Dynamic management of water transfer between two interconnected river basins

In: Resource and Energy Economics (37), 17-38. (2014)

Abstract

This paper analyzes the dynamic interaction between two regions with interconnected river basins. Precipitation is higher in one river- basin while water productivity is higher in the other. Water transfer increases productivity in the recipient basin, but may cause environmental damage in the donor basin. The recipient faces a trade-o between paying the price of the water transfer, or investing in alternative water supplies to achive a higher usable water capacity. We analyze the design of this transfer using a dynamic modeling approach, and compare solutions with di erent information structure with the cooperative solution. Contrary to standard games, where decision variables di er among players, we assume that both players take the decisions concerning the water transfer. The equilibrium between supply and demand determines the optimal transfer price and amount. If the problem were set as a static game, the non-cooperative solution would match the cooperative solution. However, in a more realistic dynamic setting, in which the recipient uses a feedback information structure, the cooperative solution will not emerge as the equilibrium solution. The transfer amount is lower than in the case of cooperation, while the investment in usable water capacity is higher. Finally we numerically compare our results to the Tagus-Segura water transfer described in Ballestero (2004). Welfare gains are compared for the different scenarios. We show that in all dynamic settings, the long-run transfer amount is lower than in Ballestero's static model. Further, we show that the long-run price settles at a lower level than in Ballestero's model, but is still higher than the average cost-based price determined by the Spanish government.