Trading Out of Trouble in the Land Down Under

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By Jeff Bennett
PERC Reports, June 2007

The aboriginal people evolved complex strategies to cope with droughts and during the 200 years of European settlement, farmers and city-dwellers alike have had to come to terms with a climatic system characterized by highly variable patterns of rainfall. Despite the best efforts of engineers to develop dams, tunnels, pipes, and channels, water scarcity remains today. Demands for water continue to increase with population growth and with the rise of irrigated agricultural enterprises. Moreover, the relatively recent recognition of the importance of healthy river ecosystems has added to the desire for water in the form of "environmental flows," the amount of water needed in a flowing body of water to maintain a healthy ecosystem.

Efforts to overcome water scarcity are now being transformed into methods for living with less water. That means making the best possible use of the water that is available. For more than 20 years, important steps have been taken in the Land Down Under to improve resource-use efficiency through the use of water markets.

Prior to 1970, rights to water were allocated by government agencies. Entitlements were assigned to parcels of land and the price charged by the state for water use on these parcels was extremely low. Demands for additional water were met through engineering initiatives with droughts being "handled" using a variety of regulations. This process had three important implications.

First, the allocation of entitlements to water became an important tool for farmers to manipulate the political environment. Farm lobby groups could secure irrigation-based wealth through their capacity to direct votes in rural electorates. Even when the capacity of river systems to supply water for extractive purposes had been exhausted, governments continued to allocate rights to secure political favor.

Second, with next to nothing being charged for water use, farmers had no incentive to conserve the resource. Technical inefficiencies in the application of water abounded. For instance, overhead sprinkler systems were used in the heat of the day ensuring maximum evaporation rates, and delivery systems such as canals and pipes allowed significant "transmission losses" between storages and farms. Negative environmental effects such as irrigation-induced salinity were evident.

Third, with water entitlements tied to land title, the transfer of water to different uses in different locations was heavily restricted. The potential to secure improvements in the returns being offered by water through transfersof entitlements was effectively lost.

The first breakthrough in dealing with these issues came in 1994 when the federal government stepped in to impose water regulatory reform on the states. Title to water was separated from land title. In addition, state agencies were required to develop plans for each river system that involved the settingof environmental flow targets.

These two measures precipitated the development of water markets in Australia. With environmental flows determined, a "cap" was defined for the amount of water available for extractive purposes. Those seeking access to water within the cap could then enter the market to trade. While water leasing has been more voluminous, permanent trades are increasingly prevalent. As a result of these trades, water has shifted around regions and between crops to its highest-valued use. Furthermore, with prices for entitlements reflecting the scarcity of the resource, irrigators have also sought to conserve water through the introduction of high-tech water application techniques such as computer-managed drip irrigation systems.

Despite these innovations, the problem of over-allocated river systems remains. The total amount of entitlements still exceeds supplies in several catchments. While many entitlements have never been activated (so-called “sleeper” and “dozer” licenses), the advent of water trading has encouraged farmers to activate their rights. The impact is that the proportion of an entitlement an irrigator may receive in even a wet year is below 100 percent.

In January 2007, the Prime Minister announced an initiative to spend A$3 billion (US$2.4 billion) to buy back entitlements from farmers in the Murray Darling Basin in Southern Australia to overcome the over-allocation problem. The buy-back scheme is targeted to meeting the environmental flow goals for the basin. Ironically, much of the fund may end up being used to buy “dry water,” as it will be the low security sleeper and dozer licenses that are likely to come onto the maerket first.

Clearly, the policy changes over the past two decades have generated fundamental improvements in the way water is used in Australia. Many issues, however, remain to be resolved.

The level of environmental flows is still defined in rather ad hoc processes driven more by politics than science and economics. Little is known about the environmental responsiveness of most river systems to redirecting water away from current extractive uses to restoring more natural flows. Even less is known about the extent of value that Australians place on the environmental public goods that are provided. The potential for markets to facilitate the allocation and management of environmental flows remains untapped.

Water accounting is still in its infancy. In some situations, water rights are not yet clearly defined or defended. For instance, rules have been implemented that restrict the capture of rainwater in farm storages. Farm forestry ventures, however, do not have to hold entitlements for the water they capture through evapotranspiration (the sum of evaporation and plant transpiration).

In addition, the water reform process in rural Australia has not been mirrored in cities. Efforts to meet growing demands for water resulting from increasing populations have been politically unpopular because of objections from green lobby groups against new dams in forested catchments. Similarly, price increases to ration demand are politically unpopular, with water being touted as an “essential” and needing to be priced at “affordable” levels. Finally, trade between urban and rural users has been restricted in some jurisdictions thus limiting the potential for arbitrage.

As a result, inefficient water regulations exist in most southeast Australian urban areas, including bans on watering suburban gardens. Local authorities also seek to encourage less-than-coste ffective water savings such as subsidizing the installation of domestic rain water tanks and water-saving shower heads in individual households.

Even in urban contexts, however, some advances are being made. For instance, Adelaide, the capital of South Australia, depends on flows from the Murray Darling Basin for the city’s water supply. Hence, the local water authority has been securing additional entitlements through purchases from dairy farms along the lower Murray River.

The severity of Australia’s climate when faced with steadily growing water demands for industrial, domestic, and environmental purposes has caused rapid policy evolution. Recognition across the political spectrum of the power of markets to provide some resolution to the conflicts arising from water scarcity has been and will continue to be a key plank in that evolutionary process.

BACKGROUND READINGS

Bennett, Jeff, ed. 2005. The Evolution of Markets for Water: Theory and Practice in Australia. Cheltenham,UK: Edward Elgar Publishing, Ltd.
Grafton, Q., J. Bennett, and K. Hussey. 2007. Dry Water. Policy Briefs No. 3. Crawford School of Economics and Government, Australian National University. Online: www.crawford.anu. edu.au/pdf/policy_briefs/dry_water.pdf.

Jeff Bennett is Professor of Environmental Management at the Crawford School of Economics and Government at the Australian National University. He is currently editor of the Australian Journal of Agricultural and Resource Economics and Director of the Australian Environmental Economics Research Hub. Bennett has been awarded a Julian Simon Fellowship at PERC in Fall 2007.

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Jeff Bennett, 2011 PERC Lone Mountain Fellow, is a professor of economics and the director of the Environmental Economics Research Hub, Crawford School of Economics & Government at the Australian National University. Bennett is a distinguished fellow of the Australian Agricultural and Resource Economics Society and also a member of the...
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