Water derivatives are a recent market-based innovation in agricultural water management. In regions where water is subject to scarcity, water derivatives may provide an option to price water use and water users. Such concepts seek to let the market to manage water more efficiently. Water derivatives were first trialled on the driest continent on earth: Australia. Water in river basins such as the Murray-Darling basin were commodified in order to allow a government-regulated water market to develop water derivatives to put a price tag on water rights. Farmers in Australia were allowed sell water rights to other farmers in order to increase the use of water used for agricultural production. The project is now under revision by the Australian government (Australian Ministry of Environment 2013; Gregson 2013).
Background: the River Reach Program
Water is a precious and limited resource in Australia; irrigators and their communities need it to prosper, as does the environment. The Australian agricultural sector has become a significant producer for East and South East Asia and the Middle East. Australia possesses high comparative advantages in infrastructure, agricultural productivity and farming skills. However, the limiting factor for further agricultural growth is water. As a result, the government has decided to fund the trial a market-based trading scheme with approximately 2 million Australian Dollars to manage available water resources more efficiently. Demand for water is likely to continue to exceed supply. Cities, environmental planners and farmers all barter for water and the highest bidder wins.
The River Reach trial programme was launched by the Australian government in New South Wales to give more choice and flexibility for people buying and selling water in the Murray Darling Basin. It also aims to act as a pilot program for regions affected by water scarctiy wherever developed markets exist. Initially River Reach presents opportunities for those in the southern connected Murray Darling Basin surface water system. It intends to allow them to manage risk better. It should allow positive outcomes for Australia including:
· Environmental Managers to buy water to meet ecological requirements including ‘overbank’ events and to manage attendant risks
· Farmers to maintain core operations and manage climatic risks
· Rural communities to be sustained
· Cities to manage supply risks
· Water Corporations to arbitrage both price and risk
River Reach does not create more water, but it does provide a mechanism to match complementary needs of farmers increasingly affected by water scarcity (Gregson 2012).
Core features of the River Reach trial
When considering what River Reach contracts are and the part they could play in a developing water market, it is important to understand the distinction between water entitlement and water allocation.
Irrigators hold an entitlement to a share in an available resource. This share is known as an allocation. The entitlement is the permanent license. The allocation is real water available on an annual basis as determined by the relevant state government authority. The entitlement can be seen as a water tank and the allocation received annually as the water level in the tank. River Reach effectively divides that tank into ten sub tanks and allows entitlement to those sub tanks to be traded. So, for example, an irrigator that requires limited but highly reliable annual water may choose to keep the bottom four sub tanks, but propose the top six sub tanks for sale. Buyers are effectively putting taps into each of these sub tanks and will receive all the water that is allocated to the sub tanks. The buyer, rather than the seller, takes the risk of that water being available, so if allocations are low and no water is actually available in the sub tanks purchased by the buyer, the buyer gets no water, and the seller has no obligation to provide any water. If, conversely, allocations are high, the buyer gets all water in the sub tank, irrespective of how much water there is. Thus, the buyer is purchasing the possibility of water being available, and the seller is selling the possibility of water being available. Water can be sold for periods of one, three, five or ten years, or permanently. A buyer can purchase some or all of the water on offer, and is not obliged to take the entire allocation from any single seller (Gregson 2012).
The likelihood of water being available in any given year is high in the lowest sub tank, but steadily decreases as the sub tanks get nearer to the top of the water tank. This means that if water is bought or sold in the lowest sub tank, a higher price can be expected. If water is bought or sold in the highest sub tank, a lower price can be expected. River Reach does not recommend price points for these sub tanks, but simply aims to provide a meeting place for buyers and seller of water, so it is intended to find a mutually acceptable price point. Prices will be recorded on a website to assure transparency (Gregson 2012).
It is not always necessary to buy or sell a River Reach water contract; an alternative that consumes less immediate cash is to buy or sell an option to take up a River Reach water entitlement. Instead of purchasing all future water that may or may not be available from a sub tank, buyers purchase the option to buy that water at a predetermined price. Importantly the buyer then has the right, but not the obligation, to buy that water at the predetermined price. The buyer pays an upfront option fee per megalitre then an exercise fee for each megalitre that they actually purchase. The seller gets the upfront option fee, irrespective of whether the water arrives or the buyer’s right to purchase water is exercised (Gregson 2012).
The River Reach Trial
The River Reach program included a not-for-profit trial website to allow both buyers and sellers to explore the concept of River Reach contracts. It is supported by the Australian Government through the Water for the Future initiative. It is not yet fully integrated with Government Registration Authorities, but if the trial proves successful it will be eventually.
Who was able to participate in the River Reach trial
Water trades can be conducted by registered water entitlement holders such as farmers and businesses; Irrigation Corporations; urban water owners; water utilities; environmental water owners/managers; agents and brokers. If farmers want to buy or sell water but do not have a water entitlement they will need to be appropriately licensed by Government to secure one (Gregson 2012).
The River Reach program is currently under review by the Government of Australia. The final outcome of this review will be expected in the next 12 months.
The River Reach Program
Government of Australia (2013) The River Reach Program. Canberra: MoE. (Online) http://www.environment.gov.au/node/24325 (accessed: 29.10.2013).
Gregson, A. (2012) River Reach Evaluation of Phase Two - Extension Phase Independent Report. (Online) http://www.environment.gov.au/system/files/pages/54ec8bde-cf76-4041-a86b-0f07517d1ff1/files/river-reach-evaluation-phase-two.pdf (accessed: 29.10.2013).