The facilitation of trade in water use entitlements by the National Water Act in South Africa.
Aug 2004

Report No. 1297/1/04


The approach to water management has changed drastically since the 1990's. This new approach was prompted by the fact that the demand for water is steadily increasing while the opportunity for developing new sources of water supply becomes scarcer and the remaining potential sources are becoming increasingly more expensive to develop. In the face of this potential imbalance between supply and demand it is logical to emphasise ways in which the existing supply can be used more efficiently. It required a shift from the previous philosophy that water is a free good that can be used without regard to its scarcity value to one where water is considered to be an economic good. As such the allocation and use of water should have a price attached to it that must reflect the scarcity value. The old centralised bureaucratic water allocation procedures should be replaced by decentralised procedures accompanied by user participation and a role for the market mechanism. The market mechanism has to fulfil its function as an efficient mechanism for allocating water between competing uses.

It is against this background that the new approach to water management in South Africa must be seen. This paradigm shift is one of the factors that informed the South African water policy reformulation process in the 1990's and that resulted in the National Water Act, No 36 of 1998 as amended (NWA).

The point of departure for this study is therefore to determine to what extent the NWA reflects this philosophy as far it relates to the use of the market mechanism for allocating water use.

It is assumed that the appropriateness of the market mechanism, as far as water allocation is concerned, has been established and that it is not necessary to repeat the arguments justifying the role of the market. The concern is therefore to determine the institutional requirements that are needed and subsequently to determine whether the NWA provides for such institutions.

Institutions refer to the rules guiding water trade such as the legal system, financial regulations and property rights that guide the operation of a market in water use.

The nature of the institutional requirements is derived from international case studies. Use was made of an investigation of the experience obtained from the Colorado Big Thompson (CBT) project, the western USA, Chili and Australia.

The institutional requirements can be categorised as those related to;

The lessons that can be learned from the experience in the countries mentioned are also listed. The major conclusion reached, based on their experience, is that a market in water use cannot be left purely to the interaction of market forces. The existence of third party effects according to which individuals not directly involved in the transaction are influenced by it as well as other social concerns related to water use require a degree of market regulation. Given this fact, the extent to which a market can perform its allocation function is dependent on the degree to which the regulatory interventions allow the market to function.

Regulatory interventions affect the cost of trade. In the case of trade in water use such costs are related to the physical and management infrastructure needed for the trade as well as the policy induced transaction costs. The policy induced transaction costs depends on the approval process and also the level of stress that a particular source is subjected to. The greater the degree of stress the higher is the probability of third party effects and the more rigorous the implementation of the approval process.

The principles that inform South Africa's new approach to water management and specifically the provisions contained in the NWA that facilitates a water market is the next issue to be tackled. A detailed evaluation of the legal issues contained in the NWA as it relates to a water market is made. It is concluded that although reference is never made in the NWA of a water market, it contains no provision that prevents its functioning.

As the study progressed this conclusion was confirmed in practice. Not only is there no legal limitation on water markets or the institutional requirements needed but that a large number of transactions, both temporary and permanent have already taken place in terms of the new legislation. Sections 25 (1) and Section 25 (2) provide for ways in which temporary and permanent trade in water use entitlements can occur.

The way in which trade is taking place at present and in which it is supposed to enfold in the future are subsequently investigated. The approach to water management as outlined in the NWA cannot be implemented immediately. The reality is that the transformation from the old to the new approach involves a large number of time-consuming steps. Water use as practised under the old act is declared an existing lawful use. The first step is to register such existing lawful uses. Subsequent steps involve, inter alia, the verification of such existing lawful uses in order to issue a license either in terms of a compulsory licensing procedure or an ad hoc procedure.

However, before licensing can commence, criteria must be put in place that will guide the conditions attached to licensed water use. Criteria, such as the Reserve requirements, class and resource quality objectives, international obligations, future needs and inter basin transfers will determine the quantity of water, from a specific source, that can be licensed.

In addition, the NWA provides for a number of new administrative structures such as Catchment Management Agencies (CMAs) at the regional level, Water User Associations at the local level and various advisory bodies to be created as needed.

The draft National Water Resource Strategy, 2002 (NWR's) contains a plan as to how and when these required procedures and structures will be instituted. It will take considerable time before all the structures are in place and fully operational. For instance, according to the NWRS it will take up to twenty years for the licensing procedure to be completed.

In the meantime until all structures are in place the changing needs of the country with respect to water use must be accommodated. Provision is therefore made for an ad hoc procedure to deal with license applications for new water use or existing water users. The ad hoc verification of an existing individual water use authorisation is necessary in order to license the use. The license, in turn, is needed before an application to trade a water use entitlement can be considered.

Each application to trade must then be assessed in terms of the Section 27 conditions in order to determine if the effect on third parties is of such a nature that the trade can commence.

Until such a time as the CMAs are operational, applications to trade in water use entitlements will be approved centrally by the Department of Water Affairs and Forestry (DWAF) involving the clusters and the regional offices for the preparatory work.

Although all the structures are not in place, trade is at present taking place reasonably satisfactorily judged on the basis of the time it takes to approve an application. Implementation problems, many of which are caused by the newness of the system and others caused by processes that must at present be followed to provide for the licensing of water use, will decline as the new approach becomes more familiar. Once water use entitlements are licensed the time needed to consider routine applications to trade should not be a factor that inhibits trade.

Since the necessary prerequisites are, by and large, in place the market in temporary as well as permanent trade in water use entitlements will function better as the various provisions as contained in the NWA enfolds and administrative procedures improve.

In the case of the temporary trade of water use entitlements, third party effects are not prominent and therefore the approval processes are less extensive and can be approved or rejected fairly quickly. This function is delegated to the local level. Temporary trade is very significant in Australia and the USA where sophisticated local markets have developed. Although temporary trade does occur in South Africa, there is room for the further development of this market at the local level . It will be necessary to investigate why it has not taken on larger proportions.

The study is concluded with a summary of the critical issues and recommendations for improving the market in water use entitlements. With regard to the critical issues it is clear that the market does function because a mechanism has been created to deal with it whilst all the required criteria and structures are not in place. Trade will become a more frequent occurrence when all the structures are in place and the required water use entitlements are licensed.

Given the fact that the new approach is in the process of being implemented recommendations for the better functioning of the water market must be seen against the background of:

The recommendations relate to considerations about the unease about some of the consequences of trade. It is argued that reliance must be placed on evaluation procedures to take both private and social costs and benefits into account. Administrative aspects are influenced by the fact that all the structures provided for in the NWA are not yet in place and it is therefore recommended that it be evaluated periodically as the process enfolds. For water markets to function properly all the relevant information is needed, and more could be done to provide such information. Although a large number a permanent and temporary transactions have taken place it is recommended that possible impediments to trade, especially temporary trade requires further attention. Lastly the new decentralised process of dealing with water management, which includes trade, is dependant on the availability of skilled personnel. It is proposed that a human resource development strategy be implemented to deal with this potential bottleneck.

The project accommodated capacity building as prescribed in the Terms of Reference, the report is attached as Appendix 6.