Missing markets for storage and the potential economic cost of expanding the spatial scope of water trade

A great deal of attention has been given in recent years to the question of externalities associated with water entitlements and how third parties can be protected without restricting opportunities for water trade. Yet one market failure that has received no attention at all is the missing market for storage that arises from the specification of water entitlements, particularly in Victoria where historically all storage decisions were made at the centralised level and where any additional carryover was treated as common property. The economic significance of the missing market for storage is demonstrated using an empirical model that represents the spatial‐temporal pattern of irrigation water demand in the Goulburn Valley and decisions regarding inter‐year storage of water in Lake Eildon. It is shown that, because irrigators have no incentive to trade‐off the benefit of current use (or sale) with the value of water storage, there is an erosion of reliability when opportunities for trade are broadened. The empirical results demonstrate that the loss in economic value associated with reduced reliability are as large as the gains from trade, so there is no net benefit from trade.     

Double trouble: the importance of accounting for and defining water entitlements consistent with hydrological realities*

When entitlements to access water in fully allocated river and aquifers are specified in a manner that is inconsistent with the ways that water arrives, flows across and flows through land, inefficient investment and water use is the result. Using Australia's Murray Darling Basin as an example, this paper attempts to reveal the adverse economic and water management consequences of entitlement and water sharing regime misspecification in regimes that allow water trading. Markets trade water products as specified. When entitlements and the water sharing system are not designed in a way that has hydrological integrity, the market trades the water management regime into trouble. Options for specification of entitlement and allocation regimes in ways that have hydrological integrity are presented. It is reasoned, that if entitlement and allocation regime are set up in ways that have hydrological integrity, the result should be a regime that can autonomously adjust to climatic shifts, changes in prices and changes in technology without compromising environmental objectives.     

Exit fees and termination fees revisited: funding irrigation infrastructure in a manner compatible with water trade*

It has long been recognised that the mechanism for funding irrigation infrastructure in Australia may be incompatible with efficient trade in the rural water market. If the revenue received by an irrigation operator is dependent on the volume of water entitlements held in the operator’s region, out‐of‐region permanent water sales threaten the operator’s revenue stream, potentially leading to higher charges on remaining irrigators, encouraging an inefficient ‘rush for the exit’. In response, irrigation operators have imposed restrictions on permanent water trade, such as exit fees and termination fees, to protect their revenue stream. Previous economic analysis has suggested that exit fees, in particular, are a barrier to efficient trade in the water market and should be abolished. In contrast, this paper argues that allowing irrigators to cancel their water delivery rights without fees or charges leads to inefficient trade in the water market, hinders efficient on‐farm investment in sunk complementary assets and leads to inefficient network rationalisation decisions. Instead, the revenue stream of irrigation operators should be insulated from water trade decisions, through high termination fees, tying irrigation charges to the land, or tagging the obligation to pay delivery charges to the new owner of the traded water.     

Third‐party effects of water trading and potential policy responses*

A key feature of water policy reform in Australia has been the separation of water access entitlements from land titles and the establishment of markets for water. However, the separation of water entitlements from land failed to account for a number of characteristics that were implicit in the joint right. This has given rise to a number of third party effects as water is traded in an incomplete market. This paper describes four third‐party effects of water trade; reliability of supply, timeliness of delivery, storage and delivery charges, and water quality and examines policy responses to address these effects. The discussion draws on the concepts of exclusiveness and rivalry to determine the applicability of property rights and other solutions to the third‐party effects of trade. It is likely that many of the third‐party effects of trade discussed in this paper do not warrant policy intervention at the national or state level, but intervention at the local level may be warranted. The costs of addressing some third‐party effects may outweigh the benefits. Where there are significant gains from trade, the existence of these third‐party effects should not been seen as a reason to impede trade.     

Upstream demand for water use by new tree plantations imposes externalities on downstream irrigated agriculture and wetlands*

Large‐scale tree plantations in high rainfall upstream areas can reduce fresh water inflows to river systems, thereby imposing external costs on downstream irrigation, stock and domestic water users and wetland interests. We take the novel approach of expressing all benefits and costs of establishing plantations in terms of $ per gigalitre (GL) of water removed annually from river flows, setting upstream demands on the same basis as downstream demands. For the Macquarie Valley, a New South Wales sub‐catchment of Australia’s Murray‐Darling Basin, we project changes in land and water use and changes in economic surpluses under two policy settings: without and with a policy requiring permanent water entitlements to be purchased from downstream parties, before plantation establishment. Without the policy, and given a high stumpage value for trees ($70/m³), upstream gains in economic surplus projected from expanding plantations are $639 million; balanced against $233 million in economic losses by downstream irrigators and stock and domestic water users for a net gain of $406 million, but 345 GL lower mean annual environmental flows. With the policy, smaller gains in upstream economic surplus from trees ($192 million), added to net downstream gains ($138 million) from sale of water, result in gains of $330 million with no reduction in environmental flows. Sustaining the 345 GL flow for a $76 million (406–330) reduction in gains to economic surplus may be seen to cost only $0.22 million/GL; but this is much lower than the market value of the first units of that water to agriculture and forestry.     

An economic assessment of options for operating within plantation forestry water entitlements and tightening cap and trade policy

The Green Triangle (GT) region of southern Australia is one of only two jurisdictions globally to licence plantation forestry's groundwater use. In response to declines in groundwater resources caused by historical plantation expansion, reductions in forest water allocations (~50%) are likely for some parts of the region, presenting novel challenges for forest managers in maintaining revenues and timber flows. This article presents a mathematical programming model evaluation of water trade opportunities for plantation forest owners to adapt to reduced water entitlements and explores how tightening groundwater policy could affect forestry returns and land use mix for the region. Results suggest that even absent opportunity to sell water, relatively limited 11% reduction in return could be expected for a large (−50%) water entitlement and (−48%) land-use change out of forestry. Results suggest that opportunities for forestry companies to sell water entitlements may allow them to maintain or even increase combined returns from forestry and water sales. Whilst the results highlight the adaptive capacity of the plantation forestry sector to operate within reduced water entitlement, a significant sectoral and regional economy adjustment would be likely. The discussion focusses on the potential to realise optimisation model-identified adaptation opportunities accounting for real-world thin markets, transaction costs and market friction.     

Capturing benefits from water entitlement trade in salinity affected areas: A role for trading houses?

While there is potential for substantial benefits from water entitlement trade, external effects such as salinity may mean that traders cannot capture these benefits. This paper demonstrates that by creating a trading house as a single seller of water entitlements, with trade profits distributed to buyers, it is possible to achieve an allocation of entitlements which gives a social outcome higher than that possible from atomistic competition for entitlements. Such an outcome may be comparable to an optimally set uniform charge for water entitlements, but the trading house mechanism has the advantage that it makes use of trade to generate information on the optimal level of charging in the presence of salinity.     

An empirical assessment of the value of irrigation water: the case study of Murrumbidgee catchment*

Evaluation of value of irrigation water is essential for supporting policy decision making relating to investments in the irrigation sector, efficient allocation of irrigation water and water pricing and for crafting policies to compare the variable impacts of water reform within and across sectors of the economy. This paper asks the question of how much an established irrigator would pay for water and at what price farmers planning to expand the area they have under irrigation would consider paying for the right to access water. An analytical framework is developed to estimate the net present value of both annual and perennial agricultural activities in the Murrumbidgee catchment. Using these estimates the total value of water used in Murrumbidgee catchment is estimated. An aggregate water supply curve is derived for the catchment from where water may be acquired from irrigators for environmental flows.     

The role of the commonwealth environmental water holder in annual water allocation markets

In recent years, the Government of Australia has bought back a significant amount of water entitlements in the Murray‐Darling Basin (MDB) through its Commonwealth Environmental Water Holder (CEWH) agency. This has been a welcome development, as it is an efficient way of securing water for the environment in the basin. However, the question of how to best manage water holdings held by the government is as yet unresolved. In particular, the question of whether and how should the CEWH engage in water markets is still grappling the government and academia alike. This paper addresses that question by evaluating total benefits to a range of water users, including the environment, under a variety of hydro‐climatic conditions. This is approached through running simulations based on environmental benefit function that varies with prevailing hydro‐climatic conditions. The findings indicate that the benefits are greater when CEWH actively participates in annual water allocation market and that such participation enables the CEWH to secure most water when it is needed the most by the environment. This suggests that policy should encourage the CEWH to further explore opportunities to engage with the water markets to the benefit of communities and the environment in the MDB.     

TRANSFERABLE WATER ENTITLEMENTS WHICH SATISFY HETEROGENEOUS RISK PREFERENCES

Irrigators in Victoria have a water entitlement which is composed of a highly secure water right and additional water which may be purchased if available. Water entitlements in NSW are based on the irrigated area with the actual volume of water received in any year depending almost entirely on seasonal conditions. Musgrave and Lesueur (1973) argued that these entitlements could be replaced by a portfolio of entitlements, with each type of entitlement in the portfolio guaranteeing a nominated minimum value of water at a different probability. Thus, irrigators could purchase a portfolio of water entitlements which would suit their individual risk preferences. The purpose in this paper is to show how a water authority can construct a portfolio of water entitlements which satisfies these requirements and also to demonstrate that the entitlements in the portfolio satisfy a first degree stochastic dominance relationship. A worked example is presented in which these results are illustrated.     

Tradable water saving certificates to improve urban water use efficiency: an ex‐ante evaluation in a French case study

This paper proposes a system of tradable Water Saving Certificates to improve the efficiency of water allocation between Drinking Water Utilities at river basin level. A market institutional set‐up, inspired from recent policy developments in the energy sector, is proposed. An original analytical price‐endogenous model is developed to simulate trade intensity, equilibrium price and efficiency gains in this urban water market. The economic model is implemented in a French case study using mathematical programming. It is used for conducting an ex‐ante evaluation of trade possibilities and efficiency gains, considering different spatial restrictions aimed at controlling environmental externalities. Our modelling exercise provides evidence of the benefits of the proposed Water Saving Certificate scheme.     

Water policy reform in Australia: lessons from the Victorian seasonal water market*

The nature of the seasonal water market is examined using a theoretical model and empirical evidence from the Victorian market. Drivers of the seasonal opportunity cost of water include the underlying nature of investment in the industry made in the context of risky entitlement yields; and the timing and nature of information regarding seasonal water availability and rainfall. Seasonal water markets facilitate the re‐allocation of water availability according to this short‐run opportunity cost. Evidence from the market suggests that transactions costs are low and most of the existing constraints to trade in seasonal allocations are the result of hydrological conditions. Analysis of market data suggests that the price response of the market to water availability is much more pronounced in years of low rainfall. The implications of the paper for wider policy reform are that attention should be paid to improving property rights for the management of intertemporal risk before other reforms, such as broadening of permanent water markets and institutionalising environmental flows, are implemented. This is because these other reforms will change the spatial and temporal pattern of water use and thus affect reliability, which underpins the value of water in irrigated agriculture.     

Who trades water allocations? Evidence of the characteristics of early adopters in the Goulburn–Murray Irrigation District,Australia 1998–1999**

This article applies a model of innovation to analyze the characteristics of irrigators within the Goulburn–Murray Irrigation District in Australia and examines the efficiency of the early water market in the late 1990s. Using multinominal and binary logit analyses we identify the factors associated with irrigators who sold or bought water allocations during 1998–1999 and irrigators who at that time had never participated in any kind of water trading. Contrary to expectations we find that early adopters of water trading were older farmers with low farm productivity, but that in line with theory they had higher levels of education, had spent less time farming, had larger irrigated area, farm operating surplus and farm assets, owned farms that were more intensively farmed, and were more progressive in their planning. There was only weak evidence to suggest that water moved from lower value uses to higher value uses, suggesting the water allocation market had limited efficiency in its’ initial years.     

Economic effects of water recovery on irrigated agriculture in the Murray‐Darling Basin*

In October 2010, the Murray‐Darling Basin Authority (MDBA) proposed that a range of 3000–4000 GL per year, on average, of additional water be made available for the environment in the Murray‐Darling Basin (MDB) to mitigate the effects of what it considers to be inadequate environmental flows. To help quantify the costs of this water reallocation, a hydro‐economic model was constructed based on the 19 regions of the MDB. The model results indicate the following: (i) substantial reductions in surface water extractions of up to 4400 GL per year impose only a moderate reduction on net profits in irrigated agriculture, Basin wide, given competitive water markets, but the effects are much more pronounced in particular regions/catchments and (ii) the costs of the water reallocation are comparable with the amount budgeted by the Australian government to acquire water from willing sellers and increase environmental flows if inter‐regional water trade is unrestricted.     

新形势下中国特色水权交易实践总结与发展对策

水权交易是发挥市场机制作用、优化配置水资源的重要手段,是落实水资源刚性约束要求、促进水资源节约和集约利用的关键举措。在总结现阶段水权交易进展及成效的基础上,分析了推进水权交易面临的主要问题及原因,结合用水权市场化交易工作部署,从顶层设计、平台建设、试点示范、交易监管等方面提出了推进水权交易的对策及措施,为完善水权交易制度体系,培育和发展水权交易市场,促进水资源节约和集约利用提供支撑。     

The impact of drought and water scarcity on irrigator farm exit intentions in the Murray–Darling Basin

Drought and future water scarcity in the Murray–Darling Basin (MDB) will continue to restructure the irrigation industry in the coming decades. There has been little work conducted in Australia that has modelled farm exit or exit intention. ABARES farm survey data were used to model irrigators’ farm exit intentions across the southern MDB from 2006 to 2013. In particular, we examined the hypotheses that drought and water scarcity positively impacted on farm exit intentions and that it is the poorest performing farms that intend to exit in times of drought. Results revealed that water scarcity impacts varied considerably. There was only weak evidence to suggest that irrigators’ exit intentions were higher in times of drought, but there was stronger evidence to support the influence of a lagged water scarcity impact on farm exit intentions during periods of nondrought (e.g. intending to exit at times when the property market was less depressed). There was also strong evidence that poorer performing farms (measured by rates of return and higher debt over a certain level) were more likely to have exit intentions in drought periods, but not necessarily so in nondrought periods. Older age is the most consistent predictor of farm exit intentions across all industries, though it was most significant in drought periods.     

Using proportional modeling to evaluate irrigator preferences for market‐based water reallocation

Irrigators’ policy preferences for water reallocation programs usually take the form of proportional data, where one option will be relatively more or less favored than another in the composition of a government's total budget apportionment to address water reform. This study applies a zero‐one inflated beta regression to model Murray–Darling Basin irrigators’ preferences for market‐based water policy programs. Market‐based arrangements are more likely to provide efficient solutions to water reallocation problems, particularly where future uncertainty and appropriate pricing induce irrigator preferences for such programs. Our modeling of drivers of irrigator preferences for government expenditure on market‐based programs identified different determinants of zero (a corner solution) and proportional outcomes for the reallocation of Murray–Darling Basin water. In addition, the proportional modeling identifies some variables (namely, state regional influences, the type of farm production and recent debt, low income, or water allocation stressors) that increase engagement with market‐based programs. Interestingly, while price variables are important and statistically significant, they appear to be less relevant to program engagement than other influences.     

Irrigator preferences for water recovery budget expenditure in the Murray-Darling Basin,Australia

This study presents results from a survey of southern Murray-Darling Basin irrigators about the percentage of funds they would allocate towards a variety of current and hypothetical trade-off choices for recovering environmental water. The findings, allowing for state-based differentials, suggest irrigators marginally prefer infrastructure expenditure above the sum of a set of market-based options (namely water entitlement purchasing, temporary water market products and exit-based packages). However, their infrastructure preference weighting is less than current budget expenditure, and use of market-based options has higher support from irrigators than current policy recognises. Further, analysis of past and current infrastructure and market-based water recovery expenditures reveals large price-per-megalitre disparities, which may be explained by diminishing marginal returns. Targeting expenditure in line with preferences of irrigators may result in increases in economic efficiency.     

Elicitation of irrigators' risk preferences from observed behaviour

Water trading in the Murray–Darling Basin of Australia has developed to the point where it is a common adaptation tool used by irrigators, making it an apt case study to elicit the marginal value of irrigation water and irrigators' risk preferences in two key industries with differing levels of water dependence. Our data come from large‐scale and representative surveys of irrigated broadacre and horticultural farms in the Murray–Darling Basin over a 6‐year period. The marginal contribution of irrigation water to profit is estimated at $547 and $61/ML on average in horticulture and broadacre, respectively. Horticultural irrigators are found to be averse to the risk of large losses (downside risk) while broadacre irrigators are averse to the variability (variance) of profit.     

Water rights for variable supplies*

The relative merits of different systems of property rights to allocate water among different extractive uses are evaluated for the case where variability of supply is important. Three systems of property rights are considered. In the first, variable supply is dealt with through the use of water entitlements defined as shares of the total quantity available. In the second, there are two types of water entitlements, one for water with a high security of supply and the other a lower security right for the residual supply. The third is a system of entitlements specified as state‐contingent claims. With zero transaction costs, all systems are efficient. In the realistic situation where transaction costs matter, the system based on state‐contingent claims is globally optimal, and the system with high‐security and lower security entitlements is preferable to the system with share entitlements.