Faced with increased risk of drought, increased climate volatility, and demand pressures due to population growth, the Environment Agency (EA) has been working with other government bodies and regulators to reform the framework in England and Wales for how water is taken from different sources (“water abstraction”). Although the current system allows trading of the right to abstract water, trading is difficult and rarely occurs. The EA has been exploring more market-based approaches to water abstraction management, but some stakeholders (including water users and license holders) have raised concerns about the impacts of possible reforms designed to make trading easier. Concerns expressed by stakeholders include the potential for the water abstraction market to be dominated by large users, and the potential role of non-users (i.e., those that do not abstract themselves) and their effects on users.

Within this context, the EA commissioned NERA to review the experience of transitions to market-based approaches in selected other sectors and countries. The review took the form of case studies, covering a wide range of experiences, such as tradable quotas in fisheries, airport slots trading, emissions trading, trading of gas transport capacity rights, and measures to improve liquidity in markets. NERA’s analysis identifies key factors affecting the success of newly created markets in other sectors. Our review also shows that the concerns expressed by water abstraction stakeholders are not unique, and that mitigating provisions have been used in other sectors to address these. Some lessons for water abstraction include:

• Clarity in the definition and application of rights is an important prerequisite for the successful transition to a market-based approach. A flexible approach to defining rights can reduce the risk of potentially costly regulatory interventions in situations where there is uncertainty about the availability of the resource for which a market is created. In water abstraction, a flexible approach can consist of defining entitlements as proportions of the water available in a catchment, and periodically setting the overall quantity available to abstract to reflect changes to the scarcity of the water resource.
• The way in which rights are allocated can differ across users to reflect their circumstances—for example, the ability to pass through abstraction costs to others. Moreover, the allocation of rights can also be used as a means to facilitate liquidity in markets—for example, obligations can be placed on large abstractors to offer a proportion of their allocations for sale, or entitlements can be time-limited and require periodic renewal.
• In addition to the allocation mechanism, various other measures can be used in water abstraction to improve market liquidity. Measures used elsewhere include: standardizing products; setting up trading platforms to compliment other means of trading; and provisions for flexibility in trading, so that in cases where the requirements of buyers do not exactly match the rights available for sale, a coordinating body can alter the terms of the trade without a full regulatory investigation.