THE CALIFORNIA STATE WATER PROJECT: ANALYTICAL DESCRIPTION OF WATER ALLOCATION, WATER PRICING; CONDITIONS FOR MARKET FORMATION AND MARKET ACTIVITY

State Water Project (SWP) water shortage allocation rules define three water types, commodities in an SWP market, given minimal institutional changes. Each is associated with a "delivery security value". The study shows that market activity, under circumstances likely to occur, imposes "delivery security losses" on some SWP contractors which are economic incentives to block market formation. Because of the legal characteristics of the SWP, blocking does not prevent market formation. However, the Department of Water Resources must prohibit market formation if it can show that market activity would increase the likelihood of bond repayment default by the SWP. Absent this finding, the Department can form a market. The most efficient way to construct the market is to provide the economic necessary conditions for market activity. There are three; commodity identification, knowledge about relative economic values, and continuous legal flexibility. The first two currently exist, the third can be provided by a distinct set of trading rules, "Set of Transfer Criteria". A Set of Transfer Criteria, satisfying likely SWP concerns and providing economic efficiency, is developed.;Water pricing rules are described in detail. On an annual basis, the "price" of water is a linear function composed of fixed charges and constant per acre-foot delivery charges. Market activity would enable contractors to earn market net revenues offsetting the fixed charges which are passed on to their constituents.;The study finds the existing legal framework of the SWP is sufficient to form a market. The missing link is the effect that market activity would have on the likelihood of SWP bond default. Future research on this matter, in conjunction with this study, would put to rest controversy about market formation within the SWP.