This study assesses the transaction cost related to the Water Use Rights (WUR) system that is in operation in Zhangye City, Gansu Province, Northwest China. The study was carried out to see whether these costs were a significant barrier to a properly functioning system, and, if this was the case, to see what could be done to reduce them. Zhangye City is severely short of water. It is located in one of the driest areas in the world and is mainly watered by the Heihe River. Almost all the water from this river is currently extracted for irrigation and this has caused widespread desertification. The WUR system, the first of its kind in China, was introduced in 2002 to try and distribute water fairly and efficiently between agriculture and industry. Under the system, every water user gets a water quota fixed by the government. These quotas can be traded. Farmers and officials in the area were interviewed to get information and opinions on the effectiveness of the scheme. Transaction costs for both the implementation of the system itself and the WUR trading scheme was assessed. It was found that transaction costs were a significant barrier to the proper functioning of the system. It was also found that these costs were linked to the key social and administrative barriers that stand in the way of the system working properly. In light of this, the study advises that to bring transaction costs down - and improve the implementation of the scheme - these social and administrative problems must be tackled head on.