Cap and trade markets for groundwater: Efficiency and distributional effects of the permit allocation mechanism

Agricultural production on the Texas High Plains is heavily dependent on the Ogallala Aquifer, which accounts for approximately 95 percent of groundwater pumped. Rapid groundwater depletion has been observed in the Ogallala Aquifer, which is attributed to low recharge rates and high water withdrawals. In an effort to manage this limitedly-renewable water resource, High Plains Water Conservation District (HPWD) No.1 has established a rule to reduce pumping 1.25 acre-feet per acre per year for all groundwater users within HPWD. This research evaluates the efficiency and distributional effects of a “cap and trade” mechanism for the HPWD region under alternative methods of allocating the allowable groundwater use: an equal distribution rule and a uniform percentage reduction rule. Marginal abatement curves are derived from producer profit functions, which include four irrigated and three rain fed crops. Optimal cropping choices, water use, water permit trades, and water permit prices are estimated simultaneously by maximizing producer profits. The relative efficiency of the programs are evaluated by comparing total producer profits. The results shows that the equal distribution cap will result in a more efficient use of groundwater resources, while the uniform percentage reduction cap will result in less wealth redistribution.