Case Study: Water Trading in Northern VictoriaSigmund FritschySenior Economist, Climate Change, Environment & Water TeamDepartment of Treasury and Finance, Victoria

Victorian Adaptation Symposium 4 June 2009

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Outline

+ History/ rationale for markets+ Water market in Northern Victoria+ Prices within season+ Prices across seasons

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History/ rationale for markets

+ Small fee for water use+ Tragedy of the commons: there was insufficient incentive

to reduce growth in water use+ Over-extraction was starting to affect reliability of

entitlements, increased concern about environment + Cap introduced, on 1994 levels+ The only way to expand or enter irrigated agriculture was

to buy water from existing entitlement holders+ Scarcity lead to trading and a water market

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History/ rationale for markets

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Water market in Northern Victoria

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Water market in Northern Victoria – how it works

+ Allocation vs entitlement+ Temporary vs permanent trade

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Water market in Northern Victoria

+ Vast majority occurs in Nth Victoria (35,000 Nth vs 3,300 Sth) + Permanent trade Nth Vic 2007/08:

– gross value of trade approx. $277 million;

– 2,200 water trades (in 2009/10, 4,000 applications in 1st month); and

– 217GL+ traded.

+ Temporary trade Nth Vic 2007/08:– gross value of trade approx $270 million;

– 14,377 water trades; and

– 313GL+ traded. + Value of ag production (if possible),

– kinds of crops (if possible)

+ Temporary market is more liquid, more data on how conditions affect trade

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Trade within season

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Trade within season

+ Less water = higher prices+ Heterogeneous participants:

– Horticulture: high value, permanent plantings– Dairy farmers: perennial and annual grasses, can substitute by

buying in feed– Broad acre: lower value annual crops and livestock, can be

opportunistic– Intermediaries: brokers speculate, take margin

+ Decisions/ strategies at different points in time: – Start of season: produce or not; substitute; uncertainty over

allocations; get certainty at a price; wait and see– Mid season: understand how season is playing out (e.g. crop

failure – sell, bumper crop – buy); lower cost water – End of season: save a crop; sell unused portion; not much water

left; carry over

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Trade – over the years

+ Goulburn system has become drier over time, with very dry years in 2002/03 and 2006/07

+ Water is moving to higher value uses+ Response from the market:

– Prices increasing over time– Prices increase more in drier years– Lower allocations increase volume traded– Value of market increases with scarcity: market has provided

additional options to farmers and reduced cost of drought

Following slides illustrate these points

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Goulburn system becoming drier

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Bjornlund, Rossini (c. 2007), Are the fundamentals emerging for more sophisticated water market instruments? Paper presented on the 14th Annual Conference of the Pacific Rim Real Estate Sociey, Kuala Lumpur, January

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Water moving to higher value uses

+ Returns vary:– Horticulture generates relatively large returns

– Dairy has reasonable gross margins, and can substitute

– Broad acre/ cropping is low value

+ During drought:– water availability decreasing

– horticulture has held its ground/ increased water use

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Water moving to higher value uses (DSE, unpub)

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Prices increasing over time

Monthly Growth 1.0%Annual Growth 12.3%

Jan 1.052Feb 1.009Mar 1.045Apr 0.998May 0.970Jun 0.997Jul 0.978Aug 0.951Sep 0.982Oct 0.989Nov 1.016Dec 1.013

Water Entitlements - Ratio-to-Moving Average Model

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Bjornlund

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Entitlement and Allocation Price Cycles

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Prices higher in drought – 2002/03, 2006/07

Bjornlund

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Lower allocation = more trade

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Bjornlund

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Trade reduces the impact of drought

+ Productivity Commission modelled 10-30% reduction in allocation in Southern MDB

+ Intra-region trade reduces impact of water reduction on GRP by 35 to 42%

+ Inter-region trade reduces impact of water reduction on GRP by further 22 to 24%

+ Together reduce impact on GRP by more than half

PC (2004), Modelling Water Trade in the Southern Murray-Darling Basin, staff working paper

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Conclusion

+ The water market has:– Increased the ability to respond flexibly within seasons and over

the years– Improved environmental outcomes– Achieved reallocation of water to higher value/ more productive

uses

+ How would all this have been achieved without markets?– Government takes water from some farmers with compensation– Government gives water to other farmers and charged them for

it– Over the years, within seasons (!)