The Australian Water Market Experiment.


Return to water home

Brian and Lynne Chatterton, Montegabbione, Italy

Abstract: Intra-country and international water trading is being discussed widely as the limits of utilizing water resources become apparent. The establishment of a water market in Australia involved government policy, institutional management, the nature of a common resource, the environmental and economic consequences of privatization, and an assessment of social costs and benefits. In essence, it provides a case study in the potential of water trading and the political differences that may have to be reconciled if such a market is to operate in a socially equitable and environmentally sustainable manner.

Keywords: Water markets, environment, closed resource, generational equity, political, irrigation.

Introduction

On January 1, 1998, a limited form of water market was introduced in a part of the Murray-Darling river system in Australia. While water markets have been developed in individual Australian states, this water market is the first to cross state boundaries (Langford, 1998).

The Murray-Darling basin covers four Australian states: New South Wales, Victoria, South Australia, and Queensland. The Murray-Darling basin is the main irrigation area in Australia, however, a number of regional towns and cities outside the basin, including Adelaide, the capital city of South Australia, draw water from the resource for domestic and industrial purposes.

The entitlement of each state to the water in the basin is determined by the River Murray Commission that is responsible to the Murray-Darling Ministerial Council, which contains a representative from each of the state governments involved and from the federal government. The federal government does not have the power to make unilateral decisions on the management of waters from the Murray Darling basin; there must be consensus among the council members. This can be difficult when different political parties are in power, e.g., the conservative Liberal Party at the federal level and several Labor Party governments in the States. This significant political barrier must be overcome when an interstate water market is being established.

Irrigation Problems in the Murray-Darling Basin.

The major problems facing the irrigation industry are:

* Infrastructure decay: Australia has joined the global rush towards the privatization of profitable government assets. Domestic water distribution has been privatized in some states. Irrigation is the main use of water from the Murray-Darling river system. As the scope for increasing irrigation water charges is limited, there has been no privatization of the Murray-Darling basin infrastructure to date (Anonymous, 1998). Public investment has not been enough to prevent the deterioration of the infrastructure.

* Low profitability of many irrigated crops: Australia has a relatively small population (18 million) and most agricultural industries need to export a considerable proportion of their output to world markets. Their unsubsidised produce, high freight charges, and high labor costs put them at a disadvantage. Returns from many crops are low and the cost of changing to more profitable alternatives is considerable. As long as most countries provide water at low cost to their farmers, it will be difficult to increase the cost of water to Australian farmers without making their competitive position even weaker.

* Increasing degradation of the water resource due to declining water quality and rising water tables: The peculiar geology of the Murray-Darling basin means that enormous quantities of salt have been deposited in the internal delta. This is flushed back into the river through drainage of irrigation areas unless intercepted and pumped to wood lots and evaporation lakes. Salt is also flushed into the river from dry land areas having only an annual vegetative cover.

These problems are not unique to Australia, and with some slight adjustments, they can be applied to irrigation systems in many developing countries.

Objectives of the Water Market

Economic Efficiency

In 1972, Musgrave was an early advocate of water markets as a means of increasing the allocative efficiency of water between different crops. He suggested that if a water market was established, excess water could be sold, helping to pay for investment in more efficient irrigation or the change to a more profitable crop. Water would be transferred from low return crops to higher return crops (Musgrave, 1972). While it is possible on a single property to move from one crop to another, there has to be a market for the substitute crop for it to be successful. For example, at present wine grapes provide the highest returns in irrigation systems, but this is dependent upon fresh grapes having reasonable access to wineries. Large wineries already exist in some areas, but where they would have to be established a complex number of factors, including the availability of capital, planning permission, and long lead time for mature grapes to become available, would have to be overcome before the investment would be considered. Trade in water enables the water to be moved to zones where wineries already exist.

Environmental Concerns

Improvements to the environment have been given considerable emphasis as a justification for the water market. Trading will be under strict environmental control and water cannot be transferred into high salinity zones. It is hoped that water will be transferred out of these zones into zones of low salinity. By reducing irrigation in high salinity zones, there will be an overall reduction in the quantity of salt that enters the river or has to be disposed of in evaporation pans. (Anonymous, 1998). If this occurs, the governments that pay for the Murray-Darling Basin Commission may benefit by being able to avoid or postpone further investment in the salinity drainage infrastructure.

The Scope of the Project

The present water market project is restricted in a number of ways:

* The water market is not intended for transfers of water from irrigation to domestic or industrial use, nor is it intended for transfers to other areas outside the Murray-Darling basin such as the wine grape growing area of the Barossa Valley. The Barossa already uses a substantial quantity of Murray water for irrigation, but this is purchased as domestic and stock water.

* All the water in the South Australian section of the Murray can be traded, but in New South Wales and Victoria only the section from the South Australian border to Nyah (Victoria) is eligible. The estimated quantities of tradable water are: Victoria, 1,600,000 m3; New South Wales, 30,000 m3; and, South Australia, 3,000,000 m3.

* Water can only be traded into areas where the impact on salinity is low. There are no restrictions on trading out of any area. At present, environmental clearances are given on an individual basis for each transaction, but there is some zoning in Victoria where high salinity areas have been defined and where water can only be transferred out.

* The scheme is, at present, restricted to private diverters (that is, farmers who pump directly from the river). It is estimated that there are 2,300 to 2,500 private diverters who can participate in the market. This restriction has been applied because of the need to examine the possible impact on government group schemes, primarily War Service Land Settlement Schemes. Varying levels of cost recovery are charged to growers in different states, and the trading of water from a scheme where the price of water is high to one where the price of water is low would in fact be chasing the subsidy rather than improving overall efficiency. Cost recovery in these group schemes is only a relative term as it refers to the cost of delivering the water from the riverbank to the farm gate. Groups schemes that are inherently high in cost due to high lift, long distance from the river, extensive drainage, and so on, will become more expensive to operate if a large amount of water is transferred out. Yet, in the long term, the transferring out of water rights, and the total closure of such group schemes, may be a better option than expensive rehabilitation of their infrastructure.

* The market is restricted to high security licenses that guarantee water in 90 to 98 years out of every 100. This restriction is being placed on the pilot scheme in the initial stage to avoid the complication of trading water at different levels of security.

* The renting of water rights is not part of the pilot project and only trading for permanent sales is permitted.

After two years it is intended to review the pilot project, and if it is considered successful, it will be extended to other areas in the Murray-Darling basin, and to other classes of irrigators, different security licenses, etc.

Benefits

At this stage of the water market there are clear benefits for growers and the community.

* The water market makes it easier to transfer water from low value crops to high value crops. This will benefit the Australian economy as well as growers. Table 1 shows the large range in gross margins for some of the principle-irrigated crops and the increased returns that are available from switching water to Chardonnay grape production.

* The market allows growers to improve the efficiency of their irrigation and sell any surplus water. This will offset some of the investment in improved efficiency.

* The market allows growers wishing to retire to sell their water rights for a good price and still retain their house and land. If the holding is small and unprofitable for another grower, it is likely that it would be sold for its "water value" only, and the house and land would be worth virtually nothing. Splitting the water from the land will provide better returns and more options to the retiring grower.

* For growers and the community, the transfer of water from high salinity areas to low sanitary areas will improve water quality, and reduce the pressure to invest in infrastructure improvements to reduce salinity.

The Debate about Tradable Water Rights

There is a lively debate throughout the world on the merits and feasibility of developing tradable water rights and water markets.

The Australian markets did not suddenly appear from nowhere, fully formed. The first step towards a tradable right was the closure of the water resource (the Murray-Darling), which took place gradually in the 1960s and 1970s. The closure of the water resource enables a price to be put on water where only a value existed before. As long as it is possible for new entrants to take water from the resource there is no need for them to purchase water rights from existing holders. Of course, irrigated properties were traded but the new owner was buying the land and irrigation infrastructure, not an intrinsic "water right." As with the closure of other common property recourses, the impact was slight: the resource is usually closed for technical reasons; there is no more water; other users need the water; or pollution problems need to be controlled. In Australia, there was a prolonged debate on the merits of closure and there was ample opportunity for new entrants to obtain permission to pump water from the Murray-Darling before the controls came into force.

Then followed a period when there were more people who wanted to dispose of their speculative water rights than there were eager buyers. As closure began to bite, and as market returns from wine grapes, particularly Chardonnay, increased, investment in irrigated land became more attractive, but was, of course, dependent on the purchase of water rights. Various local water markets were developed and finally, in 1998, a market was created that covered three states. Many other countries throughout the world have been forced down a similar path of resource closure. They may not have admitted that water rights exists as a separate entity that can be traded, and have not developed markets for them, but water rights (either independent or linked to the land) are the logical outcome of closure decisions.

The Political Aspects of Water Markets.

Closure of a common property resource such as water immediately creates a political dilemma. The following questions demand answers:

* Who should have access?

* Who should pay for the continued closure?

* Who should provide capital for infrastructure maintenance?

* Who should regulate for environmental and social protection over and above the commercial operation of the market?

There seems to be a dysfunctional aspect to the water market debate. The leap into the Australian water market has been justified on economic (allocation efficiency) and technical grounds (reduced salinity). It is described as a reform that introduced market forces and property rights to replace regulation and publicly funded subsidies (Pigram, 1999). The argument that these, rather than political factors, ensure the success of the market seems to have been accepted by the international institutions who have concentrated on "capacity building" that is aimed at determining a legal and institutional framework with appropriate managerial support to enable markets to operate as freely as possible. When one examines the barriers to establishing water markets in developing countries, there are admittedly important institutional, technical, and economic problems to be overcome, however, political problems seem to be of greater significance, yet the political aspects of water markets are generally excluded from the debate.

This also occurred during similar conversions of common property resources such as fisheries that were closed originally for purely technical reasons (conservation of the stock). Later, economics were introduced into management regimes (optimum resource rent), and only much later has it been admitted and with some reluctance that the allocation of fish resources between groups and generations is a political question (Chatterton and Chatterton, 1981).

Water policies in Australia were initially linked to political objectives such as land settlement, decentralization of population, rewards for war veterans, drought proofing and building dams to win elections.

It is easy to discredit or even mock some of these objectives, but they were believed to be valid at the time. Changing to a market-based system of priorities is a new political direction, but there seems to be a reluctance to admit the political dimension of market-friendly policies. There is also a reluctance to admit that these markets can bring about radical changes to the lives of current water users. Writing from an Australian viewpoint, Hunt (1999) points to "stable" national priorities in developed countries in contrast to "dynamic" ones in developing countries, yet the establishment of water markets in Australia has come about through quite marked changes in national priorities.

Some political questions that need to be considered are:

Nature of Property Right

The Australian water market is based on converting access to water to freehold ownership of the right to use water. One can draw parallels between the development of water rights with other property rights. In Australia, land ownership in different states took divergent courses. In New South Wales, settlers squatted on aboriginal land, paid nothing, and had their title eventually recognized (Burroughs, 1967). This converted the land to a marketable commodity. Before this event, the land was an abundant common property resource and had no price, only a value to the aborigines. In South Australia, land was sold by the government at an arbitrary price thus setting a market value (Gibbs, 1969). The purchase conferred undisputed title to the owner. The government set a price to landowners that included a capital levy to assist in the provision of the state's infrastructure, and to subsidize the immigration of farm labor needed to work the land and produce profitable returns. Land owners complained that the price of land in South Australia was higher than in New South Wales, but nevertheless, all the South Australian land was sold.

Irrigation on the Murray-Darling system could not exist on the present scale without the enormous investment in infrastructure that has been paid for by the community. While it would be politically unrealistic to impose a capital levy on growers at this stage to repay the community for this investment, it would have been feasible during the development of water rights to have demanded some payment for the conversion of "de facto" water rights to "de jure" water rights that could be freely traded. Again, there are a number of precedents in the Australian history of land tenure. At times, farmers have paid to convert their leasehold title into freehold. They have done this on a voluntary basis, because they believe the benefits and sale value of freehold are greater than leasehold.

Alternatively, the community, instead of attempting to recover its investment, could place other obligations on growers in return for the windfall benefits of freehold water rights but again these would interfere with an efficient water market.

A form of leasehold may be effective in returning some benefit to the community. In South Australia, a form of leasehold has been introduced for the land in arid grazing areas that places obligations of sustainability on land holders in return for continual renewal of their leases. The water market will, over time, move irrigation from saline areas to those with less salinity, but a water lease that placed direct obligations on water users would produce much more rapid results.

Equity between Growers and the Community

Australian farmers have been described as "Capitalising their profits and socialising their losses." Irrigated agriculture has not been profitable in Australia over a long period of time, and has received considerable support from the community, in effect a "socializing of losses." The support has been in many forms. Public funds have subsidized the development and maintenance of the infrastructure. Growers have received tariff protection for their output in an attempt to increase returns. Governments have paid direct subsidies to growers to assist them in changing from one crop to another. In spite of this assistance, grower's returns have been poor due to low prices and generally low levels of equity in their properties. In the last several years, the profitability of the irrigation properties have changed with wine grapes, particularly Chardonnay, bringing high returns. The community, having paid for years of losses, now appears to be handing over the profits in the form of saleable water rights to the growers.

Equity between Growers

There are economies of scale in irrigation, and many developing countries are concerned that the free trading of water rights will hasten the consolidation of land into larger holding. In some cases, they have carried out land reform programs to break up large land holdings into smaller family farms. In the Philippines, for example, irrigation water is charged on a progressive scale in an attempt to keep smaller farmers on the land. Water permit holders up to 30 liter/second pay 0.50 pesos/liter/second, whereas those with permits for 30 to 50 liter/second pay 0.75 pesos, and those above 50 liter/second pay at the rate of 1.00 pesos for each liter/second (Cruz, 1989). It is obvious that progressive water pricing would be incompatible with a market in water rights as the price of the water right would depend on the scale of operations of both seller and purchaser.

Developing countries may be reluctant to abandon these progressive-pricing policies. Policies to assist small farmers are pursued in the hope that they will reduce the drift to the cities. International donors are also concerned that internal migration leads to external migration. While these policies may be advantageous to urban political elites and foreign donors, it is important that small farmers who decide to migrate should receive the best possible price for their meager resources.

Equity between Generations

The granting of permanent water rights to growers that are then traded freely on the market effectively transfers what was a community resource to private ownership. The decision to close the water resource creates the water right, but the value of this is disguised until the water rights are separated from the land and traded on the open market. Like all closure decisions, there is little initial impact. All those wishing to enter the resource at that time will have done so before the closure was imposed. Some may have entered only for speculative purposes to beat the closure deadline. After closure there will probably be more sellers than buyers as speculators attempt to cash in their water rights, but over a period of years the price will increase as the limitation on entry begins to bite (Chatterton and Chatterton, 1996). After the second World War, the Australian government established war service schemes to settle returned veterans without capital on small irrigated properties dependent upon water from the Murray-Darling Basin. The pumping stations and the reticulation systems were established and operated by State government departments. Growers paid pro rata for the water they used. Many of these veterans have now sold or passed on their properties. They received their share of the community water resource without any capital payment. The granting of saleable water rights attached to these properties will represent a windfall benefit to the generation of growers who happen to be irrigating after closure took place. The second generation will receive no windfall because they will be purchasing water rights from those who received the windfall.

In the Australian context, this question seems to have been brushed aside, but developing countries may not accept so readily the transfer of a community resource to private ownership nor the burden that it will impose on future generations.

It is possible to create water regimes where a single generation does not receive all the windfall gains from closure. For example, water rights could be granted for fixed periods after which they would be reissued, auctioned, or in some way reallocated so the community retained an interest. Such regimes would not prevent a water market but would certainly make it much more complex.

Government Protection Service

Once the water resource is "closed," there is a need for an inspection and enforcement service to ensure that it is closed in fact as well as in law. If growers exceed their water rights, or if they allow unauthorized saline water to reduce the quality of the irrigation water, the value of existing rights will be devalued. The better the management of the basin the higher the value of the water rights. If growers demand more inspection, more meters, and more enforcement to maintain or enhance the value of their water rights, they could be expected to pay for these services. It should be a clear case of user pays but growers may respond to this argument by claiming that the increase in the value of their water rights is due to better returns for irrigated crops and not solely to better quality and more reliable water. The establishment of a water market based on a price for water provides a quantifiable base from which cost recovery can be calculated.

The level of water charges is a hot political issue for any government. If they are introduced before growers experience the eventual benefits they will complain of excessive taxation. If the improvements to the quality of the water are made first there is likely to be an increase in the value of the water rights. When charges are increased to cover the cost of the improvement growers will complain that they have made a capital loss on their purchased water rights.

Efficiency or Stability?

There is considerable emphasis in Australia on the benefits to growers and the nation for more efficient allocation of water through water markets. Markets are not perfect. In fact, they often overshoot and reflect speculative prices (that is, expectations of higher capital values) rather than realistic returns. Wine grapes in Australia have been a notoriously unstable market with periods of increased planting leading to severe over-production when these vines begin to yield. The present wine grape boom based mainly on Chardonnay (Table 1), has lasted longer than most but there may well be a limit to the amount of Chardonnay that can be consumed. Speculative prices paid for water rights in the Murray-Darling basin are unlikely to bring the Australian banking system to its knees as similar speculation in urban land has done in Japan, but it could have serious adverse effects on growers' profitability. Let us assume that prices will be paid that are well above those based on realistic returns over the long term, that prices are a Chardonnay bubble. The effect will be felt rapidly throughout the irrigation industry, not just by those growers who have purchased traded water, but by other growers who purchase properties with the intention of continuing to irrigate on the same piece of land. They will have to pay land prices based on the market price of water.

Growers entering the industry will incur large mortgages and are likely to have a low equity in their new property. There have been many studies in Australia that have shown that the level of grower or farmer equity is a vital factor in their ability to survive the periodic cycles of low market returns or drought that are endemic to Australia.

Collective Action or Individual Profit?

The wild card in the development of water markets is the impact on local communities. If large amounts of water were to move out of single communities undermining their economic and social viability, the political pressures on the water market could become enormous. At this stage, the direction of water transfer in Australia is not clear.

From a water cost viewpoint (delivered to the vine or tree) one would expect water to be transferred out of South Australia as the quality of the water is lower and the lifts to better irrigation soils are generally higher. South Australia is at present the major wine producing state and high grape prices provide South Australian growers with good returns on their high cost water.

If the Chardonnay bubble bursts and water moves out of some South Australian irrigation areas on a large scale, there will be considerable pressure from the towns that are dependent on wine grapes to stop or restrict water sales. At present, the party in government does not have a majority in the state parliament and is dependent on the support of a few independents including the member for the main irrigated grape-growing district. Any community protest against large-scale transfers will have a powerful effect on government policy. The operation of a water market could make a community approach difficult. If the water moves out as farmers retire, the crisis will not be noticed until the area is facing the decay of infrastructure such as schools and hospitals. At this late stage, it will be difficult to persuade governments that the community is worth saving.

Conclusions

The development of a water market for parts of the Murray-Darling basin will bring benefits to growers and should improve the quality of the water. There are also potential benefits to communities in the region and to the Australian economy as a whole. There are also disadvantages if markets for produce change or weaken, or if economic advantages of one community are upset vis-a-vis another. Political conflicts surrounding water use become sharper and more complex once water ceases to be a common resource and becomes a commodity.

For developing countries, water rights are an inevitable consequence of the closure of the water resource. A water right may be disguised in the title for land ownership, but the debate cannot be avoided. Australia has adopted a freehold system of water rights, which appears to offer an economically efficient operation of a water market but other countries may place equity and sustainability as higher priorities than economic efficiency.

While international organizations are attempting to improve the capacity of developing countries to operate a water market, this seems pointless if the political framework is ignored. If politicians in developing countries are unwilling or unable to override traditional access to water, have irreconcilable interests competing for access, an impotent regulatory authority to enforce closure, or are faced with great difficulties in maintaining sustainability of the resource, a water market may not be a practical option.

Acknowledgement

The authors acknowledge and wish to thank Jacqui Allan of the Murray-Darling Basin Commission for providing a wealth of information on the practical operations of the water market.

About the Authors

Brian Chatterton is former Minister of Agriculture in the South Australian Government, and is now agricultural consultant for the West Asia and North African region. Lynne Chatterton is a former Rural Policy Adviser to the South Australian Premier, and is now an independent scholar and consultant in the WANA region. The authors have jointly published Sustainable Dryland Farming, Cambridge University Press, 1996, as well as a number of papers on water issues, agricultural development policies, olive growing, and fisheries management. The authors can be reached at Podere Valle Pulcini, Castel di Flori, 05010 Montegabbione, Italy. Email: blchatterton@tiscalinet.it

Discussions open until June 30, 2001.

References

Anonymous. 1998. "Water Trading Project Comes to Fruition." Australian Landcare.

Burroughs, Peter. 1967. Britain and Australia 1831-1855: A Study in Imperial Relations and Crown Lands, Clarendon Press. Oxford, England, United Kingdom.

Chatterton, B. and L. Chatterton. 1996. "Closing a Water Resource: Some Policy Considerations." Proceedings of Water Policy Conference. Cranfield University.

Chatterton B and L. Chatterton. 1981. "How Much Compromise Can Fisheries Management Stand? Premiums and Politics in Closed Coastal Fisheries." Marine Policy 5, No. 2: I.P.C. London, England, United Kingdom.

Cruz, Ma. Conception L. 1989. "Water as Common Property: The Case of Irrigation Water Rights in the Philippines." In Common Property Resources, Ecology and Community Based Sustainable Development. Fikret Berkes, ed. Belhaven Press, London, England, United Kingdom.

Gibbs, R.M. 1969. A History of South Australia. Balara Books.Adelaide, Australia.

Hunt, Christopher. 1999. "Transposing of Water Polices from Developed to Developing Countries: The Case of User Pays." Water International 24, No 4: 293ñ306.

Langford, John. 1998. "Australian Experiences in Water Resource Management" Paper delivered to First Regional Seminar on Policy Reform in Water Resource Management MENA/MED Water Initiative.

Musgrave, W.F. 1972. "The Political Economy of Resource Use: Water." In The Natural Resources of Australia, Prospects and Problems for Development. J.A. Sinden, ed. Sydney: ANZAAS and Angus and Robertson.

Pigram, John. 1999. "North-South or South-South: Projecting the Australian Experience in Water Reform." Water International 24, No 4: 385-390.

PISA. 1995. "An Introduction into Olive Growing in Southern Australia." Primary Industries South Australia.

1985 Year Book Australia. 1985. R.J. Cameron, No 69, Canberra, Australia: Australian Bureau of Statistics.

Table 1. Returns from Various Crops in Government High Lift Irrigation Areas of SA

Crop under irrigation
Crop Gross Margin in $AUS/Ha.
Vines - Chardonnay $23,000
Apricots @$490/t $9,000
Olives (table) $8,750
Oranges @$300/t $8,700
Oranges @ $200/t $4,200
Source: PISA, 1995

IWRA, Water International, Volume 25, Number 3, September 2000

International Water Resources Association

Water International, Volume 25, Number 3, September 2000