Can Urban Water Markets Work? Some Concerns

Lin Crase, Suzanne O’Keefe and Brian Dollery[1]

Table of Contents

Successes of rural water markets
Failings of the rural water market
Scope for urban water markets
Other market issues
Concluding remarks

There is now considerable interest in exploring the usefulness of markets as a means of dealing with urban water provision in Australia. Buoyed by the successes of markets in electricity and telecommunication services, the reformist’s gaze has now turned to urban water, where ongoing water shortages have forced water utilities to invoke widespread restrictions to bring demand into balance with limited supply. Amongst the arguments proffered in favour of urban water markets is the view that such arrangements would result in improved allocative efficiency (see, for instance, Productivity Commission 2008). It is also contended that markets should give rise to clear incentives for timely investment in alternative water sources and new technologies which might ultimately alleviate the necessity for water restrictions.

The National Water Initiative (NWI) of 2004 established important actions and objectives to advance water reform. Notwithstanding the subsequent release of the Howard Government’s National Plan for Water Security followed by the Rudd Government’s Water for the Future manifesto, the work program outlined in the NWI continues to guide policy development, particularly in the area of urban water reform. Paragraph 92 (iv) of the NWI called for a ‘review (of) the institutional and regulatory models for achieving integrated urban water cycle planning and management, followed by best practice guidelines’ (NWC 2005) and this was later broken into several priority tasks. One of these relates to the requirement to ‘facilitate water trading between and within the urban and rural sectors’ (NWC 2005). In order to give effect to this and related objectives, a Joint Steering Committee for Water Sensitive Cities was established. The Committee subsequently commissioned several pieces of work to explore the means of introducing water markets in the urban setting.

In a related, but much earlier, development, the introduction of water markets for agricultural water users commenced in earnest in the early 1990s and has clearly yielded substantial economic gains (see, for instance, RIRDC 2007). The capacity of some agricultural industries and/or firms to cushion against the impacts of the recent drought has been substantially enhanced by access to the water market. However, the present operation of rural water markets is likely to vary in significant ways from a potentially atomistic urban water market where individual households ‘trade’ water. In this context, a question arises about the extent to which the perceived successes of the rural water market might be drawn upon as evidence of the merits of similar reforms for urban users, especially households.

In seeking to answer this question it might be helpful to consider those factors that have been important in delivering the economic gains that have flowed from rural water markets. In this regard, it may also be prudent to reflect on some of the well-documented shortcomings of rural water markets (see, for instance, Brennan 2007) to at least temper the policymakers’ ostensible enthusiasm for urban water markets. It is thus the purpose of this paper to reflect upon these issues in the hope of informing the policy debate on the potential for water-market reform in urban areas. In essence, the paper presents the case for a cautious approach to urban water markets, particularly where the scope for inter-sectoral trade at the aggregate level has not yet been fully developed.

The paper itself comprises five additional parts. Firstly, we describe the features that have underpinned the success of rural water markets, focusing specifically on what is euphemistically referred to as ‘temporary’ trade. Second, the limitations revealed during the development of rural water markets are addressed before turning to a comparison of the characteristics of rural and potential urban water-market participants. The penultimate section is used to consider a range of related matters, such as pricing, ownership and institutional design issues. The paper ends by offering some brief concluding remarks.

Successes of rural water markets

At the outset it needs to be acknowledged that rural water markets are dominated by ‘temporary’ transactions. In other words, the vast majority of resource re-allocation in irrigation occurs on a seasonal basis and permanent trades, which might be associated with enduring structural adjustment, remain modest by comparison.[2] Nevertheless, the thriving temporary water market in the southern Murray-Darling Basin is testament to the perceived usefulness of the market for participants (see, for instance, RIRDC 2007).

The motivation for temporary transactions comes from several sources, not least the heterogeneity of farming enterprises and farmers themselves. Put differently, if every farmer was growing the same crop and had relatively similar demands, the scope for trade between parties would be severely limited. It is these marked differences and the potential to bring together enterprises with different calls upon the resource that is critical in this context. After all, this is the premise upon which markets are founded — individuals or groups need to hold valuations and preferences that are so different that exchange can take place and the collective gains are more than the costs of bringing about the transaction.

Firstly, the historic allocation of the resource by the state now bears only a weak correlation to the different water demands of enterprises within irrigated agriculture. For example, dairy farming, which can use as much as 10–15ML per hectare, must now compete for water against horticulture cropping which can use half that or less. In addition, the value of the output from these enterprises can also be expected to vary markedly over time, thereby driving demand for re-allocation, albeit often on a temporary basis. Moreover, there are important disparities within enterprises where management expertise heavily influences water use (and profitability). A related feature of this heterogeneity is the differing capacities of market participants to employ substitutes (for example, dairy farmers can substitute grain or silage for water whilst other industries, such as permanent horticulture, cannot). Similarly, some annual enterprises have the option of shutting down completely when water is in short supply, thus affording the opportunity to on-sell any residual water allocations. There are also differences in risk preferences, which can stimulate trade amongst farmers.

Secondly, water is often a vital and substantial input to the production system in irrigated agriculture, at least in volumetric terms. Thus, access at a critical point in the season can represent the difference between a very profitable crop and one that generates substantial losses.

Thirdly, most participants in this market are relatively well-versed with hydrological realities (for example, they know that it will cost money to transfer water uphill and they know the cost of lifting water from an aquifer). These buyers and sellers are also generally familiar with the legislative impediments (or ease) associated with accessing different water sources, such as groundwater — possibly even more so than some regulators.

In a related vein, most of those involved in this market have at least a rudimentary knowledge of the relationship between inputs and outputs. Even the most rustic yeoman would be able to give approximations of the consequences of an extra megalitre of water, here or there, or could roughly calculate the fodder required to substitute for water.

Also, the rural participants in this market face relatively low transaction costs.[3] The temporary water market has always been keenly promoted by the irrigation sector. In fact, irrigation corporations such as Murray Irrigation Limited and Goulburn-Murray Water have been the champions of the temporary water market and were amongst the first to offer online technologies to facilitate water trade. This has not only reduced the transaction costs of farmers who chose to buy and sell water, it has also reduced the costs that would otherwise have to be borne by government to aid in the establishment of the market.

It should be remembered, too, that agricultural participation in this market is sanctioned by government in both a legal and moral sense. There is no innuendo suggesting that trading water between farmers is ‘un-Australian’. This observation carries through to the treatment of rural water trade by the press. An agricultural purchaser of water is seldom portrayed as someone draining the life-blood from a desperate seller. This makes the political cost of market participation relatively low for this group.

In important instances the administering organisation charged with physically delivering water between buyer and seller shares much in common with the trading partners. For example, in Victoria, Goulburn-Murray Water, which has responsibility for managing bulk flows to all water users in its area of operation, also has a substantial role in managing irrigation infrastructure for the benefit of farmers.

Finally, participants in the rural temporary water market are generally aware that the long-term entitlements they hold over water are likely to increase in value, in part because of the increasing uncertainty that circumscribes the status of water rights and the volumes of water involved. It can thus be argued that this is one of the major drivers of temporary water trade in the rural water market. In this context it is somewhat ironic that one of the acknowledged weaknesses of the market for permanent water-access rights has simultaneously bolstered participation in the market for temporary trades.

[1] School of Business, La Trobe University,; School of Business, La Trobe University,; School of Economics, University of New England,

[2] This is particularly the case for permanent interstate trade that has been substantially stymied by the arduous administrative arrangements that attend ‘tagging’.

[3] Unlike the constraints that currently confront someone in a communal irrigation scheme wishing to sell water permanently.