Water markets in the Murray-Darling Basin

The best bit of Per Capita’s ‘market design’ conference proved to be the case studies of public markets in Australia, rather than any gems about market design per se. One of those related to water markets operating in the largest surface water system in Australia, the Murray-Darling Basin. Straddling five jurisdictions, the basin carries water from the Murray and Darling rivers over an area equivalent to the combined size of France, Germany and the UK. Water shortages here are not a new problem by any means but have got much more extreme in recent years with:

• Reduced rainfall: rainfall in the last five years has been around 10% of the historical average;
  


• Changed rainfall patterns: with rain falling in different seasons the traditional autumn rainfall over the Murray-Darling Basin has disproportionably fallen;
  


• Over allocation of water rights: which were based on assumptions of higher trend rainfall and lower levels of land utilisation; and
  


• Higher temperatures: with three of the last five years having broken temperature records there has been increased evaporation.
  

How does the market work?

• A new inter-governmental organisation called the Murray Darling Basin Commission has been established to oversee water use: this brings together six governments (the Commonwealth plus Queensland, New South Wales, Victoria, South Australia and the Australian Capital Territory). Beneath this is a highly complex governance arrangement – each can send three Ministers to the MDBC’s Ministerial Council and a further two as MDBC Commissioners.
  
  
• State-level caps on diversions: which prevent upstream States unfairly diverting water, or building dams to reduce flow. (These first came into existence in the mid 1990s.)
  
  
• Inter-state water trades: the six governments are able to trade water rights using fixed exchange rates determined by the MDBC (or by individual states if transparently reported to the Commission).
  

Where’s it all at?

The market is still in very early development and the region remains in a semi-crisis state. Nonetheless it already appears to be triggering some of the innovation and efficiency adjustments you’d expect. For example, there’s been a recent shift in economic composition in the basin, with an increased value of wine production (a falling quantity effect being more than offset by rising quality). There’s also been a shift in use of water as a factor of production with dairy farmers trading their water rights and importing animal feed rather than growing within the basin region.

Where could the market go next?

As the market evolves it could employ a few further features:

• Leasebacks: where one entity buys the rights and then leases back some of the allocation to the user. This would be a good way to spread risk and reduce transactional economies of scale.


• Covenants: this would permanently transfer the environmental rights. Indeed this is happening in part through a Federal buyback scheme worth $10bn.


• Future and options exchange: this would allow for trade of water (and future water rights) in the same way in which that oil exchanges work. So instead of an ‘exchange rate’ you’d get spot prices. For this to work you’d need a fair degree of depth in the market – both buyers and sellers.

I don’t know enough about environmental economics to fully appraise the emerging market here, nor know if there are better examples elsewhere, but it strikes me as a potential good case study for water rights issues occurring in much more extreme environmental and governance circumstances such as the Nile Delta region.