The role of groundwater trading in spatial water management

•Groundwater trading can reduce the costs of water use restrictions in agriculture.•Institutional context and initial permit allocation determine gains from trading.•Initially unused permits and land moving to dryland cropping provide trading volume.

Agricultural groundwater use is increasingly being restricted to address the negative impacts of pumping on instream flows for downstream users, endangered species habitat, and recreation. Understanding the spatial heterogeneity of the costs of water use restrictions to farmers is critical to evaluating the effectiveness of current and alternative water management policies. We use a geospatial population dataset of irrigation wells in the Republican River Basin of Nebraska and model the simultaneous crop choice, land and water use decisions at a well level. We estimate the magnitude and distribution of costs of current groundwater restrictions as well as cost savings from alternative market-based policies that allow trading of permits between farmers. Our analysis highlights the importance of the initial distribution of permits and the institutional context in which trading occurs. Both allocated but unused permits and land estimated to move from irrigated to dryland crops provide important trading volume into the water rights market. The results show that the cost savings from allowing trading of groundwater pumping rights are distributed unevenly between wells, counties, and groundwater management institutions.