Third Party Effects and Asymmetric Externalities in Groundwater Extraction: The Case of Cherokee Strip in Butte County, California

While water markets have been shown to be beneficial to users, the transfers made through sales can have serious third-party impacts, as has been addressed in the water resources literature. Potential asymmetries arising from the hydrological characteristics of the groundwater basin could seriously affect the distribution of the impacts resulting from these transfers, when taken into account. In this paper we seek to extend the water resources management literature by examining the depletion problem experienced on the Cherokee Strip, in the hills of Butte County, and account for asymmetric external effects in a model of strategic groundwater pumping. The results of this model show that current ordinance restricting water transfers from Butte County does not serve the interests of promoting efficiency, and that volumetric limits on groundwater pumping is the preferred policy instrument. These results were robust to behavioral assumptions. This paper also highlights the need to move beyond simpe single-cell aquifer modeling and to find appropriate institutional arrangements that can mitigate the kind of asymmetric third-party impacts seen in Butte County, especially during drought periods, when third-parties are most vulnerable and the market incentives for making transfers is greatest.