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

Abstract

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 reallocation 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.

Understanding Irrigator Bidding Behavior in Australian Water Markets in Response to Uncertainty

“…Climate information only becomes available as the season progresses, so depending on how accurate irrigators were in their water expectations and the watering requirements of their permanent or annual crops, changes (or lack of changes) in monthly seasonal allocations may cause relatively high price volatility in the market. Government intervention in water markets has increased considerably over the first decade of the 21st century [27]. Government intervention affects short-and medium-term price expectations, thereby increasing costs of precise valuations.…”

“…Brennan [27] argued irrigators are generally risk averse and will hold more water than required at the start of a season when climate and allocation information is yet to be revealed, creating price premiums. As a result, some buyers may be more concerned with having their orders executed, increasing the costs of rounding.…”

Market power in water markets

“…This is appropriate for water market structures where suppliers can supply water users at other locations, but are hampered by capacity or (physical) trade restrictions, as is the case in e.g. US and Australian water markets (Weber 2001;Bjornlund 2004;Brennan 2006;Chong and Sunding 2006). In many such markets, a gravity-driven infrastructure facilitates trade from upstream to downstream, but excludes opposite water flows.…”

Modelling hydroclimatic uncertainty and short‐run irrigator decision making: the Goulburn system*

“…Although there is a growing body of market data, and Brennan (2006) estimates an econometric relationship between Watermove pool prices and allocations and rainfall, the approach here is to derive water market price expectations from a perfect information base case.…”

“…In particular, water markets are an important means of adjusting to incoming information on seasonal water availability and crop demands (Brennan 2006).…”