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(110), in the southeastern corner of California, owns senior rights to much of California's share of the Colorado River. To help meet the growing demands of the state's southern coastal region, the Met- ropolitan Water District of South- ern California (MWD) agreed in 1989 to invest approximately $115 million, plus about $3 mil- lion annually for operation and maintenance, to conserve water in the irrigation district through such measures as lining canals to pre- vent water loss through seepage. In exchange, the MWD acquired the rights to about 100,000 acre- feet of conserved water per year.l! More recently, San Diego-which depends on, but has a low prior- ity claim to, MWD water sup- plies-agreed to fund additional conservation investments in the 110 in return for conserved water. These agreements illustrate the opportunities and obstacles asso- ciated with using market forces to reallocate water. In these cases, water was transferred from rela- tively inefficient, low-value agri- cultural uses to higher-value ur- ban uses; lID's agricultural base was preserved through conserva- tion investments; and the interests of neighboring U.S. irrigation dis- tricts were protected. Yet concluding these apparent win-win arrangements required nearly five years of often conten- tious negotiations among the par- ticipants and interested third par- ties. Moreover, agreement in this in- stance was facilitated because the participants were able to ignore the adverse third-party impacts in Mexico. Indeed, before the canals were lined, some of the water seep- ing out of them had helped re- charge groundwater aquifers used by Mexican farmers just across the international border. These third- party impacts were ignored be- cause the Mexicans had no recog- nized legal claim to the water. Efforts to arrange interstate sales of Colorado River water have been less successful. The 1922 Colorado River Compact among seven west- ern states divided the river equally between the upper basin states Las Vegas-which already uses most of Nevada's entitlement to the Colorado River-is currently seeking more water. Meanwhile, it lacks rights to surplus flows, and depletion of its groundwater is causing subsidence within the city. Unused upper-basin entitlements to the Colorado River are a logical source of additional supply, and Utah appears to be a willing seller. Las Vegas lacks rights to surplus flows, and depletion of its groundwater is causing subsidence within the city. (Colorado, New Mexico, Utah, and Wyoming) and the lower ba- sin states (Arizona, California, and Nevada). The upper basin states have never fully used their entitle- ments. The MWD therefore has been able to take the unused wa- ter for free. California, however, is being required to cut back on its use of these surplus flows, and the upper basin states are seeking op- portunities to benefit from their full entitlements. The potential for mutually prof- itable transfers from the underused upper to the overused lower basin has stimulated several proposed sales. In the 1980s, the Galloway Group, a Colorado corporation with claims to 1.3 million acre- feet of Colorado River water, pro- posed constructing reservoirs to produce hydropower and store water for leasing to Arizona and southern California. San Diego paid $10,000 for an option to lease 300,000 to 500,000 acre-feet per year for 40 years, but the project died under a flood of un- resolved legal issues.12 But consummating this or any other water transfer between the two basins could require renego- tiation of the 1922 compact. Transfers among the lower ba- sin states encounter fewer legal hurdles but, because of their simi- lar hydrology, offer fewer economic benefits than do transfers between the upper and lower basins. In 1997, the U.S. Department of Interior issued a ruling designed to encourage and facilitate volun- tary transactions among the three lower-basin states. Arizona has established a Water Banking Au- thority to purchase its own unused entitlements for storage in groundwater basins and possible sale to California and Nevada. But the opportunities for profitable water transfers among these three states-each of which is trying to meet the demands of rapidly growing metropolitan areas-pale in comparison to the potential benefits of transfers to the lower basin from the upper basin, with its large quantities of unused en- titlements. Spring 2001 . 59