effects of markets to convincingly demonstrate to state watchdogs that they have charted a path to sustainability. They will need unambiguous rules to prevent unacceptable trading impacts, coupled with effective oversight and enforcement to ensure the rules are followed.

Groundwater rights law could be an obstacle for markets. For example, the most common type of groundwater right is based on overlying land ownership, and it is not clear that pumping allocations associated with such rights can be legally traded. Transparency will be essential. Groundwater agencies should seek close stakeholder involvement in market design, so they can understand and address community concerns up front and potentially head off future legal challenges.

Markets are not free. Like other management options, they have transaction costs, in this case, costs that must be incurred to enable groundwater trading that furthers sustainable management. Groundwater agencies will need to develop and fund significant physical, technological, and managerial infrastructure to support market design and implementation.

Markets may be one of the tools that helps California blaze a path toward better groundwater management. In some contexts, markets could help achieve sustainability more efficiently than regulations alone. However, markets that lack well-defined goals, appropriate rules, or effective oversight run real risks of generating unintended consequences. Market proponents should recognize that high-profile failures could damage the prospects for groundwater markets around the state. Where groundwater agencies plan to rely on markets to help reach sustainability goals, foresight and diligent preparation will be essential ingredients for success.

Nell Green Nylen is a Senior Research Fellow at the Wheeler Water Institute at the Center for Law, Energy & the Environment, UC Berkeley School of Law. Reach her at ngreennylen@berkeley.edu. Michael Kiparsky directs the Wheeler Water Institute at CLEE and co-directs the UC Water Security and Sustainability Research Initiative. Reach him at kiparsky@berkeley.edu