Market mechanisms for recovering water in the Murray-Darling Basin

• The Australian Government has an ambitious agenda for increasing the availability of water for the environment in the Murray-Darling Basin: water will be reallocated administratively through a Basin Plan; and water will be recovered through a ten-year $3.1 billion buyback of water entitlements, and a $5.8 billion investment in water saving infrastructure.
• The 2011 Basin Plan will ultimately allocate water between consumptive and environmental uses, in each catchment. The buyback aims to assist irrigators to adjust to the much lower diversion limits that are likely under the Basin Plan and to regain some water for the environment in the interim. The infrastructure program shares these broad objectives but also aims to help sustain irrigation communities.
• The buyback is occurring before sustainable diversion limits (SDLs) are set under the Basin Plan, and before the liability for policy-induced changes to water availability has been resolved. This is creating uncertainty in the minds of irrigators and affecting the efficiency of the buyback.
• SDLs must be based on scientific assessments of the amount of water that is required to avoid compromising key environmental assets and processes. Good science is a necessary but not sufficient basis for optimising the use of the Basin's water resources. The value people place on environmental outcomes, the opportunity cost of foregone irrigation, and the role of other inputs, such as land management, must also be considered. If the Water Act 2007 (Cwlth) precludes this approach, it should be amended.
• The same cost effectiveness tests should be applied to all water recovery options. Purchasing water from willing sellers (at appropriate prices) is a cost-effective way of meeting the Government's liability for policy-induced changes in water availability. Subsidising infrastructure is rarely cost effective in obtaining water for the environment, nor is it likely to be the best way of sustaining irrigation communities.
• Other water products (for example, seasonal allocations and options contracts) are potentially valuable in meeting short-term environmental needs.
• Tenders are sound purchasing mechanisms where active markets for water entitlements do not exist. But where active markets do exist, acquiring water directly from those markets is likely to be more efficient.
• The 4 per cent limit on out-of-area trade of water entitlements should be eliminated as soon as possible. Limits on the amount of entitlements that can be sold to the Commonwealth through the buyback should also be eliminated.
• Using the buyback to achieve distributional goals, system rationalisation or to manage salinity is likely to compromise its efficiency and effectiveness. Other more direct instruments should be used to address these issues.
• Governance arrangements for the recovery and management of water for the environment are fragmented. Greater coordination of water recovery and environmental watering by Basin jurisdictions is required.

The Productivity Commission has made recommendations on how the Australian Government's buyback of water entitlements in the Murray Darling Basin could be improved, in a report released today. The buyback and a larger irrigation infrastructure program are being used to recover water for the environment, and ease the transition to the much lower water diversion levels expected under a Basin Plan.

The report raises some concerns about aspects of the design and sequencing of the strategy, noting problems in having commenced the buyback before the Basin Plan is ratified. However, Commissioner Neil Byron said 'There is still much that can be done to improve the recovery and management of water for the environment in the Basin'.

In particular, the Commission recommends that:

• the Murray-Darling Basin Authority (MDBA) set 'sustainable diversion limits' under the Basin Plan in a way that balances environmental, social and economic tradeoffs (possibly requiring legislative amendment)
• rigorous approval processes be applied to all irrigation infrastructure projects, to prevent inefficient and inequitable investment, with surplus funds reallocated to the buyback or other priorities
• Jurisdictions clarify how the risks of reductions in water availability are to be shared between irrigators and governments, to allow irrigators to make more informed decisions about whether or not to participate in the buyback
• environmental watering be addressed through purchasing a portfolio of water products, not just entitlements
• restrictions on water trading imposed by state governments be removed.

The Commission also found that, where active markets exist, acquiring entitlements directly in those markets is likely to be more efficient than the current approach of using tenders.

The report was submitted to the Australian Government on 18 March 2010.

• Preliminaries
  Cover, Copyright, Foreword, Terms of reference, Contents, Abbreviations, and Glossary
• Overview - including key points
• Findings and recommendations
• Chapter 1 Introduction
  1.1 What the Commission has been asked to do
  1.2 The Commission’s approach
  1.3 Background to the study
  1.4 Clarifying objectives
  1.5 Conduct of the study
• Chapter 2 Water use in the Murray-Darling Basin
  2.1 Water availability
  2.2 Allocations for consumptive use
  2.3 Allocations for the environment
• Chapter 3 The development of water markets
  3.1 History of water markets in the Basin
  3.2 The benefits and costs of water trade
  3.3 Trade in entitlements and allocations
  3.4 Pricing of water
  3.5 Delivery fees and charges
• Chapter 4 Allocating environmental water
  4.1 Why is water use in the Basin a policy issue?
  4.2 How is the Australian Government deciding on environmental priorities?
  4.3 Challenges in setting environmental priorities
  4.4 Temporal and spatial characteristics of environmental water demands
  4.5 Environmental watering and land management
  4.6 Assessing the benefits and costs of environmental watering
• Chapter 5 Assessment framework
  5.1 Breaking down water recovery into policy design questions
  5.2 Effectiveness
  5.3 Efficiency
  5.4 Distribution of impacts
  5.5 Impact on the water market
• Chapter 6 Recovering water through non-market means
  6.1 Administrative approaches
  6.2 Infrastructure upgrades
• Chapter 7 Designing a portfolio of water products for environmental watering
  7.1 Purchasing of entitlements
  7.2 Purchasing of seasonal allocations
  7.3 Purchasing of leases on entitlements
  7.4 Purchasing of options contracts
  7.5 Purchasing of covenants on entitlements
  7.6 Purchasing water in unregulated systems
  7.7 Purchasing of land and water packages
  7.8 Contracts for environmental services
  7.9 Establishing a portfolio
• Chapter 8 Mechanics of the buyback
  8.1 Improving the purchase mechanisms
  8.2 Targeting
  8.3 Pace of the acquisitions
  8.4 The need for transparency
• Chapter 9 Institutional and governance issues
  9.1 Who is involved in managing water resources?
  9.2 Institutional options for water recovery at the Commonwealth level
  9.3 Coordination issues
• Chapter 10 Overcoming impediments
  10.1 Reducing volumetric restrictions on trade
  10.2 Improving pricing
  10.3 Addressing other direct impediments
  10.4 Overcoming indirect impediments
• Chapter 11 Concluding comments
  11.1 Diversifying the Australian Government’s water purchase program
  11.2 The implementation of water policy
  11.3 How much additional water is needed for the environment in thelong term?
  11.4 Where to from here?
• Appendix A Consultation
• Appendix B Buybacks in Australia
• Appendix C Overseas buybacks
• Appendix D Regional impacts of water buybacks
• References