| Tim Goesch, Ahmed Hafi, Sally Thorpe, Peter Gooday and Orion Sanders | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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| Introduction | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
In late 2006, the then Prime Minister convened a water summit to discuss the future of the Murray-Darling Basin (MDB). The eastern states were in the midst of an extended drought and inflows into the Murray system were at record lows. One of the outcomes of this meeting was a joint communiqué by the Prime Minister and MDB state premiers calling for ‘CSIRO to report on sustainable yields of surface and groundwater systems within the MDB’. The subsequent terms of reference for what became known as the Murray-Darling Basin Sustainable Yields Project asked CSIRO to: estimate current and potential future water availability in each catchment and aquifer in the MDB considering:climate change and other risks, surface-groundwater interactions, and compare the estimated current and future water availability with that required to meet current levels of extractive use (CSIRO 2007a). As the terms of reference suggest, CSIRO was asked to report on water availability rather than sustainable yield. While the CSIRO estimates will help inform the derivation of new sustainable diversion limits, the derivation of these limits will also require the environmental and socio-economic impacts associated with different allocation regimes to be analysed. CSIRO has now released water availability estimates for all 18 regions which comprise the MDB (CSIRO 2008a). Under the medium global warming scenario considered in its analysis, CSIRO estimated surface water availability to decline by between 3 per cent and 21 per cent for individual regions in the Basin by 2030, with the most significant declines estimated to occur in the southern regions. This is where the main regulated river and irrigation systems are located. A decline in inflows into the Basin will reduce the total volume of water available for consumptive and environmental uses. This study will estimate the direct effect of reduced water availability on irrigators’ incomes and land use by region and industry. The remainder of this article is structured as follows. The first section provides a brief overview of irrigated agriculture and regional economies in the MDB. This is followed by a brief outline of the water availability scenarios estimated by CSIRO, which in turn, is followed by an outline of the biophysical-economic model and assumptions used in the analysis. The model results are then presented, followed by a discussion on the implications for water policy. |
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| Study regions | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The MDB is located in eastern Australia, accounting for around 14 per cent of Australia’s land mass and 10 per cent of its population. Agriculture tends to be a major contributor to most regional economies, with around 10 per cent of the labour force being directly employed in agriculture (compared with 3 per cent Australia-wide), and a significant proportion being employed in related manufacturing industries. Other major employers included retail (14 per cent), health and community services (11 per cent), and government administration and defence (10 per cent) (ABS 2008). In terms of land use, agriculture dominates, accounting for nearly 90 million of the Basin’s 106 million hectares. These 90 million hectares in turn produced around 39 per cent ($15 billion) of Australia’s gross value of agricultural production ($38.5 billion) in 2005-06 (ABS 2008). Of the 90 million hectares devoted to agriculture in the Basin, less than 2 million hectares are devoted to irrigated agriculture. In terms of total irrigation, the MDB accounts for 65 per cent of Australia’s irrigated land and 66 per cent of Australia’s agricultural water use (ABS 2008). The area of land used for different irrigated activities in 2005-06 is presented in table 1. The largest activities by irrigated land use were pasture (717 000 hectares), cereals (329 000 hectares) and cotton (247 000 hectares). In 2005-06, the gross value of irrigated agricultural production in the MDB was around $4.6 billion. This is around 44 per cent of the total value of irrigated product in Australia ($10.5 billion). The largest activities in terms of gross value of irrigated output were dairy ($938 million), fruit ($898 million), cotton ($797 million) and grapes ($722 million) (table 2) (ABS 2008). The distribution of irrigated activities varies between the northern and the southern regions. These differences are not only attributed to factors such as differences in soil type and climate, but also differences in the reliability of irrigation water supplies. For example, around 80 per cent of horticultural activities are located in the southern basin. The Mediterranean climate is suited to horticultural crops and the more heavily regulated southern river system provides more reliable access to water, which is essential for permanent plantings. The regions used in this study are based on the boundaries used by CSIRO in its sustainable yields project. The 18 regions analysed by CSIRO (map 1) were constructed around river valleys, utilising existing hydrological models where possible. ABARE has modified two regional boundaries to facilitate analyses by relevant state jurisdictions. This involved splitting the Border Rivers region into Border Rivers Queensland and Border Rivers NSW and the Murray region into Murray NSW, Lower Murray-Darling (NSW), Murray Victoria, and Murray South Australia. |
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| CSIRO water availability scenarios | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| As stated in the introduction, CSIRO was commissioned to estimate water availability in each region in the MDB. More specifically, the MDB Sustainable Yields Project involved: 1 defining the reporting regions and the climate and development scenarios to be assessed; 2 conducting rainfall-runoff modelling and rainfall-recharge modelling based on these climate and development scenarios, and; 3 propagating the run-off implications through river system models and the recharge implications through groundwater models, and reporting these findings using monthly water accounts. The scenarios modelled in the CSIRO study included: 1 historical climate and current development; 2 recent climate and current development; 3 future climate and current development, and; 4 future climate and future development. The historical climate/current development scenario is the baseline against which other climate and development scenarios are compared. |
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| Focus of this analysis | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The ABARE analysis is confined to estimating the direct economic impacts of changes in irrigation water availability under the future climate/current development scenario (box 1) compared with the historical climate/current development scenario (the baseline). CSIRO estimates suggest there is little difference in inflows and diversions under current and future development (box 2). Moreover, the ABARE analysis focuses on the median climate variant, given this is CSIRO’s best estimate. The ABARE analysis also takes into account CSIRO estimates regarding changes in rainfall under the climate change scenario, since irrigators’ water use depends on both rainfall and water available for irrigation. However, the analysis did not take into account the potential for carbon dioxide fertilisation to alter plant yields, or the additional water requirements of plants because of increased temperatures. CSIRO estimates for changes in surface water availability and surface water diversions based on the median climate variant for 2030 are presented in figure a. Overall, CSIRO estimate surface water availability and surface water diversions will decline by around 11 per cent and 4 per cent respectively across the Basin, compared with the historical climate scenario (CSIRO 2008a). Surface water diversions include diversions for irrigation, rural stock and domestic use, channel losses in supplying this water and any stream flow impacts associated with groundwater extractions (CSIRO 2008a). It is important to note that the decline in surface water diversions is less than the decline in surface water availability. This is because surface water diversions have been derived assuming current water sharing rules apply. The implication is the environment will bear a disproportionate share of any decline in water availability under current water sharing rules. |
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In order to illustrate how treating the environment more favourably under future water sharing arrangements could affect irrigators’ incomes, ABARE also modelled a scenario whereby changes in surface water availability (as estimated by CSIRO) are shared equally, in percentage terms, between consumptive and environmental users. This scenario is illustrative, and in no way intended to reflect actual changes in future water sharing arrangements. The CSIRO estimates also suggest the bulk of the decline in total surface water availability in the Basin will occur in the south east, with two-thirds of this decline estimated to occur in the Goulburn-Broken, Ovens, Murray and Murrumbidgee regions (including reductions in contributions from the Snowy Mountains Hydro-electric Scheme) (CSIRO 2008a). This is where most of the Basin’s run-off is generated, and where the impact of climate change is likely to be greatest (CSIRO 2008a). For comparison, the CSIRO estimates indicate surface water availability and surface water diversions may increase by 11 per cent and 3 per cent across the Basin in 2030 under the wet climate variant, with this increase occurring mainly in the northern MDB. In contrast, surface water availability and surface water diversions are estimated to decline by 34 per cent and 21 per cent under the dry climate variant, with 70 per cent of the decline in diversions expected to occur in the Goulburn-Broken, Murray and Murrumbidgee regions (CSIRO 2008a). |
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| Method | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The economic impact estimates presented in this article were derived using ABARE’s water trade model. This model is a comparative static partial equilibrium model of water markets in the MDB. It is a biophysical-economic model which uses inputs from CSIRO (2008a) on rainfall, surface water availability and surface water diversions to estimate changes in irrigators’ incomes and land use by region and activity. As stated earlier, the model contains an additional four regions (for a total of 22 regions) compared with the 18 regions used in the CSIRO analysis. This demarcation provides the flexibility to analyse the economic impacts of reduced water availability by water management jurisdictions or regions. There are also 14 land use activities specified in the model, including irrigated citrus, grapes, stone fruits, pome fruits, almonds, olives, vegetables, cotton, rice, grains, oil seeds, lucerne and dairy. The fourteenth activity is dryland cropping. It is assumed the prices of these commodities do not change in response to changes in production. In this analysis the model has been used to solve for the optimal allocation of water between irrigated activities within a region, assuming water cannot be traded outside of a region and water use decisions by upstream irrigators have no effect on downstream irrigators. While the latter assumption may hold in terms of downstream water availability being protected by water sharing rules in each region, upstream use can potentially alter the quality of water available for downstream use, which can in turn affect the productivity of downstream irrigation. For example, water use in irrigation regions underlain by highly saline groundwater systems could lead to an increase in river salinity downstream if it results in highly saline return flows entering the river. While the water trade model can be used to estimate the impact of changes in salinity on irrigated activities, the relevant biophysical relationships, such as the impact of reduced water availability on salinity levels, are the subject of considerable uncertainty (MDBMC 1999). There are also problems in modelling the impact of increased salinity on crop yields given the different leaching and water management practices irrigators can adopt to mitigate these impacts. These are areas in need of further investigation. This is an important area for further research, not only because water use has the potential to affect the quality of water downstream, but also because lower inflows can lead to higher salinity if not accompanied by an equivalent reduction in salt loads entering rivers. |
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| Results | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The results generated from the water trade model reported in this study include changes in irrigators’ incomes, land use and water use. Any change in irrigators’ welfare because of changes in access to irrigation water will tend to be reflected in their incomes. The pathways through which reduced access to irrigation water can reduce irrigators’ incomes include: reduced yields (through applying less water per hectare or reducing the area irrigated), and; increased costs (through purchasing additional water or implementing alternative water management regimes). In reality, irrigators’ incomes can also be affected by changes in salinity. As discussed earlier, these impacts have not been considered in this analysis, and need to be considered in future analyses. While changes in incomes provide an indication of changes in welfare, changes in land and water use by irrigated activities will tend to reflect the extent to which these industries are likely to adjust in response to changes in access to irrigation water. Under the median climate scenario, CSIRO estimates that, on average, surface water availability and surface water diversions will fall by 11 per cent and 4 per cent across the Basin by 2030. ABARE has in turn estimated this decline in surface water diversions will lead to a 1 per cent decline in irrigators’ incomes across the Basin (see table 3). The percentage reduction in irrigators’ incomes is less than the percentage reduction in irrigators’ water use because of the cushioning effect intra-regional water trade has on incomes. Intra-regional trade leads to the reallocation of water from less profitable activities to more profitable activities. This reallocation of water is reflected in changes in land and water use across activities (see tables 4 and 5). For example, the results indicate the percentage decline in water use by higher value activities such as horticulture and cotton is significantly less than the decline in water use by lower value activities such as irrigated broadacre, dairy and rice. Furthermore, there is a slight expansion in the area of land devoted to horticulture and cotton, whereas there is a decline in the area of land devoted to irrigated broadacre, dairy and rice. The increase in land used for higher value activities at the same time as there is a reduction in aggregate water use by these activities can be explained by the use of deficit irrigation, which involves applying less water per hectare, and the substitution of land for water. This substitution occurs as the price of land falls relative to water. table 4 also indicates the total area of land irrigated in 2030 falls by around 1.4 per cent, as some irrigators revert to dryland production on land previously irrigated. The regional variations in changes in irrigators’ incomes in response to changes in access to irrigation water are shown in table 3. Overall, the results tend to reflect changes in access to irrigation water and the potential to offset these impacts through intra-regional trade. It should be noted these results are based on irrigators’ access to both surface water and groundwater, whereas the CSIRO estimates (figure a) refer to changes in surface water diversions only. In some regions irrigators have access to groundwater, which is assumed to remain unchanged in this analysis. In systems where irrigators have access to both surface water and groundwater, the percentage change in total diversions will be less than the percentage change in surface water diversions. The largest reductions in access to irrigation water tend to occur in the southern Basin. This is also where the largest percentage declines in income occur. In the north, the change in incomes ranges from 0.5 per cent in Barwon Darling to -1.1 per cent in Gwydir, whereas in the south the change ranges from no change in Ovens to around -3.3 per cent in the Wimmera (table 3). In Barwon Darling, a 3 per cent decline in water availability is not considered to be large enough to constrain diversions while the hotter climate increases crop evaporative demands. Consequently, the existing water sharing plan prescribes a 2 per cent increase in diversions, resulting in a slight increase in incomes in that region. The potential for diversity in irrigated activities to mitigate the impact of reduced water availability on incomes is demonstrated by comparing the Gwydir and Lachlan regions, which experience similar reductions in access to irrigation water. Incomes fall by only 0.6 per cent in the Lachlan region, compared with 1.1 per cent in Gwydir. The Gwydir region is more adversely affected by the reduction in access to irrigation water because of its lack of diversity. More than 90 per cent of the gross value of irrigated agriculture and irrigated income in the Gwydir region is generated from cotton. There is a more even distribution of high and low value activities in the Lachlan region, providing irrigators in this region with more opportunity to offset the impact of reduced access to irrigation water by reallocating water between these activities. It should be noted this scenario assumes no inter-regional water trade. Freeing up inter-regional trade will increase the number of opportunities irrigators have to engage in mutually beneficial trade, and further offset the impact of reduced water availability on irrigated activities. |
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| Restoring the balance | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| As stated earlier, the CSIRO analysis indicates current water sharing arrangements will protect consumptive users from much of the impact of climate change, transferring a disproportionate share of this impact to the environment. More specifically, the analysis suggests one of the consequences of maintaining current water sharing arrangements in the face of climate change may be irreversible ecological damage to floodplain wetlands in the southern MDB (CSIRO 2008a). The newly formed Murray-Darling Basin Authority has been given the responsibility of preparing a new Murray-Darling Basin Plan under the Water Act 2007. Among other things, this plan will establish new sustainable diversion limits for surface water and groundwater in the MDB, as well as an environmental watering plan designed to optimise environmental outcomes (MDBA 2008). The results presented in table 6 illustrate the potential impact of rebalancing current water sharing arrangements more equally with the environment. They assume the imposition of a simplistic water sharing rule which allocates reductions in regional surface water availability (as estimated by CSIRO) equally, in percentage terms, between consumptive and environmental users. Note, these estimates are in no way intended to reflect actual changes in future water sharing arrangements. At a Basin level, the results suggest sharing any changes in regional water availability, based on the median 2030 climate scenario, equally between consumptive and environmental users could increase the costs incurred by irrigators to more than 3 per cent of their incomes, compared with maintaining current water sharing arrangements. |
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| Limitations | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The impact estimates reported in this study are dependant on a number of factors, including climate projections and the specification of ABARE’s water trade model. Clearly, uncertainties surrounding global warming projections, the sensitivity of the global climate system to greenhouse gas concentrations, and regional rainfall response functions (CSIRO 2008a) have serious implications for the accuracy of these impact estimates. In terms of model specification, there is a risk these impact estimates underestimate the impact of climate change because they do not take into account the impact of salinity on irrigated activities. Research by Adamson et al. (2007) suggests that increases in river salinity can affect the returns to irrigated activities, with significant increases rendering some activities unviable. In modelling carried out for the Garnaut Climate Change Review, Quiggin et al. (2008) found river salinity in the Basin could increase from its current level of around 470 units of electrical conductivity (EC) to 670 EC by 2030, and to more than 5000 EC by 2060 under the median climate scenario. To put this in context, targets have been set for river salinity and salt loads in the Murray River and major tributary valleys under the Basin Salinity Management Strategy (BSMS). The Basin salinity target is set at Morgan, South Australia, and seeks to maintain a salinity level of less than 800 EC 95 per cent of the time (MDBC 2008a). The objective of this strategy is to maintain water quality in the Murray and Darling River systems for all beneficial uses, including agricultural, environmental, urban, industrial and recreational uses. Modelling by Quiggin et al. (2008) indicates increasing salinity will initially lead to a transition away from stone fruits to grapes, with no stone fruit being produced in 2030. This will be followed by a transition away from grapes toward citrus as salinity continues to increase. By 2050, the area devoted to grapes is estimated to decline by around 7 per cent while the area devoted to citrus increases by around 30 per cent. As stated earlier, while ABARE’s water trade model can be used to estimate the impact of changes in salinity on irrigated activities, the relevant biophysical relationships are the subject of considerable uncertainty and require further investigation. Given the potential for salinity to significantly affect the structure of irrigation in the Basin, the urgency for this type of research cannot be overstated. Another factor to consider is that run-off is projected to decline well beyond the 2030 timeframe considered in this analysis. CSIRO has projected run-off as far out as 2070 using run-off elasticities, global temperature projections and run-off results for 2030. These projections indicate average annual run-off could decline by 17 per cent by 2050 (compared with 11 per cent by 2030), and by 27 per cent by 2070 under the medium global warming scenario (CSIRO 2008a). These projections have significant implications for the future of irrigated agriculture in the Basin, especially in the event more equitable water sharing arrangements are implemented under the new Basin Plan. On the upside, there is also a risk that the estimates presented in this article overestimate the impact of climate change on irrigation. This is because the analysis does not assume any change in production technologies in 2030. In reality, lower water availability would be expected to create incentives to develop new technologies aimed at economising on irrigation water use, which could in turn reduce the costs incurred by irrigators. |
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| Adjustment/flexibility | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Given the potential for climate change and an increasing emphasis on environmental flows to impact on the level and pattern of irrigated activity in the Basin, it is critical that jurisdictions adopt institutional settings which allow irrigators to adjust to a lower and more variable water supply at minimal cost. The National Water Initiative (NWI) is an agreement between the Commonwealth, State and Territory governments on water reform. Its overarching goal is to optimise the economic, social and environmental benefits which can be derived from water. Among other things, the parties to the NWI agreed to: create water access entitlements for consumptive water that are separated from land; give statutory recognition to environmental water; adjust overallocated and/or overused water systems to more sustainable levels of use, and; implement water trading arrangements which facilitate the efficient operation of water markets (Commonwealth of Australia 2004). While the states and territories have made some progress in meeting these objectives, overall the pace of reform has been slow. In 2008, the Commonwealth Government allocated $3.1 billion to purchasing water for the environment from irrigators under the Restoring the Balance in the Murray-Darling Basin program, which is part of the broader Water for the Future program (DEWHA 2008a). The rationale was that immediate action was required to address the continued deterioration in ecosystems in the Basin, and it was unacceptable to wait until the new Basin Plan came into effect in 2011 before returning more water to the environment (DEWHA 2008b). The urgency for reform is highlighted in CSIRO’s water availability estimates. While CSIRO has estimated surface water diversions under current water sharing arrangements, new diversion limits would seem to be much more likely to resemble changes in water availability under new water sharing arrangements to be determined under the forthcoming Basin Plan (see figure a). |
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| Restrictions on inter-regional trade | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The water availability estimates in figure a suggest that the southern Basin is particularly vulnerable to climate change, and that some irrigators in some sectors in the south could face significant adjustment pressures in the near future. Currently there is a threshold limit on the net level of water entitlements that can be traded out of an irrigation system in any one year equivalent to 4 per cent of total entitlements in that irrigation system. There is evidence this limit is binding in some regions, particularly in Victoria (figures b and c), which suggests that the limit is constraining the ability of some irrigators to autonomously adjust to changing circumstances. As can be seen in table 7, considerable intersectoral adjustment may be required in the face of moderate reductions in water availability. Limiting inter-regional trade will not only slow adjustment in regions seeking to sell water, but could also restrict irrigators from investing in greenfields projects in other regions, which could be both economically and environmentally beneficial. The entry of a new significant player into the water market (the environmental manager) will add to adjustment pressures, further strengthening the case for the removal of trade restrictions. While irrigators can circumvent the 4 per cent rule to some extent by entering the temporary water market, much of this trade in recent times has involved irrigators purchasing water to protect existing stands of tree and vine crops. The capital losses irrigators incur in the event permanent plantings die because of a lack of moisture can be substantial. It is unlikely that irrigators contemplating investing heavily in new permanent plantings will do so based solely on access to the temporary water market. That said, there may be some opportunity for irrigators investing in new activities to reduce their risk by entering into long-term lease arrangements for temporary water. However, the transaction costs associated with this type of lease arrangement are likely to be higher than for trading permanent entitlements. It may also be easier for irrigators purchasing water through a multi-year lease to subvert regional environmental goals than would be the case when purchasing a permanent water entitlement. The 4 per cent rule also has the potential to limit the volume of water entitlements the Commonwealth Government can purchase in any one region. This could force the Commonwealth Government to purchase entitlements in more expensive regions, reducing the cost effectiveness of the buyback. There is evidence the trade limit did restrict purchases under the initial $50 million tender for entitlements held in 2007-08, with the Minister for Climate Change and Water stating some purchases were not approved because of the 4 per cent rule (Commonwealth of Australia, p. 7. 2008). |
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| One of the original arguments for restricting inter-regional trade in water entitlements was the potential for unregulated trade to lead to the stranding of irrigation infrastructure. However, the risk of stranded assets is being dealt with through termination fees. While fees relating to exiting an irrigation service have been in place for some time now, their inconsistent application may have led to trade distortions. In early 2009 the Minister for Climate Change and Water, on advice from the ACCC, updated regulations on termination fees which allow these fees to remain in place, up to a maximum of 10 times the annual access fee (DEWHA 2009). These updated regulations are to come into effect on 1 July 2009. Given this development, there would appear to be little justification for maintaining restrictions on inter-regional trade, unless these restrictions are based on environmental grounds, in which case other more flexible mechanisms should be investigated first. |
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| Restrictions on intertemporal water use | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Another factor that could potentially constrain irrigators’ ability to deal with climate change is the lack of flexibility in intertemporal water use under the current announced allocation system. In the main, state governments centrally manage the intertemporal use of water through their management of water storages, releasing water for use in the current period based on the volume of water held in storage and expected future inflows. This type of allocation system fails to take into account that many irrigators have different water needs and attitudes to risk than those assumed by the government on irrigators’ behalf. Some jurisdictions do provide irrigators with a degree of flexibility over intertemporal water use by allowing them to carry over a proportion of their current year’s allocation into the following year. In systems where irrigators cannot carry water over, their options are limited to using all of their allocation, selling part or all of it, or forfeiting it to the common pool at the end of the season. Irrigators may forfeit unused allocations if they receive these allocations too late in the season to be useful, and if there is no market for this water. Even if irrigators can find a buyer for unused allocations, they would have preferred to carry this water over if they believed that the discounted value of using this water next season was higher than the sale price in the current season. In spite of the obvious benefits in terms of risk management, carryover facilities tend to be heavily regulated and subject to sovereign risk, with access to carryover water having been suspended in the past. One reason governments place restrictions on the proportion of irrigators entitlements which can be carried over is to protect the rights of other users of the water storage. The carryover system reflects an incomplete property right in that it does not explicitly define access to dam capacity, and as a result, does not ensure access to dam capacity is efficiently allocated. In the absence of restrictions on carryover it is possible for owners of large entitlements to carry over large volumes of water, which can in turn lead to dams spilling earlier than they would have in the absence of carryover, and a reduction in the yield of other users’ entitlements. This is likely to be more of a problem in smaller storage systems. An alternative to the announced allocation system is capacity sharing. Capacity sharing reflects a different system of property rights which has the potential to deliver significant benefits to irrigators and other water users. Capacity sharing involves allocating water users an explicit share in both storage capacity and inflows into that storage. They also share in any losses from the storage system. This negates the need for a central planner to second guess the storage release decision for water users, and prevents users with large entitlements from impinging on the storage capacity of other users. Capacity sharing is a decentralised approach to storage management which allows individual irrigators to make storage/use decisions based on their individual water needs and risk preferences. By making their own storage decisions, irrigators can effectively manage the reliability of their entitlements to match their preferences. This system of property rights can also be extended to other users, such as town water utilities. Given the consequences of reduced availability of water for human consumption, it is likely these utilities would be conservative in managing their storage/use decisions, helping avoid the type of interventions which have been necessary in recent times to maintain town water supplies. In terms of irrigation, another advantage of capacity sharing is that it has the potential to stimulate investment in higher value activities which require access to a more reliable water supply. More closely aligning individual water entitlements with reliability preferences can also reduce the volume of temporary water trade required to achieve a more efficient allocation of water, and hence reduce transaction costs associated with trade. Recent illustrative modelling by ABARE demonstrated the potential for a decentralised storage management system, such as capacity sharing, to deliver a superior outcome in terms of higher and less variable incomes than a simplistic centralised allocation system, which allocated all available irrigation water for use in the current season up to 100 per cent of irrigators’ entitlements. In the illustrative case study analysed, decentralising the storage management decision resulted in a 12 per cent increase in average incomes for irrigators, and a 66 per cent decrease in the variability of these incomes (Hughes 2009). Importantly, the ABARE modelling also demonstrated the gains, in terms of higher and less variable incomes, from adopting a decentralised storage management system increase substantially as the level of water availability declines. While there would appear to be significant advantages in converting to a system of capacity sharing, there are a number of issues the relevant authorities will need to take into account. For instance, introducing a system of capacity sharing may involve substantial set up costs. These costs could include the costs of developing a computer based accounting system, educating and consulting with irrigators, and making the necessary changes to regulations. Once in place, however, the operating costs are likely to be relatively low. In fact the operating costs may potentially be lower than those incurred under traditional announced allocation systems, as has been the case for SunWater at St George (SunWater pers. comm. 2008). There may also be some irrigator resistance to converting to capacity sharing, based on irrigator concerns surrounding the entitlement conversion process. This will be the case if there is the perception some entitlement holders are going to be potentially worse off, and others better off, after the transition. ABARE’s analysis focused on a simple water supply system involving a single major water storage. In practice there are a range of more complicated water supply systems, including systems with multiple storages and multiple connected rivers. Despite this added complexity, there are a number of options for dealing with multiple storages, including defining separate rights to each storage or defining rights to combined system storage capacity (Dudley 1990). This is an area in need of further research. |
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| Increase emphasis on market solutions | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The previous discussion provides a strong rationale for increasing the emphasis of markets in resolving any resource allocation decisions regarding consumptive water, with market solutions (such as freer inter-regional trade and decentralised storage management) having the potential to significantly increase the ability of irrigators to manage their own risk, and in some cases, stimulate investment in higher value activities which require access to a more reliable water supply. This is not to deny that more interventionist approaches may be needed to deal with any unwanted third party effects such as increases in downstream salinity associated with upstream use. Where these types of problems do arise, the use of more market oriented instruments which are directly related to the problem (such as a levy on trade into regions with highly saline return flows) are likely to be preferable to a blanket regulation preventing all inbound trade. Markets are also the key to ensuring water is used efficiently in irrigation and other consumptive uses. figure d highlights the difficulty in taking a more interventionist approach to allocating water across industries. The significant variation in rates of return on capital employed within each irrigated industry illustrates that there are operators generating high and low returns in each industry. While the distribution of returns differs between industries, it is not possible to classify some industries as relatively poor performers. In addition, the view that some industries use water inefficiently is perpetuated by inappropriate and misleading measures of economic efficiency such as megalitres of water used per hectare (or unit of output) or revenue earned per megalitre of water used. Clearly, some irrigated activities will require more water than others. Irrigated activities involve the use of multiple inputs, of which water is just one, and water is no different to any other input that has value. The demand for water in any irrigated activity is a function of its price. Given this, the best way to ensure water is used efficiently across regions and industries is to let price signals prevail. The restrictions which currently apply to trade and intertemporal water use act to distort water prices by restricting the transfer of water between regions and time periods where the returns to water use are higher. Irrigators engaged in these industries will also have different risk preferences for water. This was reflected in the level of temporary water purchased recently by South Australian irrigators to maintain permanent horticultural crops. There is also evidence that many dairy farmers substituted buying in feed for irrigated pasture during the drought. This type of diversity suggests it will be difficult for any centralised agency to successfully manage intertemporal water use decisions on behalf of irrigators, and that there may be significant benefits from devolving these decisions to individual irrigators. |
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| Markets and environmental water | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| The benefits from more fully utilising markets are not restricted to consumptive water. There may also be significant benefits from more extensively utilising markets for environmental water. To date, environmental water purchases have been restricted to permanent entitlements. It is stated in the National Water Initiative that the environmental manager will have the flexibility to sell temporary water which is attached to the entitlements it purchases back to irrigators when it is not needed for the environment, providing benefits to irrigators during dry periods. There would also appear to be benefits if the environmental manager was able to enter the temporary market or options contracts to opportunistically purchase physical water to top up a high flow event to flood a wetland. With this type of flexibility, the environmental manager may not need to keep so much water in storage to create or top up a natural high flow event. These alternatives are also likely to be more cost effective in creating or augmenting natural high flow events than through the use of permanent entitlements. In the case of options contracts, the environmental manager would pay irrigators an option premium for the right, but not the obligation, to buy a quantity of water at a determined price when allocations exceeded a certain threshold (say 70 per cent) at specified periods during the year (see Hafi et al. 2005 for a detailed discussion on the use of water options). The irrigator would retain the permanent entitlement and, in addition to receiving the option premium, receive a further pre-specified payment (the option exercise price) when the environmental manager exercised the option to buy water. A water options contract should provide the environmental manager with additional planning flexibility while irrigators would receive monetary compensation for losing some flexibility in farming decisions. Extending the range of water products to include water allocations and water options negates the need for the environmental manager to own a permanent water entitlement if the water is only required during periods when water is plentiful. It also allows irrigators to retain their permanent water entitlement, which is a natural hedge against the risk the pool of water resources available to irrigators will decline in the future. It is important to note the use of allocation and options markets is more suited to achieving environmental goals where water is needed infrequently, such as piggy backing high flows to create a flood. In situations where water is needed every year, such as for minimum flows, the purchase of permanent entitlements would be a more cost effective and reliable method of achieving these flows. Implementing a system of capacity sharing also has the potential to resolve any storage conflicts which could arise with the entry of the environmental manager into the water market. This is especially so, given the potential for the environmental manager to hold over large volumes of water in anticipation of creating or topping up a flood event, which could create problems for other water users under a centralised storage management system where property rights to storage are ill defined. This aspect of managing environmental water should not be understated. |
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