The basic economic problem – scarce resources squared up against insatiable demand – has long been recognised as relevant to environmental issues (Pigou 1920). Many studies have focused on the scarcity of natural resources – particularly fossil fuels – but what about water, one of the most vital fuels for human life? In many areas of the world this resource is desperately scarce, and if some climate-change forecasts are to be believed, the situation will only get worse.
In this column, I outline the use of “water trading” by the Australian Government to improve the efficiency of water use. Between 2008 and 2009, the market for water licences witnessed trade in water to the value of 2.74 billion Australian dollars – an increase of about 70% over the previous year (National Water Commission 2009). Cap-and-trade initiatives are growing in popularity despite the political obstacles, with some recent evidence of success (see for example Hahn and Stavins 2010 on this site). Many countries facing their own concerns over the water supply are watching Australia’s experiment with cap-and- trade with keen eyes.
What is water trading?
Water trading involves the temporary or permanent transfer of a water licence. A temporary or term trade involves the transfer of an allocation of water for a set period of time and traditionally occurs within the Australian financial year.
Permanent transfers of water entitlements were introduced in the States of South Australia in 1982, New South Wales and Queensland in 1989, and Victoria in 1991 (Murray-Darling Basin Commission 1995). This allowed trading of surface and ground water within state borders.
Following a government push for greater flexibility with the trading of water licences, and the introduction of a cap on licences in 1995, the Murray-Darling Basin Commission established the first “pilot interstate water trading project” in 1998 “that allowed limited interstate trade of permanent water entitlements” (Murray-Darling Basin Commission 2007c). The States of New South Wales, South Australia and Victoria agreed to allow state based licences to transfer to another State. This co-operation has continued and trading of permanent and temporary licences across State borders has expanded significantly.
Nowadays, an increasing number of temporary trade allocations facilitated through the use of electronic exchanges and more third parties, such as lawyers, conveyancers and brokers, are required for their specialist knowledge as the wider market is continuing to grow in traffic and value.
A change brewing in the water
By far the largest water users in Australia are irrigators. Between 2004 and 2005 irrigators used roughly 65% of available water (Australian Water Resources 2009). Many water utilities supply potable water to the major Australian cities and trade of water within cities is limited. Despite this, the existing rural-urban divide – where water trading occurs in the country and water supply occurs in the cities – is changing and the lines becoming more blurred. Urban water utilities are buying water licences from irrigators and moving water to their storages to supplement their potential supply shortages, meanwhile innovative small scale trading is occurring in some cities.
The Murray-Darlin Basin
Murray-Darling Basin offers an example of a rural water market. The Basin is a relatively dry area, accounting for roughly 6% of Australia’s runoff (National Water Commission 2007). The region has large-scale public and private infrastructure to regulate water delivery on a district basis, and is hydrologically linked enabling interregional water trading (Australian Competition and Consumer Commission 2006). The Basin the largest water trading area within the Australian continent and possibly, the largest in the world, as the Murray-Darling Basin extends across one seventh of the Australian continent and is the size of France and Spain combined. Approximately 2 million people live within the Basin and another million people are heavily dependent on its water. Its rivers cross the jurisdictions of the Australian Capital Territory and the States of New South Wales, South Australia and Victoria. The region accounts for around 70% of irrigated agriculture in Australia.
The Basin and its rivers can be seen in Figure 1 showing its location within the mainland continent of Australia. Its major irrigation districts are depicted and water trading is active between states and irrigation districts.
Figure 1. Major irrigation districts in the Murray-Darling Basin
Source: Murray-Darling Basin Commission (2007a)
Billions of dollars in trading
New State Wales is the largest trading State followed by Victoria and then South Australia. Water trading in Queensland will grow and is likely to overtake the States of Western Australia and South Australia in the future (see Figure 2).
Figure 2. Value of water trading in Australia
Source: National Water Commission 2009
Between 2004 and 2005, the total volume of water access entitlements in Australia was 18,608 gigalitres (Productivity Commission 2010). Assuming a value of A$2,000 per megalitre, then the total value of water access entitlements in Australia in 2007 is approximately A$37 billion1. Also, the price of water licence bought from the River Murray-Darling has increased significantly over the last 18 years. Different growth rates apply in different geographical areas but 15% annual growth in the value of water licences have been found (Bjornlund and Rossi 2006). The increase in price is due to:
- the policy initiative to assist the trading of water licences,
- the introduction of a cap on new licences issued by governments,
- the growth of managed investment schemes2 and
- significant droughts in Australia.
The increase of price suggests that water is being moved to higher value users but further study is required.
Value of water licences
Water licences have significantly increased in value over the years. In 1990, the value of a permanent water licence in the State of South Australia for a megalitre of River Murray water was reported to be about A$50 - A$100 per megalitre and reached a high of about A$2,600 in 2007.
Since 2007, prices paid for River Murray water licences in South Australia have fallen. In 2010, the Federal Government has been paying irrigators around A$2,075 per megalitre to buy their water licences and these licences will be converted to environmental entitlements controlled by the Federal Government. Figure 3 shows the increase in the price of permanent and temporary water licences from the South Australian section of the River Murray-Darling. Similar price trends have occurred across the Basin.
Figure 3. Increase the price of water licences in SA
Source: Percat Water 2010
Water markets in Australia are new and evolving. The value of licences traded is in the billions of dollars. But it should not be forgotten that this has been a slow, incremental process since 1994. Both ground and surface water in the Basin crosses State and Territory borders and disagreements between jurisdictions have slowed down the development of a market. Meanwhile, the scope and size of the change needed to introduce a cap-and-trade system has required new policy and legislation as well as support from the latest scientific methods. Despite these obstacles, the speed of progress accelerated from 2004 onwards as Australia has been affected by the combination of:
- on-going drought over the southern part of the continent
- over-allocation of water licences and
- climate change.
The Australian experience suggests that the efficient trading of water licences is more likely to occur when there is:
- a driver for change – such as a stressed water resources;
- a commitment to market-based instruments to drive water reform;
- policies adopted by stakeholders that reflect a commitment to water markets;
- compatible legislation and regulation that support water markets;
- the application of science in order to understand the characteristics of the water resource from which water is traded; and
- government support for market systems and private enterprise involvement in water trading.
The need to reform water use and manage water more efficiently has resulted in greater understanding of Australia’s water resources, significant policy and legislative change, and emerging water markets.
Australian Competition and Consumer Commission (2006), “A regime for the calculation and implementation of exit, access and termination fees charged by irrigation water delivery businesses in the southern Murray–Darling Basin”, Dickson, ACT.
Australian Water Resources (2009), “Agricultural Water Use in Australia”.
Bjornlund Henning and Peter Rossini (2006), “An empirical analysis of factors driving outcomes in markets for permanent water – an Australian case study”, Centre for Land Economics and Real Estate Research, School of International Business, University of South Australia.
Council of Australian Governments (1994), “Attachment A to Water Resource Policy”, Council of Australian Governments Meeting communiqué.
Council of Australian Governments (2004), “National Water Initiative”.
Hahn, Robert W and Robert N Stavins, “Why cap-and-trade should (and does) have appeal to politicians”, VoxEU.org, 13 April.
Murray-Darling Basin Commission (1995), “An Audit of Water Use in Murray-Darling Basin”.
Murray-Darling Basin Commission (2007a), eResourse Book.
Murray-Darling Basin Commission (2007b), “Water Trading”.
Murray-Darling Basin Commission (2007c), “The Murray-Darling Basin Agreement”.
National Water Commission (2007), “Australian Water Resources 2005: a baseline assessment of water resources for the National Water Commission, Key Findings of the Level 2 Assessment: Summary Results”, Commonwealth of Australia, Canberra.
National Water Commission (2009), “Australian Water Markets Report 2008 – 2009”, NWC, Canberra.
Percat Water (2007), “Increase in the Price of South Australian Water Licences 1990 – 2010”, private company research.
Pigou, Arthur C (1920), The Economics of Welfare, London: Macmillan.
Productivity Commission (2010), “Market Mechanisms for Recovering Water in the Murray-Darling Basin”, Research Report, March.
Young Michael, Darla Hatton McDondald, Randy Stringer, and Henning Bjornlund (2000), “Inter-State Water Trading: A Two Year Review”, Draft Final Report.
1 The price of rural water licences across Australia is highly variable and this figure should be considered an unscientific estimate.
2 Since 1995, grape growers in South Australia with access to River Murray water expanded vine area by 67% (Young et al 2000:13)