Hydrological challenges to groundwater trading: Lessons from south-west Western Australia

► Externalities from trading may be uncertain and not monetarily compensable. ► Differing spatial distributions of water use will have differing total costs. ► Trades should leave overall welfare constant or improved. ► Scheme design should incorporate future effects and impacts on third parties. ► Sustainable use, trading rules, zones, and exchange rates have potential as tools. Perth, Western Australia (pop. 1.6 m) derives 60% of its public water supply from the Gnangara groundwater system (GGS). Horticulture, domestic self-supply, and municipal parks are other major consumers of GGS groundwater. The system supports important wetlands and groundwater-dependent ecosystems. Underlying approximately 2200 km 2 of the Swan Coastal Plain, the GGS comprises several aquifer levels with partial interconnectivity. Supplies of GGS groundwater are under unprecedented stress, due to reduced recharge and increases in extraction. Stored reserves in the superficial aquifer fell by 700 GL between 1979 and 2008. Over a similar period, annual extraction for public supply increased by more than 350% from the system overall. Some management areas are over-allocated by as much as 69%. One potential policy response is a trading scheme for groundwater use. There has been only limited trading between GGS irrigators. Design and implementation of a robust groundwater trading scheme faces hydrological and/or hydro-economic challenges, among others. Groundwater trading involves transfers of the right to extract water. The resulting potential for spatial (and temporal) redistribution of the impacts of extraction requires management. Impacts at the respective selling and buying locations may differ in scale and nature. Negative externalities from groundwater trading may be uncertain as well as not monetarily compensable. An ideal groundwater trading scheme would ensure that marginal costs from trades do not exceed marginal benefits, incorporating future effects and impacts on third-parties. If this condition could be met, all transactions would result in constant or improved overall welfare. This paper examines issues that could reduce public welfare if groundwater trading is not subject to well-designed governance arrangements that are appropriate to meeting the above condition. It also outlines some opportunities to address key risks within the design of a groundwater trading scheme. We present a number of challenges, focusing on those with hydrological bases and/or information requ