Communities and government world-wide have growing concern over the protection of groundwater resources. We have been studying smart markets as a tool to efficiently allocate groundwater, to protect against groundwater depletion, and to prevent damage to environmentally sensitive areas. In this paper, a smart market is proposed for the combination of ground water and surface water, which includes bids for reservoir releases by a hydropower generator. The smart market here is a periodic auction which uses an optimization model to allocate water. The optimization model includes physical constraints based on the aquifer, surface water availability as calculated in a simulation model, and user bids. The simulation model calculates characteristics of an aquifer such as water availability and the interaction under various pumping regimes with surface water, as water is released for hydropower generation. In addition to the physical constraints provided from the simulation model, the optimization model is constrained by each user's demand for water. A piece-wise linear demand function relates each user's willingness to pay for incremental volumes of water. Under the market, users can use their water right, or sell some or all of it to the central pool, or buy additional water. Prices are determined by the exchange of water rights in a bidding system, as in an auction. The bidding system is based on each user's demand curve, which relates additional volumes of water to prices that they are willing to pay for that additional volume of water.