The Evolution of Markets for Water: Theory And Practice in Australia (New Horizons in Environmental Economics)

The Evolution of Markets for Water

NEW HORIZONS IN ENVIRONMENTAL ECONOMICS Series Editors: Wallace E. Oates, Professor of Economics, University of Maryland, USA and Henk Folmer, Professor of General Economics, Wageningen University and Professor of Environmental Economics, Tilburg University, The Netherlands This important series is designed to make a significant contribution to the development of the principles and practices of environmental economics. It includes both theoretical and empirical work. International in scope, it addresses issues of current and future concern in both East and West and in developed and developing countries. The main purpose of the series is to create a forum for the publication of high quality work and to show how economic analysis can make a contribution to understanding and resolving the environmental problems confronting the world in the twenty-first century. Recent titles in the series include: Econometrics Informing Natural Resources Management Selected Empirical Analyses Phoebe Koundouri The Theory of Environmental Agreements and Taxes CO2 Policy Performance in Comparative Perspective Martin Enevoldsen Modelling the Costs of Environmental Policy A Dynamic Applied General Equilibrium Assessment Rob B. Dellink Environment, Information and Consumer Behaviour Edited by Signe Krarup and Clifford S. Russell The International Yearbook of Environmental and Resource Economics 2005/2006 A Survey of Current Issues Edited by Henk Folmer and Tom Tietenberg The Greening of Markets Product Competition, Pollution and Policy Making in a Duopoly Michael Kuhn Managing Wetlands for Private and Social Good Theory, Policy and Cases from Australia Stuart M. Whitten and Jeff Bennett Amenities and Rural Development Theory, Methods and Public Policy Edited by Gary Paul Green, Steven C. Deller and David W. Marcouiller The Evolution of Markets for Water Theory and Practice in Australia Edited by Jeff Bennett Integrated Assessment and Management of Public Resources Edited by Joseph C. Cooper, Federico Perali and Marcella Veronesi Climate Change and the Economics of the World’s Fisheries Examples of Small Pelagic Stocks Edited by Rognvaldur Hannesson, Manuel Barange and Samuel F. Herrick Jr.

The Evolution of Markets for Water Theory and Practice in Australia

Edited by

Jeff Bennett Professor of Environmental Management, Asia Pacific School of Economics and Government, The Australian National University, Canberra, Australia

NEW HORIZONS IN ENVIRONMENTAL ECONOMICS

Edward Elgar Cheltenham, UK • Northampton, MA, USA

© Jeff Bennett 2005 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical or photocopying, recording, or otherwise without the prior permission of the publisher. Published by Edward Elgar Publishing Limited Glensanda House Montpellier Parade Cheltenham Glos GL50 1UA UK Edward Elgar Publishing, Inc. 136 West Street Suite 202 Northampton Massachusetts 01060 USA

A catalogue record for this book is available from the British Library

Library of Congress Cataloguing in Publication Data The evolution of markets for water : theory and practice in Australia / edited by Jeff Bennett. p. cm. – (New horizons in environmental economics series) Includes index. ISBN 1-84542-400-X 1. Water-supply–Economic aspects–Australia. 2. Watersupply–Government policy–Australia. 3. Water rights–Australia. I. Bennett, Jeff, 1954- II. New horizons in environmental economics HC603.E96 2005 363.6’1’0994–dc22

2005049814

ISBN 1 84542 400 X

Printed and bound in Great Britain by MPG Books Ltd, Bodmin, Cornwall

Contents Figures Tables About the Authors Acknowledgements Preface by Alan Moran

vi vii viii xi xii

1. Markets and Government – An Evolving Balance Jeff Bennett 2. Principles and Issues for Effective Australian Water Markets John Freebairn 3. The Historical Variation in Water Rights Richard A. Epstein 4. State Administration versus Private Innovation: The Evolution of Property Rights to Water in Victoria, Australia Edwyna Harris 5. A Property Framework for Water Markets: The Role of Law Poh-Ling Tan 6. Registration of Water Titles: Key Issues in Developing Systems to Underpin Market Development Michael Woolston 7. Accounting for Water Flows: Are Entitlements to Water Complete and Defensible and Does this Matter? Anthea Coggan, Stuart Whitten and Nick Abel 8. Potential Efficiency Gains from Water Trading in Queensland John Rolfe 9. Water Trading Instruments in Australia: Some Thoughts on Future Development of Australian Water Markets David Campbell 10. Realising Environmental Demands in Water Markets Jeff Bennett Index

1

8 24

38 56

76

94 119

139 165

180

v

Figures 6.1 7.1 7.2 7.3 7.4 8.1 8.2 8.3 8.4 8.5

Water Rights, Trading and Titling Systems Human Influences on the Hydrological Cycle Precipitation to Water Resources in Victoria Water Supply and Use in the Australian Economy 2000–01 Relationship Between Land Cover, Mean Annual Rainfall and Mean Annual Evapotranspiration Surpluses from Water Use by Different Industries Planning for Water Shortages How Additional Dams Have Been Planned The Market Mechanism and Additional Demands Average Demands for Selected Farms in the Mackay and MDIA Areas

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84 96 98 101 110 122 123 123 124 132

Tables 4.1 Number of Squatting Runs in Victoria, Various Years 4.2 Victorian Population by Location, 1860–1880 4.3 Amount of Land Claimed to be Irrigable and Amounts Actually Irrigated 7.1 Water Entitlements in NSW, Victoria, South Australia and Queensland 7.2 Land Use and Runoff 7.3 Irrigation Water to Evapotranspiration and Groundwater Percolation 8.1 Gross Margin Budget for Citrus and Cotton at Emerald 10.1 Attribute Value Estimates ($ per household) 10.2 Direct Conservation Activities 10.3 PSCE Activities by Focus of Operations 10.4 PSCE Revenue Sources

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43 45 50 107 109 113 130 169 173 174 175

About the Authors Nick Abel leads the CSIRO project ‘Benefits from Water in the Murray Region’, a component in the CSIRO Flagship Project ‘Water for a Healthy Country’. The purpose of the Murray project is to increase the efficiency, equity and sustainability of water use systems through institutional changes. He previously led the Myer Foundation-CSIRO Ecosystem Services Project. His research is focused on the effects of institutions on the resilience of resource use systems, with particular interest in thresholds, and system collapses and recoveries. Jeff Bennett is Professor in the Asia Pacific School of Economics and Government at the Australian National University and is Director of the Environmental Management and Development Programme there. Jeff is widely published in environmental, natural resource and agricultural economics and is currently President of the Australian Agricultural and Resource Economics Society. David Campbell is a Sydney-based Executive Director of ACIL Tasman Pty Ltd, specialising in investment analysis and strategy for sectors and activities involving high levels of uncertainty including water. He has many years of experience in relation to both rural and urban water and wastewater management. He has worked with evolving water markets since the mid-1980s, was Economics and Finance Adviser to the Snowy Water Inquiry and has recently co-authored, with Michael Woolston, studies of prospective trading instruments (including the one that provides the base for this paper) and of appropriate systems of water title. Anthea Coggan is an environmental economist at CSIRO Sustainable Ecosystems. Her experience is focused on applying economic analysis to public policy development, particularly in the agriculture and environment sector. Anthea joined the Markets for Ecosystem Services team in June 2004 to pursue her interest in the design and application of market based approaches to achieve environmental objectives. Richard A. Epstein is the James Parker Hall Distinguished Service Professor of Law at the University of Chicago, where he has taught since 1972. He has also been the Peter and Kirstin Bedford Senior Fellow at the Hoover Institution since viii

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2000. Prior to joining the University of Chicago Law School faculty, he taught law at the University of Southern California from 1968 to 1972. At present he is a director of the John M. Olin Program in Law and Economics. His many books include Skepticism and Freedom: A Modern Case for Classical Liberalism (University of Chicago, 2003) and Cases and Materials on Torts (Aspen Law & Business, 7th ed. 2000). John Freebairn is a Professor in the Department of Economics at the University of Melbourne. He has a wide range of research interests in applied microeconomics. Edwyna Harris is a lecturer in the School of Management at RMIT University. She completed her doctorate at the University of Melbourne in January 2002. Her research focuses on the historical evolution of property rights institutions used to price and allocate water within Australia, particularly around the Murray River, and their effects on environmental outcomes. In 2003 she was nominated for the Economic History Society of Australia and New Zealand’s Butlin Prize for the Best Masters or Doctoral Thesis in Economic History. Edwyna completed a student fellowship at the Property and Environment Research Centre (Bozeman, Montana, USA) in 1999 and is a member of the Economic History Association (USA), the Economic History Society (UK), and the International Water History Association. Alan Moran is the Director, Deregulation, at the Institute of Public Affairs. Until 1990, he was a senior official in the Productivity Commission and Director of the Commonwealth’s Office of Regulation Review. Subsequently, he played a leading role in the development of the principles of competition policy review as the Deputy Secretary in the Victorian Government responsible for formulating energy policy. Dr Moran is among Australia’s best-known economists working in the area of regulation. Much of his published work can be found on the Institute of Public Affairs website www.ipa.org.au under Regulation. John Rolfe is a resource economist who is Associate Professor in the Faculty of Business and Law of the Central Queensland University at Emerald. He has Commerce and Economics degrees from the University of Queensland, and a doctorate in economics from the University of New South Wales. John has a number of research interests, including non-market valuation, regional economic development, and agricultural economics. Poh-Ling Tan studied at the University of Malaya, practised law in Kuala Lumpur, Malaysia for several years before completing a doctorate at the Australian National University. She now teaches law at the Queensland

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University of Technology. Her research interests include water law reform particularly property rights and the sustainable management of water. She has conducted research for several institutions including the Murray-Darling Basin Commission and the New South Wales Department of Land and Water Conservation. She contributes to water law reform in Queensland through membership of the Water Reform Implementation Group set up by the Department of Natural Resources and Mines. She has also been appointed to a Referral Panel set up under the Water Act 2000 (Qld) to make recommendations on particular issues arising from the implementation of Water Resource Plans. In 2004 she visited institutions in Europe and the US on a travelling fellowship awarded by Land and Water Australia. Stuart Whitten leads the Markets for Ecosystem Services project at CSIRO Sustainable Ecosystems in Canberra, Australia. His experience is focused on solving the obstacles to the practical application of markets at the regional level through the development and implementation of pilot markets. Stuart also has extensive experience in environmental market and non-market valuation having been involved in benefit-cost analyses as well as travel cost, contingent valuation and choice modelling exercises. Michael Woolston is a Senior Economic Consultant at ACIL Tasman, specialising in microeconomic and regulatory reform with a particular focus on the water sector. Michael has undertaken several national studies on water markets and trading, advised on water resource management charges in Queensland and WA, advised on water allocation issues in NSW and Victoria, and assisted water businesses in regulatory price reviews. His early career was with Victorian Treasury and the Productivity Commission.

Acknowledgements The genesis of this volume was a workshop on property rights and water held in Melbourne in August 2004. The sponsorship of that workshop by the Institute of Public Affairs is gratefully acknowledged. Mike Nahan, Alan Moran and Andrew MacIntyre, all of the IPA, played key roles in facilitating the workshop and subsequently in the preparation of this book. Chris Ulyatt was always the consummate professional in preparing the manuscript for publication. Finally, my thanks go to the authors of the following chapters for their good-natured patience in dealing with the detail. Jeff Bennett

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Preface Alan Moran Like many natural products with a more-or-less fixed supply, water’s worth has increased as its usage has risen. Its availability has also been affected by the notion that has come to be called ‘the environmental Kuznets curve’ – rising income levels bring even greater increases in the demand for a better environment and this often incorporates the non-use of rivers, forests and land. This phenomenon is seen with water in Australia. Although sometimes referred to as the driest continent, in terms of the amount of rainfall per capita, Australia ranks behind only Iceland and Russia. About 5 per cent of the water that falls on Australia is diverted for human usage with irrigation accounting for over 70 per cent of this. Irrigated agriculture, comprising less than one half a per cent of Australia’s agricultural land, has come to account for some 30 per cent of agricultural output. Most of Australia’s rain falls in the sub-tropical north and flows into the sea. Australia’s prime irrigation resource is currently the Murray-Darling system, draining most of the south-eastern part of the continent. In its natural state, the system reflected the Australian rainfall pattern and the rivers alternated between vast flood lands and the merest trickle. Settled agriculture brought dams and diversions to the Murray-Darling river system, which is now predominantly confined to established channels. Water always flows through the system even in the most serious drought conditions like those that the region has experienced over the past three years. The development of the region through which the river system flows has brought increased demands for water, largely for irrigation. These demands have progressively stretched availability and been the midwife of shifting economic and institutional frameworks for water. The migration of water value from abundance to scarcity is readily observable in prices for irrigation water. Indeed, only 20 years ago additional water rights were being freely distributed by governments to farmers as a resource which was beneficial but not greatly valued. Many irrigation rights to water were superfluous in years of high rainfall. A decade ago, concerns about over-usage led to a cap being imposed on new diversions, and we now have proposals for reduced extractive usage to allow increased environmental xii

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flows. The so-called ‘sleeper’ and ‘dozer’ rights to water which remained unused in the past have now been activated, adding to demand at the same time as pressures were being placed on supply. The danger of an overreaction to the previous allocations of water became apparent to the Australian Institute of Public Affairs (IPA). A primary element of a potential overreaction is an erosion of property rights to water through seizure of rights by the state. High productivity levels are only possible with secure property rights. These should also be tradeable in free and competitive markets to allow the water to be used by those valuing it most. Though it seems modest in the context of Murray-Darling diversions totalling 12 000 gigalitres, current plans to take back 500 gigalitres effectively mean taking 7 per cent of irrigators’ water. The proposal advanced by the Australian Greens political party to take 3 000 gigalitres would mean a colossal restructuring accompanied by considerable immediate wealth loss. Much of the groundswell for returns of water for environmental purposes was created by the so-called Wentworth Group of environmentalists and scientists. This group published the value-laden document Blueprint for a Living Continent.1 IPA’s concerns resulted in its publication of Backgrounders by me, ‘Property Rights to Water’,2 and by Jennifer Marohasy ‘Myth and the Murray: Measuring The Real State of the River Environment’.3 Jennifer Marohasy drew attention to the need for sound science to be the basis for any government decisions on the use of the environment. Her work successfully punctured the alarmists’ claims that the use of Australia’s most important irrigation resource was in need of radical surgery. The collection of papers published in this volume stems from the IPA’s concerns about the standard of debate on water in Australia and the attempts by some radical green lobby organisations to distort the picture in ways that might lead to some far-reaching adverse economic consequences. The collection itself is the result of an IPA-sponsored workshop held in August 2004 on how water markets in Australia might result in more efficient outcomes and how such efficiencies can be made to co-exist with a healthy environment. Professor Jeff Bennett chaired the workshop and contributed an innovative chapter on the way forward. In this he draws on the literature that addresses free-riders, intangible goods and unpriced values. He notes how expensive the transaction costs of government regulation can be and sees promising approaches in club-like purchasing associations (private sector conservation enterprises). In addition, he has undertaken the never inconsiderable task of ensuring that the papers are pulled together in an internally consistent manner and contributed a valuable summary chapter. The IPA is much indebted to all the contributors for their work on the highly contentious matter of water policy

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and the light they shed on the future policy directions in which we should be heading.

NOTES 1. Cullen P. et al. (2002), Blueprint for a living continent, Sydney: WWF Australia. 2. Moran, A. (2003), ‘Property rights to water’, IPA Backgrounder, June, Melbourne: Institute of Public Affairs. 3. Marohasy, J. (2003), ‘Myth and the Murray: Measuring The Real State of the River Environment’, IPA Backgrounder, December, Melbourne: Institute of Public Affairs.

1.

Markets and Government – An Evolving Balance Jeff Bennett

How frequently has Australia been described (erroneously) as the driest continent? Yet not only is Australia, in the words of poet Dorothea Meckellar, ‘a land of droughts’ but it is also one of ‘flooding rains’.1 The wet season in the north of the nation dumps metres of water on Darwin, Cairns and Broome. Floods that leave millions of hectares of cropping and grazing land inundated and country towns isolated for days are periodic but well known through the river systems of the Murray-Darling Basin. The salient point is that Australians suffer from a scarcity of water at varying times and in varying places. This temporal and geographic scarcity of water has acted as a constraint to human behaviour ever since the continent was first inhabited. The aboriginal people evolved complex patterns of locational behaviour as well as water detection and storage skills to cope with water scarcity (Flannery 1994). Early European settlers were also forced to adapt often in dramatic circumstances as sequences of lush seasons were followed, ruinously, by periods of prolonged drought. For instance, the belief that rain follows the plough was dispelled in the northward march of farmers from Adelaide in South Australia when a run of bad seasons led to the drawing of the Goyder Line to demark the area of ‘safe’ farming.2 However, not all have been satisfied to be so constrained. Pioneers of irrigated agriculture in Australia sought to free themselves from the limits of natural rainfall through the construction of weirs and dams, channels and tunnels to relocate water in both time and space so as to overcome the immediacy of scarcity. Canadian brothers George and William Chaffeys’ struggles at the turn of the twentieth century to create the irrigation districts around the city of Mildura are illustrative.3 As late as the 1940s through to the 1970s the logic of escaping the constraint prevailed in the construction of the Snowy Mountains Hydroelectric Scheme (http://www.snowyhydro.com.au/). Despite the best efforts of engineers, scarcity prevails today. Demands for water have continued to increase with expansions of irrigated agriculture, resource processing, industrial application and domestic use. There has also 1

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been a growing recognition of the inverse relationship between the health of riverine ecologies and the extent of water extractions. This has promoted the emergence of demands for environmental flows in rivers. At the same time, the total amount of water available remains constant (if somewhat stochastic) and the possibilities for relocating water have been reduced through increased competition for the environmental resources required for the construction of dams. Furthermore, water supply is, in places, becoming increasingly compromised in terms of its suitability for different purposes because of quality deteriorations. Hence the saga of ‘overcoming’ scarcity is being transformed into the development of means to live with scarcity. This means attempting to make the most of the water that is available primarily through the establishment of institutions that provide the incentives for society to derive maximum social well-being through its access to the water resource. Scarcity, and the development of social coordination mechanisms for living with it, is the central focus of economics. A key finding of economics that goes back to the thinking of Adam Smith – regarded widely as one of the founders of the discipline – is that the trading of rights to property in markets constitute a social coordination system that acts like an ‘invisible hand’ to direct scarce resources to their most valuable uses. The system harnesses the decentralised incentives of individuals to achieve improvements in their own condition toward the common good of society. This finding has provided the cornerstone for the building of affluent market-based economies around the globe. However, a good deal of debate remains over the suitability of the market mechanism when applied to the allocation of scarce water resources between competing uses. This is despite the extent of the differences – both over time and space – between the marginal values of water. Such large differences imply that strong gains are available to society from trading water in markets. Societies that have no qualms about the use of market forces to allocate land labour and capital have maintained state ownership over their water resources and have centralised the regulation of its allocation. Why? The answer to that question is far from simple. There are multiple facets to the issue. One of those facets relates to the political economy of water. By maintaining control over water resources, those in government (and those advising government) can hold onto the ability to achieve their individual goals through making allocations to vested interest groups. But another facet relates to the fundamental characteristics of water that make defining, defending and trading property rights to water problematic. Before markets in any resource can emerge, rights of ownership must be clearly defined. Quite simply, if ownership cannot be established, there is nothing for a buyer and a seller to exchange in a market. Furthermore, for Adam Smith’s proposition to be fulfilled, the full range of impacts associated

Markets and Government – An Evolving Balance

3

with a resource (both positive and negative) need to be specified within the rights definition. That is, there can be no ‘externalities’ either positive or negative. Furthermore, even where rights are completely defined, if they are not adequately defended then the prospects for trade – and hence welfare improvement – are compromised. What prevents rights from being both adequately defined and defended can be summarised simply in the expression ‘transactions costs’. Where the costs to each person of defining and defending rights exceed the potential for gains from trade, then there is no incentive to act. In such circumstances, there is the potential for governments to step in to take advantage of any economies of scale in rights definition and defence. It remains the case that transaction costs must be below anticipated gains from trade to make the formation of markets socially worthwhile. Where they are still not, a further option exists for government and that involves direct intervention to control the supply of a resource. Again, the case must be made that net welfare improvements would result from such a strategy relative to a ‘do nothing’ alternative. Water embodies a number of characteristics that create transaction costs in the formation of markets that are of a scale to call into question the efficiency of allocation by markets. For instance, water is in many circumstances, a fugitive resource in that it moves through the environment in ways that can be difficult to trace – for instance through groundwater flows. In addition, some of the uses of water produce public goods – namely those associated with environmental protection – which by definition are non-excludable and therefore impossible, or at least extremely costly, to defend against use by those who do not pay. So whilst there are arguments to support abandonment of markets as the appropriate water allocation devices in society, there are also arguments that are contrary to the notion of government regulation as the alternative. These specifically relate to the incentive structures facing politicians and their advisers, and transaction costs of a different sort. In terms of incentive structures, rent seeking and the principal-agent problem cause doubts to be cast with regard to the motives of politicians and their advisers to achieve efficiency in water allocation from a societal perspective. However, even if politicians and their advisers could be relied upon to extricate themselves from personal motivation in favour of the best interests of the wider community, it remains doubtful that they could generate socially efficient allocations of water. This is because of the high costs faced by the state in collecting and processing in a timely fashion, the sort of information required to determine just what is the efficient allocation of water at any particular time.

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These are the ‘transactions costs’ that are borne by the state. For instance, to achieve the familiar ‘equi-marginal’ principle that defines efficiency in resource use, that is, that the marginal values of all possible uses of a resource are equated, governments need to know the marginal benefits arising from both extractive uses of water such as surpluses available from the production of irrigated crops and non-extractive environmental values such as the existence values arising from the protection of riverine ecosystems. The complexities involved in estimating the latter, non-marketed values are well known but even the task of estimating marketed extractive values in real time is by no means straightforward given that private producers are unlikely to be interested in revealing their financial arrangements to the state. The balance between the transaction costs arising from the defining defending and trading of water rights and those arising from government regulatory information collection and processing is therefore not clearly weighted one way or the other. Furthermore, the balance shifts through time. For instance, technological changes that reduce the costs of monitoring water flows can tilt the balance more toward market-based allocation whilst advances in political accountability may give society the confidence in a regulatory approach. The situation is therefore one that is ever evolving and is likely to involve a complex mixture of both styles of approach rather than falling to one side or the other. The aim of this book is to present a picture of that evolutionary process in the context of Australian water markets. The Australian situation is of interest internationally because of the focus on the issue that policy makers and advisers, economists, lawyers, biophysical scientists and lobbyists of all persuasions are giving to it. The current movement in the balance between market-based and regulatory-based mechanisms is toward the use of markets. Numerous reforms are underway or proposed in that direction. This provides an ideal opportunity to observe the factors at play in determining the balance and hence the mix of policy instruments at work. The approach taken is to begin with two chapters that provide the conceptual underpinnings to the issue. The first by John Freebairn considers the path taken by Australia in recent years toward a greater reliance on markets (and hence property rights) to allocate scarce water resources. Freebairn provides the key principles of efficient resource allocation through markets and government intervention. He goes on to analyse recent Australian government policy initiatives in terms of these key principles, finding that some key problems remain. Most notable of these are continued ‘restraints from trade’, arbitrary assignment of water for environmental flows and the failure of governments to subject investments in water infrastructure to cost benefit scrutiny.

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Richard Epstein in Chapter 3 provides a tour de force of the development of water rights in England and the United States. His conclusion that dogmatic adherence to any one rights position will always get it wrong is based on his observation that the trade-offs between transaction costs and efficiency outcomes vary over time and jurisdictions. The development of a balance between common law rights and ‘intelligent legislation’ is called for. The remaining chapters are grouped into three parts that relate to the definition of rights, difficulties in their defence and finally, matters relating to the ways in which markets in those water rights have and (potentially) will be traded. The chapters dealing with the definition of rights take three different but related approaches. As the Epstein chapter demonstrates, history matters when it comes to property rights. Edwyna Harris substantiates Epstein’s theme of evolving institutional structures – particularly property rights – for the allocation of water in the Australian context. She does this by showing how government action in the state of Victoria has limited that evolutionary process with negative impacts on water use efficiency and the government’s coffers. She concludes by arguing that, whilst the separation of water entitlements for land title has now set the scene for increased water trading, clarification of water title ownership is required before long-term sustainable water use will be achieved. Poh Ling Tan in Chapter 5 argues for a reconciliation between private values derived from the use of water and the public values associated with water as a stock resource. She advocates that, just as legal rules need to be established to resolve conflicts between extractive uses, so too do they need to be established to resolve potentially competing claims between private and public uses. In that regard, Tan points to what she sees as a common misinterpretation of the rights held by the state over water: rather than having vesting ownership over water, they instead have the power to regulate water use. Hence she argues that the state has an obligation to protect the public right to water and that courts are not the appropriate venue for setting the parameters associated with such an obligation. Tan calls on the state to provide clear legislation over water that is consistent with the concept of public property and so able to provide a clear definition of the resource protection obligation. In Chapter 6, the last chapter in the rights definition part of the book, Michael Woolston focuses on the development of a system of registering water title. He argues that water markets will only deliver their full potential if the processes involved in the registration of title are reformed. This is consistent with the principle of reduced transaction costs leading to greater gains from trade. The chapter is primarily concerned with the analysis of the key issues that need to be addressed in that reformation. Woolston concludes by setting

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out a set of practical guidelines that he argues need to be met in order to achieve a registration system that would allow for efficient water trading. In the part of the book that deals with the defence of water rights, some of the core issues associated with the arguments of ‘market failure’ are considered. Coggan, Whitten and Abels’ Chapter 7 is focused on the links between the biophysical characteristics of water and the potential for water markets to operate effectively. They follow the ‘water cycle’ in all its phases to demonstrate the complexities of securing links of ownerships and the consequential transaction costs associated with alternative institutional arrangements. They point out segments within the water cycle where there are no well-defined entitlements at all and where sequential allocation gives rise to definition and defence problems. Instances include changing land use practices in catchment areas, water harvesting on-farm, transmission losses and irrigation efficiency differences. They argue that a balance must be established between the improvements in water use efficiency enabled by completing the water entitlement definitional process and the associated transaction costs. The final part of the book focuses on trade in water rights. Despite the rhetoric that extols the benefits of trading water rights – water being reallocated to higher marginal value uses to create net benefits to society – Rolfe in Chapter 8 points out that studies estimating the extent of these net benefits are rare in Australia. He presents evidence that supports the hypothesis that water trading has the potential for social benefit in the context of Central Queensland irrigation areas. The benefits are shown to be available through increased water trading between sectors in the economy, within sectors, reduced inefficiencies resulting from less government intervention and greater innovation and entrepreneurship on the part of more independent water users. Rolfe presents data from the state of Queensland, notably from the sugar, cotton, citrus and coal industries to support his arguments. Campbell in his Chapter 9, also looks to the future. He outlines reforms to water trading that are already in place and goes on to consider further potential evolutions. Campbell is particularly concerned with ways of removing impediments to increase market flexibility. These include measures to further ‘unbundle’ entitlements such as the timing of releases from storages and the delivery capacity of river systems. He argues that the delivery capacity aspect of water rights is a key component of the ‘stranded assets’ debate that arises from the potential for trading water ‘out of district’. Campbell also considers a number of mechanisms designed to expand the range of transactions involving water rights. These include secondary markets in which traders can operate to achieve greater flexibility in managing for supply irregularities. Some key regulatory restrictions are identified as currently impeding the development of such secondary markets and arguments are advanced for their relaxation in the interests of improved resource use efficiency.

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The final chapter in the water trade part raises the environment as a source of people’s demands for water. Bennett notes the significance of the public good characteristics of environmental protection derived from water but presents evidence of private sector conservation enterprises that seek to provide environmental public goods either for profit or on a voluntary, non-profit basis.

NOTES 1. http://www.poetry.com.au/classics/authors/m/mackellar.html 2. http://www.peterborough.au.com/goydersline.html 3. http://www.uh.edu/engines/epi594.htm

REFERENCES Flannery, T. (1994), The Future Eaters, Sydney: Reed New Holland.

2.

Principles and Issues for Effective Australian Water Markets John Freebairn1

INTRODUCTION Most of Australia experiences a scarcity of water. Allocating more water for irrigation, households, industry, recreation or for the environment means less water for other uses. As a result of history, and especially the strategy of allocation primarily on a first-come-first-served basis, much of the present water allocation pattern departs from the efficiency norm where marginal social benefits are equated across the different alternative uses of limited water. Further, future changes in relative market prices, incomes, technology and so forth will call for a continuous process of reallocation of limited water resources. There is a growing consensus, supported by direct government initiatives at the Commonwealth and State levels, for greater use of effective water markets to allocate scarce water. This chapter explores some of the principles and issues to further the development of effective water markets in Australia. In particular, it considers some of the details necessary to turn into practice the general ideas canvassed in recent Council of Australian Governments (COAG) statements (including those of 1994, 2002 and 2004) and the White Paper released by the Victorian Government (2004). Section 1, by way of background and to provide a reference evaluation benchmark, briefly summarises the principles of allocative efficiency and the situations where market forces of price coordination are likely to be effective. The present state of water market development, and recent government policy initiatives, are sketched in Section 2. The main part of the chapter lists and evaluates some of the options on details of the operation of effective water markets. Section 3 considers the definition of water property rights for private good uses of water. Options for government intervention in the market to allocate water for environmental flows to provide public goods are considered in Section 4. Section 5 focuses on some of the implications of effective operating water markets, including questions of structural changes, efficiency and equity. Issues of prices, regulation and investment in the 8

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9

Victorian Government White Paper (Victorian Government 2004), and to a lesser extent in the COAG statements (COAG 2002 and 2004), are reconsidered in Section 6. A final section provides some conclusions.

IDEAL ALLOCATION2 Efficiency in a static sense is achieved by allocating water from a given reservoir (dam, aquifer or river basin) between the different uses and users so that the marginal social benefit from each water use is equal. Different water uses or users could be different irrigators of a particular crop, different households along a street, or irrigators versus households versus the environment. In the end, individuals benefit from the different uses of water, including irrigation to produce food, running showers, and providing life to red gum forests and biodiversity to pass on to future generations. Investment to increase effective water supplies by, for example, new dams, piping, recycling and desalination would be efficient if the marginal social benefit of the extra water at least covered the marginal social cost of the investment. Subject to inter-reservoir linkage costs, different marginal social benefits will be found at a point in time across the different reservoirs, and different allocations and marginal social benefits will be found over time as circumstances evolve and change. Competitive water markets using changes in the price of water to signal changes in scarcity achieve allocative efficiency where the water uses have private good properties of rival consumption and low costs of exclusion, and all social costs of water supply and consumption are also private costs. In these cases, marginal social benefits (and costs) also equal marginal private benefits (and costs). Then, the pursuit of personal well-being by individual firms and households will draw on all the available information to equate marginal private benefits, which also equal marginal social benefits, with the market price across the different uses and users of water. Most commercial uses of water by irrigators, industry and households have private good properties. If clearly defined and administered property rights are provided, a water market will efficiently allocate scarce water, and then reallocate it in response to changes in market circumstances. In some cases the consumption of water, particularly the disposal of wastewater, will involve external costs. In one sense these externalities reflect incomplete property rights, that is, the costs of pollution are not included explicitly in the responsibilities of the water user. Alternative market failure correction measures for consideration include taxes (set at the marginal external cost), tradeable pollution permits (with the aggregate permit quantity

10

The Evolution of Markets for Water

to equate marginal external costs and marginal abatement costs), and regulations (to equate marginal pollution costs and marginal abatement costs). Government intervention to increase the allocation of water to provide for environmental flows which generate public goods, which have the characteristics of non-rival consumption and high costs of exclusion, is likely to be necessary if the marginal social benefits are to be equated across different uses of the water. Examples of public goods provided by water allocated to the environment are the existence and option values of biodiversity and heritage supplied for the current and future generations. As individuals in the cities and the country, we have to trade-off the opportunities of more water for, say, an extra 100 hectares of red gum forest versus, say, an extra five-minute shower or more water for summer lettuce. Since public goods are characterised by nonrival consumption, the sum of individual marginal benefits gives the marginal social benefit. Ideally, this sum would be equated with the market price for water used for the commercial products to achieve an efficient allocation. Almost certainly a mixture of a competitive water market and government intervention in response to market failures associated with pollution and with public good properties of some environmental uses of water will be required to achieve a close to efficient allocation of scarce water resources.3

HISTORY AND RECENT POLICY INITIATIVES Up to around 1970 the methods of water allocation in Australia were primitive by economic standards and the principles enunciated above. Typically water was a part of the land right, available water was allocated on a first-come-firstserved basis, and the charge or marginal cost to users was close to zero. To an important extent, increases in demand were met by government-funded investment that often was motivated more by political motives than by a formal benefit cost assessment. During droughts a variety of quantitative regulations were used to ration supplies. These allocation procedures applied for city and country, and for surface and underground water.4 Around 1970 many urban and rural areas of Australia entered into the socalled mature water economy stage where demand by commercial users at close to zero prices exceeded the available supply on average. Competition between farmers for limited water, and to a lesser extent between irrigators and other users, was accompanied by perceptions, and then later by formal analysis, that some potential new users placed higher marginal values on water than did existing users.5 There also was a growing awareness that the health of some rivers, however defined, was being placed at risk, together with increased political support and pressure to maintain flows, if not to increase water,

Principles and Issues for Effective Australian Water Markets

11

allocated for environmental flows. These changing circumstances contributed to significant policy moves from the 1990s to the present. A major policy switch point was the 1994 statement from COAG (COAG 1994). It was proposed that the ownership of land and water be separated, that trade in water from low value to higher value uses be encouraged, that the need to allocate some water for environmental flows be recognised, and that prices for water be set to at least cover operating costs of delivery. These reforms were overseen by the NCC. Water trading developed, more so for temporary trades within regions. Trade across years and across regions has been less important, in part because of greater uncertainty about property rights for trade over time and across regions, and partly because of the regulatory restrictions and other transaction costs. In some rivers and underground aquifers, caps were placed on water that could be withdrawn for commercial use to protect environmental flows. COAG has pushed the reform story further over 2002 and 2004 (COAG 2002 and 2004). It has proposed that farmers be given secure water rights, not unlike land rights. These rights include a schedule to claw back overallocations, and a formula for sharing the risks if forthcoming scientific analysis suggests the need for a further claw back. Many operational details about the water rights and about operation of the water market remain to be resolved. Increased flows for environmental purposes are to be met partly by the claw back, partly by Commonwealth and State government funded investment projects, and with the right to purchase water at market prices from the commercial water market. So far the policy discussion has been more about the magnitudes of flows for the environment than about the type of flows and the gains in environmental outcomes, and no formal assessment of society’s values on the enhanced environmental outcomes relative to the opportunity cost of commercial use values of water have been reported. These and other reforms are to be overseen by a newly created National Water Commission. The Green and White Papers produced by the Victorian Government in 2003 and 2004 (Victorian Government 2003 and 2004) have complemented the COAG policy initiatives, and in several areas they have filled in some of the details for Victoria. For irrigators, it is proposed that there be an unbundling or a separation of the system for irrigation with water rights, and then two types of water rights (namely high security water rights and lower security rights for formerly ‘sales’ water reduced by 20 per cent for environmental flows) which are legally recognised and independently tradeable rights, a water delivery right closely tied to land, and a use licence tied to land (but maybe also to crops and irrigation methods) to reflect relative pollution costs which might be addressed by regulations, taxes or tradeable permits. Grandfather arrangements give the water and delivery rights to existing irrigators. A 15 year review system is proposed to transparently review water rights in the event of climate change

12

The Evolution of Markets for Water

and other external changes affecting the availability of water. To a large extent the urban water market, and in particular Melbourne, has been isolated from competing against irrigation users (not just north of the divide but also south of the divide). In addition, for Melbourne there are to be no more dams, with the water demands of population growth to be catered for by restrictions on demand which are to be achieved by a combination of education and awareness, pricing of water, regulations on usage, rebates for water saving technology, water sensitive urban development, and recycling for nonhousehold uses. No allocative arguments are given for the balkanistion of urban water from rural water. A number of State funded investment projects have been flagged to increase the available water to meet target environment flows.

WATER PROPERTY RIGHTS For markets to be effective in allocating outputs and inputs, including water, from low value uses to higher value uses, a pre-condition is a well-defined system of property rights for the product being bought and sold. This means that the characteristics of the product are clearly defined and generally understood and measurable, that the benefits and costs of the product are captured in the property right, that property rights can be freely traded, and that these conditions have a legal basis which is effectively administered. In developing effective water markets in Australia, good property rights raise questions about the system design, the product characteristics, the accounting or recording system, and the initial allocation of water property rights. The use of water involves at least the three stages of the initial water product in a dam or aquifer, delivery of the water to the user, and use of the water including waste disposal. For many different potential users and uses of water the delivery and use stages involve very different activities which incur different costs. For example, delivery costs vary with proximity to the prime water source, the evaporation and seepage losses during transit, competing opportunity costs where capacity is limited, and with the required water quality. Water usage can result in different pollution costs associated with the different types and toxicity of wastes, soil type, irrigation method, and so forth. Given the different costs associated with different users and uses of water which need to be included in social costs to allow a market to efficiently allocate limited water, at least in a transaction cost free world these different costs need to be recognised as characteristics of water property rights. One way to approach this multiple characteristics issue is the White Paper (Victorian Government 2004) model to unbundle the issues by establishing separate property rights for the primary water product, essentially at the dam or aquifer, a delivery right, and a use licence which seeks to internalise pollution costs

Principles and Issues for Effective Australian Water Markets

13

associated with wastes. This then leaves a thick market for a homogeneous water product at the dam wall or in the aquifer. Water use then would require holding a water entitlement, a delivery right and a use licence, which collectively involve prices or costs reflecting the social marginal opportunity cost of water to each user and use. There are a number of options in specifying the water property right, especially in recognition of the natural volatility of rainfall across seasons and perhaps in a trend sense over time with climate change. The simplest measure is to specify a single water entitlement as a share either of water released from the primary supply, or as a share of the net inflow. Another strategy is to specify one entitlement in volumetric terms with a high probability of availability, a high security entitlement, and then a second lower security entitlement for a share of the residual supply. Where different users have different preferences regarding security of supply, for example household demands for drinking water versus for garden watering, and the irrigation of perennial crops versus annual crops, I have argued elsewhere (Freebairn 2004) for the two entitlement model over the single share product, and this model is proposed in the White Paper. There has been some discussion about whether the water entitlement should be for a gross water diversion or for a net diversion (adding back returned quality water) (for example, Young and McColl 2003). In principle net use is the appropriate measure, but it raises measurement costs for the quantity and quality of return flow water, which may result for practical reasons in the choice of gross flows as a second best solution. Given the seasonality of water catchment for most dams in Australia, a water entitlement per year seems the appropriate time interval. Because most uses of water require complementary investments with effective lives of many years, and often decades, water entitlements with long lives are sought to provide confidence in making these investment decisions. Current arrangements have been unsatisfactory because of uncertainty about future water entitlements. Both COAG (COAG 2004) and the White Paper (Victorian Government 2004) have proposed entitlements with perpetuity characteristics, but with qualifications. COAG has flagged a schedule for adjusting water rights downwards in the event of new scientific information, and climate change, reducing the available water for consumptive uses. The White Paper discusses a revolving 15 year review process. Clearly different options affect the allocation of risk between entitlement holders and government. However, so long as future adjustments are explicit and believed, property rights remain clear and markets can work. Water losses due to evaporation and seepage in the process of delivery to different points may be handled in at least one of two ways.6 One way is for the effective water rights to be specified with a discount factor to reflect losses from the dam wall to the delivery point. Another option is to include the losses

14

The Evolution of Markets for Water

in the operating cost of the delivery charge price. Losses are likely also to vary with seasonal conditions which may justify a further fine tunning of the property right definition. Issues concerned with the description, pricing and operation of water delivery rights are not fully developed. In several cases, sometimes for particular regions and more so for particular times of the year, capacity constraints are being reached with the existing water delivery infrastructure. For these periods, the property right should be specified for relatively short time intervals, perhaps as short as a day, with market bidding and associated scarcity prices to allocate limited delivery capacity. At a minimum, the delivery right should include a charge for variable costs, usually defined by governments as operating costs and the annuity value of new investment (and major refurbishment) extensions. The White Paper proposes also that urban customers pay for historical capital costs, but that rural customers only pay operating costs; with political and equity supporting arguments. From an economic perspective, past capital costs are sunk costs, but, if the water entitlement is to include a scarcity rent, as it will, it is arguable that some of this rent could be skimmed off to meet past investment costs. A contentious area with delivery rights is the issue of stranded water delivery assets. The problem situation of concern is one where the operating costs are largely of a fixed nature (at least for quantities up to capacity), and some but not all users of a particular infrastructure unit sell their water. As a result, the remaining users are faced with a higher share of the operating costs. The White Paper (Victorian Government 2004) proposes that water delivery property rights be specified so that all existing users (in a type of grandfather arrangement) be required to meet their share of the operating cost regardless of whether they use the delivery infrastructure or not, primarily on the argument that the water delivery infrastructure provides a valuable option which is capitalised in a higher property value. This property right specification seems to provide for efficient decisions on the transfer of water, and assuming small group negotiating works it also can result in efficient decisions on infrastructure investment and closure. Almost always the water delivery infrastructure will have natural monopoly characteristics. To avoid monopolistic exploitation and inefficiency requires government intervention, either by direct ownership and setting prices at marginal cost or by regulation by price ceilings on private firm suppliers. The White Paper (Victorian Government 2004) proposed that the Essential Services Commission provide this monitoring/regulatory role. Many of the uses of water involve pollution costs, such as sewage and industrial waste, and irrigation run-off into the water table, and these costs are important components of social costs of the use of water. Further, the magnitude of the costs of pollution per unit of water use varies widely, and

Principles and Issues for Effective Australian Water Markets

15

there are a number of operating and investment options that can ameliorate the magnitude of external costs. Water use licences provide one way to internalise the pollution costs. The licence could take the form of regulation, for example requirements to treat sewage and blocking the transfer of irrigation water from low-impact to high-impact regions, or of taxes on the externality, for example a tax per ML of sewage or per ML of irrigation of rice in region X, or the requirement to purchase an emissions permit, for example on sewage into a river or salt emission. In some cases the pollution is of point form, and measurement is relatively easy and low cost, for example most household and industrial wastewater. By contrast, much of irrigation related water pollution, for example seepage into underground water tables and salinity damage, is of a non-point and difficult to measure form. Here recourse may be required to the measurable inputs, outputs or production methods that are only imperfectly related to the pollution externality. Sometimes the second best solution may be worse than allowing the externality. Effective water markets will require a registry of information on the ownership and transfers of water entitlements, delivery rights and use licences which is transparent and available to all at minimal cost and which has the full backing of the law. Suggested options include a public operated system similar to that which applies to land titles, or a share system as now applies to the ownership of rights in public companies and is administered by a regulated private organisation. State governments are choosing the former option using their Land Departments. Electronic markets would bring buyers and sellers together to negotiate mutually beneficial transfers and prices. Again, information on transfer prices and quantities would be readily available to the public. The initial allocation of property rights (for water and for delivery) is a contentious political issue. The Coase theorem (Coase 1960) shows that a competitive market will reallocate well defined property rights to achieve an efficient allocation regardless of the initial pattern of rights allocation, but clearly the initial allocation will affect the distribution of wealth. Historically, to a large extent water and delivery rights in Australia have been allocated as a joint input with land on a first-come-first-served basis, but there have been some market transfers in recent years. At the same time, the legal basis of water rights ownership has been unclear (for example, Godden 2003). Both COAG (COAG 2004) and the White Paper (Victorian Government 2004) have proposed an initial allocation of perpetual leases to water, and in the case of the White Paper also to delivery infrastructure, to existing users in a type of grandfather arrangement, but with a right of ultimate government ownership and with payment to current holders on just terms. This allocation strategy has the advantage of preserving a perceived status quo distribution of wealth without compromising an arrangement of future market reallocations to shift

16

The Evolution of Markets for Water

water from low value to higher value uses. Where additional water becomes available, or for those few cases where the view is that surplus water is available, additional rights would be auctioned to the highest bidders with the scarcity rent accruing to the State. A contentious area in the initial allocation of water rights has been the case of offering the new water entitlements to current holders of so called ‘sleeper’ and ‘dozer’ rights. These are cases where the land had a water right, but the right to use water had not been exercised, or only infrequently, in recent years. Some of these holders claim the sleeper and dozer rights have had insurance value, although non-use suggests the marginal value was relatively low. Clearly, offering the ability to separate land and water into distinct property rights has provided new market opportunities and additional wealth for the holders of sleeper and dozer rights. At the same time, sale of the largely unused rights to active water users augments the use of water in many already stressed river systems. Unfortunately, in many river systems it is too late to avoid the validation of sleeper and dozer licences since they have already being sold, at least in temporary water sales. There is a compelling case to issue explicit and formal water entitlements for upstream (or above dam) users as well as for downstream (or below dam) users, and again to grandfather the present allocation. For example, whether water should be used upstream for additional forests or expanded farm dams, or whether it should be used downstream for irrigation of cotton or for urban consumption on green lawns is part of the general water allocation problem. Markets would provide the coordinating mechanism for sorting out who values the water more highly.

ENVIRONMENTAL FLOWS Everywhere the Australian water allocation debate is coloured with calls for more water to be allocated to environmental flows.7 It is important to recognise that in a mature water economy, additional water allocated to environmental flows has opportunity costs of less water for irrigation, industry and households. At the same time, it is important that the choices between the different uses recognise that the ultimate benefits of additional water allocated to the environment come in the form of enhanced survival of biodiversity, heritage, recreation and other products valued by households when compared with food, showers, green lawns, housing and other consumer products. The present allocation and flows, including the effects of already-built dams and channels and the near reversal of seasonal flows, is the starting point from which changed allocations have to be assessed. Ideally, water should be reallocated to (or from) environmental flows so that the marginal social benefit

Principles and Issues for Effective Australian Water Markets

17

of the change in biodiversity, heritage, recreation and other products made possible with the extra allocation equals the marginal social value of the marginal water allocated away from irrigated food production, a shower, a green lawn and so forth. Clearly many challenges have to be surmounted in obtaining estimates of the marginal social benefits of water allocated to environmental flows. Nevertheless, the general strategy is well known. First, information is required on the changes to biodiversity, heritage, recreation and the other products provided by extra water for the environment. An important sub-question here is the form and timing of the environmental flows, with the extreme examples of mimicking the seasonality and volatility of pristine flows versus a regular and constant flow per week. Second, household valuations of the marginal benefits of changes in the biodiversity, heritage and recreation products are required. Contingent valuation and choice modelling techniques, while contentious, are available for this purpose.8 Given the non-rival property of most of the household benefits of greater environmental flows, the sum of individual benefits across the members of society will be required to reach a measure of the marginal social benefit. Third, the derived marginal social benefit of extra products provided by the extra environmental flows would be compared with the market price of water traded between irrigators, industry and households. Several options for the actual administration of the allocation of water to the environment might be considered. The water allocation for the environment could be specified as a minimum share of supply, or as a minimum volume, or water entitlements of comparable attributes to those given to commercial water users could be provided to an environmental manager. The objectives, operating institution and procedures, and monitoring and reporting requirements for the chosen environmental manager would need to be explicit and transparent.

OPERATION OF EFFECTIVE WATER MARKETS To a particular household, business, irrigator, environmental manager and other water user, the cost of water at the point of water use would reflect three components. These are the scarcity value of water, delivery costs, and costs associated with the use licence. Use licence costs primarily reflect the external or pollution costs of wastewater disposal, for example sewage treatment and remaining pollution costs to third parties, or costs of water table and salt additions in the case of irrigation. The licence costs might be in the form of taxes and charges, or the market price of tradeable permits, or the cost of complying with regulations. Delivery costs include the operating costs of water

18

The Evolution of Markets for Water

treatment and delivery plus any scarcity rents set by the market for allocating limited delivery capacity. The market price of water entitlements essentially would be a scarcity rent representing the opportunity value of water in its next most valuable use. Several water entitlement product prices would co-exist. A price for water flows over a short time interval of a season or year for temporary transfers would be relatively volatile, and in particular it would respond to variations in rainfall. An asset stock price would reflect the discounted expected value of future flows and be used in permanent transfers. In between the temporary flow and permanent stock prices, the market is likely to develop a range of lease and other arrangements for the transfer of water entitlements for a number of seasons or years. Because of geographical isolation, differences in relative aggregate demand and supply of water by region, and the high costs of interconnection infrastructure, different prices are likely for the different geographic water basins Prices in the water market will respond to changes in demands of the different uses of water and to changes in water supply. On the demand side, changes could come from changes in the prices of products which use irrigation water as an input, changes in the government allocation of funds to purchase water for the environment, changes in urban populations and building codes affecting water needs, and from changes in technology affecting the efficiency of water and other production inputs. Supply changes could come from climate variation, both across seasons and from trends over time with climate change, and from investments in dams, delivery systems and by water users. It seems likely that in time the finance industry will develop a range of options, futures, derivatives and related instruments to assist water users to hedge against the volatility of water prices and quantities where risk aversion is important.9 A well functioning water market will improve the allocation of water and associated investment activities, both in a static sense and in response to changing future conditions, including changes which are not foreseen with perfect knowledge. In their own self interest, irrigators, other businesses, households (and in some cases the environmental manager) voluntarily will redistribute water from low value to high value uses and users at a market price which falls below the marginal value of the water to the buying higher value user and above the marginal value of the water to the selling lower value user. If land markets are to be taken as a comparative market indicator, not all individuals who could benefit by trade will in fact do so immediately on the formation of a water market because of satisficing behaviour and for noncommercial reasons, but over a number of years most mutually advantaged trades will occur as the true opportunity value of water becomes known.

Principles and Issues for Effective Australian Water Markets

19

With secure property rights, firms have the incentives and will reap the rewards of productive investment in new technology, such as water saving equipment and R&D into new cultivars, and of investments to increase effective water supply, such as piping and expanded delivery capacity. With a market, additional water gained or saved can be sold as a market return on the investment outlay. Further, secure property rights, and the development of hedging instruments to spread risks, improve the ability of investors to borrow the required funds. For many of these investment opportunities, private firms have greater access to the necessary ideas, information and opportunities than is available to government investors. The achievement of a more efficient allocation of limited water resources, whether by market forces or by government direction, necessarily involves structural changes and some redistribution effects. The grandfathering of existing property rights preserves the status quo at worst, and for most the shift from uncertain rights with a doubtful legal basis to secure property rights represents an improvement (at the expense of government). For the buyers and sellers of the property rights, the transfer is a voluntary Pareto exchange in which both parties gain in what is a positive sum game. The issue of potentially stranded water delivery assets was considered earlier, where it was noted that the alleged problems can be avoided by attaching a water delivery property right (with payment obligation) to the land whose value it enhances. Possibly the only serious concern on equity criteria of water trading and associated structural change is the effects on some third parties who provide services to an intensive irrigation area. For example, farm hands, machinery sellers and maintenance providers, and local shop keepers, may lose their current livelihood in an intensive irrigation farming region, for example dairying, which becomes an extensive agricultural region, for example beef. Such structural change is a normal aspect of regular economy evolution, although it might be argued that an unexpected change in government policy was the cause. Generally available social security and structural adjustment instruments, rather than a specific and special additional program, could be considered to provide an adequate minimum social safety net for these people.

GOVERNMENT POLICY There is much in the proposals of COAG (COAG 2002 and 2004) and the White Paper (Victorian Government 2004) that is positive and proactive to the greater use of market forces in the allocation of scarce Australian water resources. In particular, there is a path for providing secure water property rights, including some clarity on a specific allocation for environmental flows.

20

The Evolution of Markets for Water

However, a number of rough edges and questionable parts of the proposals remain. The White Paper in particular seeks to isolate and balkanise water for rural use and water for urban use. Effectively, it seeks to prevent urban users, and particularly Melbourne, from buying water from rural users.10 Further, this restriction on market transactions is to apply not only to water flowing north of the great divide, but also on water flowing south of the divide. It also imposes additional charges on urban users to recover sunk capital costs and a higher environmental levy charge than is to be imposed on rural users.11 This artificial categorisation of the water market fails to recognise that urban consumers are the final beneficiaries of most irrigation products, and that efficiency requires free choice between rice, fruit and vegetables from irrigation versus long showers and green lawns. Also, the separation seems to make a simplistic assumption that the retail prices of the irrigation products are insensitive to the costs of inputs, including water inputs. Perhaps ironically, it is likely that Adelaide and country urban areas along the Murray and its tributaries will buy water from irrigators, but not Melbourne. Current debate and policy about appropriate environmental flows takes the form of caps on water available for commercial uses and on the reallocation of X GL for the environment. These allocations almost certainly are a long way away from the economic framework of allocating water across environmental and commercial uses so as to equate marginal social benefits across the different water users. Most of the current debate places an emphasis on flows per se, and then very little about the timing and form of the flows, and almost no reference is given to what will be gained in terms of more diversity, heritage and recreation from the extra water diverted to environmental flows, let alone any assessment of the value households attach to these extra environmental products relative to the opportunity value of water taken away from irrigation, industry and conventional household water uses. At a minimum, an economic estimate of the marginal social value of extra water for environmental flows should be included as a key information component in the political determination of these flows. Both COAG and the White Paper have announced a raft of public funded investment projects to improve river flows and recycling which are to increase effective water availability to meet environmental flow targets. These investment projects have not been submitted to a formal benefit cost assessment. In particular, the question as to whether such projects versus buying water from existing commercial users represent the most cost effective way of increasing environmental flows has not being contemplated. As higher incomes in the future are likely to mean increased demands for the provision of environmental amenity, a more logical cost effective route to acquiring additional water is desirable. Also, as discussed, a well functioning market will

Principles and Issues for Effective Australian Water Markets

21

provide incentives and rewards for much socially beneficial investment to increase effective water supply.

CONCLUSIONS Australia has been moving down a path of greater use of markets to allocate its scarce water supplies, and this process was given another push in 2004 with proposals from COAG (COAG 2004) and the White Paper (Victorian Government 2004). For those uses with largely private good characteristics, and this includes most water used for irrigation, industry and households, market prices provide a flexible coordination signal for the allocation and reallocation of supplies under changing circumstances and for complementary investment decisions affecting the supply of and demand for water. Government intervention to counter external pollution costs of waste water, and to allocate water for those public good property services provided by environmental flows, is required to complement competitive water markets. Granted the significant advances in water policy, there remain some important design flaws with the recent government proposals, and details of the specification of property rights and the operation of water markets remain to be fully developed. Three general problem areas from an economic efficiency criterion perspective are noted with recent policy proposals. First, the separation or balkanisation of an urban water market from rural water markets creates efficiency losses. Second, the mechanistic assertion of required environmental flows is arbitrary and unlikely to focus on a required assessment of the marginal social value of changed allocations for environmental services. Third, the absence of formal cost benefit or cost effectiveness analysis of different options, including public funded investments and recycling versus market purchases, to meet environmental flow targets is likely to allow expensive interest group lobbying to dominate decisions. How well water markets work is going to depend on the ‘devil in the detail’ on such issues as the specification of property rights, the integrity and transparency of the market, and on the initial allocation of property rights. A number of options are explored in the paper. The White Paper proposals for unbundling rights into water entitlements, delivery rights and use licences for irrigation water have many attractive attributes, as does the proposal to formalise a high security entitlement and a low security entitlement. Grandfathering the current property rights, both for upstream as well as for downstream users, meets most perceptions of distributional equity and with clear property rights in time will lead to a reallocation of water from low value users and uses to higher value users and uses.

22

The Evolution of Markets for Water

NOTES 1. I am grateful for the comments of Geoff Edwards and Alistair Watson on an earlier version, whilst retaining full responsibility for the views that follow. 2. This section draws on Edwards (2003) and Freebairn (2003). 3. This point is further developed by Epstein in Chapter 3 of this volume. 4. Details of the historical context are provided by Harris in Chapter 4 of this volume. 5. Reference here is to the marginal value of water to a particular use, namely P - Σ Wi Xi, where P is the output price, Xi is the i-th non-water input and Wi is the cost of the i-th nonwater input. Further, the marginal value of water will be a declining value of the amount used for each use. The marginal value of water does not necessarily correlate with the commonly reported dollars per megalitre of water, namely P / Xw, where P is output price and Xw is water per unit of product. 6. Note that for most rivers and canals with a continuous flow, for marginal changes in river and canal flows the additional losses are thought to be very small. 7. But, there is debate as to whether the health of major rivers has fallen or not, for example, Marohasy (2004). 8. Bennett in Chapter 10 of this volume provides some examples of Australian applications of these techniques 9. Campbell in Chapter 9 of this volume considers the potential for initiatives in this area. 10. Alistair Watson advises that regional towns in irrigation areas are not balkanised, including Euchuca, Mildura and Shepparton, but those not in irrigation areas are, including Bendigo and Castlemaine. 11. I am grateful to Alistair Watson for alerting me to this issue. For a related point, on economic grounds there seems no rationale for the proposed three-step block pricing scheme for urban water. In terms of opportunity costs and allocative efficiency, water is water whether it comes in small or large quantities suggesting a single price. Equity concerns are already largely met by a system of rebates for low income households with benefit cards.

REFERENCES Coase, R. (1960), ‘The Problem of Social Cost’, Journal of Law and Economics, 3, 114–127. Council of Australian Governments (COAG) (1994), ‘Report of the Working Group on Water Resources Policy: Communique’, February. Council of Australian Governments (COAG) (2002), ‘National Water Initiative: Communique’, 6 December. Council of Australian Governments (COAG) (2004), ‘Intergovernmental Agreement on a National Water Initiative: Communique’, 25 June. Edwards, G. (2003), ‘Water Policy: Setting the Scene’, Australian Economic Review, 36 (2), 193–202. Freebairn, J. (2003), ‘Principles for the Allocation of Scarce Water’, Australian Economic Review, 36 (2), 203–212. Freebairn, J. (2004), ‘Water Rights for Variable Supplies’, paper presented to Australian Agricultural and Resource Economics Society Annual Meeting, Melbourne. Godden, L. (2003), ‘Perception of Water in Australian Law: Re-examining Rights and Responsibilities’, paper presented at Australian Academy of Technological Sciences and Engineering, Melbourne.

Principles and Issues for Effective Australian Water Markets

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Marohasy, J. (2004), ‘Myth & the Murray: Measuring the Real State of the River Environment’, IPA Backgrounder, No 15/5, Melbourne. Victorian Government (2003), Securing Our Water Future: Green Paper for Discussion, Melbourne: Department of Sustainability and Environment. Victorian Government (2004), Securing Our Water Future Together, Melbourne: Department of Sustainability and Environment. Young, M. and J. McColl (2003), ‘Robust Reform: The Case for a New Water Entitlement System for Australia’, Australian Economic Review, 36 (2), 225–234.

3.

The Historical Variation in Water Rights Richard A. Epstein

THE THEORETICAL AND CUSTOMARY FOUNDATIONS OF WATER RIGHTS At the outset let me admit that I do not know anything about the peculiar rules of any regimes in water rights within 5000 miles of Australia. The systems that I understand are the American markets and the English markets, especially with regard to the influences that the latter have had in shaping the operation of the former. What I propose to do here therefore is to offer a complementary approach to the one provided by Freebairn in Chapter 2 of this book. I hope to explain how it is possible to work through all of the problems he identified, not so much via the modern system designs for the administrative state, but looking at the institutional origins and evolution of water law through three stages: at common law, through legislation, and then ultimately through constitutional challenge, which counts as the hallmark of the American system. Water rights, precisely because they are so difficult to calibrate and so difficult to quantify, have proved to be the source of immense complexity not only at the theoretical level, but also in the fits and starts of their historical evolution. My task is to give some hints about its winding course of development. In searching for a convenient starting place, I can think of no better place to look than one of my favourite philosophers, John Locke, who for all his brilliance made a profound, and hence instructive, mistake in the analysis of water law. Our point of departure is the basic Lockean theory of the origins of private property which starts with the bald general proposition that any individual acquires ownership of a particular thing by ‘mixing’ it with his labour (Locke 1689). The proposition was said to be as good for the acquisition of rights in a litre of water as in an acre of land. If you can mix your labour in order to acquire title to land, then you can mix your labour to remove water from the fountain and thereby make the water your own. There is no doubt that the first part of this proposition resonates with the common law tradition, which itself echoes the Roman, that in the initial position land was treated as a res nullius, or literally, as a thing owned by no one. Individual acquisition by taking possession was thought to be appropriate to the common lawyers no 24

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matter how much or little labour was used (so in that they rightly differed from Locke in calling for less stringent conditions for ownership). But at the same time both the Roman and English tradition of customary water rights differed sharply from the Lockean conception on water rights. Water in the original position was regarded not as a res nullius, but as a res commune, that is, as property that was owned by the community at large, although the precise domain was never specified. The jurisdictional issues, such as the one that Freebairn referred to in Chapter 2 over the boundaries between Melbourne water and county water, were left unaddressed in the original common law and Roman formulations, which aspired to a higher level of universality. For our purposes, however, the important point about the term, res commune, is that it establishes a background legal environment for water rights that is the exact opposite of what it is for land. As a first approximation, the paradigmatic act for acquiring ownership of land (reducing it to private possession) now constitutes the quintessential violation of the communal rights to water. The fundamental inquiry into the formulation of property rights in these two settings is this: what accounts for the profound differences in the starting point for the allocation of property rights in these two regimes? Once their polar differences are explained, the follow-up question is whether courts or legislatures find ways to soften these differences as the details of the overall systems get fleshed out.

LAND AND WATER The process here works not only for water rights but also for land. On this score Blackstone (1766) understood the opposition, for when he spoke of land he referred to ‘that sole and despotic dominion which one man claims and exercises over the external things of the world, in total exclusion of the right of any other individual in the universe’. His treatment of water law is quite brief, for he contents himself with the observation that the rights of individuals tend to be usufructuary, by which he meant that they had limited rights of consumption but could never claim ownership of a river. These different starting points make real sense when looked at in modern functional terms. Anyone who examines land quickly concludes that exclusive rights make an excellent first approximation of the ultimate efficient distribution of rights. After all, unless an owner has exclusive rights in land, he will not be prepared to make any long-term investment in clearing or improving that land. Prehistorically, land tended to be something that nomadic individuals passed through rather than something that settlers, chiefly farmers, owned. It was only when agricultural activity required extensive clearing and cultivation that land became privatised, a trend that is only accelerated with the more intensive use of real estate for industrial growth.

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The Evolution of Markets for Water

At the same time that exclusively sets the dominant trope, however, there’s a built-in fuzziness at the boundary line. By customary practice neighbours start following a ‘live and let live’ regime with respect to low-level reciprocal nuisances; they recognise support obligations between neighbouring lands.1 The whole point of these modifications is that they tend to create, by operation of law, Pareto improvements between neighbours, under circumstances where transaction costs prohibit readjustments by voluntary covenants. The approach still informs much of the best work in dealing with conflicts between neighbours in all kinds of settings. I think it is simply amazing how astutely a group of common law judges followed these customary practices even though they had none of the advantages of modern economics to guide their deliberations. They were deadly accurate in their choice of particular rules. Often they had better instincts on the optimal regime for land rights than many modern judges and environmental regulators, who in their zealous pursuit of grander social objectives are often less sensitive to the needs of the parties to any particular dispute. For years I have stressed the theme2 and the approach offers an ideal exhibit of how that can work, by creating rules that produce social improvements in practice without plunging the courts into case-by-case cost/benefit analyses. The history of water rights is amenable to exactly the same kind of story, only now the picture works in reverse.3 The initial assumption, which is that water creates some kind of a negative community – that is, one in which all may participate but from which none may be excluded – was at least, in the English riparian experience adopted for the most part on the simple ground that the in-stream uses of water had very great value which would be effectively destroyed if the rule of first possession allowed water rights to be reduced to private ownership. Here their intuitions were surely correct because it seems quite clear that these in-stream uses are very extensive. First of all, in effect, they create nutrients that support the entire environmental system, which allows for the maintenance of fish and other forms of aquatic life, not to mention the nutrition that they supply to adjacent lands. Rivers and lakes are commonly in such recreational uses as bathing and swimming. Waters are also extremely valuable for navigation and transportation in a primitive age when roads are very bad. The moment that somebody can simply divert all the water from a particular river and consume it, or dam it up in order to obtain some other kind of advantage, then their conduct will precipitate huge losses for everybody else who has a stake in the management of water resources. And so the irresistible impulse in any settled community is to decide that no one person can engage in unilateral appropriation strategies; rather, the water has to be retained in some form of a common.

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SECOND-BEST ALLOCATIONS AT COMMON LAW: WHAT USES, HOW MUCH, AND TO WHOM Now the moment any community makes such a determination by the shadowy and customary practices of the common law, it has made a solid start to a sound definition of water rights. But, by the same token, it has not reached a final solution for the optimal distribution of rights in water. In this context, the common lawyers anticipated exactly what Freebairn states in Chapter 2 is the critical task in water law: how do we equate at the margin between various public uses, which are in-stream, and private uses, which are not? Here they began with the strong intuition that the collective in-stream uses were, on average, of greater value than the private uses. Hence they set the background norm, which was subject to deviation for more limited private uses. Hence water could be removed from the commons in limited amounts. One hard question is to ask how much. Here that answer could not be zero because the first drop of water in private hands has to be greater than the value of that drop of water in the river. But from this it would be a mistake to assume that water in private hands is always equal to or greater than its value in the common pool. On this question, therefore, John Locke was right, but only in part, to note that the water that a private person removes from a river (he said a ‘fountain’ but river is surely a more accurate term) is his just as the first acre of land separated from the common is his. But he is wrong to suppose, as he seems to have done, that any private individual could remove as much water from the common as he chose by this method. Clearly, some limits on the amounts of acquisition were imposed. The question is how best to sort them out. The answer to that question comes in two parts. First, it is necessary to develop some rules that indicate the total amount of water that could be removed from a river or lake; next it is necessary to figure out how to allocate that water among various possible claimants to it. The answer to these questions will differ in part by the natural setting in which the water is found; the same distribution of rights will not work for a raging river as for a gentle stream. There is no once and for all efficient solution. But amidst all this diversity it is instructive to start with the English system, which had to allocate rights in a system where water was relatively abundant and rivers were numerous and small with, as became critical, a close hydrologic connection to various other sources of ground water. There is some unavoidable simplification of the facts on the ground, which helps put the central theme into clearer focus. The first question – how much water an individual can remove from a river? – is not easy to resolve because the answer depends at least in part on the amount of water that runs through it. Thus in rainy seasons, when water is plentiful, greater quantities can be removed from the river. But when the river

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is dry, then it could be imperative to cut down on removals. At common law, part of the answer to this first question came from creating a hierarchy of uses, which favoured domestic over agricultural uses that were in turn favoured over more intensive industrial uses. Thus the cutbacks came in strict reverse order of the types: industrial first, then agricultural and finally domestic. Now anybody who does neo-classical economics will instantly recognise that this set of crude priorities offers a distinct second-best solution, for there may well be types of industrial use that prove more valuable than consumptive uses for domestic purposes: indeed that’s the whole point of having an intense discussion about the trade-off between long showers on the one hand, and irrigation on the other. In an ideal world, a price system for water would allow those trade-offs to be made more accurately. But for some early society running a primitive system without mechanisms for transfer between private users, then, as a good educated guess, generally speaking, domestic uses, which allow people to drink and perform elementary hygiene and sanitation, should be on average more valuable than the agricultural uses that would ordinarily be put aside by a single owner who controlled all water resources and had to choose between competing uses. It is not as though the English common law hit upon a perfect allocation system, but it did choose one that looks better than random. Accordingly, the great challenge for legislation is to figure out how to make – or better, facilitate – the marginal adjustments not at the class level, but at the individual level. This is why thoughtful defenders of a common law system of property rights always recognises that legislative intervention, if properly structured, offers room for improvement right across the board. Water rights has never been an area in which the ardent defender of property rights says, ‘above all, leave the common law alone’. Owing for the need to compare values at the margin when transaction costs are high, this case is not like the contract at will, which likely is a dominant contract solution for the people who choose to adopt it. The common law rules offer a first, intelligent set of approximations, to the equimarginal ideal across all in-stream and out-of-stream uses. The success or failure of legislation depends on whether it moves us closer to that ideal. As ever, it is a classic trade-off between improved incentives for use on the one hand and the greater administrative expenses to bring them about. Now the second issue that the common law judges had to face was, of course, the allocation issue: as among people who own property along the river, how should those private use rights be allocated. On this score, the common law system was never a first-come, first-serve system, at least under the English system of natural use allocation. Rather, since there were so many riparian land-owners, the rule was exactly the opposite: it didn’t matter when a particular riparian took title to his particular piece of property, each was always entitled to a pro-rata share of the water flow. This meant, in effect, that

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early takers had to reduce their consumptions proportionately when subsequent people came onto the river. The explanation for this rule rests on the ground that in the absence of a coherent system of transfer between private users, the best guess is that the first gallon of use, or the first litre of use, by one person is probably going to be more valuable than the nth gallon or litre by the other, no matter when each party arrived at the river. Hence, this system of allocation will give a better result in a world in which transfers are not possible, than an alternative system that confers strict and rigid priorities to the first user. The second practical reason for using this system derives from the weak social infrastructure for water rights at common law. If the legal system does not have a registry, which is again something to which Freebairn referred to in Chapter 2 and is discussed in detail by Woolston in Chapter 6, it’s very difficult to know the precise time each person took title to his or her riparian lands. Yet any priority system requires judgments as to when all took original title to their riparian lands in settings where large consequences could attach to small differences. Yet the law is right to avoid getting into priority fights because these are particular difficult to resolve when the two individuals are not chasing after the same plot of land. Neither can observe each other’s conduct, and back off if the other person has arrived first on the scene. Without a clear system of metrics and bounds, the entire priority enterprise breaks down, especially with dozens or even hundreds of potential claimants. This system that denies priority based on the time that people acquire their interests is frequently used in other contexts when these relative judgements are also hard to make. Thus the common rule in bankruptcy, for example, is that all general creditors are said to have an equal priority, not withstanding the time at which their debts are contracted. The correlative argument is that, if anyone wants to gain a priority, then he should take a security interest, but again that requires a recordation system that common law regimes did not have. Another unique feature of the common law system of water rights related to the alienability of interests in water. As a matter of first principle, the ideal regime is to allow the sale of water rights in limited packages on the ground that voluntary transactions move resources from lower to higher valued uses. But that system will not work under a riparian system, given that each of the rights to remove water must respect the continued value of the in-stream uses. For good reason, the common law rule was exactly the opposite, and it said, quite clearly, that if someone owned a riparian interest, he was entitled to transfer the water to somebody else, but only if he transferred the underlying riparian land with it. So the basic rule treated the package as inseparable. This, at first blush, looks to be inconsistent with the basic bias of modern economics in favour of free alienation. Yet once again the force of this criticism is effectively combated by taking into account the radical uncertainty that pervades the basic system. In a world in which neither regulators nor

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landowners have reliable meters, there is no reliable way to price directly the water that is taken from the river. At this point, allowing a transfer of water rights apart from the land imposes a surcharge on the common use of the river, because self-interest dictates that the transferee is likely to make more intensive use of the water rights than the transferor. By tying the use of the water to the riparian lands, the law places an imperfect restraint on that tendency, for now the needs of the riparian lands constrain the permissible consumptive uses available to the transferee.

GROUNDWATER In sum, the basic common law system over water rights, first in England and early on in some eastern American states, created a strong initial priority in favour of in-stream uses over out-stream uses. One reason for that sensible bias comes from the answer given to this simple question: ‘Do landowners have alternate sources of water available for private and domestic uses?’ If the frame of reference is England and not Australia, then the topology is marked by a landscape with many small rivers, most of which need to preserve water for navigation and other in-stream uses. At the same time, ground water seems available in relative abundance, so that it is always possible to supplement river water by digging wells from which it is possible to take water, at least early on, in unlimited quantities. Hence the opportunity costs of the natural use system appear to be low. Historically, the early English cases4 adopted a pure appropriation rule that allowed a landowner to pull out as much water as he pleased so long as his well did not trespass onto the land of another. The place of the drilling mattered; the direct consequences on the amounts of water still available to others did not. The great advantage of this rule is that it discharges one of the central functions of any property system, namely, that it allows everyone to identify the owner of water once it is removed from the well, so that the wellestablished set of property rules can govern its consumption, use or exchange. Stated otherwise, this rule facilitated the emergence of voluntary markets in water after it was removed from the well. Now it is critical to recognise that this system of groundwater rights is highly sensitive to the overall demand for water. Hence water rights follows a historical pattern that parallels that of Demsetz’s (1967) economic explanation of Eleanor Leacock’s account of how the Montagnes Indians in Quebec organised territories to control the over-hunting of beaver once the French traders entered the region. The basic explanation is that the arrival of the French in force generated a huge exogenous increase in the demand for pelts by opening up an entirely new market for their use. Under the previous

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regime, the rule of first possession meant that each hunter could kill or trap animals for their fur without taking into account the adverse effect that their actions had on the size of the herd itself. But with the low levels of demand of the Montagnes, those externalities were smaller than the hefty administrative costs needed to shift to a different system of property rights that required the demarcation and the enforcement of territorial boundaries for hunting. Once those relative costs shifted, then with some difficult transition problems, the shift from a rule of capture to a rule of territories took place. The same transformation happens with water rights. With low levels of groundwater consumption, the common pool problems are not severe enough to require the implementation of a more comprehensive system of property rights. But once populations increase and groundwater use becomes more extensive, the rule of Acton v Blundell becomes a source of immense mischief. The large withdrawals of water could undermine the surface. More importantly perhaps, it becomes evident that it is no longer possible to think of the groundwater system as though it operates independently of the river system, for at high levels of consumption, the opposite becomes true. So whether one looks at England, or the United States, or Japan, and I dare wager, Australia, the property rights system has to adjust to take into account the overall externalities that withdrawal of water from one well has on the operation of a the system as a whole (Ramseyer 1989). The dominant trope thus shifts from one of individual appropriation to one of correlative rights. It becomes imperative to think of more comprehensive administrative solutions to respond to the increased pressures on the system that derive from the increased use of water resources.

THE AMERICAN TRANSFORMATION So the point that Freebairn made in Chapter 2 about how changes in levels of consumption brought about by changes in technology alter the frame of water rights is in fact confirmed by the earlier common law history of the subject. It is equally true that the needed responses are dependent not only on technology but on the nature of the entire water system. The English rivers, for the most part, were relatively small affairs, for which the definition of navigable was whether or not the water levels in the river would fluctuate with the tides. Now the Mississippi River is not navigable under that definition. But that definition was of little relevance to the extensive navigation industry that developed along the river, so that the legal test had to change to reflect the dominant economic realities, and it did. Long inland rivers are very different affairs from the smaller English ones.

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In addition, rivers flow downward at different rates, and the changes in height offers in the American context (and to some extent in the English, which was not wholly immune to these changes) opportunities for the construction of mills to generate power for all sorts of industrial uses. These were new instream uses that did not fall within the traditional catalogue. Now these mills necessarily back up water behind them, and thus alter the natural balance among water users on the rivers. They could not be accommodated under the English natural user theory because of the major disruption of the ordinary flow. But the net social gains from the introduction of some mills along the river became too apparent to deny within the American context, so the question then became how mills and dams should be spaced along a river. At this point, it is no longer possible to have an improvement that makes every riparian on the river better off: some people are inconvenienced by these mills and dams. Yet it was difficult indeed to organise a compensation system that required winners to pay losers out of their new profits. Hence the evolution of the natural user system into a reasonable user system allowed the unilateral action by some riparians to construct mills to work to the (smaller) prejudice of others who were precluded from such actions or inconvenienced by the practice. The question then arises whether this situation could have been avoided by a rule that required the prospective builder of a new dam to obtain consents from all the riparians that were prejudiced by his innovation. The answer was that this simply was not practicable in light of the large number of riparians that had to be bought off to make the changes in question. But here the risk of blockade threatened to stand in the way of very large overall social improvements, and so in the end the judges blinked, and changed the criterion of judgments for the creation of water rights. Under the natural user situation, the allowable practices all tended to create Pareto improvements, so that each riparian benefited from the changes in the system at large. But once the dams and mills were introduced the large improvements were sanctioned under a Kaldor-Hicks standard of social welfare – one that only requires that the winners be able hypothetically to compensate the losers and still be better off than before. The want of any real compensation for overall social improvements carries with it the usual unhappy consequence for those persons who come out on the short end of the social transformation. They have every reason to resist a change by which they were hurt. At some point these claims had to be respected socially, and here the line, roughly speaking, was drawn at the point when the new dams created lakes so large that they flooded the dry lands adjacent to the rivers, or cut off all access to the rivers by those who were below. The term ‘reasonable’ is not the clearest of terms. It came therefore as no surprise that those individuals who administered this system did not think it to be the counsel of perfection even if it promised some improvements over the earlier natural flow system.

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THE CONSTITUTIONAL DIMENSION In light of all the confusion it caused, the emergence of this reasonable user system of water rights therefore increased the pressure to have administrative determinations to decide who should be able to build what dam. The movement toward this centralised planning was justified because of the very substantial externalities that were created by a unilateral decision to construct a new dam. The administrative system gave at least some opportunity to decide where the dam should be placed, and how large it could be. A major set of common law problems was traded in for a somewhat smaller set of administrative issues. Within the American context, the use of legislation to alter the pattern of common law rights quickly raises the stakes to constitutional levels. The key constitutional provision was the ubiquitous takings clause of the Fifth Amendment to the United States Constitution – ‘nor shall private property be taken for public use, without just compensation’. The issues that were specifically raised involved the question whether the alteration of water rights counted as a taking of property rights, and if so whether that taken was for public use. If not, then the taking could not go through. But if so, then compensation had to be provided for any losses in question, so long as the property was taken. One set of instructive cases that brought these issues to a head were the so-called Mill Act cases. Head v. Amoskeog Mfg Co., 113 U.S. 9 (1885); Here the approvals referred to above were routinely required for flooding of nearby uplands. These floodings were limited in extent by administrative order, and the flooding party was required to pay compensation at 50 per cent over market value of the flooded land, which compensated for any loss of subjective value, and operated as an effective break against overclaiming in this context. Even the extra compensation did not stop many landowners from seeking to block the deal altogether by claiming that the flooding was only for a ‘private use’, and could therefore be undertaken only with consent. But the courts, sensing the difficulties in dealing with multiple holdouts, held that the public use requirement was satisfied. In some cases this was easy because the mills in question were grist mills, which were by law open to the public at large. But that same judgment was made in Head even for a mill that was used only for manufacture. The division of the surplus created by the extra compensation did the work of public use. If the takings clause of the United States Constitution was held to require compensation for the flooding of uplands, it did little in practice to constrain government action on a host of issues that related to dam construction and internal improvements that altered in-stream use. Thus one common conflict arose when the dredging or damming of a river compromised the access rights of individual riparians to public waters or rendered ineffective the head of water that a riparian had used to generate power for a mill. The traditional

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version of private property rights in water stressed the importance of correlative rights, in contradistinction to land. But in dealing with these conflicts the routine view was to recognise a dominant ‘navigation servitude’ in the United States that allowed it to run roughshod over these private interests.5 The origin of this navigation servitude is of some note because it stems not from property law itself but from one of the many manifestations of power under the Federal Constitution. The key provision here is critical to American constitutional law, but has no obvious parallel elsewhere. Among the enumerated powers given to Congress in Article I, section 8, was the power ‘to regulate commerce with foreign nations, among the several states and with the Indian tribes’. Among the many twists of law for which this clause is responsible is the navigation servitude. From the first decision under the commerce clause,6 the clause was held to give the national government the power to regulate navigation between the several states, and eventually within each state. That power to regulate was then transmuted into a servitude that swept everything before it aside. It was a classic confusion between the sovereign powers of the national government and the ownership interests of government in particular resources that are under state ownership. This exaltation of the navigation servitude is unsound as a matter of general property law doctrine: the state law defines ordinary property rights in water. There is no reason why the correlative rights of a water law system are less entitled to constitutional protection and respect than the absolute rights in land. That doctrinal result is backed up by the economic analysis that Freebairn set out in Chapter 2: if one wants to make sure that the equi-marginal conditions are satisfied for different forms of water use, then the government should be forced to pay for the interests that it destroys in order to give some assurance that it will generate higher levels of social value by the new interests that it creates. The constant legal talk about non-compensable regulations and the dominant navigation servitude creates a systematic incentive to overvalue the public uses created relative to the private uses destroyed.

PRIOR APPROPRIATION AND IMPERATIVE NECESSITY Just to push this discussion one bit further, it is useful to offer one more instance of how the different configuration of natural resources leads to a redesign of systems of legal rights. The earlier discussion pointed out that certain larger rivers were suitable for dams and mills, and that the system of reasonable user was intended to exploit an option that the English system of natural use tended to foreclose. But in the western United States, mighty rivers such as the Colorado run through deep gorges. It is quite impossible to see how any riparian could take his cows to the edge of the river unless he wanted them

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to fall hundreds of feet to their deaths. The visual image of cows drinking peacefully at the water’s edge does not fit the newer landscape. By the same token, the in-stream uses of these waters were often limited, especially for navigation and commerce. The natural topography therefore spurred the adoption of new systems to allocate the water to preferred uses, which were out-of-stream uses for irrigation and similar purposes. Here the transfer of water required extensive investments in sluices and pipes, which no one would lay unless they could guarantee themselves some continuous right to the water in question. Hence the rule of prior appropriation allowed all comers who built these improvements to take those quantities of water used in their business before the next person could take his. This strict priority was like a system of mortgages. The first claim is satisfied in full before the next claimant receives any water at all. The clarity of the rule allows individuals to guess the estimated flow to see whether new construction is appropriate in light of the earlier claim. The entire system is a variation of the first possession rule that is used to acquire ownership in land under the common law system. This prior appropriation system will clearly outperform the English system of natural user or the American variant of reasonable user. It will certainly appeal to those who hold Lockean beliefs about property rights. But again it will be far from ideal. As with the riparian system, transfer of rights is difficult, for selling the right to divert at a different point on the river could alter the nature of the ‘return flows’ and thus reduce the amount of water available to others. Thus the entire system locks in a sensible allocation that could easily prove to be less than ideal. The type of imperfections encountered with the riparian systems just manifest themselves in a somewhat different form. One interesting issue with water law stems from the unhappy circumstance that the multiple systems of water rights often lead to tension between two individuals who claim under rival systems. Just that happened with the tension between the doctrine of riparian rights and that of prior appropriation. One of my favourite cases in this area is that of Coffin v. The Left Hand Ditch Co., 6 Colo. 443 (1882), where the Left Hand Ditch Co., which claimed water was a prior appropriator, sued Coffin, the riparian, who had taken the law into his own hands by knocking out the ditch and dam that allowed for the Left Hand Ditch Company to use the water for irrigation purposes at some distance from the river. Here the question was whether Coffin was within his rights as owner of the water that vested under a riparian rights theory. The case was complicated because it appeared that Colorado had adopted that theory by legislation. But to respect those rights across the river would create manifest inefficiencies that could not easily be cured by contract. There are too many parties with vested rights for the appropriators (who could never act in unison anyhow) to buy their way in. But here the Court took the position that ‘imperative necessity’ meant that the prior appropriation system would govern,

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without any explicit compensation to the riparians for rights that had little if any value in use. The case offers a useful application of the general principle – easy to state, but difficult to apply – that ‘necessity trumps property rights’. Here the view is that the prior appropriation system increases the use value of the water in the river by a factor of 10 or 100, or perhaps even more. Yet there is no way to organise compulsory sales that would allow one to get from the current system to the future ones. There are too many rights holders under both systems. Yet if this shift in rights could be obtained, then the indirect benefits to the riparians would compensate in part for their loss of property rights so that this transaction looks almost like a Pareto improvement. The maxim is that in this high transaction cost environment, courts will reassign property rights because they think that the overall allocative gain dwarfs any unfortunate distributional consequence. Stated in modern terms, when the overall social gains are hard to identify, requiring compensation to be paid puts the legislature to a test of its convictions. But when the gains from redefinition of property rights are enormous, and the compensation process arduous, then just shift the rights system quickly before the sense of entitlement becomes too entrenched. We move from the world of Pareto improvements to the world of Kaldor-Hicks improvements. Messy it surely is. But by the same token it is probably a wise thing to do as well, but only in moderation, not only with water rights, but in any other setting where the problem arises.

BETTER SOMETIMES RIGHT THAN ALWAYS WRONG This short tour through water rights in the English and American systems has I think some real messages for people in Australia who struggle with their own allocation questions. Everyone must be struck at the diversity of systems in water rights, which is far greater than the variation that one sees in systems of land law (which, themselves, are by no means uniform). This variation is largely of customary origin, and I have given reasons to indicate why it should be regarded as far from arbitrary. The efficiency properties of these various rules are closely tied to the ecological niche of which they are a part. This exercise thus reminds us of the practical origins of common law property rights. After any close acquaintance with water rights, no one could say that all property rights are immutable or inevitable. Yet by the same token, it is easy to see why these common law systems have real disadvantages of their own, which once again paves the way for intelligent legislation that moves more aggressively to satisfy the equi-marginal conditions on which successful regime design rests, and which were rightly stressed by Freebairn in the previous chapter. That task is not made any easier by virtue of the fact that many of these

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in-stream uses are hard to evaluate because they involve the creation of complex public goods which have two features: they are of great value, but they are hard to value, even by the modern techniques of contingent valuation. Against this background, it is just a pipe dream to assume that someone will be able to devise a system that gets water law ‘right’, if by that we mean hits on the ideal system from which no one could improve. But the language of trade-offs is not a language of despair. It recognises that one can do either better or worse, and that the differences between the two could be great even if perfection alludes us. The right maxim here is simply that to be forewarned is to be forearmed. Those people who aren’t so informed will be unable to understand either the logic of property rights or the economic dynamics of the overall situation. In consequence, they will tend toward dogmatic positions of the sort that says, always place all of use X ahead of use Y, which means that they will always get it wrong. Whereas those who understand the appropriate principles of markets and the need to regulate with respect to externalities, at least have a fighting chance of getting it right.

NOTES 1. See Bamford v. Turnley, 122 Eng. Rep. 27 (Ex. 1862). Baron Bramwell’s is the most insightful of the opinions provided in this case. 2. See Epstein (1995). 3. See Getzler (2004). 4. Most notably, the famous 1843 decision in Acton v. Blundell, 12 Mees. & W. 324, 354, 152 Eng. Rep. 1223, 1235 (Ex. Ch. 1843). 5. United States v. Willow River Power Co., 324 U.S. 499 (1945). 6. Gibbons v. Ogden, 22 U.S. 1 (1824).

REFERENCES Blackstone, W. (1766), Commentaries on the Laws of England, Oxford: Clarendon Press. Demsetz, H. (1967), ‘Toward a Theory of Property Rights’, American Economic Review, Papers and Proceedings, 57 (2), 347–359. Epstein, R. (1995), Simple Rules for a Complex World, Cambridge MA: Harvard University Press. Getzler, J. (2004), A History of Water Rights at Common Law, Oxford: Oxford University Press. Locke, J. (1689), Two Treatises of Government, Oxford: Oxford University Press, Chapter 5. Ramseyer, J.M. (1989), ‘Water Law in Imperial Japan: Public Goods, Private Claims, and Legal Convergence’, Journal of Legal Studies, 18 (1), 51–77.

4.

State Administration versus Private Innovation: The Evolution of Property Rights to Water in Victoria, Australia Edwyna Harris

INTRODUCTION Historically, securing adequate water supply has been one of the fundamental issues confronting every generation of Australians since European colonisation. Cyclical, crippling drought is a permanent feature of the continent. From the squatters adapting land use patterns to limit the effects of water supply variability in the 1830s to the current emphasis on changing urban consumptive habits the question of water supply security is never far from the surface of public debate and intellectual musing. Recent reforms have signalled an historical, atypical willingness on the part of the government and users to move toward more sustainable uses of a resource Australians have long taken for granted. Gone are the days of water shortages being tackled through engineering feats of brilliance with attention now being turned to the institutional framework within which water exploitation takes place with a corollary emphasis on pricing. As a result, reform has seen many states introduce water markets as a way to restructure water thirsty industries such as irrigation. Markets will provide a means by which structural adjustment can take place away from low valued output on marginal lands to higher valued production in more suitable areas. In effect, this may well mean the shrinking of some major industries but it can also provide the opportunity for the growth of a more appropriate industrial structure in some regions, states, and, indeed the country as a whole. It is the current reforms that are the first, decisive step toward establishing an institutional framework that will provide for sustainable water use. In light of recent reforms it must be recognised that a crucial prerequisite for the successful creation and maintenance of water markets is the establishment of private property rights that are defined, defendable and tradeable. Historical examination of the evolution of property rights institutions 38

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provides a deeper appreciation for significant events that may limit future institutional choices. In this way, in light of the current water reform agenda, it is crucial for policy makers, scholars and stakeholders to recognise the impacts of past institutional decisions on the current and future reform agenda. This chapter focuses on the evolution of water rights in the state of Victoria with an emphasis on rural areas, especially those in the northern parts of the state. Victoria has been chosen because it was the first state in Australia to acknowledge the significance and extent of rainfall variation in the continent that produced constant rainfall deficiencies in many regions. As a result, it was the first state to introduce irrigation, a move that forever altered the path of evolution for water rights within Australia as this model was adopted in other irrigating states specifically New South Wales (NSW) and South Australia (SA). Such an examination will allow for considerable depth of analysis. The evolution of property rights to water in Victoria’s rural north was dominated by successive government intervention preventing private entrepreneurial responses to promote institutional change and limiting the evolution of well-defined, defendable, tradeable rights to water. This evolution can be broken up into three distinct phases. First, between 1830 and 1877 water rights were dominated by the British common law doctrine of riparian rights. Second, the rise of decentralisation with the introduction of ‘irrigation trusts’ from 1878 to 1904. Third, between 1905 and 1984 control of water rights was centralised under the auspices of the State Rivers and Water Supply Commission (SRWSC). Given this distinct evolutionary path this chapter is broken up into the following sections. Section 1 outlines the nature of property rights and the notion of collective action in being able to establish and refine property rights systems as scarcity increases. Section 2 focuses on squatter settlement expansion and the operation of riparian rights. Section 3 considers the rise of government intervention in water administration and the impacts this had on private collective action. Section 4 briefly outlines the move to full centralisation under the SRWSC and more recent reforms of the water sector from the 1980s.

THE NATURE OF PROPERTY RIGHTS Property rights are evolutionary in nature and can be defined, reorganised or redistributed (Anderson and Hill 2004). Definition occurs when property rights are absent, while reorganisation and redistribution will occur when rights already exist. Property rights definition, reorganisation and redistribution is determined by scarcity. In creating property right to increasingly scarce goods owners are able to exclude non-owners from use and extract rents associated

40

The Evolution of Markets for Water

with ownership of a unique asset. In this way, the creation of property rights prevents over-use of resources thereby avoiding the tragedy of the commons that occurs when no one owns a resource and competition is characterised by a race as users act to exploit as much of the good as possible before others (Hardin 1968). With the creation of property rights via collective action, the tragedy is prevented as groups of individuals band together to ensure efficient levels of exploitation through the definition of ownership and rules of use. These groups tend to use a combination of both formal rules and socialisation to create property rights. Ostrom (1990) has undertaken extensive analysis of the social institutional characteristics that typify a collective action approach. These societal groups had a higher ability to prevent over-use via collective action because the transaction costs of organising were lower than for larger groups. This was a direct function of the relatively small size of the group, their geographical proximity to each other resulting in ease of observation of other members’ actions and their homogeneity. These smaller groups were also better able to overcome the free-rider problem that characterises group action because the contribution of each member is more easily monitored. Organisation of larger groups has higher transaction costs because the negotiation and enforcement of agreed rules is more complex when a larger number of individuals need to concur, contribution is less able to be delineated, and cheating is not easily observed. Property rights redistribution can result in the wasteful exploitation of resources as entrepreneurs attempt to force a change of ownership through theft or lobbying. Such theft or lobbying requires another individual or group to defend their property against hostile acquisition. For example, the introduction of land selection in Victoria during the 1860s required squatters to spend time and resources defending their holdings against government-sanctioned reallocation through using dummy selectors and peacocking their runs. This was a negative-sum-game where defence of property rights against government reorganisation attempts channelled squatters’ efforts away from productive activities, such as sheep grazing, into non-productive pursuits such as bribery. Economists typically refer to this process as rent seeking where entrepreneurs seek rents that are already owned by others (Anderson and Hill 2004, p. 22). Reorganisation of property rights occurs through self-interested individuals buying and selling their rights in an attempt to maximise wealth. Exchange takes place when one individual believes a certain asset could be put to a higher valued use and will therefore contract through the market mechanism to obtain this asset from its current owner. A crucial requirement for wealth generating exchange to occur is the existence of well-defined and defendable property rights. A corollary requirement is that this exchange can take place at a cost low enough to remain profitable (Anderson and Hill 2004, p. 19). Firms will

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replace markets as the costs of market contracting increases; if specialist knowledge can be exploited; or when scale economies are required. In this way, the costs of market contracting are offset against the monitoring and coordination costs of organisation via a firm. In choosing between the market or the firm, individuals seek to maximise efficiency in contracting. In Victoria, irrigation began with a reliance on individual experimentation that rapidly resulted in the creation of small firms to exploit economies of scale in the construction of infrastructure and overcome right-of-way access problems. In these cases, each member of the firm was given a share of the main canal with the contribution of labour being determined by the size of land ownership. For instance, for members of the Meering and Leaghur Irrigation Company formed in 1883 an owner of 320 acres had to construct about 20 chains (approximately 600 metres) of the main channel while the building of all other infrastructure such as dams and bridges required all owners to send one man a day until the construction was completed (Agricultural Reporter 1885, p. 422). In addition, members of firms generally owned all the land through which construction was required. As a result, rightof-way and hold-up problems were avoided. As mentioned above, one of the key requirements for contracting via the market mechanism is the existence of defined, defendable and tradeable property rights. Traditionally, economists have argued that for many natural resources property rights are unable to be allocated because these goods are unable to be broken up into units that can be bought and sold. Water is one natural resource that has been subject to this argument. This is because water is rivalrous but non-excludable preventing exclusivity of ownership, leading to market failure and in turn, requiring government administration to provide certainty of allocation and price. Therefore, property rights are unable to be established for water leading to market failure and in turn requiring government administration. However, this argument tends to ignore the evolutionary nature of property rights and their associated institutions because it fails to recognise that the absence of rights simply signals that scarcity has not yet become an issue (Anderson and Leal 2001). In turn, it fails to acknowledge the ability of users to engage in collective action responses to changing levels of scarcity over time that can promote the creation of inherently flexible, sustainable property rights systems such as those identified by Ostrom (1990). As a result, this argument supports the early intervention of government in property right evolution thereby limiting the possibilities for private institutional innovation. The history of water rights in Victoria provides much support for the argument that government intervention is often premature and less efficient than private collective innovation.

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The Evolution of Markets for Water

THE EVOLUTION OF WATER RIGHTS IN VICTORIA: RIPARIAN RIGHTS, 1800 TO 1877 Settlement expansion into the Port Phillip District increased rapidly after 1830 following two distinct routes: the Major’s line and from Portland in the east fanning outward.1 Settlers found life in Australian colonies particularly harsh and hazardous due to the extreme environmental uncertainty resulting from a significant divergence in climate, topography, soil type, flora and fauna from that experienced in their homelands. The most significant environmental risk posed was rainfall variation. In order to combat this risk settlers adopted a less permanent, semi-nomadic form of settlement referred to as squatting, and a more flexible organisation of farming that is, sheep grazing.2 Squatting and sheep grazing gave settlers assurance against drought due to their inherent mobility that was complimented by a wide distribution of land ownership allowing flexibility in production location. Rainfall variation made river frontage blocks the most highly valued by squatters (Powell 1989, pp. 44–46).3 However, the issue of the institutional arrangement that delineated rights to water during this period is a contentious issue. While it is argued here that squatters’ water rights were dominated by the British common law of riparian rights, the extent to which this institution existed in Victoria is disputed in the literature (Davis 1971, Clark 1971 and Powell 1989). This stems from the absence of case law indicating whether a Victorian court would apply the riparian doctrine prior to 1887 (Newstead v. Flannery).4 And, while it is claimed riparian rights did indeed exist in Victoria prior to this judgment, exactly how the doctrine operated in practice is unclear. Theoretically, riparian rights tied water use to land resulting in only those who owned land coming into contact with the water source acquiring such rights. The rights conferred on a riparian owner were usufructuary in nature that is, riparians had rights of use but not rights of ownership. This stemmed from the fact that water ‘is a moveable, wandering thing . . . [hence, one] can only have a temporary transient, usufructuary property therein’ (Blackstone in Kinney 1912, p. 770). Riparian rights provided holders with an entitlement to put water to ordinary use that is, for culinary, cleansing, feeding and suppling ‘an ordinary quantity of cattle’ (Clark and Renard 1972, p. 71) during which they were unencumbered by restrictions under this doctrine. Nonetheless, in any other uses the effects of a riparian owner’s activities on downstream riparians would be considered by a court in determining reasonableness. In this way, riparian rights implied an inter-relationship of owners along a stream referred to as the ‘community of the river’. In this respect owners were equal in both right and responsibility (Scott and Coustalin 1995, pp. 935, 959). Riparians were also entitled to licence or contract their right to water to non-riparians allowing access via riparian property (Harris

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2002, p. 82). However, at no time did non-riparians become privilege to the community of the river, nor were they protected from any negative effects of upstream riparians use under the doctrine. In practice, because delineation of land ownership was uncertain being enforced only by some vague notion squatters had the right to graze stock over all land within three miles of a home-station (Roberts 1924, p. 179), the difficulty in understanding the practical operation of riparian rights is not surprising. In addition, due to rainfall variation, it would be expected that there would be more evidence to suggest either increased number of formal disputes over water access and use as settlement expanded or, an alteration to the riparian doctrine like that which occurred in the Western frontier of the United States as noted by Epstein in Chapter 3 of this volume. However, evidence suggests that neither of these things occurred. This lack of evidence can be explained via two main factors. First, the lack of formal disputes that is, those listed in court records, was limited due to the fact that water supply outweighed demand. Table 4.1 (below) indicates the number of runs in the Port Phillip region during this period was quite low. Table 4.1 Number of Squatting Runs in Victoria, Various Years Region

Year

Number of Runs

Western Port Bourke (Melbourne) Gippsland Grant (Geelong) Murray Normanby (Portland) Portland Bay Wimmera

1840 1843 1843 1843 1843 1843 1843 1846

192 69 44 72 149 72 282 67

Source: Roberts, S. H., (Reprint 1964), The Squatting Age in Australia, 1835–1847, p.161. Note, because squatters were not required to register ownership of runs, evidence of their occupation is sketchy at best. As a result, this is the best information available as to the extent of squatter expansion during this period.

Second, lack of adaptation was a function of four key features of squatter settlement during this period: mobility and the scattering of land ownership; precarious land tenure; run size; and access to artesian water supplies. First, as mentioned above, squatters not only adapted their economic activity to increase mobility in order to limit the negative effects of rainfall variation, they

44

The Evolution of Markets for Water

also scattered ownership over a large area to increase production location flexibility giving them few reasons to adapt riparian rights. Second, there was also a high uncertainty of land tenure at this time with the Crown being able to revoke occupational licences at any time. As a result, what little efforts there were to harness water supplies were relatively insignificant. Third, typically, the average size of squatters’ runs was large enough to ensure continuous inclusion of smaller rivers where the construction of diversions or dams had little impact on adjacent owners. For instance, average run size in 1848–49 was 24 000 acres (Roberts 1964, p. 362). On larger rivers, dam construction was not sufficient to cause significant impacts on downstream owners. Finally, squatters also overcame surface supply variation via the sinking of wells and bores on their properties to tap into artesian water supplies providing some water supply security in times of severe regional drought without requiring any alteration to the riparian doctrine (Powell 1989, p. 45). The relative equilibrium in water rights institutions that persisted for the first couple of decades of settlement expansion came to an abrupt halt with the discovery of gold at Ballart in 1851. Gold discoveries resulted in an expansion of population in Victoria from 76 162 in 1850 to 364 324 by 1855 – the likes of which have not been paralleled (Hayter 1875). Subsequent gold mining efforts required prospectors to harness water resources to assist mining activities with most fields experiencing severe water deficiencies. However, unlike with the expansion of squatter settlement, the administrative machinery of government was quick to establish legislation to regulate water use by miners. Horse-driven puddling demanded the greatest use of water and became the dominant form of mining after the exhaustion of most surface gold and consequent discovery of relatively shallow alluvial deposits in the mid to late 1850s. Hence, regulation for this water use was encapsulated in the Gold Fields Act (1857) that allowed for the establishment of local Mining Boards and Committees that formulated water use rules suited to local conditions such as miner numbers, claim size, predominant mining techniques and water availability (Harris 2002, p. 86). These Boards and Committees were also responsible for issuing licences for the construction of dams, storages and diversions on Crown land for mining purposes thereby conferring usufructuary interest in running water unrelated to the common law riparian doctrine (Clark and Renard 1972). In essence then, it can be argued that gold mining had little impact on water use and the riparian doctrine outside populous mining districts. Lack of fundamental alteration to the riparian doctrine remained a feature of the institutional framework up until the mid-1870s. However, legislative action on the part of the government to divest squatters of their land ownership during this period did signal the beginning of more significant changes in the decades to follow. These efforts were a direct response to the increased population caused by the gold rush and the limited opportunities for

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employment in Victoria’s underdeveloped industrial economy. Land settlement and the creation of a viable agricultural sector was, at the time, considered by colonial legislators to be the ideal solution to this challenge. However, while this period of land policy change, referred to as the selection era, was considered largely a failure, it did lead to a marginal increase in the number of small-hold, permanent agricultural settlers in the more remote areas of the colony (see Table 4.2). Table 4.2 Victorian Population by Location, 1860–1880

1861 1871 1881

Capital City (Melbourne)

Other urban*

Rural

123 061 191 449 262 389

112 249 182 701 173 054

303 357 357 378 426 903

* Other urban is representative of regional centres such as Ballarat and Bendigo. Source:

Vamplew, W, (ed.), (1987), Australian Historical Statistics, p. 41.

Due to the more permanent nature of agriculture pursued under the selection acts, water supply security became a fundamental issue for these settlers who did not have the inherent mobility advantages characterised by squatter settlement. And, when the drought of 1877–1881 dried up many inland rivers and lakes, these permanent settlers found themselves unable to secure water supplies leading the government to consider the need for more secure domestic supplies in the more remote parts of the colony. This, in turn, signalled the beginning of the end of the riparian doctrine.

THE NATURE OF WATER RIGHTS IN VICTORIA: THE INTRODUCTION OF IRRIGATION, 1878 TO 1905 The drought of 1877–1881 was devastating for the small farmers settled under the selection acts. As Powell (1989) aptly notes: In previous droughts only a small number of squatters had been affected, but now thousands of small farmers and their families were in dire distress, with only their votes to lift them out of their misery (p. 98).

Until this drought, the colonial government had remained complacent about water supply security for the expanded agricultural population. It was this exogenous shock and the potential for political backlash it created that jolted

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The Evolution of Markets for Water

legislators to move from rhetoric to action in water right redistribution attempts. These accelerated actions culminated in the passing of the Irrigation Act (1886) that discouraged private collective responses due to the incorporation and financial advantages provided. Government action in relation to the 1877 drought was confined to securing domestic supplies for those settlers in more remote areas. To these ends parliament appointed the Water Conservancy Board (WCB) in 1878 to investigate the possibilities for water conservation in the colony.5 Generally, the WCB’s reports on domestic supply were cautious as to the extent of works required to provide suitable supplies noting: It is wise not to rush into expensive projects at the risk of financial failure, but rather so to lay out the works that they be gradually developed as the demand for water increases (Gordon and Black 1881, p. 6).

Initial WCB reports detailed a number of schemes in various districts throughout the colony for the provision of stock and domestic supply with management being vested in specially created local authorities referred to as Waterworks Trusts. And, almost immediately after the receipt of these reports, parliament enacted the Water Conservation Act (1881) providing for the formation of trusts and conferring on them extensive powers over the control, allocation and pricing of water. However, these powers were confined to the administration of a particular source(s) within the trust district. All other water sources were still controlled to a large degree by riparian owners or miners who acquired usage licences from the Board of Land and Works under the Mining Act (1865). The major contribution of the WCB and subsequent creation of the trust system was that they ushered in a new theme of decentralised administration that came to dominate water supply frameworks for the duration of the nineteenth century. Paralleling the investigations of the WCB into domestic water supply security for the colony, a small number of private individual landowners had begun to experiment with irrigation. Reports regarding private irrigation were published in a widely circulated supplement to the Melbourne paper The Argus called The Australasian. This supplement had a special section, ‘The Yeoman’, devoted to discussion of issues affecting the agricultural population in remote parts of the colony. Generally, private irrigation reports began to be more frequently publicised after 1878; however, many of the schemes being reported had started in the preceding years.6 Nevertheless, it was not until 1882 that the undertaking of private irrigation within the colony accelerated as reports of successful schemes became more frequent leading many other individuals to pursue small-scale irrigation. Primarily, these individual efforts highlighted the experimental nature of irrigation within the colony. As a result, the main focus was on the contribution

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of these trials to the understanding of the technical requirements of irrigation such as the details of how water was applied to properties from low-lying rivers; the method of application via canals and furrows; the cost associated with these schemes; and the increased productivity achieved. In most cases, these reports were accompanied with praise for the virtues of private initiatives that were attempting to protect agriculture from the vagaries of rainfall. In most instances, individuals engaging in irrigation owned river frontage properties and used pumps to lift water from the river to apply to their land. And, while under common law, these activities would have been found unreasonable by a court there was no challenge brought by any owner under the riparian doctrine during this period. This was due to the fact that most of these individuals were wealthy pastoralists who had managed to avoid land redistribution under the selection acts therefore, as explained above, the average acreage of land ownership was still relatively large thereby including smaller streams within property boundaries. Therefore, it can be argued that these activities posed little disruption to the continued use of the riparian doctrine. The extent of success of private irrigation led the government to encourage this activity via amendments to the Water Conservation Act (1883) that inserted sections to provide for establishment of bodies similar to Waterworks Trusts (referred to as Irrigation Trusts) that would have exclusive responsibility for promoting irrigation in the district within which they were formed. This was part of a wider government aim to encourage the creation of a large-scale irrigation industry that would protect farmers against the devastating effects of drought. Nevertheless, in the years that followed, while no trusts were formed under the 1883 legislation there was an increase in private collective action to further irrigation within the colony. This seemingly dichotomous situation was the result of transaction costs associated with trusts’ formation by way of legislatively sanctioned collective action. Transaction costs were high for three main reasons: minimum numbers required for trust formation; details required in application for trust formation; and lack of finance. First, the 1883 act required three-quarters of landholders owning two-thirds of the land within a district to agree to form a trust. However, via private irrigation schemes the minimum number of members and size of schemes was highly flexible preventing costly, protracted contracting negotiation with a large number of owners and potential hold-up problems. Second, the legislation required extensive details regarding the particular irrigation scheme to be submitted to parliament including: amount of land irrigable and its estimated value; quantity of water to be used; value of waterworks already constructed in the district; plans and descriptions of works to be constructed; and costs of these works. The provision of this information required potential trusts to

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The Evolution of Markets for Water

expend large amounts of money prior to the beginning of a scheme which they had no guarantee would be sanctioned by parliament. If the scheme was approved there would be little ability for a trust to deviate from the original details provided unless an application to do so was again submitted to parliament for approval. This merely increased the costs associated with formation while limiting the flexibility afforded to irrigation organised via this method. Third, while the monetary costs of petition were high, once a scheme was approved, trusts had to finance infrastructure construction by raising capital on the open market. This proved difficult as trust members had little understanding of the operation of financial markets. As a result, in all aspects of formulation, the costs associated with using bureaucratic channels were far higher than those of local collective action. In this way, there was little incentive for farmers to create trusts. Private schemes that began to dominate during this period were on a much smaller scale than that which framers of the 1883 legislation envisaged due to the fact they were much less costly to organise and manage given ease of monitoring and enforcement resulting from group homogeneity and geographical proximity. In addition, they had the added dimension of being highly flexible in the construction of infrastructure. These factors indicate that the experimental nature of irrigation slowed its development implying that, counterfactually, had private collective action continued into the twentieth century a very different evolution of water rights institutions may have taken place. However, the widespread publication of both individual and collective irrigation experiments resulted in much public and political excitement regarding the possibilities irrigation provided for drought proofing farmers. And, it was during this time that one of the most influential individuals in Victorian water history, Alfred Deakin, began his rise to prominence. 7 Deakin’s influence was at the forefront of the irrigation debate during the early 1880s and, by the middle of that decade, Deakin had single handedly guided both a Royal Commission (1884) into irrigation and its resultant legislation, the Irrigation Act (1886), through parliament. The main impact of Deakin’s role on water rights institutions in Victoria under the 1886 Irrigation Act was two-fold. First, he gave unwavering emphasis to government intervention to control water right allocation in Victoria, motivated by his meeting with Elwood Mead during a tour of the western region of the United States as Chief Commissioner of the 1884 Royal Commission.8 As a result, in framing the 1886 Irrigation Act, Deakin included a section (section 4) that permanently vested ownership of all water resources within the colony in the Crown. This was a radical alteration to the institutional framework used to govern water, the effects of which continued to dominate all future institutional changes right up until the introduction of water trading

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in 1989. In effect, this section removed the possibility for any further acquisition of riparian rights within the colony resulting in a forced redistribution of water rights.9 Nonetheless, owners that had already acquired these rights maintained them even after this act was passed while all other individuals within the colony were vested with statutory riparian rights. It was not until the 1905 Water Act that legislation fully removed all riparian rights within Victoria. The second impact was via the framework provided in the 1886 act for the introduction of full-scale, government-sponsored irrigation in the colony that was accompanied by finance provision in the form of treasury loans and incorporation powers not previously available to private collective schemes. Hence, by forming a trust under the 1886 act these organisations would not only have access to increased funds allowing them to build much more extensive schemes, they would also be afforded the protection of incorporation. As a result, the number of trusts formed under the 1886 legislation increased substantially in the following years. And, by 1895, 25 trusts had been formed and £934,277 of loans advanced (Anderson, Grattan, Langdon, and White 1896, p. 200). However, it was not long before the trust system met with difficulties eventually leading to its collapse at the turn of the twentieth century. Of all the problems trusts faced during these years, the most significant were lack of water supply due to construction coordination failure, lack of water supply security, and extremely poor financial management. Construction coordination failures resulted in trusts completing the necessary infrastructure but having to wait significant periods of time before securing water supplies. Once water was available, this infrastructure was unable to support water provision due to lack of maintenance. Lack of water supply security was a result of the institutional arrangement itself with the government allocating a certain volume of water from a certain source(s) to each trust. This allocative system was fraught with difficulties because trusts had no guarantee that the amount of water allocated to them in one year would be continued into the next as government could change allocations at any time. Hence, they were unable to assure members that sufficient supply would be available therefore creating a disincentive to irrigate. Poor financial management was in part related to the above two problems confronting trusts in that if water was unable to be supplied then farmers could not make use of supplies and therefore, would not be required to pay for the water. This was a crucial failure of the trust system because calculations for loan amounts from the colonial treasury and subsequent repayment requirements were based on the assumption that all land claimed able to be irrigable within a trust would in fact be irrigated thereby providing revenue to pay off both interest and principal on loans. However, this did not occur (refer

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to Table 4.3 below), and in some instances, even where water was available farmers did not use it due to relatively abundant rainfall during the late 1880s. In turn, there was no provision within the 1886 act for Commissioners of trusts to enforce payment if the water provided was not used. These factors resulted in trusts being unable to pay back even the interest on government loans and the financial failure of the system. Table 4.3 Amount of Land Claimed to be Irrigable and Amounts Actually Irrigated Area Irrigable Percentage of Land Irrigated (acres) 1891 1892 1893 1894 1895

Trust Bacchus Marsh Benjeroop and Murrabit Cohuna Dry Lake East Boort

750 10 000 96 771 1 513 10 796

8.00 5.50 0.53 0.00 4.87

21.33 16.67 19.47 42.40 14.34 18.74 8.58 39.03 5.48 7.60 5.49 24.48 6.68 16.46 39.39 27.96 4.81 5.24 9.07 29.26

Emu Valley Harcourt Kerang East Koondrook Leaghur and Meering

1 000 500 16 000 6 500 10 300

0.00 0.00 0.00 6.42 6.79

0.00 0.00 8.00 8.40 9.40 8.40 12.69 16.63 24.58 6.35 5.00 0.45 6.87 13.30 15.17

Marquis Hill Myall North Boort Rodney Swan Hill

9 500 4 000 10 000 230 616 13 500

0.00 0.00 0.20 0.13 12.25

0.00 11.13 26.63 82.08 6.95 25.85 2.95 12.05 0.20 0.20 0.06 0.00 0.81 1.17 1.63 5.30 9.16 13.48 8.22 19.77

Tragowel Twelve Mile Wandella Western Wimmera Yatchaw

192 000 8 830 16 000 900 000 6 753

5.86 10.05 6.60 0.05 0.00

4.50 7.29 6.54 13.23 15.89 36.46 14.76 38.70 4.39 20.72 16.87 59.40 0.06 0.08 0.06 0.09 0.00 22.21 44.42 14.81

Source:

0.00 10.00 66.26 15.12 21.14

Adapted from Anderson, Grattan, Langdon and White (1896).

Failure of the trust system led to yet another reorganisation of water rights institutions with the full centralisation of water allocation and pricing under the SRWSC in 1905. And, as had decentralisation before it, this alteration prevented any ability for collective action or private innovation to influence institutional change and establish flexible, adaptable property rights

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institutions. In addition, centralisation subsequently resulted in significant financial losses for Victorian taxpayers during the entire period of the SRWSC existence as the government continued to subsidise water schemes construction, maintenance and management well into the 1980s. This resulted in the Victorian irrigation industry becoming highly inefficient as the institutional framework created incentives to maintain the production of low valued crops on marginal lands via the continuance of low water prices that were unable to cover the true cost of provision.

THE NATURE OF WATER RIGHTS IN VICTORIA: THE MOVE TO CENTRALISATION, 1905 TO 1984 The failure of the trust system signalled to legislators that decentralised allocation and pricing of water resources was not an effective arrangement for their administration. Nevertheless, government control was still considered the best method of administration. Therefore, in keeping with this theme, once trusts failed, legislators believed that the only way to overcome the problems of decentralisation and retain control over water supplies was to move to full centralisation of water right allocation and pricing. This was achieved via the passing of the Water Act (1905) which created a new state agency, the SRWSC, to administer all rural water supplies within the now state. Theoretically, this body was instilled with the power of government combined with the initiative of private enterprise (East 1962). In practice, private initiative gave way to political preferences for economic development the keystone of which was cheap water. Under SRWSC management, surety of revenue was a key aim of the government. To this end the government created an institutional arrangement that compelled farmers to pay for a minimum amount of water regardless of whether they used it or not. The compulsory charge was intended to ensure that those who benefited from water provision would also meet the associated costs. Another significant feature of the 1905 act was that it prevented farmers from selling water unless they sold the parcel of land to which the water right was attached. Combined, these features of the new institutional framework established a system with inherent, inbuilt rigidity preventing farmers from being flexible in their production decision and encouraging them to use water inefficiently because they had to pay for it. And, while fragmentation of land ownership had increased in the 1890s due to closer settlement leading to the costs of organisation being lower under the SRWSC, the problems of inflexibility under this institutional arrangement were compounded by the compulsory charge being set at a level that did not cover the costs associated with supply,

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management and maintenance of irrigation. As a result, this system was characterised by the provision of massive subsidies to rural areas via a direct subsidy, the amounts owed by districts written off over time, and the costs of infrastructure construction absorbed by the government.10 These costs were spread over the entire tax paying population resulting in residents in rural areas gaining the benefits of irrigation while those in urban areas shouldered much of the cost. In turn, this institutional system resulted in income redistribution away from urban areas to the rural population. The SRWSC dominated water management in Victoria for almost a century and while it overcame some of the impediments to the development of a largescale irrigation industry it did nothing to foster efficiency or sustainability in water use throughout the period. The resultant structure of irrigation was dominated by production of low valued crops, such as wheat and dairy, on marginal lands unsuited to intensive cultivation. It also inhibited flexibility in production by locking agriculturalists into irrigated farming. And, much like the effect of Reclamation in the United States, there was little incentive for institutional efficiency because rule makers did not bear the full cost of their actions (Anderson and Hill 2004). It was not until the passing of the Water (Central Management Restructuring) Act (1984) that significant changes to this institutional framework took place with the move back to decentralisation as government attempted to rationalise the operations of the bureaucracy. These changes led to the abolition of the SRWSC and its replacement with the Rural Water Commission (RWC) as well as the creation of eight regional water authorities that became responsible for the allocation and pricing of water to specific areas of the state. This renewed interest in decentralisation, previously experimented with in the 1880s and 1890s (as explained above), and the desire for increased accountability of public bodies formed the basis for more fundamental changes later in the 1980s. The most significant of these institutional changes took place with the passing of the Water Act (1989) that removed the nexus between land and water via the introduction of water trading. Nonetheless, the 1989 act did nothing to alter the nature of ownership of water rights regardless of its provisions to permit trading. As a result, water rights are still owned by the government that has the ability to remove these rights from any farmer(s) at any time with or without compensation. In effect, this prevents individuals from having exclusive rights of ownership to the good they trade. This fundamentally undermines two of the three basic requirements as mentioned above for markets to successfully evolve that is, defined and defendable property rights. Without the provision of ownership to water the impacts of reforms will be significantly limited as farmers are unsure about their ability to exclude others and extract rents associated with ownership of a unique asset. At the very basic level government has introduced the

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mechanisms to allow for markets to evolve, that is, trading water rights separately from the land to which they are attached, but has refused to seceded ownership rights to farmers. This is an example of traditionalist economic ideas regarding private property and water stifling the evolution of a true water market. As a result, the current reform agenda will be threatened by continued uncertainty as to the rights of water holders in respect of what bundle of rights are being traded under this new legislation. Should current reforms attain their main aim of sustainable water use then this is one fundamental issue that requires urgent clarification.

CONCLUSION As it can be seen from the above historical investigation, for the bulk of Victoria’s history, water rights have been dominated by successive government redistribution that has limited the evolution of well-defined, defendable and tradeable rights. From the earliest replacement of squatter settlement adaptations to deal with high levels of uncertainty because of rainfall variation, government has consistently imposed institutional changes that have undermined the ability for private water development to evolve. At all junctures government action has proved to be premature especially in regard to the encouragement and support for irrigation during the early 1880s. The costs associated with private collective action were far smaller than those connected with legislatively approved organisational forms and indicates that small-scale schemes were inherently more efficient and flexible being more suited to the state of Victorian agriculture and farmer knowledge than the larger schemes envisioned by the government of the day. However, the promotion of government endorsed organisation during the mid-1880s providing financial and incorporation advantages that could not be paralleled in the private sector resulted in the replacement of private initiatives. Centralisation decreased the costs associated with irrigation but limited the flexibility inherent in legislatively sanctioned collective action preventing both water use efficiency and ownership. With the introduction of trading without clarification of water right ownership, the effects of this successive intervention has resulted in high levels of uncertainty as to what bundle of rights farmers are exchanging when they sell their water rights. This will do nothing to assist the evolution of a market for water and will only prove to limit the capacity of current reforms to ensure long run sustainable water use is achieved.

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NOTES 1. The Port Phillip District was the name given to the geographical boundaries that define modern day Victoria. This district became known as Victoria on its separation from New South Wales in 1851. The Major’s line was the path established by Major John Mitchell’s successful expedition over the Great Dividing Range in 1836 and became the controlling access for pastoral expansion in Victoria becoming a kind of internal boundary for the colony (Roberts 1924, p. 175). Squatters runs were defined according to their location in relation to this line for example, a run of 1841 was described as being ‘situated on the Major’s Line about 70 miles from Melbourne’ (ibid., p. 175). 2. Dominance of sheep grazing over more permanent forms of agriculture was also reinforced by the increasing value of Australian wool on British markets during the period (see Vanplew 1987, p. 109). 3. This statement is also supported by evidence from newspapers later in the nineteenth century for example, a letter relating to experimental irrigation by R. Officer in Swan Hill during the 1880s published in The Australasian has the author stating quite clearly that Officer claimed, ‘I would rather have 2,000 acres on the banks of a river at a fair price . . . than I would have 14,000 acres for nothing out back’ (Anon, ‘Letter to the Editor’, The Australasian, 2 December 1882, 33 (870), 731). 4. While the judgments of courts in other British colonies such as Canada (Miner v. Gilmour, 1858) and New South Wales (Lord v. Commissioners of the City of Sydney, 1859) indicated they would apply the riparian doctrine in the absence of relevant case law in Victoria, these findings did not imply that a Victorian court would apply this doctrine (Harris E., (2002), Treading Water: An Analysis of Institutions and Natural Resource Sustainability, the case of the Murray River, Unpublished Ph.D. Thesis, The University of Melbourne, p. 76). 5. The WCB comprised two members: George A. Gordon, Chief Advisory Engineer of Water Supply to the Board of Land and Works; and Alexander Black, Assistant Surveyor General. 6. One farmer, Mr. Patchell from Kerang had reportedly engaging in small scale irrigation of 13 acres for 19 years (Agricultural Reporter 1883, p. 55). 7. Alfred Deakin was Victoria’s first Minister for Water Supply and, after Federation in 1901, became Australia’s second Prime Minister. 8. Deakin’s scepticism was motivated by a meeting with Elwood Mead during a tour of the western region of the United States as Chief Commissioner of the 1884 Royal Commission. At the time of his meeting with Deakin, Mead was the Chief of the Irrigation and Drainage Investigations Bureau, a division of the US Department of Agriculture and later came to Victoria as Chairman of the SRWSC (1907 to 1915). Mead was bitterly opposed to private ownership of water resources claiming it led to wasteful exploitation and speculation as had been experienced in the western states of the United States due to the prior appropriation doctrine. Deakin became convinced such problems would occur in Victoria should private ownership be permitted. 9. The inclusion of efforts to remove further acquisition of riparian rights within the colony within this legislation indicates that the government believed, regardless of the absence of case law, that water frontage owners did acquire riparian rights. 10. For more details on the nature and extent of the various subsidies refer to Harris (2002) Chapter 4.

REFERENCES Agricultural Reporter (1883), ‘Irrigation on the Loddon’, The Australasian, 34 (876), 13 January. Agricultural Reporter (1884), ‘Irrigation Experiments’, The Australasian, 36 (951), 21 June.

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Agricultural Reporter (1885), ‘Irrigation at Kerang’, The Australasian, 39 (1009), 1 August. Agricultural Reporter (1885), ‘Among the Irrigators’, The Australasian, 39 (1041), 5 September. Anderson, A., W. Grattan, T. Langdon and J.S. White (1896), ‘Report of the Royal Commission on Water Supply’, VPP, Paper Number 80. Anderson, T. L. and P.J. Hill, (2004), The not so Wild, Wild West: Property Rights on the Frontier, California, USA: Stanford University Press. Anderson, T. L. and D.R. Leal (2001), Free Market Environmentalism: Revisited, Pulgrave Press, USA. Anon (1882), ‘Letter to the Editor’, The Australasian, 33 (870), 2 December. Anon (1883), ‘Irrigation in Victoria’, The Australasian, 34 (888), 7 April. Clark, S. D. (1971), ‘The River Murray Question: Part I – Colonial Days’, Melbourne University Law Review, 8, 11–40. Clark, S.D. and I.A. Renard, (1972), Law of Allocation of Water for Private Use: Framework of Australian Water Legislation and Private Rights, Volume One, Melbourne: Australian Water Resources Council. Davis, P.N. (1971), Australian Irrigation Law and Administration, Volume One, Two and Three, Thesis Submitted as part of the requirements for the Degree of Doctor of Juridical Science, University of Wisconsin, USA. East, L.R. (1962), ‘Pioneers of Irrigation in Victoria,’ Aqua: The Official Journal of the State Rivers and Water Supply Commission Victoria, 13 (9), 141–153. Gordon, G.A. and A. Black (1881), ‘Report of the Water Conservancy Board’, Victorian Parliamentary Papers, Paper Number 18, Melbourne. Hardin, G. (1968), ‘The Tragedy of the Commons’, Science, 3855 (162), 1243–1248. Harris, E. (2002), Treading Water: An Analysis of Institutions and Natural Resource Sustainability, The Case of the Murray River, Unpublished Ph.D. Thesis, The University of Melbourne, Australia. Hayter, H.H. (1875), Victorian Year Book, Melbourne: Victorian Government Printer. Kinney, C.S. (1912), A Treatise on the Law of Irrigation and Water Rights and the Arid Region Doctrine of Appropriation of Water, Volume 1, San Francisco, USA: Bender-Moss. Ostrom, E. (1990), Governing the Commons: The Evolution of Institutions for Collective Action, Cambridge University Press, USA. Powell, J.M. (1968), ‘Three Squatting Maps for Victoria’, The Australian Geographer, 10 (6), 466–471. Powell, J.M. (1989), Watering the Garden State: Water, Land and Community in Victoria 1834–1988, Sydney: Allen and Unwin. Roberts, Sir S. (1924), History of Australian Land Settlement, Melbourne: Macmillan Press. Roberts, S.H. (Reprint 1964), The Squatting Age in Australia, Melbourne: Melbourne University Press. Rutherford, J. (1964), ‘Interplay of American and Australian Ideas for the Development of Water Projects in Northern Victoria’, Annals of the Association of Australian Geographers, 54, 88–106. Scott, A. and G. Coustalin, (1995), ‘The Evolution of Water Rights’, Natural Resource Journal, 35, 821–943. Umbeck, R. (1981), A Theory of Property Rights: with application to the Californian gold rush, Iowa State University Press, USA. Vamplew, W. (ed.) (1987), Australian Historical Statistics, Melbourne: Fairfax, Syme and Weldon.

5.

A Property Framework for Water Markets: The Role of Law Poh-Ling Tan

INTRODUCTION In 1994 the Council of Australian Governments agreed to reform the Australian water industry because water use was inefficient, river systems were seriously degraded, and a better balance in water resource use was required. Water would need to be re-allocated to ‘higher-value’ and sustainable use. Re-allocation through the water market was chosen because it fitted current ideology and probably was least contentious politically. Trade in water required it to be separated from land, and defined as a commodity by itself. To do this, a wide range of specific measures was required including a system of title for water. Because trade might cause detrimental effects to rivers and their communities, water for environmental contingencies would need to be allocated. The policy placed property rights at the heart of reform. In 2004 several Australian States and the federal government have agreed on a further raft of measures referred to as the National Water Initiative (NWI). The debate over the central objective of the current reforms – to develop a water market – initially took place on an ideological plane between the advocates of markets and advocates of regulation.1 Yet in western USA, where water markets have been recommended since the 1960s and a common reality since the mid 1980s, water practitioners have accepted a role for both markets and regulation.2 This view also has been accepted by Australian policy makers. Public debate then shifted to the issue of the characterisation of property. This tended to focus on whether existing water licences constituted a ‘property right’, and whether new water entitlements would constitute property. Discussion was largely fuelled by the question whether licence holders under the existing and future legal regimes would be compensated if their access to water was to be adversely affected by reform measures. During all of this there was little analysis of the framework of property that would underpin the water market. In this chapter, this last aspect of the COAG and NWI reform is considered. The questions addressed are first, whether there are models of water markets 56

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elsewhere that have lessons for institutional design, in particular for a property framework and second, has the reform incorporated a clear legal framework of property rights. From that analysis, it is suggested that public property in water resources should be expressly addressed.

BACKGROUND Australia is an old continent, with areas that are prone to salinity problems (MDBMC 1999). Water is scarce and its supply is variable. As is often said, Australia is both wet and dry. It has some of the wettest areas on earth, while other areas experience prolonged droughts, seasons of low and variable rainfall broken by sweeping floods. Access to water resources in Australia has, in the last 250 years, been governed by three different regimes. Until colonial settlement, indigenous peoples’ relationship to land and water was characterised by a custodial obligations only recently recognised as a form of communal property rights.3 As part of the reception of the English common law into Australia,4 the colonisers instituted a regime of access to water based on a different sort of common property regime. Riparian rights were restricted to a select group of people who occupied land next to rivers. It was recognised in the 1880s that common law riparian principles were not suitable for development of water resources of the colony. Hence a regulatory regime was instituted to vest use and control of water resources in the state.5 Incremental changes were made to that regime for the next 100 years. Under federal and state constitutions, management of water resources is considered a state matter. In the mid-1990s the Commonwealth and state governments agreed that reform was necessary for an efficient and sustainable use of water resources. They noted widespread natural resource degradation and called for new measures to halt this. Most of the Australian states have now passed new water legislation. Amongst the many objectives of reform was the introduction of: • clearly specified water entitlements which separate water property rights from land title; • allocation of water for the environment, and where river systems were overallocated, for ‘substantial progress’ to provide a better balance in water resource use; and • public consultation where new initiatives are proposed especially in relation to pricing, specification of water entitlements and trading in those entitlements.

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Several Australian states entered into the National Water Initiative Agreement (NWI) on 25 June 2004. Unlike the 1994 COAG Framework that was entered into by the Commonwealth all states and territories, Western Australia and Tasmania did not agree to the NWI, thus it cannot be properly called a national initiative. Even so it is an important step for many reasons. Arguably its most important aspect is the setting up of a National Water Commission by the end of 2004. For this discussion the most relevant parts of the NWI are: Entitlements • Consumptive access to water should be described as perpetual/open-ended share of the consumptive pool of a specified water resource (para 28) except if the resource is poorly understood or in other circumstances outlined (para 33). • Essential characteristics of the water product and its ability to be traded, bequeathed, leased, subdivided, mortgaged, enforced and registered are all to form a part of the water access entitlement (para 31). • That after 2014 the risk of reduction in the nominal volume or reliability of the entitlement arising from reductions to the consumptive pool because of natural factors will need to be shared (para 48). Water planning • This specification is dependent on a water plan that has two broad purposes • resource security (as above) and • ecological security by describing environmental and other public benefit outcomes for water systems (para 37). • Native Title will require that plans allocate water for indigenous rights to water, and that traditional cultural values be accounted for. • The plan should provide adaptive management to meet productive, environmental and public benefit outcomes (para 25(iv)). • Planning and regulation will need to recognise that activities may potentially intercept significant volumes of surface or groundwater, e.g. farm dams and bores, use of overland flows and large scale plantation forestry. Therefore a number of measures have been proposed e.g. licensing of significant activities in stressed catchments (paras 55–57). • By 2005 allocations will provide better balance in resource use in systems that are overallocated or deemed stressed, and that by 2010 substantial progress will be made in adjusting all overallocated and overused systems. • Any adjustment to the consumptive pool in water plans (because of natural events such as climate change) after 2014 will need to shared according to a risk formula if no other risk sharing formula is agreed to (paras 46–51).6

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• If adjustments are made to the consumptive pool in water plans because of new environmental objectives, then governments will bear the risks. However no proportionment was given, and it is an assumption that this refers to the states. Water markets • By June 2005 there should be removal of barriers to temporary trade within and between states (para 60). • This deadline applies also for a reduction of barriers for permanent trade for the Southern Murray-Darling Basin. An interim threshold limit is placed on the level of permanent trade out of water irrigation areas of 4 per cent pa of the total entitlement (para 63).7 • By 2007 compatible institutional and regulatory arrangements for trade should be put in place including principles for trading rules (para 60 and Schedule G).

MYTHS OR MODELS OF MARKETS Markets depend on four fundamentals: well-defined rights to goods or resources; many buyers and sellers in the market; goods or resources which are mobile and easily shifted to different use and users; and reliable and adequate information about the market.8 Economists of all persuasions agree that the fundamentals of perfect markets seldom exist in practice. The literature on markets failing to perform efficiently under real conditions (market failure) is voluminous.9 Among the recognised reasons for market failure are externalities, public goods, common property resources and monopolistic situations (Randall 1983). Are there any models of water markets? Writing of the US situation, Dellapenna (2000–01), while declaring that markets are the best tool for managing resources when markets work reasonably well, argues that ‘markets have not worked and will not work for raw water’ (p. 320). He is of the view that markets in the United States have been used to transfer fairly small quantities of water among similar users in close proximity to each other, such as farmers or ranchers within a single irrigation or water management district (p. 324). Others such as Haddad (2000) do not share that pessimism. They observe growing short-term markets in places such as the San Joaquin Valley in California, and even more frequent short-term trades in North Colorado (Carey and Sunding 2001). California’s water market is firmly established with annual trades accounting for roughly 3 per cent of water use (Hanak 2003). However, large-scale long-term trades are few and far between (Haddad 2000 pp. 133–

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146). Those who have significant experience studying water markets in the US advocate a strong role for regulation of markets (Haddad, 2000, pp. 141–148 and Colby 1995, p. 475). Regulation, in their view, should relate to the scope and direction of water reallocation, and also take into account externalities. Have water markets worked well elsewhere? The World Bank points to longstanding and successful water markets in Brazil, Spain and Colorado (Marino and Kemper 1999). However the Chilean model is said to be the world’s leading example of a free market approach to water law, water rights and water resource management. Boldly introduced in 1981, the Chilean model has been trumpeted as a success story by many including the World Bank (Bauer 2004). However, Bauer (1998, p. 120), who has studied the Chilean water market for over a decade, considers that many proponents of the free market policies, particularly neo-liberal economists, oversimplify what is involved in several key processes that market forces depend on but cannot carry out themselves: defining property rights, resolving conflicts and dealing with externalities. Bauer’s early research published in 1998 showed that Chilean water markets were relatively inactive, took place within the agricultural sector and did not involve non-agricultural water uses (Bauer 1998, p. 56). Later empirical research has substantiated this with the primary exception being the Limari water market which has frequent short-term trades within the agricultural sector, with water moving to higher value uses within the same reservoir system (Bauer, 2004, p. 89). Optimism by commentators on the Chilean water code is based on their ignorance of Chile’s political and constitutional system (Bauer 2004, p. 28). What limited the Chilean water market? A range of obstacles were initially identified including physical geography and existing infrastructure which made it difficult to redistribute much water, and legal and administrative factors such as uncertainly of titles, with rights granted under previous legislation not being registered or updated. Therefore there were an unknown number of legal valid rights that in theory could be asserted at any time (Bauer 1998, pp. 56–62). Later research has identified other broader difficulties within the Chilean water regime.10 Among them are: 1. an adequate framework for river basin management, coordination of multiple water uses and conjunctive management of surface water and groundwater is lacking in Chile; 2. reliance on private bargaining to coordinate different water uses and resolve water basin conflicts between consumptive and non consumptive uses has failed. 11 Neither the regulatory authorities (which have very limited functions) nor the courts reliably address the conflicts;

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3. both economic and environmental externalities are not successfully internalised; and 4. a lack of public assistance to poor farmers to improve social equity in matters of water rights and water markets. Bauer’s most recent observation is: The critical problem is that property rights to water are defined as strictly private commodities in such broad and unconditional terms that there is no effective way to assert or defend public rights and interests – whether these public interests are economic, social or environmental.… Legislation should be drafted to clarify the rules governing the exercise of non-consumptive versus other water rights in managing river basins, dams and reservoirs (Bauer 2004, p. 130).

In other words, Bauer is telling us that it is essential to protect public rights and interests in water, more so if water markets are created. He suggests that rules should be clear, but at the same time there should not be an overemphasis on the definition or specification of private tradeable rights in water. In terms of a property framework, the Colorado and Spain case studies undertaken by the World Bank show that a market was developed for usufructuary rights while the water itself remained public property (Marino and Kemper 1999). The next part of the chapter explores some of these terms.

A PROPERTY FRAMEWORK Throughout history, society has accepted that there are degrees and types of property, and that it is a concept that is not of standard content and invariable intensity. All societies have had ideas of property that transcend their individual members. To help in our understanding, analysts use a construct, a continuum of many gradations from ‘individual’ (private) to ‘communal’ (public). Despite the existence of the many intermediate forms of property holding, it is the dichotomy between the individual and the communal which has particular resonance in Western liberal societies (Gray and Gray 1998, p. 16 and Tan 2002b, p. 269). Legal writing since the time of the Romans recognises that there are at least four property regimes: completely open access, common property, private property, and state/public property. An open access (res nullius or nobody’s property) regime most typically applies to wild animals, birds or fish. Any person may capture the animal and thereby appropriate property in it. Where resources were in such a state of abundance and purity that restrictions on control and regulation were not necessary the Romans, rather misleadingly, referred to them as ‘common property’ but recognised that no property in them

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existed, rather it was available to all users. State or public property was similar to common property but a property interest did exist and the state could exercise powers of exclusion. Rivers as such were considered public property and running water was common property. Rights of usufruct, to take and use the resource but not to destroy or fundamentally alter its character could exist, and these were considered rights of property as well, but ‘ownership’ of the resource lay elsewhere. The Romans recognised private property along the same lines that we do today, and once animals were captured, or water was collected, it became private property. Generally, under Roman law individual consumptive values were given lesser weight than collective values in water. It may be helpful for this discussion to keep these types of property and these values in mind. At English common law, running water was considered publici juris that is, public and common and no property existed in it. Rivers were not considered public property. In England the availability of a plentiful supply of water meant that the public interest in rivers was seldom, if at all, threatened. The English common law focused on access rights not on property rights. At English common law, rights to access became more important than who owned the water. Based on Roman law concepts, European and Middle Eastern legal systems have long accepted rivers as public property.12 Amongst others, contemporary Spanish and French laws expressly acknowledge that water in rivers are public property. In the USA, water resources are declared as public property in many state constitutions.13 On the other hand, Islamic law views water and ‘great rivers’ as common property 14 while private rights are confined to small volumes of water within well-defined boundaries.15 The law as it developed in Scotland added to the property framework. In Scotland a civil law system based on Roman law exists. Initially, running water was subject to restrictions in the common interest. Eventually by the late eighteenth century the common interest became a type of ownership in itself (Reid 1996, p. 222). At present the most prevalent understanding of common property is that it is a right in the resource itself except that it accrues to a group of individuals (Williamson, Brunckhorst and Kelly 2003, p. 64). It is probable that holders of common property may be allowed to exercise their rights through customary arrangements.16 However Australian courts have yet to give shape and form to the concept of common property. COAG’s Property Framework A mix of types of property in water resources is implicitly acknowledged in COAG policy. In calling for water to be allocated for the environment, and for environmental studies to be done before implementation of any new significant

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irrigation or dam projects, COAG recognised that public interests are to be considered. 17 Market theory also recognises public property through acknowledging that certain aspects of water such as environmental quality are public goods.18 So too are instream use of water,19 the protection of aquifers, and conservation of biodiversity. In a policy document developed pursuant to COAG directions, public property in environmental water provisions was implicitly recognised.20 But neither COAG nor the NWI has established an expressed conceptual framework of property rights in water. In my view, a place for public property needs to be reserved in the property framework. Epstein (1994) theorised the nature of property in rivers this way: It hardly makes any sense for one person to own a river, or some portion of it, if the price of that ownership is to exclude access to its waters by all riparians, and travel and recreation along the river by the public at large. These are cases where the costs of exclusion are high relative to the benefits that it generates. While the primary values of rivers and seas are preserved when they are held in common, further improvement is possible if some limited conversion of water for private use is tolerated . . . The underlying instinct shows the importance of making marginal adjustments to fundamental institutions. In principle, the formal problem to be solved (although Justinian and the Romans would scarcely have put it this way) is how to take a body of water, which has value in multiple uses simultaneously, and devise a system of rights that maximises the value from the sum of its common and private uses. The Romans had a intuitive sense of the relative values at stake because they in fact adopted an intermediate solution that left the commons dominant, but allowed some diversion from it . . . It was routinely held that each of the riparians had a ‘usufructuary’ interest in the water which allowed them to make limited diversions for domestic uses (p. 28).

The argument that Epstein makes is compelling. He points to the subsequent evolution of water law in support of his proposition that there is an intermediate position that needs to be struck.21 In a changing world, where and how does society decide where to draw the lines between protection of the commons and the private use of the resource? Epstein concludes that the ultimate judgment depends on the reconciliation of two opposing claims to the resource with the objective of maximising the total value of the resource. Legal rules need to be adopted to resolve claims to both the common stock (public values) and its yield (private values). These legal rules are best formulated when there is a clear framework of property drawing from an understanding of the forms of property that have historically existed in water. If private values are embodied in private property rights, in a new legal regime that is based on property in water, public values similarly need to be embodied in public property rights. Because it is society as a whole that formulate the relationships which sustain a property regime,

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communal (public) rights need to be just as well defined as private rights, especially when markets are introduced. Historically the legal regime in water was that of a common property regime where no property existed in flowing water. It will be argued in the next part of this chapter that the licensing regime introduced since the late nineteenth century by state legislation superimposed on that a right by states to regulate the resource. However that regime did not fundamentally disturb the common property regime of the common law. Regulation not Ownership – the ‘Vesting’ Formula The formula in early Australian water legislation was to ‘vest’ the use, flow and control of water in the Crown. Many think that Australian legislation already provides for public ownership of water through the ‘vesting’ provisions.22 It was certainly the intention of Deakin’s original formula in his proposals in the late nineteenth century for vesting title to water in the Crown and limiting private riparian rights by declaring that all water at any time in any river ‘shall in every case by deemed to be the property of the Crown (emphasis added)’.23 However there was strong opposition to the formula, because of the common law’s abhorrence of property in running water. The formula eventually adopted in Victoria vested in the state the ‘right to use and control’ of water resources. In Clark and Myers’ (1969) opinion, the adopted formula conferred sufficient regulatory powers on the state by creating a rebuttable presumption of a superior usufructuary interest in the Crown, and did not confer ‘ownership’ in any sense. They argued that where statutory declaration followed private law terminology in declaring that waters were the property of the state, confusion resulted.24 Arguing that the state’s regulatory power was sufficient to carry out the public control of resources, they wrote that provided that particular powers conferred on the Crown are ample to carry out its objects, it would be preferable to settle for a system of regulative intervention rather than to invoke conceptual confusion by introducing superfluous notions of property (p. 256).

Their view would have persuaded the drafters of the Water Act 1989 (Vic) to dispense with the word ‘vesting’. Instead the Act states ‘the Crown has the right to the use, flow and control of all water in a waterway and in all groundwater’.25 Victoria’s current regime is deliberately based on control, not ownership, of flowing water. It is only in the Northern Territory where section 9 of the Water Act vests ‘property in and the rights to the use, flow and control of all water’ in the Territory. In all other states the water regime generally married two legal approaches – it introduced public control while retaining the common law’s disdain of acknowledging property rights in water. For example the legislative

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formulae in NSW and Queensland continue to use the ‘vesting’ concept,26 which may connote a right of property.27 But Fisher (2000) considers the vesting formula as merely giving a right of primary access to the Crown, a legal mechanism ‘through which the public management regime is given effect (p. 91)’.28 The Australian High Court in at least two decisions has regarded statutory vesting as confined to the purpose to be fulfilled. The first, H Jones v Kingsborough Corporation, arose from vesting rivers in local councils,29 and the second, Yanner v Eaton30 from vesting fauna in the Crown. In Yanner’s case, the joint judgment of Gleeson CJ, Gaudron, Kirby and Hayne JJ regarded statutory vesting as nothing more than a legal fiction expressing that a State has the power to preserve and regulate the exploitation of an important resource.31 Gummow J, in agreement with the majority, applied a decision of the Privy Council that the term ‘vest’ is of elastic import; and a declaration that lands are ‘vested’ in a public body for public purposes may pass only such powers of control and management and such proprietary interest as may be necessary to enable that body to discharge its public functions effectively.32 While Gummow J took the view that the purpose of vesting was for the limited statutory pecuniary purposes of charging royalties and imposing penalties on the taking of fauna,33 the majority were of the view that the Crown’s interest included guardianship of the resource for social purposes.34 The majority view in both H Jones and Yanner consistently accepted that if the purpose of vesting the resource is limited, the extent of vesting will similarly be limited. Present water legislation has now expanded purposes of regulation beyond the confines of early legislation. For example Water Management Act 2000 (NSW) s 3 states: The objects of this Act are to provide for the sustainable and integrated management of the water sources of the State for the benefit of both present and future generations and, in particular: (a) to apply the principles of ecologically sustainable development, and (b) to protect, enhance and restore water sources, their associated ecosystems, ecological processes and biological diversity and their water quality, and (c) to recognise and foster the significant social and economic benefits to the State that result from the sustainable and efficient use of water, including: (i) benefits to the environment, and (ii) benefits to urban communities, agriculture, fisheries, industry and recreation, and (iii) benefits to culture and heritage, and (iv) benefits to the Aboriginal people in relation to their spiritual, social, customary and economic use of land and water, (d) to recognise the role of the community, as a partner with government, in resolving issues relating to the management of water sources, (e) to provide for the orderly, efficient and equitable sharing of water from water sources,

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The Evolution of Markets for Water (f) to integrate the management of water sources with the management of other aspects of the environment, including the land, its soil, its native vegetation and its native fauna, (g) to encourage the sharing of responsibility for the sustainable and efficient use of water between the Government and water users, (h) to encourage best practice in the management and use of water.

When interpreting this provision, it is probable that the courts may find that the State may indeed be guardian of the resource for the community. Gap in the Present Statutory Framework Some of the more recent Australia literature comments on the misconceptions about property rights.35 From a legal perspective, these misconceptions are arguably derived from how the common law and statutes characterise property. While state and federal statutes define the term ‘property’ they are really referring to private property.36 The political scientist, MacPherson (1978), provides an explanation for the elevation of private property under common law. He observes that property is a relationship between human beings with reference to an object, which may not be material. It is so important a relationship that the state extends protection to it, and whatever the state accords protection, lawyers and judges call ‘property’.37 Therefore society’s actions initialise the creation of a property right, and governments recognise and articulate that creation. Because property rights serve human values, it is a concept continually in the state of change, and it is a balance struck between competing individual and collective goals.38 MacPherson shows that this identification of ‘property’ with private property only goes back to the seventeenth century. It was only when capitalist society flowered, that the concept of common property dropped virtually out of sight. Before that, societies were familiar with the other categories of property. Gray (1991) comments that the formative phases of the common law concept of property coincided with a remarkable culture of bargain and exchange. Non-transferable rights or rights which failed on transfer were simply not ‘property’. In other words the institution of property began to take its meaning from private property which could be bought and sold. This approach resulted in the classic definition of property made by Lord Wilberforce in National Provincial Bank v Ainsworth that: before a right or an interest can be admitted to the category of property . . . it must be definable, identifiable by third parties, capable in its nature of assumption by third parties, and have some degree of permanence or stability.39

The Australian High Court in R v Toohey; Ex parte Meneling Station P/L40 adopted the test in Ainsworth, and concluded that a grazing licence issued

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under Northern Territory crown lands legislation was not an interest in property because of two features: • The statutory power of the Minister to forfeit the licence for non-compliance by giving three months notice. No default on the part of the licensee is necessary. • The inability of the holder to assign the licence to a third party. Assignability was considered not to be an essential characteristic of a right of property, but Mason J said that a proprietary right must be ‘capable in its nature of assumption by third parties’.41 Later, courts such as the Federal Court in Western Mining Corporation Ltd v Commonwealth 42 and the High Court on appeal in that matter43 have accepted that for the purposes of determining whether exploration permits issued under Commonwealth petroleum legislation was property within the context of the Commonwealth Constitution, the following factors were accepted as indicia of property: that the subject matter was identifiable, assignable, stable and potentially of substantial value. Flexible statutory schemes for fishing permits have also been accepted as property by the Federal Court.44 Discussion on the characterisation of property tends to focus on whether the subject matter is that of private property. This is just one of the building blocks in the property framework, with public property as another important building block. If water legislation is silent on this, then it will be for the courts to deal with the issue whether the state is a guardian of the resource. The next part of the chapter deals with the important respects in which public property different from private property and the implications of declaring water as public property.

WATER AS PUBLIC PROPERTY It has been argued earlier that the Australian administrative regime in water is based on control not ownership of the resource. Where the resource is ‘vested’ in the State by statute, the vesting is limited to the purposes that the statute sets out to fulfil. Vesting of water in the state may result in the finding that the State has the power to preserve the resource and a guardianship interest. This may mirror the public trust doctrine that has been developed in US jurisprudence, but I shall argue that an express provision of the state holding public property in water is preferred. US water lawyer Trelease (1957) showed that state ‘ownership’ of water as enacted in several western US state constitutions had been interpreted by the courts to denote sovereignty rather than proprietorship. The State as the holder

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of legal title conferred under a state constitution does not hold property in the sense of private property but in the sense of trustee for the benefit of the people of the state. As trustee, the state and its agencies are bound to faithfully administer that trust and are answerable to the courts in the exercise of their duty. The trusteeship concept has roots in Roman law’s distinction of imperium versus dominium. Natural resources are held in trust for the public where state ownership is imperium, as in beds of navigable streams.45 Historically the public trust had fairly narrow limits, but Sax (1970) revived the concept of the public trust in more recent times, maintained that there is no reason why the doctrine should not be enlarged to wherever diffuse public interests needed protection against tightly organised groups with clear and immediate goals.46 Where private interests intersected with public claims, the former should give way to the latter.47 The doctrine as applied in the US, involved a continuing duty by the state to regulate water uses for the benefit of the general community. This duty required the state to supervise the exercise of water rights, and reconsider those rights when public trust values were endangered. When the exercise of a previously legitimate claim to water began to damage public interest, the state should reallocate the water right in a way that minimised such damage (Swenson 1999). Although responses to the doctrine were often polarised, the public trust doctrine has become an accepted part of the natural resource jurisprudence in the US.48 Courts have held that a public right to water comes with an obligation on the part of the state to protect, control and regulate the use of water for the benefit of its people.49 The Supreme Court of Hawai’i in 1974 declared that the right to water is one of the most important usufruct of lands and it was specifically reserved for the people of Hawai’i for their common good in all land grants. Thus the ownership of water in natural watercourses remained in the people of Hawai’i.50 Recently, the same court clarified that the State ‘owned’ water not in the corporeal sense where the state could do with the property as it pleases, but as a retention of such authority to assure the continued existence and beneficial application of the resource for common good. Admitting that the State unquestionably had the power to accomplish much of this through its police powers (or its power as a sovereign), the Hawai’ian Supreme Court ruled We believe that the [Hawai’ian] king’s reservation of his sovereign prerogatives respecting water constituted much more than restatement of police powers, rather we find that it retained on behalf of the people an interest on the waters of the kingdom which the State has an obligation to enforce, and which necessarily limited the creation of certain private interests in waters.51

In Australia, as long ago as the late nineteenth century, court decisions constrained governments’ action in recognition of the State’s duty to protect

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current and future public interests in parklands and foreshores. Bonyhady (1995) argues that events surrounding those early cases support the idea that a public trust was part of Australia’s popular, political and legal culture.52 Judgments in several contemporary cases have used the language of public trust, although the public trust doctrine as recognised in the US has not been specifically applied.53 In lieu of a clear framework for public property rights in water, should Australian policy-makers and legislators leave acknowledgement and protection of public rights of property for the courts to develop by a doctrine of public trust?54 Although no declaration of property or ownership existed over water, beds and banks of the rivers were declared property of the State in Victoria and Queensland, thus there may be grounds for arguing that a public trust arises over these resources. While the doctrine allows courts to intervene in the allocation of precious natural resources, it has been criticised as archaic and amorphous, and distinctly an American creation which had no foundation in the English common law.55 It may be further argued that the courts may not be the best legal institution to protect environmental flows in water. Courts make decisions in fact-specific cases. They are ill suited to be, and are reluctant, policy-makers. They cannot provide the details of a program of public rights that should be part of a state’s water allocation and planning policy.56 It would be preferable to have a clear legislative expression of public property and provision for its protection in a framework of property rights. Perhaps only a pedant will find that there is a difference between the present (regulatory) regime and one where public property is express. However it may be argued that if a guardianship function by the state is specifically stated in legislation then public agencies will be mindful that they do not merely exercise an administrative role in exercise of the political authority of the state to grant interests in water resources. Private property and interests created in the resource will be recognised as being merely usufructuary, meaning that they are rights to take and use, not to destroy or fundamentally alter the character of the resource. Markets created to trade in those rights and interests are subject to the ultimate guardianship of the State, whose role is to regulate not merely for the sake of efficiency. If ultimate ‘ownership’ of the resource lies with the state, it justifies the state’s role in regulating markets in the scope and direction of water reallocation, and also to intervene in transactions that fail to take into account externalities. The objects of state regulation such as expressed in section 3 of the Water Management Act 2000 (NSW) is made known to the populace in a way which is entrusted to assure the continued existence of beneficial application of the resource for common good. Where there is privatisation of water services, the idea of the common good inherent in public property in the resource will also provide guidance in the ethical debate.

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CONCLUSION Express acknowledgement that water is public property will do more than just affirm the State’s power to control and use. A framework that clearly acknowledges public property in water will be a starting point for better policy and better drafted legislation. In accordance with the jurisprudence that has developed in the US, such a statement will impose an obligation on the State to protect the public’s interest in water, and to limit the creation of private interests in water which conflict with the public interest. Using the concept of property instead of merely relying on the state’s power to control is to call on property’s most important role – to provide an educative function under the law (Rose 1996). Words such as ‘state ownership’ convey the meaning that in a crowded world the social interest in the use and conservation of water has become more important than some individual interests (Lasky 1929, Trelease 1957). Words have a magic and may clarify or obscure an idea. If the words ‘property’ and ‘markets’ have entered the lexicon in allocating and managing water, then to communicate to the ordinary person who holds water rights, that these rights are merely those of use and emanate from a higher ‘owner’, then public property in water should be specifically provided for in statutes that allow water markets.

NOTES 1. See for example Moran (1995) and Kinrade (1995). 2. See for example Saliba and Bush (1987), Colby (1990), Committee on Western Water Management (1992), Carter, Vaux Jr. and Scheuring (1994) and Tarlock (1995). 3. For a description of Aboriginal use of water see Smith (1998) and for an analysis of Aboriginal title to water resources, see Bartlett (1997). 4. The common law was received into Australia on British acquisition of sovereignty. See generally Mabo v Queensland (No 2) (1992) 175 CLR 1. 5. For an account see Tan (2002a). For a general text see Fisher (2000). 6. For the first 3 per cent, risk will be borne by the entitlement holder, from 3 to 6 per cent to be shared between States and the Commonwealth in a one to three proportion; and greater than 6 per cent shared equally between States and the Commonwealth. 7. It is unclear whether the base total entitlement is that at June 2005 or whether it is a shrinking base, i.e. readjusted each year. 8. For literature and discussion on conditions for a perfect market see Brajer et al. (1989). 9. See Lecomber (1979 pp. 83–4) for a list of literature critiquing the perfect market paradigm. 10. Bauer (2004, p. 124) states that these flaws were widely recognised by water experts within Chile. 11. Bauer (2004) refers to inter basin transfers where there were conflicts between irrigators and electric companies over how to operate dual purpose reservoirs and environmental impacts on transfers. Some of the reasons he cites at p. 100 are that the economic stakes are high, legal rules not sufficiently clear, and the relative bargaining power of actors are unequal. 12. See Teclaff (1972). Spanish law, influenced by Moorish and Roman laws has, since the thirteenth century, considered rivers as public property. French law has since 1669 treated navigable and floatable rivers as destined for public use and not susceptible to private

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13.

14. 15. 16. 17. 18. 19. 20. 21.

22. 23. 24. 25. 26. 27. 28. 29.

30. 31. 32. 33. 34. 35. 36. 37. 38.

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ownership. Iranian laws which bear the imprint of many ancient legal systems, treat all waters in their natural state, whether on private or public land, as in the public domain. Although the exact formulation differs, several western constitutions declare that water is the property of the state, for example the Colorado Constitution Art XVI, § 5; Montana Constitution Art IX, § 3, New Mexico Constitution Art XVI § 3: see Blumm (1989) pp. 583, 576 note 12. Small rivers are predominantly for riparian use. Nanda (1977) p. 43. For example water contained in a cistern, or in ownership with others who built an artificial channel for water: see Nanda (1977) p. 42. There is extensive literature on common property institutional arrangements. For example see Williamson, Brunckhorst and Kelly (2003), Bromley (1992) and Ostrom (1990). Working Group on Water Resources (1994) and Working Group on Water Resources (1995). None of the submissions received by COAG disputed that environmental requirements of water bodies should be determined: Second Report, 6. See for example Howe, Schurmeier and Shaw (1986) and Mäler (1984). See for example, MacDougall (1996), Butler (1985) and Day (1996). Agricultural and Resource Management Council of Australia and New Zealand and Australian and New Zealand Environment and Conservation Council (1996). Principle No. 3 states that environmental water provisions should be legally recognised. Epstein (1994) refers to Rose on how technology, specifically the use of mills for power, changed the system of property rights in water. The older system of water rights, through numerous disputes that courts adjudicated, changed to a new system that allowed more extensive private use of water. The new position had the same generic feature of the old system but struck the balance in a different way. For example, see Challen (2000). Irrigation Bill 1886 cl 4. See discussion in Clark and Meyers (1969). Clark and Meyers (1969) pp. 247 and 256, referring to Cutler (1965). Water Act 1989 (Vic) s 7. Water Management Act 2000 (NSW) s 392, and Water Act 2000 (Qld) s 19. Coverdale v Charlton (1878) 4 QBD 104 per Brett LJ, 120. Fisher, Water Law, LBC, Sydney, 2000, 91. See also chapter 5 particularly at 94, 103-116. H Jones v Kingsborough Corporation (1950) 82 CLR 282. Dixon J at 320 in applying English authority ruled that statutes which vest highways, and sewers in a public authority which serve a definite public purpose have received a construction according to which the authority takes less than the full property in the site. The same sort of construction appeared appropriate when rivers, creeks and water courses were vested in a water supply authority. The description of the subject vested was indefinite. It is not a piece of land with defined boundaries therefore the purpose is limited. Yanner v Eaton (1999) 73 AJLR 1518. Yanner v Eaton (1999) 73 AJLR 1518, 1525 per Gleeson CJ, Gaudron, Kirby and Hayne JJ. Yanner v Eaton (1999) 73 AJLR 1518, 1538 per Gummow J citing the decision of the Privy Council in Attorney-General for Quebec v Attorney-General for Canada [1921] 1 AC 401. The emphasis was added by Gummow J. Yanner v Eaton (1999) 73 AJLR 1518, 1539. Yanner v Eaton (1999) 73 AJLR 1518, 1525. See for example, Martin and Verbeek (2002). For example the Interpretation Act 1987 (NSW) defines property to mean ‘any legal or equitable estate or interest (whether present or future and whether vested or contingent) in real or personal property of any description, including money, and includes things in action’. Many property texts deal with the theoretical arguments justifying the idea of property for example see Penner (1997) and Waldron (1988). See Underkuffler (1990). One school of thought sees that the concept has been subject to a shifting of the balance from individual rights towards a greater emphasis on the collective social interest: Cribbet (1986).

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39. [1965] AC 1175, at pp. 1247-8. That statement, made in 1965 the context of a matrimonial dispute over assets, is often taken as an authoritative pronouncement of the essential elements of the institution of property. 40. (1982) 158 CLR 327. 41. (1982) 158 CLR 327, at pp. 342–343. 42. Western Mining Corporation v Cth (1994) 121 ALR 661, at 682. The permits were issued under the Petroleum (Submerged Lands) Act 1967 (Cth) and authorised exploration for petroleum in the seabed in an area of the continental shelf between Australia and Indonesia. 43. Commonwealth v Western Mining Corporation Resources Ltd (1998) 194 CLR 1, at 17. 44. See Bienke v Minister for Primary Industries and Energy (1995) 135 ALR 128 and Minister for Primary Industries and Energy v Davey (1993) 119 ALR 108. For a full discussion see Tan (2003). 45. Sax (1970) p. 113, 645 citing the decision of Ivanhoe Irrigation District v All Parties 47 Cal 2d 597, 625, 306 P 2d 824, at pp. 840–41. 46. Sax (1970) pp. 471, 556 identifies these as the land below the low water mark on the margin of the seas and lakes, the waters over those lands, waters within rivers and streams of any consequence, and parklands. 47. When it was in the public interest to promote industrialisation, the Supreme Court of Pennsylvania in ruling that the downstream landowner’s riparian rights to have a flow of water unchanged in quality and quantity had to yield to an upstream coal company’s actions of dumping its waste into the river: Sanderson v Pennsylvania Coal Co 86 Pa 401 (1878), rev’d, Pennsylvania Coal Co v Sanderson, 113 Pa 126, 6 A 453 (1886), cited in Sax (1989) pp. 473, 476–7. 48. The leading case accepting the public trust doctrine and applying it to land under navigable waters of is Illinois Central Railroad v Illinois (1892) 146 US 387. The celebrated California Supreme Court case of National Audubon Society v Superior Court of Alpine County (1983) 658 P 2d 709, Cal. (the Mono Lake case) applied the public trust doctrine to water resources. 49. See for example the Hawai’ian Constitution, s 7. See also section 1 which states: ‘for the benefit of present and future generations, the State . . . shall conserve and protect Hawaii’s natural beauty and all natural resources, including land, water, air . . . and shall promote the development and utilization of these resources in a manner consistent with their conservation and in furtherance of the self sufficiency of the State’. 50. McBryde Sugar Co v Robinson 54 Haw 174, P. 2d 1330, affirmed on rehearing 55 Haw 250, 517 P 2d (1973), appeal dismissed, 417 US 962, 94 S ct 3164, 41 L Ed 2d 1135 (1974). 51. In the matter of the water use permit applications, Petitions for Interim Instream Flow Standard Amendments, and Petitions for Water Reservations for the Waiahole ditch Combined Contested Case Hearing 94 Hawai’i 97, 9 P 3D 409 (2000), 218. 52. Bonyhady (1995) pp. 329, 337. The cases involved the Victorian government in 1875 selling Albert Park for development of housing, and the NSW government’s 1895 attempt to grant part of the foreshore of Port Jackson for setting up a coal mine under the Sydney Harbour. 53. See York Bros (Trading) Pty Ltd v Cmr of Main Roads, [1983] 1 NSWLR 391, 393; and Worimi Local Aboriginal Land Council v Minister (1991) 72 LGRA 149, 161 both of which acknowledge the existence of a public right to navigation and anchorage over tidal navigable rivers. See also Stein (1996). 54. The public trust doctrine is seen as an adjunct to legislative schemes especially where those schemes are weak: see Stein (1996). 55. Application of the doctrine has been criticised on four main grounds: that the doctrine is vague and indeterminate; that the statements of Roman law on which it is based is of undeserved authority because they were meant as mere introductory comments, or normative statements of what the Emperor wished the law to be; that enactment of environmental legislation has rendered the doctrine obsolete; that the doctrine results in overturning of serious legal processes, and conflicts with fundamental legal institutions such as the ‘takings’ clause. See for example Lazarus (1986); Walston (1982); Rosen (1982); Huffman (1989); and more recently Scott (1998). 56. Tarlock (1988)and Getches (1998).

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REFERENCES Agricultural and Resource Management Council of Australia and New Zealand and Australian and New Zealand Environment and Conservation Council (1996), National Principles for the Provision of Water for Ecosystems, Occasional Paper SWR No 3, Canberra. Bartlett, R.H. (1997), ‘Native Title to Water’, in Bartlett, R.H., A. Gardner and S.Mascher (eds) Water Law in Western Australia, Perth: Centre for Commercial and Resources Law, UWA and Waters and Rivers Commission. Bauer, C. (1998), Against the Current: Privatization, Water Markets, and the State in Chile, Boston: Kluwer. Bauer, C. (2004), Siren Song: Chilean Water Law as a Model for International Reform, Washington DC: Resources for the Future. Blumm, M. (1989), ‘Public Property and the Democratization of Western Water Law: A Modern View of the Public Trust Doctrine’, Environmental Law, 19, 573–604. Bonyhady, T. (1995), ‘A Usable Past: The Public Trust in Australia’, Environmental and Planning Law Journal, 12, 329–337. Brajer V., A. Church, R. Cummings and P. Farah (1989), ‘The strengths and weaknesses of water markets as they affect water scarcity and sovereignty interests in the West’, Natural Resources Journal, 29, 489–510. Bromley D. (ed.) (1992), Making the Commons Work: Theory, Practice and Policy, San Francisco: Institute for Contemporary Studies. Butler, L. L. (1985), ‘Allocating Consumptive Water Rights in a Riparian Jurisdiction: Defining the relationship between Public and Private Interests’, University of Pittsburgh Law Review, 47, 95–181. Carey, J. and D. Sunding (2001), ‘Emerging Markets in Water: A Comparative Institutional Analysis of the Central Valley and Colorado-Big Thompson Projects’, Natural Resource Journal, 42, 283–330. Carter, H.O. H.J. Vaux Jr. and A.F. Scheuring (eds) (1994), Sharing Scarcity: Gainers and Losers in Water Marketing, California: Agricultural Issues Center, University of California. Challen, R. (2000), Institutions, Transaction Costs and Environmental Policy, Cheltenham, UK and Northhampton, MA USA: Edward Elgar. Clark, S.D. and A.J. Meyers (1969), ‘Vesting and Divesting: The Victorian Groundwater Act 1969’, Melbourne University Law Review, 7, 237–257. Colby, B. (1995), ‘Regulation, Imperfect Markets and Transaction Costs: the Elusive Quest for Efficiency in Water Allocation’, in D. Bromley (ed.), The Handbook of Environmental Economics, Cambridge Mass. and Oxford: Blackwell. Colby, B.G. (1990), ‘Enhancing Instream Flow Benefits in an Era of Water Marketing’, Water Resources Research, 26, 1113–1120. Committee on Western Water Management (1992), Water Transfers in the West: Efficiency, Equity and the Environment, Washington DC: National Academy Press. Cribbet, J. (1986), ‘Concepts of Transition: The Search for a New Definition of Property’, University of Illinois Law Review, 1–42. Cutler (1965), ‘Chaos or Uniformity in Boating Regulations. The State as Trustee of Navigable Rivers’, Wisconsin Law Review, 311–321. Day, D. (1996), ‘How Australian Social Policy Neglects Water Environments’, Australian Journal of Soil and Water Conservation, 9, 3–9. Dellapenna, J. (2000-2001), ‘The Importance of Getting Names Right: The Myth of Markets for Water’, William & Mary Environmental Law and Policy Review, 25, 317–378.

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Epstein, R.A. (1994), ‘On the Optimal Mix of Private and Common Property’, in Paul, E.F., F.E. Miller Jr and J. Paul (eds) Property Rights, Cambridge: Cambridge University Press. Fisher, D. (2000), Water Law, Sydney: LBC Information Services. Getches, D.H. (1998), ‘Pressures for Change in Western Water Policy’, in D.H. Getches (ed.) Water and the American West, Boulder: Natural Resources Law Center. Gray, K. (1991), ‘Property in Thin Air’, Cambridge Law Journal, 50, 252–307. Gray, K. and S. Gray (1998), ‘The idea of property in land’, in S Bright and J Dewar (eds), Land Law: Themes and Perspectives, Oxford: Oxford University Press. Haddad, B. (2000), Rivers of Gold: Designing Markets to Allocate Water in California, Washington DC: Island Press. Hahn, C.M. (1998), ‘Introduction: The embeddedness of property’, in Hahn, C.M. (ed.), Property Relations: Renewing the anthropological tradition, Cambridge: Cambridge University Press. Hanak, E. (2003), Who Should Be Allowed to Sell Water in California? Third –Party Issues and the Water Market, San Francisco: Public Policy Institute of California. Howe, C.W., D.R. Schurmeier and W.D. Shaw (1986), ‘Innovative approaches to water allocation: the potential for water markets’, Water Resources Research, 22, 439– 445. Huffman, J.L. (1989), ‘A Fish Out of Water: The Public Trust Doctrine in a Constitutional Democracy’, Environmental Law, 19, 527–572. Kinrade, P. (1995), ‘Towards Ecologically Sustainable Developments: The role of Shortcomings of Markets’, in Eckersley, R. (ed.), Markets, the State and the Environment: towards Integration, Melbourne: MacMillan. Lasky, M. (1929) ‘From Prior Appropriation to Economic Distribution of Water’, Rocky Mountain Law Review, 1, 161–216. Lazarus, R.J. (1986), ‘Changing Conceptions of Property and Sovereignty in Natural Resources: Questioning the Public Trust Doctrine’, Iowa Law Review, 71, 631–716. Lecomber, R. (1979), The Economics of Natural Resources, London: Macmillan. MacDougall, D.W. (1996), ‘Private Hopes and Public Values in the “Reasonable Beneficial Use” of Hawai’i’s Water: Is Balance Possible?’, University of Hawai’i Law Review, 18, 1–70. Macpherson, C.B. (ed.) (1978), Property: Mainstream and Critical Positions, Toronto: University of Toronto Press. Mäler, K. (1984), ‘Cost-benefit Analysis: The Basic Facts’, in Ahmad, Y.J. et al., Environmental Decision-Making, Vol. 2, London: Hodder and Stoughton. Marino M. and K. Kemper (eds) (1999), Institutional Frameworks in Successful Water Markets: Brazil, Spain and Colorado, USA, Technical Paper no. 427, Washington DC: World Bank. Martin, P. and M Verbeek (2002), ‘Property rights and Property Responsibility’, in Property: Rights and Responsibilities, Current Australian Thinking, Canberra: Land and Water Australia. Moran, A. (1995), ‘Tools of Environmental Policy: Market Instruments versus Command and Control’, in Eckersley, R. (ed.) (1995), Markets, the State and the Environment: towards Integration, Melbourne: Macmillian. Murray-Darling Basin Ministerial Council (1999), The Salinity Audit: A 100 year perspective, 1999, Canberra: MDBMC. Nanda, V.P. (1977), Water Needs for the Future, Boulder: Westview Press. Ostrom, E. (1990), Governing the Commons: The evolution of institutions for collective action, Cambridge: Cambridge University Press.

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Penner, J.E. (1997), The Idea of Property in Law, Oxford: Clarendon Press. Randall, Alan (1983), ‘The problem of market failure’, Natural Resources Journal, 23, 131–148. Reid, K.G.C. (1996), The Law of Property in Scotland, Edinburgh: Butterworths. Rose, C.M. (1990), ‘Energy and Efficiency in the Realignment of Common-Law Water Rights’, Journal of Legal Studies, 19, 261–296. Rose, C.M. (1996), ‘Property as the keystone right?’, Notre Dame Law Review, 71, 329–371. Rosen, M. (1982), ‘Public and Private Ownership Rights in Lands under Navigable Waters: The Governmental/Proprietary Distinction’, University of Florida Law Review, 34, 561–613. Saliba, B.C. and Bush, D. (1987), Water Markets in Theory and Practice, Studies in Water Policy and Management No 12, Boulder: Westview Press. Sax J.L. (1970), ‘The Public Trust Doctrine in Natural Resource Law: Effective Judicial Intervention’, Michigan Law Review, 68, 471–566. Sax J.L. (1989) ‘The Limits of Private Rights in Public Waters, Environmental Law, 19, 473–485. Scott, G.R. (1998), ‘The Expanding Public Trust Doctrine: A Warning to Environmentalists and Policy Makers’, Fordham Environmental Law Journal, 10, 1–70. Smith, D.I. (1998), Water in Australia, Melbourne: Oxford University Press. Stein, P. (1996), ‘Ethical Issues in Land-Use Planning and the Public Trust’, Environmental and Planning Law Journal, 13, 493–501. Swenson, E. (1999), ‘Public Trust Doctrine and Groundwater Rights’, University of Miami Law Review, 53, 363–392. Tan, P.L. (2002a), Legal Issues Relating to Water Use, Issues Paper No.1, MurrayDarling Commission Project MP2002, Report to the Murray-Darling Basin Commission. Tan, P.L. (2002b), ‘The changing conceptions of property in surface water resources in Australia’, Water Law, 13, 269–275. Tan, P.L. (2003), Substance and Degree: The debate over ‘Water Rights’ in NSW, Brisbane: QUT. Tarlock, A.D. (1988), New Commons in Western Waters’, in Getches, D.H. (ed.) (1988), Water and the American West, Boulder: Natural Resources Law Center. Tarlock, A.D. (1995), ‘Reallocation: it really is here’, in K.M. Carr and J.D. Crammond (eds) (1995), Water Law: Trends, Policies and Practice, Chicago: American Bar Association. Teclaff, L.A. (1972), Abstraction and Use of Water: A Comparison of Legal Regimes, New York: United Nations Department of Economic and Social Affairs. Trelease, F. (1957), ‘Government Ownership and Trusteeship of Water, California Law Review, 45, 638–654. Underkuffler, L.S. (1990), ‘On Property: an Essay’, Yale Law Journal, 100, 127–148. Waldron, J. (1988), The Right to Private Property, Oxford: Clarendon Press. Walston, R. (1982), ‘The Public Trust Doctrine in the Water Rights Context: the Wrong Environmental Remedy’, Santa Clara Law Review, 22, 63–94. Williamson, S., D. Brunckhorst and G. Kelly (2003), Reinventing the common: crossboundary farming for a sustainable future, Leichhardt, NSW: Federation Press. Working Group on Water Resources (1994), Report of the Working Group on Water Resource Policy to the Council of Australian Governments, unpublished paper. Working Group on Water Resources (1995), Second Report of the Working Group on Water Resource Policy to the Council of Australian Governments, unpublished paper.

6.

Registration of Water Titles: Key Issues in Developing Systems to Underpin Market Development Michael Woolston

INTRODUCTION Over the last two decades in Australia there has been significant progress towards the development of active markets for water as key instruments in achieving the more efficient and sustainable use of our limited water resources. In order to enable markets to deliver their full potential benefits, however, it has increasingly been recognised that there was a need for more clearly defined and secure property rights for water users whilst providing for adaptive management of the environment. It has also become apparent that the separation of water from land titles – while an essential initiative required to unleash value from water trading – entailed a range of financial, legal and related issues that were perhaps not fully anticipated at the time the Council of Australian Governments (COAG) water reforms were introduced. This chapter1 provides an overview of the development of water markets in Australia through the conversion of water licences to tradeable property rights or water entitlements. It then examines some of the key issues to be addressed in developing the new titling systems needed to support the security of and trading in these water entitlements. Finally, the chapter outlines current and future policy directions being adopted by governments in Australia for the registration of water titles.

THE EVOLUTION OF WATER TRADING State Control over Allocation of Water The first water laws in Australia were based on English common law that gave rights to use water in streams and rivers to the adjacent (riparian) landholders. 76

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This soon came to be seen as inadequate for Australia given the inherent uncertainty of supply and the consequent need for storage and delivery infrastructure to enable water to be used when and where required. Under the influence of Alfred Deakin, early Australian statutes during the late nineteenth and early twentieth centuries therefore sought to limit riparian rights and vested the right to ‘the use and flow, and to the control of water resources’ in the Crown (i.e. each of the States).2 With rights to manage natural resources, including water, clearly vested in the States (rather than the Commonwealth), each of the States actively developed water resources as a key driver of economic and social development for much of the twentieth century. During this ‘development’ phase, water was available virtually on demand on a ‘first come first served’ basis. Each State developed statutory licensing systems whereby rights to use water were granted, in the form of statutory privileges (such as licences and permits) to take water. Potential users simply applied to state agencies for licences, and there was an expectation of – if not a legal right to – automatic renewal. These licences were typically issued based on the area of irrigable land and crop needs, and were tied to the land on which the water was to be used. As such, these licences were inextricably tied to land and not separately tradeable as assets in their own right. Pressures for Change While there was limited pressure on the resource in terms of competing resources, this approach to resource management was not an issue. From around the 1970s and certainly by the 1980s, however, viable options for increasing water supply were diminishing. At the same time, demand for water was increasing: water use in Australia increased by 65 per cent between 1983– 84 and 1996–97. There was also increasing recognition of the environmental damage (e.g. the salinisation of land and impacts on the aquatic ecosystem) associated with existing water extraction and usage patterns. As the squeeze between competing uses for the water (both from consumptive users and from those wishing to see more water allocated to the environment) and caps on supply began to bite, increasing public and government attention was devoted to managing limited water resources in a more efficient and sustainable way. The focus of water resource management in Australia shifted from the development of new water resources and further investment in infrastructure, to the re-allocation of water through trading, as well as the provision of water for the environment. A major step in the evolution of water allocation arrangements in Australia away from administrative allocation by governments towards a market-based

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approach was the 1994 Council of Australian Governments agreement. This committed State Governments to reforms including: • separation of water entitlements from land title, clear specification of entitlements in terms of ownership, volume, reliability, transferability and, if appropriate, quality; • development of water markets so that water maximises its contribution to national income, subject to the physical, social and environmental constraints of catchments; • establishing formal allocations of water for the environment based on the best scientific information available; and • consultation and public education on issues such as water use, pricing reforms, and water allocation and trading. Further impetus to water trading as a mechanism for re-allocating water resulted from limits imposed on water diversions because of growing concern for the health of the waterways. In particular, in 1997 the Murray-Darling Basin Commission (MDBC) capped the level of extraction from the Basin at the 1993/94 levels. Establishment of Tradeable Property Rights A pre-requisite for an effective market is a clearly specified property right that people can understand and are able to trade. In economics jargon, an efficient market requires property rights that are: • • • • •

clearly specified; secure; exclusive; enforceable; and transferable and divisible.

As noted above, in the past, water licences were typically attached to land, had uncertain security and were often imprecisely defined – making trade in water entitlements difficult or impossible. Since the 1994 COAG agreement, however, there has been a thrust towards new entitlements that clearly define users’ rights to water, thereby enabling them to be traded. The key elements of this conversion have been the specification of entitlements with clearly defined volumes and reliability, separation of entitlements from land, and, as discussed in more detail shortly, ‘unbundling’ of various components of entitlements such as the associated works and use approvals and delivery capacity.

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Removing the link between land and water to enable water to be traded as an asset separate to land has occurred only gradually. It commenced with temporary trading of current season water allocations between irrigators within the same region, but has now extended to permanent trades of the underlying entitlements and to inter-regional and interstate trades. In several jurisdictions, linkages between water and land are maintained in that water can still only be held by landholders, and hence ‘re-attaches’ to land after a transaction. This process has progressed sufficiently to support a sizeable volume and value of water trading in most Australian jurisdictions. The majority occurs within the Murray-Darling Basin, which accounts for 71.1 per cent of the total area of irrigated crops and pastures in Australia.3 Over the last two decades, there has clearly been significant progress towards the development of active markets in water (separate from land) as a key instrument in achieving more efficient and sustainable use of water resources. There is considerable evidence that water trading has in practice facilitated the movement of water from low value to higher value uses. Water trading has also increased the flexibility available to individual water users in how they operate, manage their risks and utilise their capital. Need for Better Trading Systems Despite this, water markets in Australia are still at a relatively formative stage, while changes continue to be made to the regulatory and water allocation frameworks. At the heart of recent policy debate in Australia about water allocation and trading has been the question of whether current patterns of water usage are ecologically sustainable. Balancing the need for secure property rights for productive economic activity with the need for adaptive management of the environment as scientific knowledge improves over time was a key driver of the recent National Water Initiative agreed to by the Commonwealth and State Governments. Significantly, however, the operation of efficient water markets is seen by most stakeholders – including many environmentalists – as being a key part of the solution to making best use of an increasingly scarce resource, rather than being the problem. Indeed, a key part of the new national water framework is to fast-track ‘an efficient water market structure, expanding markets to their widest possible geographic scope’. In order to enable markets to deliver their full potential benefits, however, it has increasingly been recognised that the legal, administrative and regulatory arrangements underpinning the market needed significant reform. Amongst the most important outstanding issues are refinement of property rights and title registration processes in a manner consistent with efficient trading.

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ROLE OF TITLING/REGISTRATION SYSTEMS A titling system can be seen as the legal and administrative mechanism to underpin the operation of a property rights regime. In the words of Small (2002) ‘property titling represents an administration mechanism to give certainty to the legal existence of a property right and thereby support its economic value’. The term ‘title’ is taken here to refer to the legal instrument held as evidence of the right, rather than the right itself.4 Titling systems perform two main functions: enforcement of current property rights and facilitation of trade. The title to a property right can be crucial to the security and enforceability of the underlying property right. Without title that provides an appropriate degree of certainty of the right, the incentives for efficient trade and investment may be substantially undermined. Even though one person may value an asset or resource more than another, they are unlikely to be prepared to pay potentially considerable amounts of money to purchase it if it is not clear that they will in fact gain secure rights to it. Similarly, the incentives for investment will be blunted if there is significant likelihood of future expected returns being expropriated. The title to a property right can therefore play an important role in providing the necessary assurance to the right holder that the right is secure enough to warrant investment. The ability to use assets as collateral for loans is also impacted by the quality of title to a property right. If there is uncertainty over the legal existence of a property right over an asset, or the ability to have and protect an interest (e.g. a mortgage) in that asset, its ability to be used as collateral for financing productive activity will be reduced. In addition to helping to assure the ‘security’ of a property right, a titling system also plays a key role in the way in which transfers of ownership of that property right are effected. Unnecessarily cumbersome systems could add to the ‘transactions costs’ of market participants and discourage trading. Titling/registration systems can therefore play a key role in efficient market operation through underpinning the security of the property rights and through lowering transactions cost (e.g. reducing the need to verify title). Different titling/registration systems apply to asset such as land, water, cars, shares, and other natural resources such as fishing quotas and logging. In other cases, there is no formal or public titling system and ownership is essentially determined by possession. This suggests that the most effective system of titling system may vary according to factors such as: • the nature of right being administered; • the physical nature of the asset or resource;

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• the nature of the transactions that need to be administered with respect to the rights or entitlement; • the extent of the unbundling/divisibility of resource; • the value of the asset involved; • the cost of establishing and operating the titling system; and • the extent to which the asset underpins investment. While there are many different titling systems in place for different resources, all the systems that could be considered formal are essentially one of two types: a ‘recording system’, frequently known as ‘registers of deeds’; or a ‘registration’ system, more technically ‘registers of rights’. The Torrens system applied to land in Australia is a ‘register of right’. A fundamental principle of the Torrens system is that, subject to certain exceptions, a person who becomes the registered proprietor of the land will obtain an indefeasible title. Essentially this means that the registered proprietor’s title in that land cannot be affected or defeated by any existing estates or interests, other than registered interests that are noted in the Register. The register is intended to provide a record of all dealing with respect to particular land. Accordingly, a purchaser should only have to search the Register in order to ascertain the state of the title and should not have to go behind the ‘curtain’ of the Register. Under the ‘old title’ system, in order to verify a proprietor’s title to the land, a person intending to deal with the land (for example the purchaser) had to rely upon the written records of previous dealings in relation to the land. The perceived advantages of the Torrens land title system is that it reduces the transactions costs associated with verifying title and provides a greater quality of title that is more conducive to investment and the provision of financing using land as collateral. It needs to be recognised however, that there are alternative potential approaches to managing these risks (e.g. title insurance market) as have emerged in other countries. In addition, it does not necessarily follow that a Torrens land titling system is appropriate for all types of assets or resources. Notwithstanding the nature of the water entitlements as inherently less secure ‘property rights’ than fee simple title to land, the question arises as to the most effective form of ‘titling’ system for this asset.

KEY ISSUES IN DEVELOPING TITLING REGIMES FOR WATER Background In the past, water licence registers maintained by responsible authorities constituted simply a record of licences. Such registers provided an appropriate

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way of recording and administering statutory based privileges. However, as water entitlements developed into divisible, tradeable and often highly valuable assets, and increasingly became de-linked from ‘Torrens title’ land titles, registration systems needed to serve an additional purpose – providing certainty of title and facilitating trading markets. It has become increasingly apparent that old licence registration systems were inadequate to the role required of them in this new environment. These inadequacies were highlighted by a case of fraudulent sale of non-existent water entitlements in Victoria during the 1990s. It has also become apparent that the separation of water from land titles – while an essential initiative required to unleash value from water trading – entailed a range of financial, legal and related issues that were perhaps not fully anticipated at the time the COAG reforms were enunciated. For example, while the overall value of combined land/water assets should in principle be increased when both elements can be traded separately, the value of a piece of land may be much diminished without an associated right to use water on that land. This has potentially significant implications for: • the security of loans secured through mortgages on land (rather than over the water entitlement); • the transfer of water entitlements as a result of directions in the Family Court or provisions in wills (e.g. the intent of the deceased may not be fulfilled under wills, where, as is common, land is left to the son, and the residual to the daughter); and • the rating base for local government. This is not to suggest that these issues are insurmountable or justify not proceeding with market-based water allocation reforms. Rather, it emphasises the need for a range of issues to be addressed in establishing the titling systems for water as an asset separate from land. While all jurisdictions have a legislative basis for a water entitlement register, these registers are in different forms and various stages of implementation. Some States have adopted systems similar to the Torrens land titles system. Some registers are managed by departments responsible for water resource management, in other cases the register is managed or will be managed by the Land Titles Office (or equivalent). Irrigation schemes also maintain their own registers. The overarching aim in developing these new water entitlement registration systems is to ensure that they support the efficient operation of water markets by reducing transaction costs of trading and providing appropriate security over title, while at the same time integrating effectively with natural resource management processes and objectives.

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The Nature of Water Entitlements The design of an effective system of registering entitlements depends, in part, on the nature of the entitlements themselves. The current system of entitlements across Australia is in a state of transition, as jurisdictions progressively convert from ‘old’ forms of licensed entitlements to ‘new’ entitlements. Even after conversion, however, it is important to recognise that the property right held by users is a conditional one. The rights to manage and control water itself vest in the Crown, which then provides conditional rights to private users to use the water by issuing licences or entitlements. The rights conferred by these ‘access entitlements’ typically encompass conditional rights to access or withdraw water, rather than ownership of the resource itself. Notwithstanding the conditional nature of these rights, the increasing propensity of governments to cap extractions or ‘claw back’ water for the environment (particularly in New South Wales) has however engendered a debate about ‘property rights’ and in particular whether compensation should be payable where conversion of entitlements has resulted in perceived attenuation of pre-existing entitlements to water, and the level of such compensation. The recent Intergovernmental agreement on the National Water Initiative established a risk assignment framework to apply to reductions in the availability of water for consumptive use that more clearly defines and quantifies the risks to be borne by users and Government respectively. There also appears to be growing consensus – now codified in the National Water Initiative – on the appropriate way of specifying water entitlements. Specifically, the National Water Initiative defines water access entitlements as a ‘perpetual or ongoing entitlement to exclusive access to a share of water from a specified consumptive pool as defined in the relevant water plan’. Thus water entitlements confer a number of rights and obligations: • Entitlement – the long-term interest (share) in a varying stream of periodic allocations. • Allocations – a unit of opportunity (usually a volume of water) as distributed periodically. The actual volume of water may vary year-by-year depending on water availability. • Delivery – the right to have an allocation of water delivered to a certain offtake location or to obtain water from a particular location. • Use – permission to use allocations with specified conditions and obligations to third parties. • Transfer – the right to be able to transfer all or part of the entitlement or allocation. • Obligations – the responsibilities associated with holding of an entitlement.

Figure 6.1

Land/water separation ▼ Basic land owner rights (e.g. riparian rights)

Share of water available (entitlement)

Right to have water delivered Annual allocations

Water Rights, Trading and Titling Systems

Land Rights

Water Rights

Right to use water (site use licence with conditions)

Year 3

Year 2

Year 1

Temporary trade

Trade through land transfer

Permanent trade of entitlement

▼

Bundled land/ water title ▼ ▼

Titles office (right security role)

▼

Accounting register (resource management role)

Registration/titling system

▼

Water Rights

▼

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In the past, many of these components tended to be ‘bundled’ together within the one licence. There is now a trend towards ‘unbundling’ these components into separate instruments and allowing some to be traded separately. Unbundling of water entitlements is now extending beyond the separation of water from land, to separate property rights and instruments for other components of the water entitlement itself, as illustrated in Figure 6.1. For example, in Queensland, water allocations specifying entitlements to water are separated from site use licences and from contracts with suppliers for delivery. Similar unbundling has occurred in New South Wales and South Australia, and has recently been foreshadowed in the Victorian Government’s recent White Paper (Department of Sustainability and Environment, 2004). While unbundling of water entitlements may improve the efficiency of water markets, it also has significant implications for the titling/registration system for those entitlements. For example, a system is needed to record transactions in both the underlying entitlement (i.e. permanent trades) as well as to account for annual allocations of water under those entitlements and any ‘temporary’ trades. The extent of unbundling affects the nature of the right that is being registered, and also raises issues as to whether there is a need to link the registration systems for unbundled rights in some way, as illustrated in Figure 6.1. The Victorian Government’s White Paper5 foreshadows developing a new system to keep track of linkages between unbundled rights, as well as continuing to record metered use for billing and other administrative purposes. Nature of Transactions The titling system can play a key role in ensuring transactions are finalised in a timely fashion by being administratively efficient. In addition, the registration system must be suited to the nature and type of transactions in the market. In the case of water, trades to date have largely been for ‘temporary trades’ of seasonal allocations. Increasingly, ‘permanent trades’ of the underlying entitlement have occurred, and, in some jurisdictions, leasing of entitlements is now permitted. As water markets develop, the number, scope and frequency of transactions are likely to continue to increase. This reflects the more divisible nature of water entitlements both in time and space, relative to land and some other natural resources. So-called ‘permanent’ trades in the underlying entitlements are likely to become increasingly important and require robust procedures to ensure security of title. At the same time, temporary trades of annual water allocations/assignments are also likely to continue to be a major part of market transactions, where the primary requirement is speed and efficiency, and where the underlying entitlement is not altered and does not change hands.

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In addition, other types of transactions such as leases and derivative/options contracts need to be adequately provided for. The titling system also needs to be able to cater for any future developments in the nature of market transactions that may entail further unbundling (e.g. the timing of releases from dams at different times, or the development of various derivative products of value to water users as a risk management tool). A key issue is how each of these types of transactions is handled by the tilting/registration system. For example, those registers currently maintained by government departments tend to cover both permanent and temporary trades. In Queensland (and proposed in New South Wales) there has been institutional separation whereby the Queensland Resource Registry (QRR) deals only with permanent trades and other defined interests, while the Department of Natural Resources and Mines (DNR&M) maintains its own register to track temporary trades. Clearly, while a ‘Torrens title’ system as described above may provide the robustness and security necessary for permanent trades in underlying entitlements, the fundamental basis of the Torrens system, that is of title being effected by registration alone (rather than by execution of the associated contractual document), may be less well-suited to temporary trades where time is often of the essence. In order to track accumulation, trade, and use of water volumes accrued under water entitlements, a separate water accounting system (distinct from the water entitlement register), is needed.6 This would operate in a similar way to a bank account, whereby annual allocations are credited to the entitlement holder (as recorded in the register). Debits to the water account would be made as the water is taken (in conjunction with a use approval). Depending upon the rules applying in each region, carry-overs between seasons may or may not be permitted. Monitoring and enforcement would be required to ensure that a user did not use more water than was available in their water account. Under this system, trades in annual water allocations would be recorded through the water accounting system, and would not involve the water entitlement register. There is therefore a clear separation between the titling function and the resource management function. As discussed above, this function may also be separated institutionally. This has in fact been the approach adopted in both New South Wales and Queensland. Protection of Registered Interests In some parts of Australia, water entitlements now represent very valuable assets, and underpin often very large capital investments. This highlights the need for the titling system to provide appropriate ‘quality of title’ and for adequate protection of third party interests (e.g. mortgagees).

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The title registration system impacts heavily on the ability to use water entitlements as collateral for loans. Previously, rural loans have been secured against the combined assets of land and the water rights tied to it. With separation of land from water, it will commonly be necessary to secure loans against both assets. The untying of these assets able to be traded separately may affect their market and hence bank values in several ways: • the overall value of the assets together should, all else being equal, be higher, due to the new-found ability to trade water in the market; and • the value of land by itself may be considerably lower than it was previously. The ability to register and enforce interests is fundamental to using an asset as security for a loan. Key issues for the lender here include: • ability to register the interest; • ability to obtain ‘clear’ title of security;7 • assurances that the right of the registered interest can be enforced without interference; and • risk that ‘rights’ can be altered without registered interest knowledge, consent or compensation. The existing Torrens land title system provides a benchmark for a robust registration system. Key features of a registration system that would protect security interest holders include: • the ability to register interests; • the ability of lenders to register interests, with approval of entitlement holders; • notification and approval of transfers to all third parties with registered interests; • notice to all third parties of all events affecting the entitlement; • provisions to protect priority of interests; • the ability of a mortgagee in possession to enforce its rights and deal with the entitlement with the same rights as its client; • guarantee of titles through ‘indefeasibility’; • arrangements to novate existing interests; and • transitional provisions to uphold the intent of wills. At present, the extent to which existing registration/titling systems for water entitlements provide quality of title and protect registered interests varies considerably. While some States have moved some way to this benchmark, others have systems that provide relatively poor security to third party interests.

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While the legislation in most States does require the relevant water entitlement registers to enable registration of interests, including mortgages, this is not yet the case in Victoria. In the case of irrigation schemes, charges can generally be registered over water entitlements held as shares in irrigation companies or co-operatives (but not for irrigation schemes formed as Trusts). While most States require formal notice and approval of dealings in water entitlements by parties with registered interests in those entitlements, this is not always the case. Without this, there is a risk that water will be traded away by the entitlement holder without the knowledge of the security interest holder. In addition, unless notice is also given of other events affecting the water entitlement (e.g. material defaults, amendment, cancellation, surrender, renewal, imposition of additional conditions), the security held by a lender may be affected without the party’s knowledge. Another risk arises during the process of conversion of old forms of entitlement to new forms of water entitlement separate from land. Some process is required for protecting existing mortgage arrangements when land is separated from water so that mortgages previously taken over the combined asset are appropriately transferred to the separate assets. However, this process, whether by an automatic novation or a requirement to re-register interests, may have implications, for example, for the priority of various registered interests and for the need for new security documentation. Additional risks to financiers may arise if there is lack of clarity or inadequate arrangements in relation to matters such as rights to take possession, power of sale, appointment of a receiver and remedy default. Indefeasibility One issue on which there has been considerable but not necessarily wellinformed debate is whether water titles should be ‘indefeasible’. Essentially, indefeasibility means that the registered proprietor’s title in that land is better than earlier but unregistered interests and is subject only to earlier interests noted in the Register (and certain statutory exceptions). In contrast, the titles recorded on existing water entitlement registers are not guaranteed by the government, so that verification of title requires searches of written records of previous dealings in relation to the entitlement. This has implications for the risk and cost of providing finance. No register of water entitlements in Australia currently provides for the same ‘indefeasible’ title as that provided under the Torrens land title system. State governments have been reluctant to adopt indefeasibility into their water titling systems, even where many other features of Torrens title systems and protocols have been incorporated (NSW officials have, however, canvassed the possibility of adopting indefeasibilty in the future). Often, these arguments have cited the

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nature of water access entitlements as statutory entitlements – that the concept of indefeasibility cannot apply to water entitlements, as governments wish, with good reason, to retain the power to cancel an entitlement where the holder does not comply with the conditions of the entitlement or the requirements of the relevant governing legislation. A further argument against the concept of indefeasibility is the power of governments to regulate the resource by varying the allocation under an entitlement and other conditions of the entitlement. Another apparent concern is that a State guarantee has the potential to lead to additional costs to government through provision of an indemnity for loss suffered by reason of the functioning of the register. In considering this issue, however, a clear distinction must be made between the titling/registration aspect of water entitlements and the management of the resource. If the entitlement is based around specified shares of a resource, the issue of indefeasibility is quite separate from the issue as to whether compensation should be paid for attenuation of entitlements. A clear title to a share of the available resource is not a guarantee to a defined volume of water in perpetuity. The costs of claims to the government must be weighed up against the public and investor confidence that is instilled by a State guarantee of title. A State guarantee of title is a fundamental element of a Torrens based system and inextricably linked to the concept of indefeasibility. Ideally therefore, the accuracy and integrity of the register should be guaranteed by the State, as this will contribute to public and investor confidence in the register and ensure that appropriate resources are devoted to the maintenance of the register. On balance, adopting a Torrens title system may prove to be a more efficient and effective means of managing the risks and transactions costs in dealing with them than alternatives such as relying on the advent of private title insurance. Relevant considerations here include the existing familiarity and confidence in the Torrens system applying to land in Australia, the fledgling nature of the local private title insurance market, the fact that many transactions will involve both water and land together where having different underlying titling systems for each may increase costs, and the difficulty in accurately assessing and pricing risks given the current status of State water entitlement registers. Public Accessibility Public accessibility of water entitlement registers will contribute to market efficiency by assisting buyers or lenders to verify title in a relatively timely and inexpensive manner. Under the land registration system, on-line searching is now available in all jurisdictions. This further increases the speed at which those dealing with the title can obtain title verification and has the advantage

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of allowing searches to be undertaken remotely. It is desirable that on-line searching of water entitlement registers be available, as is the case with land titles. On-line searching could be unrestricted and available to any member of the public via the internet. This is available on some systems already (e.g. the Water Allocation Register operated by the Queensland Resources Registry). Alternatively, on-line searching could be provided on a subscriber basis, which has the potential to provide the relevant government departments with additional revenue. Appropriate search parameters should be available. For example, persons searching the register should be able to search by name as well as the entitlement number/identifier and/or location. Public accessibility of the register would also help to facilitate trade in water entitlements as it provides the market with essential information in relation to the water entitlements. This would particularly be the case where information with respect to price and volume are available. With respect to land titling systems, generally a transfer of the title is not registered unless the consideration (that is, the price paid for the land) is set out in the transfer. The transfer document is lodged at the titles office and registered on the title. A search of the register in relation to the land indicates the dealing number of the transfer document. Persons can then quickly obtain a search of the transfer document itself if they wish to ascertain the consideration paid under the transfer. It is preferable that a similar system be adopted in relation to water entitlements, to enable persons to obtain access to information with respect to price and volume. Even if not strictly required for registration of the transfer, inclusion of the price in the transfer document may, in some cases, be unavoidable. For example where the transfer is subject to stamp duty, the consideration would need to be stated in order to allow the transfer to be assessed. It is considered important for market efficiency for registers to be readily open to access by interested parties and the general public. This assists buyers or financiers in verifying title, and also facilitates trade through provision of market information (e.g. identity of entitlement holders who may be potential sellers, the price at which trades have taken place). There is, therefore, a strong case for mandating that these registers be publicly accessible. While most State registers already are publicly accessible, this is currently not necessarily the case with respect to registers held by private irrigation companies. Water for the Environment The titling system for water also needs to ensure there are no unnecessary impediments to water being allocated to the environment, or restrictions on environmentally sensitive usage patterns being regulated.

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To a large degree, resolution of the balance between the needs of users for resource security and those of adaptive environmental management is in the definition of the underlying entitlements themselves (e.g. as a share of the water available for consumptive use), and the issue of compensation for attenuation of these entitlements, rather than in the technical details of the tilting/registration system. To date, environmental allocations have predominantly taken the form of ‘hard-wired’ management rules such as minimum environmental flow rules.8 Such rules are taken into account in the hydrological modelling that defines what is then ‘left over’ for extractive users. Only these latter entitlements (i.e. those for extractive users) are recorded on the titling/registration system, because the entitlements they confer are net of water set aside for environmental purposes. Alternatively, or in addition to the ‘prior right’ model, environmental water allocations could be, and in some cases have been, defined in similar volumetric terms as those of extractive entitlements. Under the ‘equivalent right’ model, such agencies could become traders in the market in their own right, buying and selling water in pursuit of environmental objectives. It would seem that formal title to such entitlements held, for example, by an environmental agency, could be incorporated into the water entitlement titling system relatively easily. Arguably, formal title to water entitlements (to be used for achieving environmental goals), provides a more secure allocation than does environmental flows specified in rules within subordinate legislation or other management instruments. It would also be possible to ‘reserve’ part or all of the entitlements earmarked for environmental purposes in an analogous fashion to Crown land that is reserved for certain public purposes (e.g. national parks). Just as parcels of Crown land are able to be brought within the Torrens title land register and issued with a certificate of title, so too could environmental water entitlements. Transition Issues Finally, it needs to be acknowledged that the detailed design and implementation of a titling system for water is, by its very nature, likely to be an ongoing exercise. In some areas, it may take considerable time to convert all existing water entitlements into clearly specified tradeable entitlements (e.g. finalisation of catchment planning processes may take many years). In addition, there may be merit in a system that guarantees title in accordance with the register, conditional on the initial registered title being valid. Provisions could exist for registering these searches as they occur – essentially on a needs basis – and for governments then issuing a guarantee of

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absolute title. Adoption of robust water entitlement registration systems is likely to occur gradually, rather than being a one-off initiative.

RECENT AND FUTURE DIRECTIONS IN REFORM As noted above, while all jurisdictions have a legislative basis for a water entitlement register, these registers are in different forms and various stages of implementation. The NSW and Queensland Governments have titling systems which are based on the Torrens System with registers managed by their land titling departments. The Queensland registry is computerised and uses identical forms and similar protocols to land transactions. There are some variances from the Torrens System used for the land registry, the most significant being that title does not provide for indefeasibility. As previously noted the titles office only deals with permanent trades, while temporary trades are recorded by the Department’s own register. In Victoria, the White paper released recently by the Victorian Government has indicated significant changes to its register system, including the establishment of a single web-based register of registers and inclusion of the ability to register third party interests. Unlike a land titles register, the new system will need to keep track of links between unbundled rights, as well as continuing to be the basis for recording metered use, for billing, and other dayto-day administrative functions. 9 A similar system (WILMA) is being developed in South Australia. The National Water initiative has however provided common principles for the future direction of reform of water registries. As part of the agreement, States have agreed to establish publicly accessible water registers that foster public confidence and state unambiguously who owns the entitlement, and the nature of any encumbrances on it. The relevant guidelines require the registers to: 1. contain records of all water access entitlements in that jurisdiction, and trades of those entitlements, including their location; 2. be of sufficient standard to achieve the characteristics of secure water access entitlements contained in the Agreement; 3. contain protocols for the protection of third party interests; 4. be administered pursuant to certain procedures and protocols, based on land title office manuals and guidelines that exist in various States and Territories that seek to minimise transaction costs for market participants; 5. be publicly accessible, preferably over the internet, and include information such as the prices of trades and the identity of entitlement holders; and

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6. enable resource managers to monitor and accumulate trade and water use volumes accrued under water entitlements in a separate water accounting system. It is expected to take some time before all jurisdictions establish water entitlement registration systems that contain all these features. Their adoption would go a long way to providing a robust property rights and trading system that provides the necessary confidence and efficiency of transactions to underpin the further development of water markets in Australia.

NOTES 1. This chapter draws on a consulting report prepared by ACIL Tasman in association with Freehills for Land and Water Australia and the Australian Government Department of Agriculture, Fisheries and Forestry (ACIL Tasman and Freehills 2004) as well as on work undertaken by ACIL Tasman for other clients. 2. See Harris in Chapter 4 of this volume for more details. 3. http://www.mdbc.gov.au/education/encyclopedia/irrigation/irrigation.htm 4. While the term ‘title’ is generally used to refer to private ownership, for the purposes of this chapter we assume that this ‘ownership’ might be ownership of a lesser property right. 5. See Freebairn’s Chapter 2 in this volume for details 6. See Coggan, Whitten and Abel’s Chapter 7 in this volume and Young and McColl (2002) for more details. 7. Clear title means that the lending institution can be assured, given reasonable clarification through the registrable body, there is no ‘hidden’ interest or that the asset has been altered in any way which may either reduce the right of the bank under its mortgage or the value of the asset than what is stated on the details provided to the bank by the client or registration office. 8. See Bennett’s Chapter 10 in this volume for a discussion of the setting of these rules. 9. Victorian Department of Sustainability and Environment (2004), chapter 4.

REFERENCES ACIL Tasman and Freehills (2004), An Effective System of Defining Water Property Titles. Report to The Australian Government Department of Agriculture, Fisheries and Forestry, and Land & Water Australia, downloadable at http://www. aciltasman.com.au/pdf/effective_water_pt.pdf Small, G. (2002), Initial Scoping Report on the development of water property rights, Parameters for the research and development of an effective system of transportable property in water, Property Economics Program, University of Technology Sydney. State of Victoria, Victorian Department of Sustainability and Environment (2004), Victorian Government White Paper, ‘Securing Our Water Future Together’. Young, M.D. and J.C McColl (2002), Robust Separation: A search for a generic framework to simplify registration and trading of interests in natural resources, CSIRO Land and Water, September.

7.

Accounting for Water Flows: Are Entitlements to Water Complete and Defensible and Does this Matter? Anthea Coggan, Stuart Whitten and Nick Abel1

INTRODUCTION Institutions that structure resource access and use are intended to reduce uncertainty about the behaviour of others and make higher levels of coordination and social organisation possible. These institutions aim to facilitate the security of resource access that individuals and businesses need to invest and create income in the economy. Our goal, in this chapter, is to explore the institution of water entitlements with a focus on the exclusivity of water use. Specifically, we ask whether existing water entitlements facilitate defensible exclusion of other potential and actual water users. We also comment on the transaction cost implications of alternative policy responses to incomplete exclusion. Across Australia, entitlements to water are formally allocated through a licensing system. Although this system varies between States, in most cases, entitlements are defined in two parts. First, a specified share of the total water in a defined river or major storage that is available to the water user. Second, rules outlining responsibilities for this water use such as when, where and how this water can be used. Current entitlements include provisions to ensure water quality outcomes. These water quality criteria are not discussed in this chapter despite their importance to water users. Existing water entitlements are incomplete because they do not cover all aspects of the hydrological cycle of water, from its source as rainfall onto farms and other lands to its eventual exit from the system as evapotranspiration or runoff. Water is both a stock and a flow resource depending on where in the system it is considered and the time scales used. Entitlements are structured to specify access and use rights to stocks and flows of the water resource held in storages and in unregulated rivers and streams.2 For example, entitlements 94

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as licences specify share and use conditions for regulated systems. However, these entitlements are incomplete because they do not cover all of the stocks and flows in the system. As a result there are opportunities for landholders to manage landscapes and operating regimes in order to capture additional water. In this respect, downstream agents are unable to defend their entitlements from upstream actions. However, the impact of transaction costs such as gathering information about the consequences of upstream agents’ actions, as well as monitoring and policing those actions, means that incorporating these impacts into the market frameworks may not necessarily be the most efficient approach. The chapter is structured into five sections as follows. The hydological processes yielding water resource generation and use are set out in the next section, this includes broad estimates of current water allocation and use. This section defines the physical space that complete rights need to extend across. In the third section the institutional framework defining the nature of entitlements to water and issues in their defensibility is set out along with the nature of the transaction costs in allocating water. Current water entitlements arrangements in Australia are then identified together with the implications of the existing entitlement structure for their defensibility in the fourth section. The focus is on the incompleteness of water entitlements and their potential implications given the impact of human activity on the availability of water resources. Emphasis is placed on the impact of harvesting surface flows, land use change (such as reafforestation) and irrigation efficiency. The chapter is concluded with some discussion of policy options in light of the issues raised in the defensibility of water entitlements.

WATER IN AUSTRALIA The Hydrological Cycle There are many pathways that water may take in its continuous cycle of falling as precipitation and returning to the atmosphere. On its journey, water may be intercepted by vegetation and evaporated directly back into the atmosphere (evapotranspiration) or absorbed into the soil and later be transpired by plants, or continue on to percolate into the groundwater. Alternatively, water may become surface runoff and reach rivers or be captured on land. Human Influences on the Hydrological Cycle There are many places where human activity can influence the natural ‘life cycle’ of water. Figure 7.1 simplifies the hydrological process into four interlinked quadrants. The heavy solid boxes demonstrate the places where

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1

Environmental Allocation Evapotranspiration

Precipitation

On-farm water harvesting Land use (tree planting or clearing, crop type etc)

Percolation to groundwater

Runoff & sub surface lateral flow

Rivers, Streams and Large Storages

Transmission losses

Percolation to groundwater

Aquifer 1

3

2

Irrigation efficiency

Irrigation

Aquifer 2

Return flows

4

Notes: Return flows may return to rivers and streams from which they may then be reallocated. Environmental flows in one part of the system may be reallocated to consumptive uses further down the system. The link between return flows and the surface water system is not demonstrated in Figure 7.1.

Figure 7.1 Human Influences on the Hydrological Cycle human activity is identified as having a potentially significant impact on the rest of the water cycle. The dashed boxes represent one definition of the flows of water. The first quadrant of Figure 7.1 represents the point of contact with the ground. Once an initial stock of rain falls a number of things can happen: • it may be absorbed into the soil and percolate through to underground water resources (aquifers), moving laterally to rivers, streams and storages as subsurface lateral flow;

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• it may be absorbed from the ground by vegetation and then return to the atmosphere through transpiration; or, • it could run off either naturally or through man-made drainages joining surface flows such as rivers, streams and drainage channels. From this very first water contact, landholders can immediately influence the life of that water through land use and on-farm water harvesting.3 Water that is not captured where it falls or on-farm as overland flows will eventually reach rivers and streams either directly or through shallow groundwater flows. Some of these flows are captured in large storages to be released later as flows for extraction by licensed irrigators. Water is also allocated to the environment. For example in Victoria a share of water in rivers and aquifers is set aside for environmental uses through environmental water reserves (Victorian Government 2004). This environmental water is represented in quadrant 2 of Figure 7.1. Whilst some water runs off the landscape, some water will infiltrate through the soil profile and, when not used by vegetation in transpiration, percolates through to the groundwater reserves. This flow of water is represented in quadrant 3 of Figure 7.1. Quadrant 3 also illustrates that many aquifers are connected with water flowing between aquifers and water flowing from aquifers back to rivers and streams as base flows. Aquifers are also used for irrigation and are impacted by land use and extraction in direct and related aquifers. Human impacts once water leaves the farm or land management unit on which it falls are demonstrated in quadrant 4. In quadrant 4, water is extracted from rivers, streams and groundwater for use in irrigation and other consumptive and non-consumptive uses such as hydroelectricity generation. Figure 7.1 only refers to irrigation because it is the dominant consumptive use of water in much of Australia. Some of the water allocated to irrigators will be lost through transmission losses, or may return to the system following irrigation through percolation to groundwater or return flows to rivers and streams (all of these are in bold dashed boxes representing a flow of water). Of note is that water returning to the river or groundwater through return flows is often already allocated to downstream users. Therefore, activities by upstream water users that may reduce the amount of water recharging aquifers or returning to rivers may impact on the entitlements of downstream water users. Factors that can influence the flows of water to downstream users include transmission losses and irrigation efficiency. From Figure 7.1 it becomes apparent that there are key places in the life cycle of water where human impact can significantly influence the amount of water in the whole system. These actions, how they impact on water availability, and the property entitlements surrounding them are the focus of the chapter.

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Australian Water Availability On average, Australia receives approximately 3.3 million GL of rainfall each year (Dunlop et al. 2001) although this is both spatially and temporally variable. On average across Australia, only 12 per cent of rainfall runs off to collect in rivers. Like rainfall, this runoff varies spatially across the continent. For example, in Victoria, of the 150 million ML of rain or snow falling each year (Victorian Government Department of Sustainability and Environment): • 84 per cent (126 million ML) evaporates, or is transpired by vegetation to the atmosphere (evapotranspiration); • 15 per cent (22.5 million ML) is discharged as surface runoff and stream flow; and, • 1 per cent (1.5 million ML) infiltrates the soil to groundwater aquifers.

1.5 million ML (1%)

evaporation and transpiration by vegetation

22.5 million ML (15%)

surface runoff and streamflow

123 123 123 123

126 million ML (84%)

percolates to groundwater

Total annual average precipitation: 150 million ML

Source: Victorian Government Department of Sustainability and Environment

Figure 7.2 Precipitation to Water Resources in Victoria

Water users commonly access water from runoff (harvesting water before it reaches a waterway), surface flows (rivers and streams) and groundwater resources. The available resource of each of these is described in the following subsections.

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Surface water Surface water resources are often represented by Mean Annual Run-off (MAR). This is the average annual stream flow passing a specified point or the maximum average annual flow observed in a river basin (ABS 2004). In 2000 the MAR for Australia was 385 923 GL (ABS 2004). Similar to rainfall, the MAR is spatially variable across Australia. The physical capacity to extract water from a river is referred to as developed yield. Developed yield is the average annual volume of water that can be diverted for use with existing infrastructure. The developed yield demonstrates the extent to which surface water assets are or can be used. In 2000 developed yield was approximately 14 859 GL, representing 4 per cent of Australia’s MAR (ABS 2004). In 2001, according to the National Land and Water Resources Audit (NLWRA 2001) 84 of Australia’s surface water basins were close to or overused in terms of meeting sustainable flow regimes. Further, only 31 had a formal environmental allocation. Groundwater The volume of groundwater that exists in Australia is not known with certainty. Instead of an absolute measure of the groundwater stock the sustainable yield is used as a proxy. It is estimated that the sustainable yield of groundwater in Australia is 29 173 GL (ABS 2004). Sustainable yield is defined by the ABS (2004) to be the level of extraction measured over a specified planning time frame that should not be exceeded to protect the higher value social, environmental and economic uses associated with the aquifer. The NLWRA (2001) states that 2 489 GL of groundwater is currently used (NLWRA 2001). In 2001, according to the NLWRA (2001), 168 of Australia’s 538 groundwater management units are close to or over-allocated, and 161 are over-used. Only three of the groundwater management units across Australia have formal environmental allocations. Stored water There are approximately 500 large dams in Australia with a storage capacity of 84 793 GL (ABS 2004). Australia also has several million farm-dams that contain an estimated 9 per cent of the total water stored (NLWRA, 2001). The total amount of water stored in farm dams is unknown. However, if 9 per cent of the known quantity of water in large storages is used as an estimate, water stored in farm dams could be as much as 7 631 GL.

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Water Use in Australia In 2000–01, 72 431 GL of water was extracted from the environment to be used within the Australian economy. Of this, 12 784 GL was extracted by water providers4 and 59 647GL was self extracted.5 Of the total water extractions, only 24 909 GL was actually consumed by the economy (ABS 2004). The difference returns to the system as regulated and unregulated discharge (see Figure 7.3).6 In 2000–01 agriculture, the largest consumer of water in Australia, consumed 16 660 GL of water or 67 per cent of Australia’s total water consumption in this period (ABS 2004). Of the water used by the agriculture industry 9 132 GL was from self-extracted sources, 7 105 GL was from mains (supplied by irrigation authorities) and 423 GL was reuse water (ABS 2004).

THE SECURITY AND DEFENSIBILITY OF WATER ENTITLEMENTS Property rights are the fundamental institutional components that facilitate individual access to otherwise contestable resources. Water entitlements are the institutional framework used in Australia to assign rights to individuals intended to reduce uncertainty about the behaviour of others and make higher levels of co-ordination and social organisation possible.7 In short, the allocation of water entitlements is intended to facilitate the security of resource access that individuals and businesses need to invest and create income in the economy. Entitlements can be defined as ‘a claim to a benefit (or income) stream that the State will agree to protect through the assignment of duty to others who may covet, or somehow interfere with, the benefit stream’ following Bromley (1991). Entitlements are a government allocated benefit to an individual to access or consume a resource. The importance of rights such as water entitlements lies in the way in which they enable individuals to benefit from activities. For example, there are often different, graduated levels of rights such as Ostrom and Schlager (1996) describe which can be applied to water as follows (Whitten 2003): • access: the right to access a defined physical area of water for non extractive benefits (for example swimming); • withdrawal: the right to obtain water for a consumptive use (such as irrigation); • management: the right to regulate internal water use patterns and transform the resource by making improvements (weirs and storages);

101

Figure 7.3

ENVIRONMENT

50 136 GL (Includes in-stream use 48 039 GL e.g. Hydro-electricity generation)

REGULATED DISCHARGE

517 GL

REUSE WATER

(not quantified)

59 647 GL

SELF-EXTRACTED WATER

(not quantified)

On-site/on farm reuse

Agriculture Mining Manufacturing Household Other industries Also includes use by Water Providers

WATER USERS

Unregulated Discharge (not quantified)

Sewage and other wastewater

12 324 GL

MAINS WATER

Water Supply and Use in the Australian Economy 2000–01

Source: ABS, 2004.

12 784 GL

WATER

Environmental Flows 459 GL Unregulated Discharge (not quantified) SELF-EXTRACTED

Water supply, sewerage and drainage service industry + Some Mining and Electricity and gas supply businesses

WATER PROVIDERS

ECONOMY

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• exclusion: the right to determine who will have an access right and how that right may be transferred; and • alienation: the right to sell or lease either or both of the access and withdrawal rights. Entitlements to water usually comprise of withdrawal and alienation rights, often with some level of management rights attached. In this chapter the focus is on the defensibility of water entitlements. Defensibility is broadly the completeness of the rights that are allocated combined with the legal ability to exclude others from use of the resource. However, many entitlements structures are a complicated bundle of explicit and implicit rights as discussed by Beare and Heaney (2003). Explicit rights have a sound and secure legal basis and those who do not hold these rights can be excluded from resource use. Implicit rights are less secure and may not even have an implied legal basis. Beare and Heaney (2003) describe two types of implicit rights: 1. rights to resource use are implied by a history of resource usage. An example is where farmers modify tillage practices to more effectively capture and store water, and, 2. implied rights may be bundled with explicit rights. Beare and Heaney use the example of implied rights to storage and delivery infrastructure in regulated systems that are bundled with water use licences in irrigation areas. Implicit rights have no legal basis that facilitates their defence. Explicit rights are more secure but may still lack the legal basis for defence depending on how they are structured. For example, explicit entitlement to a share of a variable stock of water may not be defensible against impacts on the source of the stock. Some Aspects of Water Entitlements that Complicate Defensibility Water is often described as a common pool resource. The technical definition is a resource that is ‘rivalrous in use and from which it is difficult or costly to exclude users’ (Grafton, Pendleton and Nelson 2001). In simple terms, common pool resources are ‘a valued natural or human made resource or facility that is available to more than one person and subject to degradation as a result of overuse. A common pool resource is one for which exclusion is costly and one person’s use subtracts from what is available to others’ (Connor and Dovers 2002). Hence, defence of entitlements incurs costs on the part of users. The common pool nature of the water resource is further complicated by its physical properties as a fixed stock at any point in time and place that is linked by variable flow components. For example, at any particular point in time there

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is an extractable stock of water stored in the catchment in dams, streams and aquifers. The available stock varies from year to year according to flows, which in turn are influenced by seasonal conditions and water demands. The stock/flow characteristic of water has been handled in many systems by specifying long-term entitlements as a share of the available resource, and short-term entitlements as a fixed maximum quantity available for harvest within a set time period. For example, irrigation water licences are commonly expressed as a share of the available resource (the variable flow). Each annual irrigation season the share of the resource is converted to an announced maximum volume of water that can be accessed. The harvestable volume is often calculated after allocating environmental or other priority entitlements that may or may not be related to the flow component. The approach of allocating a share of the available resource that is then available as a specified quantity varying according to time period is a standard approach to defining entitlements to most common pool resources such as fisheries. However, with respect to water, location specific and uni-directional flows complicate this process. Put simply, rain falls in a specific location and runs downhill. While some local pumping may reverse this flow it remains downhill for most practical purposes. This introduces two different but interrelated practical problems: 1. the degree of substitutability of water sources in catchments is location specific. Importantly, water sources become more substitutable at downstream locations as tributaries join together (but potentially at the cost of transmission losses); and, 2. upstream agents are independent of downstream agents but may be able to influence the quantity of resources available to downstream agents if water entitlements are incomplete or non-defensible. Substitutability of water sources is often dealt with by considering separate aquifers or streams as separate common property resources. Special rules may then apply to the spatial alienability of entitlements to prevent trades from occurring that would compromise the entitlements of other holders. For example, there are a number of spatial rules governing trades in the Murray and Murrumbidgee systems. The impact of uni-directional flows on entitlements is much more complex. The uni-directional nature of the system can be thought of as a set of sequential allocation decisions where the behaviour of upstream agents affects the resource availability of the downstream users. This problem is illustrated in Figure 7.1 with respect to irrigation and the hydrological cycle. At any stage in this cycle users are able to change their management to capture water resources. However, entitlements may not cover all steps in the cycle. For

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example, land managers in quadrant 1 may change their land management to reduce runoff or groundwater percolation. Similarly, delivery agents may be able to change their behaviour to be more or less efficient. If there are multiple irrigation areas then there will be sequential opportunities to capture additional water by reducing return surface or groundwater flows. If entitlements are not linked both upstream and downstream then they may not be defensible. Two types of priorities in water systems may further complicate the sequential allocation problem that characterises water entitlements. First, the uni-directional system effectively grants prior entitlements to those upstream because their actions can be taken first. Furthermore, some residual entitlements, or abilities to influence the system, will always fall to on-ground users (Wills 1997) and upstream users can exercise residual entitlements first thus impacting on downstream users. Second, the entitlements of some users may be given priority over other users. For example, the environment or water used by urban areas and towns may be allocated before other allocations become available. Thus, in a sequential system, the impact on the downstream users may be cumulative. For example, Young and McColl (2002, 2003) identify these types of impacts at each stage in the hydrological cycle due to impacts such as farm dams, farm forestry, channel leakage and improved irrigation efficiencies. From an entitlement defensibility perspective it is important to identify whether there is a legal entitlement to the source of water that can be enforced and who has the responsibility or ability to employ that entitlement. To some extent this depends on whether water users hold an implicit or explicit entitlement. An explicit entitlement would allow entitlement holders to enforce their entitlements using the courts. Water users with a history of use hold an implicit entitlement to continued usage (Beare and Heaney 2003), but have no legal mechanism to continue to benefit from that implied entitlement. However, implicit entitlements could be legally enforceable if they are held through other linkages in the supply chain such as water supply and transmission operators. Transaction Costs and Entitlements Entitlements define access to resources and facilitate the exchange of these resources by virtue of the agreed rules for measurement and access to water amongst other parameters that they represent. However, the design and implementation of the rules and any exchanges of entitlements are not cost free. Rather, significant investment is required to develop an effective system of property entitlements, and further costs are incurred in any changes to this system. Similarly, costs are involved in any exchange of entitlements. These costs are termed transaction costs and include:

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1. codifying entitlements, and identifying and enforcing ownership over entitlements; 2. seeking out buyers or sellers of entitlements; 3. negotiating a sale; 4. measuring the quality and quantity of goods; and, 5. contracting specifications about the transfer of entitlements. Contracting issues include when delivery will occur and the uncertainty about any intervening period and incomplete aspects of the contract. Transaction costs are important because they consume resources that could be used for other purposes (Wills 1997).8 In the context of this paper transaction costs are important at two levels: 1. any change to existing water entitlements structures will involve transaction costs in changing policy. Information and monitoring costs may be especially important where yield parameters are poorly specified and large catchments feed into spatially separated or sequential storages; and, 2. any changes to policy are likely to influence transaction costs in markets. Who is allocated entitlements may be especially important in reducing transaction costs. For example, transaction costs are likely to be lower in well-established markets with easily identifiable buyers and sellers compared to new markets with uncertain and difficult to identify buyers or sellers. The nature of the transaction costs will differ depending on the policy structure that is employed. For example, a command and control framework will incur a differing mix of costs to extending market frameworks. The influence of technology on transaction costs may also be important, particularly where tools and techniques such as remote sensing may significantly reduce the transaction costs. In the remainder of this chapter we focus on identifying where water entitlements may not be defendable with respect to the hydrological cycle in Australia and whether this is in fact a problem. We also note some of the transaction cost implications of potential policy options for dealing with incomplete entitlements.

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ENTITLEMENTS AND WATER IN AUSTRALIA Water Entitlements in Australia In Australia, formal entitlements to water are granted for stock and domestic use, regulated and unregulated surface water access, and, groundwater access. Although varying by State, entitlements to the water resource once it reaches defined streams and river stocks are generally well defined (see Table 7.1). Figure 7.1 illustrates that there are also some significant flow components linking these stocks. In Figure 7.1 these flow components are represented by dashed boxes as the movement of water from one quadrant to another and separated out as water after it leaves the farm boundary to storages (quadrant 1 to 2), the transmission of water from the storage then back to land (quadrant 2 to 3), the flow of water from the land to and between groundwater systems (quadrant 1 to 3), and, the flow of the water to the irrigator and back to the stream or groundwater system (quadrant 4 back to 2 or 3). In Table 7.1 the current structure of entitlements for water as a stock and a flow resource is summarised. Table 7.1 and the remainder of this section focuses on surface water interactions (quadrants 1, 2 and 4 of Figure 7.1 and the flows between them). Subsurface interactions (quadrant 2) are not included in the discussion of water entitlements. Although subsurface interactions are important, surface water use dominates water use issues and is therefore the focus of the remaining discussion. What is Missing in Entitlements and Landholder Actions and Implications for Defensibility? There are some key hydrological characteristics that are not incorporated in water entitlements. The missing entitlements primarily relate to: • flows of the water resource between allocated stock resources such as transmission losses (quadrant 1 to 2) particularly for private distribution systems; • return flows from water application such as irrigation (quadrant 4 to 2 and 3); and • to the initial stock of water falling as rainfall and subject to land use changes such as reafforestation before water leaves the farm boundary (quadrant 1). Also included in Table 7.1 is an indication of whether there is some priority of entitlements. Different entitlement holders have different priorities to the water resource. The priority of entitlements is specified in the legislation for each State. For example, in NSW under the Water Management Act 2000, the

107

✓, varies according to location

✓, varies according to location

✓, varies according to location

✕

✕

✕

Vic

SA

State

State

State

State

Public distribution

✕/?

✕/?

✕/?

✓

Private distribution

Yes

Yes

Yes

Yes

Priority Entitlements*

✓, % stock,
✓, % stock,
✓, % stock,
✓, % stock,
Regulated

✓, % flow,
✓, % flow,
✓, % flow,
✓, % flow,
Unregulated

✕

✕

✕

✕

Return Flows

Quadrant 4 – Surface water application

Entitlements are not defined at all Entitlements are well defined Entitlements to losses and savings in transmission are unclear. Entitlements are either not specified, or savings can not be isolated to either the public or private water distribution entity Water Access Licence required Before water enters a private irrigation district or area, transmission losses in its delivery are owned by the State % of the stock of dam inflows available at any time % of the volume of water that may be accessed at any given time Share of the available stock generally with a maximum quantity specified (it may be exceeded in certain circumstances)

Source: Productivity Commission (2003 a, b, c, d, and e); Whitten (2003); and National Competition Council (2001 a, b, c and d).

WAL State % stock % flow
✕ ✓ ?

Key:

*

✓, varies according to location

✓, varies according to location

✓,
✓, WAL

Overland flows

Quadrant 2 – Transmission

Priority entitlements vary by State but usually include environmental flows, town water supplies and landholder entitlements have priority over licensed water use such as irrigation

✓, 10%

✕

NSW

Qld

Run off

Quadrant 1 – before the farm boundary

Water Entitlements in NSW, Victoria, South Australia and Queensland

Land use9

Table 7.1

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fundamental health of a river or groundwater system must be protected and has priority. The Act then specifies that local water utility licences, along with major utilities (such as Sydney and Hunter Water Corporations and electricity corporations) and basic landholder entitlements have priority over other licensed water users. Basic landholder entitlements allow those landholders along a river, or who overlie an aquifer, to take water for their domestic and stock needs without an access licence (DIPNR 2001). The lack of well-defined entitlements that are then compounded by the sequential allocation of water means that there are a number of actions that could have a potentially significant impact on the flow of the water resource and the resource available to other and downstream users. These actions include water source land use and interception, irrigation delivery efficiency and irrigation water use efficiency. The implications of these missing entitlements in terms of the biophysical outcomes and defensibility of entitlements are discussed in the remainder of this section. Quadrant 1: water within the farm boundary, land use and land use change Currently, agricultural uses dominate land in Australia with 485 million hectares (63 per cent) under agriculture (Keenan et al. 2004). Annual crops and pastures common to Australia’s agricultural lands use considerably less water through evapotranspiration than native or perennial vegetation. A number of Australian studies show that evapotranspiration from predominantly agricultural catchments ranges from 440mm/yr to 783mm/yr and never exceeds 700–800mm/yr, even in a wet year, due to other climatic limitations (Keenan et al. 2004). The lower use of water by agriculture on some soils can result in a greater quantity of water percolating to groundwater or running off to streams and rivers. Groundwater percolation is estimated to have been between 1 and 5mm/yr before European settlement (under native vegetation across what are now mostly agricultural regions in Australia). On the same land, under agriculture, percolation can now range from 0 to 63mm/yr but can be as high as 150mm/yr in high rainfall regions (Keenan et al. 2004). Introducing grazing into the production mix can lead to soil compaction in some areas and result in increased runoff rather than increased percolation. Runoff associated with different land uses with and without grazing is presented in Table 7.2. In general, land use such as stable communities of vegetation (forests) capture and use a larger proportion of rainfall (through a higher evapotranspiration) compared to pasture or agricultural lands. Changes in land use of currently agriculture and pastoral lands such as reafforestation, if undertaken on a sufficiently broad scale, will have a profound affect on catchment hydrology (Keenen et al. 2004). The most significant impact will be reduced

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Table 7.2 Land Use and Runoff Site

Treatment

Wheat Stubble Heavy grazing Ungrazed Pasture Heavy grazing in summer No grazing and pasture retained from previous 2 years No grazing but pasture removed Source:

Runoff as a proportion of total rainfall (%) 57–81% 4–42% 45–48% 15% 30–60%

Keenan et al. 2004.

water yields and reduced groundwater recharge. It is also likely that changes will be seen in the seasonal distribution of runoff, the timing and magnitude of peak flows and the length of low flow periods (Vertessy 2001). Current estimates of the likely impact of the government-endorsed vision of trebling plantation forestry across Australia by 2020 indicate that it is expected to reduce flows in the Murray-Darling Basin by around 1 300 GL (Young and McColl 2003). The impact of changed land use (changing from agricultural land to native forest or vice versa) has been extensively researched by Holmes and Sinclair (in Keenan et al. 2004). Here 19 catchments in Victoria were analysed to demonstrate that the difference in evapotranspiration between the two land uses (forest or agriculture) increases as rainfall increases above 500mm/yr (Keenan et al. 2004). For example, when annual rainfall is 1500mm/yr, the evapotranspiration of forested land is 200mm greater than agricultural land (equivalent to 2ML/ha of forest/yr). When rainfall is 800mm/year the difference is smaller at 130mm/yr. The Holmes and Sinclair Relationship (HSR) is demonstrated in Figure 7.4. The implication is that land use change in higher rainfall regions may significantly impact on downstream water yields, and a significant proportion of these areas are privately owned and may be subject to changing land use. One potential solution to the impacts of land use on the stock and flow of water is to incorporate impacts on allocated stocks further down the system (Keenan et al. 2004 and Productivity Commission 2003a). However, Keenan et al. (2004) point out that if the impacts of upstream water users such as forestry are to be included in water entitlements a number of issues need to be well thought through first. Many of these issues are associated with the information transaction costs of a policy change and are as follows:

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110

Mean annual evapotranspiration(mm)

1600

HSR Forest

1200 800

Grass 400

500

1000

1500

2000

Mean annual rainfall (mm) Source: Holmes and Sinclair (1986) in Keenan et al. 2004.

Figure 7.4 Relationship Between Land Cover, Mean Annual Rainfall and Mean Annual Evapotranspiration • although there is good science about the impact of reafforestation or clearing on stream flow, this knowledge is only site specific and results regarding relationships cannot be applied broadly across a catchment or catchments (for example, significant proportions of catchments can be hydrologically isolated from streams). Therefore for each small change the impact to the greater system is difficult to determine. This could make the defining of entitlements difficult. • vegetation in forests provide a range of other benefits (biodiversity and water quality benefits for example). If water entitlements are established for water use by forests, then additional benefits of forests also should be considered and brought into the entitlements system. This is likely to have high information costs. • where would entitlements start? Will owners of existing forest plantations be liable for water use? Will there be a water credit once the trees are harvested? Could this provide an incentive for land clearing? Should farmers who convert from annual to perennial pastures which also use more water be liable for this increase water use? Who is liable for the water use if the property and the trees are owned by different entities? From the issues raised by Keenan et al. (2004) it is clear that the transaction costs associated with defining and implementing any policy changes to better define entitlements related to land use change are likely to be high. Transaction costs would also influence the potential efficiency of the resultant market.

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For example, the cost of trades in any market is likely to vary depending on where the entitlements are assigned in the first place. Assigning water supply entitlements to downstream irrigators incurs a significant monitoring and enforcement cost to defend water supplies. Assigning entitlements to large numbers of upstream users with relatively small impacts would incur significant search and contract negotiation costs on the part of potential downstream purchasers. Indeed costs could blow out given the numbers involved and therefore the negotiation cost as well as the cost of information. Quadrant 1: water within the farm boundary – water harvesting Currently landholders can, to an extent, capture water falling on a property as rain, or running over the surface of a property. Water harvesting includes capturing water on farm in dams to be used later in activities such as topping up irrigation allocation, or through on land works that slow down the runoff (to increase soil percolation). The impact of water harvesting on downstream water users has already been recognised by some governments. For example NSW, Victoria, Queensland and South Australia all have rules and entitlements regarding the harvesting of water. These entitlements and rules range from a blanket 10 per cent of flow restriction to a percentage take that varies according to the location of the property in the catchment. In some catchments the sheer number of farm dams is having a significant impact on surface flows of streams. For example, Neal et al. (2002) determined that in the Yass River catchment in NSW, farm dams had increased from 491 dams in 1976 to 1 402 dams in 1988, an increase of 911 dams in just over ten years. This increase in farm dams has seen an increase in storage capacity in the catchment from 1 430ML to 5 022ML. This is an increase in stored water in the catchment of approximately 300ML each year over the period of the analysis. In the same analysis Neal et al. (2002) assessed the relationships between rainfall and runoff with farm dams. Over the period of the analysis there was a statistically significant (at the 5 per cent level) reduction in stream flow of around 1 700ML each year. This reduction in stream flow corresponds to an approximate reduction in mean annual flow of 8 per cent. Neal et al. (2002) also found that farm dams in the Yass catchment have a greater than proportional impact on flows, with a 1 ML increase in on-farm storage corresponding to a 1.3 ML reduction in stream flows. Despite the implementation of a cap on on-farm water harvesting in most areas, the impact of developments up to the cap together with any more than proportionate downstream impacts has yet to fully appreciated. For example, in NSW a 10 per cent blanket cap is applied to the harvesting of overland flows. Furthermore, in most cases the cap is not yet binding with resultant potential for future downstream impacts as development continues. This potential should be of particular concern given the recent decision of the NSW

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Farmers Federation to lobby for an increase in the NSW cap to 20 per cent of on-farm run-off (Sydney Morning Herald 21 July 2004). Quadrant 1 to 2 and 2 to 3: transmission of water Once water leaves the farm boundary, both in naturally occurring watercourses, streams and rivers and man-made channels, there are significant quantity losses through evapotranspiration and percolation to groundwater systems (from which it may eventually return as return flows). These transmission losses can be significant with anecdotal reports of over 200 per cent losses in some systems.10 Entitlements surrounding the losses in transmission are complex as they are a combination of state-owned and private water entitlements depending where in the system they occur (See Table 7.1). Furthermore, some state-owned entitlements have been assigned to private or quasi-private interests. Un-allocated transmission losses that occur between the water source and final water user are part of a common pool resource until water enters a distribution system for which a single responsible entity can be defined. It could be said that a system that clearly defines and allocates entitlements to losses to a single private entity would give a direct incentive to the entity to improve distribution efficiency. Even if this allocation occurs, this efficiency does not extend upstream to the state distribution agency. It appears that only NSW has a clearly specified entitlement to losses owned by supply management companies (Productivity Commission 2003b). Management actions that reduce transmission losses have often been called win-win outcomes as they have been seen to have the potential to provide additional water for the environment without reducing consumptive users entitlements. The potential for private investment to access efficiency gains in these systems is also of interest given the investment of the Pratt Water Group in the Murrumbidgee, in part to identify whether cost effective opportunities to reduce distribution losses via piping may exist. The current operating framework may have created some potential opportunities for private actions to receive entitlements from such actions. For example, the NSW Murray Wetlands Working Group (MWWG) and Wetland Care Australia (WCA) have undertaken works that reduce evapotranspiration in transmission by constructing weirs that facilitated wetland flooding and drying. In return they have been granted access to the evapotranspiration savings for use in flooding other wetland systems. This pragmatic mixed approach may be effective to achieve environmental outcomes but the administrative transaction costs will need to be carefully monitored. Already anecdotal evidence from both the MWWG and WCA indicates that much time and effort was required to secure water access but no formal entitlement to the water is held by either organisation.

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Quadrant 4 to 2: water application – irrigation efficiency Irrigation efficiency is defined as the proportion of irrigation water extracted that is returned to the atmosphere through evapotranspiration. The remainder of the water that is applied returns to streams and rivers and groundwater aquifers. This relationship is demonstrated in quadrant 4 of Figure 7.1. In horticultural regions such as in Western Victoria and the South Australian Riverland, irrigation efficiency is around 75–80 per cent for horticulture. In other areas where application is primarily through flood irrigation, efficiency is usually around 50 per cent (Heany and Beare 2001). The range of evapotranspiration (Et) and groundwater recharge levels associated with different agricultural activities in different regions is displayed in Table 7.3. Table 7.3 Irrigation Water to Evapotranspiration and Groundwater Percolation Irrigation area

Goulburn Broken Campaspe NSW Murray Loddon Barr Creek Loddon Cohuna Loddon Tragowel Murrumbidgee Robinvale

Irrigated activities

Water allocation Murray Tributary (GL) (GL)

Pasture, 320 cropping, horticulture Pasture, 207 cropping Pasture, 2 464 cropping Pasture, 163 cropping Pasture, 455 cropping Pasture, 455 cropping Pasture, 0 cropping, horticulture Horticulture 31

Et fractiona

Recharge fractionb

(%)

(%)

853

65

50

75

50

60

0

65

75

0

65

75

0

55

75

0

55

75

2 045

65

80

0

80

100

Notes: a Et is evapotranspiration, the percentage of irrigation subject to evaporation and transpiration. b The percentage of excess water, irrigation water and precipitation less evapotranspiration that enters the groundwater system (this is the same as ‘percolation to the groundwater’ in Figure 7.1). The remainder exits as surface flows, some of which may be captured and recycled on-farm. Source: Heaney and Beare (2001).

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At present most irrigation licences are defined as an entitlement to access a quantity of water (share of the available volume) with no regard to the proportion that flows back to the river systems either through runoff or groundwater recharge (Young and McColl 2003). Irrigators pay for the volume that they divert, regardless of how much of that water they actually use. Improving water use efficiency means that less water is required to sustain current production therefore less water is applied to an area, less water percolates through or runs off and therefore less water re-enters the system. By allowing entitlement holders the ability to utilise gains from water use efficiency (for example, increased irrigation area) the current entitlement structure allows upstream users to ‘capture’ an increasing share of the resource at no additional cost to themselves but at the potential expense of the downstream users. Young and McColl (2003) highlight this impact. In the Riverland of South Australia it has been estimated that an increase in irrigation efficiency from 80 to 90 per cent will reduce groundwater inflows to the Murray River in the region by approximately 22 per cent (Young and McColl 2003). Managing the impact of improved irrigation efficiency on return flows and downstream water entitlements could be relatively straightforward through the allocation of a net allocation. In other words an allocation that already takes into account the return flows. Young and McColl (2003) point out that this is already occurring in some states, particularly NSW and Victoria. Young and McColl (2003) also note that for some irrigation areas in these states ‘net’ bulk entitlements are being allocated to irrigators that allow for a reduction in surface flow returns from improved irrigation efficiency. This means that as one irrigator improves irrigation efficiency, water is reallocated to this person, taking into account the reduction in return flows by reducing the allocation to other users in the system. In Victoria, this is achieved by reducing allocations of sales water and in NSW by decreasing allocations to general security irrigators. The transaction costs associated with such a policy change will be influenced by the level of information on the current efficiencies and return flows and the numbers of irrigators involved in any potential negotiation.

DISCUSSION AND CONCLUSIONS Water is both a stock and a flow resource depending on where in the system it is considered and what timescales it is considered under. Allocation of the resource via water entitlements tends to focus on a series of sequential stocks held in large storage dams and aquifers. Stocks (or flows) of water in streams and rivers are also allocated via water entitlements. These entitlements are held

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by a range of consumptive and extractive users including primarily irrigators but also including towns, households (stock and domestic) and other industries with prior allocation given to the environment. What is made clear in this chapter is that the allocation framework for water entitlements does not fully capture the complete hydrological cycle of the resource. As a result, water users higher up in the catchment are effectively granted a ‘first to access’ priority over the water resource resulting in indefensible entitlements between downstream and upstream entitlement holders. Incomplete entitlements to water resources imply that a number of land activities could potentially impact on the flow of the water resource and hence significantly compromise the defensibility of entitlements between entitlement holders at different points in the hydrological cycle. Land activities identified as having the greatest impact on water resource flows in the absence of complete entitlements include current and changed land use (for example moving from cropping to agroforestry), water harvesting and a change in irrigation efficiency. Although the scale of the impact of these activities is not known with certainty and perhaps does not appear large when viewed individually (for example a farm dam here and a 10 ha plot of agroforestry there), the cumulative impact on downstream users in an incomplete property entitlement framework is likely to be significant. Finally, no discussion that has implications for policy should occur without reference to transaction costs. In the context of this chapter, transaction costs were identified as significant at two levels. First, any change to existing entitlements may incur significant information and monitoring costs, especially where yield parameters are largely unknown and the catchments are large. Second, changes in policy such as introducing new entitlement holders could influence the transaction costs of already established markets. Further investigation should be undertaken into the nature and extent of transaction costs of better-defined entitlements before any recommendations for specific changes are made.

NOTES 1. A previous version of this paper was presented at the IPA Symposium on Establishing Australian Water Markets in Melbourne, Australia, 9 August 2004. We are grateful for comments from Jeff Bennett (The Australian National University) and Russell Gorddard (CSIRO Sustainable Ecosystems). Naturally all errors remain the responsibility of the authors. 2. Water supply in Australia is either regulated or unregulated. Regulated water supply is that which is released from large storages operated by the State, unregulated supply is that water in rivers and streams not regulated by any storage. 3. Other agents may also influence the amount of water that reaches the ground through cloud seeding. This is not discussed here.

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4. As demonstrated in Figure 7.3, water providers are defined by the ABS as primarily the water supply, sewerage and drainage service industry. This water is extracted and provided to users through a network of infrastructure such as channels and pipes and is supplied to users for a fee. 5. Defined by the ABS as water extracted from the environment and includes water from rivers, lakes, farm dams and other water bodies. 6. Regulated discharge refers to water discharged after use where that discharge does not match the natural flow regime of the receiving water body. For example, wastewater discharged into a river, ocean or land outfall by a sewerage service provider is considered a regulated discharge. Many irrigation water providers were unable to quantify the volume of drainage water discharged and it is likely that this volume is larger than indicated in the flow tables. Unregulated discharges are currently not included in the ABS water account. 7. Water entitlements are not true ‘property rights’ in the economic or legal sense as some attributes differ. For example, water entitlements are generally time limited rather than allocated in perpetuity. 8. Transaction costs may be so high that no entitlements are allocated or alternatively no trades take place, even under the most efficient frameworks. In this case the optimal outcome will be to do nothing and allow the market or government failure to continue because no net benefit can be created by allocation or trading. 9. The National Water Initiative is currently considering a framework to address uncontrolled and significant interceptions of water from land use activities (Australian Government Department of Prime Minister and Cabinet). 10. The Yanco Creek anabranch south off the Murrumbidgee is reported to have losses of over 200 per cent (Murrumbidgee Irrigation pers. com.).

REFERENCES ABS (2004), Water Account Australia 2000–2001, Cat no. 4610.0, Canberra: Australian Bureau of Statistics. Barzel, Y. (1997), Economic Analysis of Property Entitlements, 2nd edn, Cambridge: Cambridge University Press. Beare, S. and A. Heaney (2003), Water entitlements, transactions costs and water policy reform. ABARE Conference Paper 03.17. Bromley, D.W. (1991), Environment and Economy. Oxford: Blackwell. Connor, R. and S. Dovers (2002), Property Entitlements Instruments: Tranformative Policy Options. Property Entitlements and Responsibilities: Current Australian Thinking, CSIRO Land and Water. Department of Infrastructure, Planning and Natural Resources (2001), Water Access Information Sheet Number Seven. The Water Management Act 2000, What it Means for Town Water. Department of Sustainability and Environment (2004), Securing Our Water Future Together; Victorian Government White Paper. Dunlop, M., N. Hall, B. Watson, L. Gordon and B. Foran (2001), Water Use in Australia, Report 1 of 4 in a series on Australian Water Futures, Working Paper Series 01/02, CSIRO. Grafton, R.Q., L.H. Pendleton and H.W. Nelson (2001), A Dictionary of Environmental Economics, Science, and Policy, Cheltenham, UK and Northampton, MA, USA: Edward Elgar. Heany, A. and S. Beare (2001), ‘Water Trade and Irrigation, defining property entitlements to return flows’, Australian Commodities, 8 (2), June quarter 2001, Canberra: Australian Bureau of Agriculture and Resource Economics.

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Keenan, R., M. Parsons, E. O’Loughlin, A. Gerrand, S. Beavis, D. Gunawardana, M. Gavran and A. Bugg (2004), Plantations and Water Use: A Review, Forest and Wood Products Research and Development Corporation, Project Number PN04.4005, Australian Government. National Land and Water Resources Audit (NLWRA) (2001), Australian Water Resources Assessment 2000, Natural Heritage Trust, Australian Commonwealth Government. National Competition Council (2001a), Assessment of Governments Progress in Implementing the National Competition Policy and Relate Reforms: New South Wales reform, June 2001, Canberra: Ausinfo. National Competition Council (2001b), Assessment of Governments Progress in Implementing the National Competition Policy and Relate Reforms: Victoria reform, June 2001, Canberra: Ausinfo. National Competition Council (2001c), Assessment of Governments Progress in Implementing the National Competition Policy and Relate Reforms: Queensland reform, June 2001, Canberra: Ausinfo. National Competition Council (2001d), Assessment of Governments Progress in Implementing the National Competition Policy and Relate Reforms: South Australia reform, June 2001, Canberra: Ausinfo. Neal, B., R. Nathan, S. Schreider and A. Jakeman (2002), ‘Identifying the Separate Impact of Farm Dams and Land Use Changes on Catchment Yield’, Australian Journal of Water Resources, 5 (2), 165–176. Ostrom, E. and E. Schlager (1996), The Formation of Property Rights, Washington DC: Island Press. Perman, R., Y. Ma and J. McGilvray (1996), Natural Resource and Environmental Economics, London and New York: Longman. Productivity Commission (2003a), Water Entitlements Arrangements in Australia and Overseas, Melbourne: Commission Research Paper, Productivity Commission. Productivity Commission (2003b), Water Entitlements Arrangements in Australia and Overseas: Annex B, New South Wales, Melbourne: Commission Research Paper, Productivity Commission. Productivity Commission (2003c), Water Entitlements Arrangements in Australia and Overseas: Annex C, Victoria, Melbourne: Commission Research Paper, Productivity Commission. Productivity Commission (2003d), Water Entitlements Arrangements in Australia and Overseas: Annex D, Queensland, Melbourne: Commission Research Paper, Productivity Commission. Productivity Commission (2003e), Water Entitlements Arrangements in Australia and Overseas: Annex E, South Australia, Melbourne: Commission Research Paper, Productivity Commission. Sjasstad, E. and D.W. Bromley (2000), ‘The prejudices of Property Entitlements: On Individualism, Specificity, and Security Property Regimes’, Development Policy Review, 18 (4), 365–389. Tan, P. (2002), Legal issues relating to water use. Property Entitlements and Responsibilities: Current Australian Thinking, CSIRO Land and Water. Vertessey, R. (2001), ‘Impacts of Plantation Forestry on Catchment Runoff’, Proceedings of a national workshop 20–21 July 2000, Melbourne, Water and Salinity Issues in Agroforestry No. 7 Rural Industries Research and Development Corporation, Publication No. 01/20.

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Whitten, S.M. (2003), Water Property Entitlements and Water Management in the Fitzroy Basin, report prepared for the Central Queensland University and the Central Highlands Regional Resource Planning Cooperative. Wills, I. (1997), Economics and the Environment, A signalling and incentives approach, Sydney: Allen and Unwin. Young, M.D. and J.C. McColl (2002), Robust Separation: A generic framework to simplify registration and trading of interests in natural resources, CSIRO Land and Water. Young, M.D. and J.C. McColl (2003), Robust Reform Implementing robust institutional arrangements to achieve efficient water use in Australia, CSIRO Land and Water.

INTERNET REFERENCES Australian Bureau of Meteorology: http://www.bom.gov.au Australian Government Department of Prime Minister and Cabinet: http:// www.pmc.gov.au NLWRA: http://www.nlwra.gov.au/ Victorian Government Department of Sustainability and Environment: http:// www.dse.vic.gov.au Sydney Morning Herald ‘Greens pour cold water on push for bigger dams’ www.smh.com.au

8.

Potential Efficiency Gains from Water Trading in Queensland John Rolfe

INTRODUCTION Economic reform in the water industry in Australia is an important issue. The supplies of regulated water have been constrained by restrictions on the construction of new dams as a consequence of environmental and political concerns, while demands have continued to increase from agricultural, urban and other users. The water industry is notable because price has rarely been used as a mechanism for allocating the resource, and when it has, it has only been used as a partial cost-recovery mechanism. Water prices have generally been set at very low levels through the public funding of major impoundments, with the effective subsidisation of many government operated distribution systems (Smith 1998). Two key themes that have driven recent water policy in Australia and internationally are that resource management should be ‘integrated’ across various sectors, uses and demands, and that water reforms should take a more ‘economic’ approach (Bauer 2004). The first theme refers to the realisation that water extraction and use has hydrological, ecological, economic and social consequences, and these need to be recognised to design more ‘sustainable’ water use patterns. The second theme refers to the trend to use more market incentives and other economic instruments to improve economic and social outcomes of water use. Over the past decade in Australia, there have been moves towards a more competitive and efficient basis for allocating water resources. These changes are being driven by the strategic framework for water sector reform adopted by the Council of Australian Governments (COAG) in 1994. Among the COAG reforms to be implemented by the year 2001 were: • pricing based on principles of full-cost recovery and transparency; • the development of property right systems over water; • the deregulation and development of trading systems for water. 119

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These reforms will essentially remove water as a factor input supplied by public institutions to being a factor input supplied by more competitive market processes. Key steps in that process include the specification of water entitlements between the environment and use purposes, the establishment of property rights to allow apportionment and trade at the farm enterprise level, and the development of appropriate regulatory and governance mechanisms. There are some differences in the ways that the various state governments have set out to achieve these goals, and the reform process has not been as swift as initially set out under the COAG agenda (Whitten 2003). Economic theory predicts that freeing up inputs to flow towards highest value use can generate substantial efficiency dividends (Easter et al. 1998, Tsur et al. 2004). However, the moves towards competitive market pricing and allocation often meet substantial resistance. In a political sense, there is a need to not only advance theoretical economic arguments for establishing water trading mechanisms, but also give practical examples and explanations of how economic growth and regional communities are benefited by these reforms. To counter the variety of arguments against water trading put forward by the variety of interest groups, it is useful to be able to explain and demonstrate some of the potential gains. However, it is difficult to find clear examples in Australia of gains from water trading. This is because (a) water trading is still being established in many irrigation regions in Australia, (b) the gains from water trading are difficult to identify in the short run, and (c) there are a number of other confounding factors such as weather events and macroeconomic settings that impact on economic performance in irrigation areas. There are a number of international case studies (e.g. Easter et al. 1998, Tsur et al. 2004, Bauer 2004) which have shown that the use of competitive trading mechanisms in water resources has been advantageous. Tsur et al. (2004) report the use of farm level analysis of derived demand to analyse water prices and returns in a number of international case studies. They also review a large number of international studies which demonstrate increasing adoption of competitive market mechanisms for water. Easter et al. (1998) provides a number of international case studies about the applications and benefits of water trading systems. For example, Archibald and Renwick (1998) estimate the gains from trade in developing water markets in California, while Hearne and Easter (1998) estimate the gains from trade in Chile’s water markets. Horbulyk and Lo (1998) analyse water markets in Alberta and estimate that potential gains in consumer surplus of 56 per cent are available from the introduction of competitive resource allocation. Bauer (2004) argues that the benefits of water trading in Chile have been overestimated, and that the design, in the 1980s, of the competitive market process could have been better. He considers that the real benefits of water reform process in Chile have been the improved security over property rights.

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This has led to increased private investment in water use. These arguments indicate that the benefits of water trading may not simply arise from allocating water to more efficient uses, but may also result from the changed institutional and incentive structures required to implement a water reform process. In this chapter, a number of approaches to demonstrating the potential benefits gained from water trading mechanisms are outlined, with a particular emphasis on case studies from the state of Queensland. The chapter is organised in the following way. In the next section, a brief overview of background economic issues is outlined, with some discussion about what types of benefits might be available from the introduction of water trading. In Section 3, some evidence is presented about the potential gains from water trading in Queensland, with examples selected from four broad areas. These include gains from trading between different sectors, gains from trading within sectors, gains from avoiding government failure and gains over the longer term when innovation and entrepreneurial behaviour is encouraged. Conclusions are presented in the final section.

BACKGROUND ECONOMIC ISSUES Economic analysis focuses on efficiency as a key criterion for allocating water resources, where efficiency is broadly defined as a measure of the net benefit gained from changing resource allocations. An efficient allocation occurs when the total net benefits of water use are maximised. Distributional issues are not necessarily included in economic analysis, but because they are important for equity and political reasons, are normally assessed in some sense as well. The equity impacts arising from water trading issues are discussed briefly in the next section. The efficiency of different resource allocations is measured by estimating the consumer surplus and producer surpluses that are gained, net of any surpluses lost. Some key concepts can be shown with the aid of Figure 8.1. Here, downward sloping demand curves are shown for both agricultural and industrial users. If water is supplied to either industry at supply level Q1, the market demand price would be set at $A. If all the water is allocated to agricultural use, the economic surplus is the triangle ABD, while if all the water was allocated to industry, the economic surplus is ACD. Industrial and urban users typically have high demand levels for discrete water quantities, meaning that they have substantial economic surpluses over relatively small volumes of water. In contrast, agriculture typically has relatively flat demand curves, meaning that economic surpluses per unit of water tend to be small. If all of Q1 was supplied to agriculture, and then transferred to industry and urban,

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the surplus would shift from ABD to ACD, an improvement in efficiency of CDB. $

Demand from industry

C

B

Demand from agriculture D

A

Q1

Demand

Figure 8.1 Surpluses from Water Use by Different Industries It is normal that industrial and urban users have first priority over water, often expressed in terms of higher security levels. Agriculture tends to have lower security, but often has high quantity demands for water (although at lower prices). A key allocation problem is how to apportion water between different sectors, especially when price mechanisms are not used to indicate scarcity levels. Earlier allocation mechanisms for water resources have involved governments building supply storages and allocating water (mostly on a volumetric basis) to different sectors (Figure 8.2). Typically water charges are set with higher cost recovery rates for industry than for agriculture, as is shown. Allocations to sectors have tended to remain relatively fixed, so that even though demands (and by implication marginal benefits) have risen in particular sectors, allocations have not tended to change much between sectors. The classic example in Australia is where there have been few transfers of water between agricultural and industry/urban sectors, even though the marginal benefits of supplying more water to the industry/urban sectors (as measured by willingness to pay) is probably much higher than the marginal losses of transferring water out of agriculture. Instead, governments have tended to respond to increased demands by building new storages (Figure 8.3). Additional water storage capacity tends to come in discrete units because of site limitations and scale economies, so it is common to build storages to satisfy key demands with additional supply left over. In most cases the balance of available water is supplied to agriculture.

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123

$ Water storage capacity

Industry demand

Quantity

Agricultural demand

Figure 8.2 Planning for Water Shortages

Economic tools can be used to allocate water supplies and make decisions about new storage capacity in much more efficient ways. In a competitive market framework where no market failures are present, maximum efficiency is found at a market equilibrium point where supply and demand are matched. Water prices are the signalling mechanism that match supply with demand and transfer new information about potential gains from water trades. The signalling mechanism means that water is automatically transferred over time from the low value users to the highest value users, generating economic $ New dam needed

Limit of existing storage capacity

New industry demand

Extra agriculture Demand Quantity

Figure 8.3 How Additional Dams Have Been Planned

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surpluses. In this way, transfers between sectors can be made automatically rather than at the discretion of government. An example of an efficient market approach to water allocation issues is shown in Figure 8.4. This shows that when additional demands are injected into a competitive market framework, the demand schedule shifts out, and with supply fixed, prices rise from P1 to P2. The higher prices signal more efficient uses of water, and reward lower return users to give up water supplies in favour of higher return users. If returns at increased supplies are estimated to be high enough, then an economic case for adding to water storages can be made. This would occur if the marginal benefits of increasing supplies exceeds the marginal costs of the providing the storage. $

Old demand curve

P2

New demand curve

P1

Existing Supply

New Supply ?

Figure 8.4 The Market Mechanism and Additional Demands Flexible market allocation mechanisms are expected to generate greater economic efficiencies, and ultimately higher social returns, than the cruder allocative approaches of government. This is not to say that free market models of water management are always fully efficient. Bauer (2004) notes that the free market system in Chile has had marked weaknesses as well as strengths, and issues such as social equity, environmental protection, river basin management and conflict resolution were not adequately considered when market mechanisms were being established in the 1980s. Whitten (2003) details the various approaches that Australian states have taken to consider these different issues when designing competitive market processes. To identify the efficiency gains available from water trading that might be predicted from a basic economic analysis, it is important to perform two key steps. The first is to identify the types of gains that might be made, while the

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second is to identify how these might be measured. A further step to consider is how to present examples of the benefits of water trading in ways that promote understanding among stakeholders. Here, each of those issues is addressed in turn. The Categorisation of Net Benefits from Water Trading There are four key groups of net benefits that can be identified from the introduction of water trading. The first are the benefits available from shifting water between sectors, for example between industrial and agricultural uses, or from low value to high value agriculture. There are often substantial gains available from shifting water between sectors within agriculture, for example from broadacre crops to horticultural uses. Much of the interest in water trading has focused on these potential gains from inter-sector trade. The second key group of benefits relates to trade within sectors. This occurs when heterogeneity in resources, skills, infrastructure and other factors means that the opportunity costs of using water varies between farmers. This variation means that it is profitable for more efficient farmers to purchase water from other farmers, leading to overall gains in efficiency. This reallocation of resources already occurs in relation to land resources, but additional gains should be available when water can be traded separately. The third key group of benefits relates to potential reductions of government failure. This should occur in two main ways. First, competitive market allocation mechanisms reduce the need for government involvement in allocation choices, and reduce opportunities for governments to be captured by rent seeker behaviour. Second, market mechanisms provide clear signals about resource scarcity, and the potential value of providing additional supply. These market signals should help to improve the efficiency of infrastructure planning. The fourth key group of benefits is slightly more intangible, but none the less important. It relates to the benefits gained from fostering self-reliance and entrepreneurship in the agricultural sector. Although public subsidies for agriculture in Australia are low by world standards, there is always interest in ‘farming the government’ (Godden 1997). The introduction of water trading should encourage greater efficiencies in water use, develop a better skill base for dealing with resources, and make farmers more responsive to changes in factor prices. In this way, a very important benefit to flow from water trading may be a more self-reliant and innovative irrigation sector.

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The Measurement of Net Benefits from Water Trading The standard approach in economics to evaluating the net benefits of policy changes or infrastructure development is to use partial equilibrium analysis. This quarantines the analysis to the impacts of the proposal being considered. For example, an analysis of the impacts of establishing water trading markets might involve consideration of the net returns of different production enterprises, the amount of water that might be transferred between sectors and enterprises, the increase in net production that results, and the net production and consumption surpluses that might be generated. A similar process would be undertaken for new water storage developments, where a cost benefit framework might be used to assess the production benefits from additional water supplies, the costs of providing the supplies, as well as any environmental and recreational impacts. Demands for water can be calculated with the use of farm production models (Tsur et al. 2004). The analysis occurs by identifying in a production model what the commercial returns would be from adding additional units of water to an enterprise unit. It is normal that the amount of return diminishes with increasing units, so that the derived demand function for water supplies is downward sloping. Demands across individual farmers can be summed to derive sector or regional demand functions. These farm production models and derived demand functions can be used to predict returns from different allocations of water (Tsur et al. 2004). While an analysis of differences in gross margins is often employed by economists to emphasis the potential for inter-sector trade, it is more difficult to capture real differences at the enterprise unit from such an analysis. For example, farmers in areas where a dominant crop such as cotton or sugarcane is grown may argue that there is little point in establishing water trading because the gross margins are relatively uniform. Farm production models or simpler gross margin analysis models can be used as inputs in linear programming models to simulate the introduction and operation of potential water markets. Linear programming methods are often used to model water demands in the short and long term, where resource constraints, production, management and market information are combined to predict what the response of farmers would be to changes in the price and/or supply of different factors. Briggs-Clark et al. (1986) and ONECG (2001) provide demonstrations of this type of approach. A different way to predict how farmers will engage in and benefit from water trading mechanisms is to employ stated preference techniques. These economic tools have been traditionally used in the environmental valuation field, but there are emerging applications in the agribusiness field (Lusk and Hudson 2004). Stated preference techniques involve some form of an

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experiment where farmers are asked, through a survey format, to indicate their preferred choice from different price and/or supply and demand formats. Another tool for exploring water demand and supply issues is experimental economic procedures. The most common of these are the classroom trading exercises, such as water bank games (Crouter 2003), although other applications include field experiments with farmers or computer simulation exercises. These experimental economic procedures have useful applications in terms of designing new markets, modelling potential interactions and institutional rules, and encouraging use through learning effects (Roth 2002). The Political Economy Issues Although the economic arguments in favour of competitive water markets are strong, it can be difficult to convince governments and stakeholders of the benefits (Easter et al. 1998). It is for this reason that it is important in the political economy sense to be able to present examples and case studies of the net benefits of water trading as well as the economic arguments. To help design these case studies, an understanding of why stakeholders may not accept arguments about the benefits of water trading is useful. For simplicity, resistance can be identified from four broad groups: irrigators, environmentalists, bureaucrats and communities. Irrigators Irrigators in Australia are often very suspicious of new water pricing mechanisms, particularly when the changes mean that water prices will rise. The COAG reform process means that there is potential for water prices to rise to farmers from four main impetuses. The first three stem from governments and the reform process, while the fourth reflects the influence of competitive pressures. The first is the requirement to recover all costs of storage and delivery. In some irrigation systems, delivery costs were highly subsidised, meaning that water charges had to rise substantially just to cover operational costs. A second is that under the COAG reforms, account needs to be taken of the negative externalities generated by use (Beare and Heaney 2002). This may take the form of a Pigovian tax used to signal to irrigators that there may be social costs associated with water use. However, difficulties in identification and measurement mean that moves to incorporate externalities in water prices have been limited to date. In many cases, problems of negative externalities have been addressed in other ways such as volume caps, voluntary actions (e.g. the adoption of Best Management Plans in the cotton industry) and regulatory mechanisms (e.g. the requirement to establish Land and Water Management Plans for new irrigation developments in Queensland).

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A third potential driver of higher water prices is the potential for resource rents to be charged. While mechanisms to capture resource rents are common in the mining industry, there were no comparable mechanisms in the water industry to transfer rents to society. Instead, the flow of rents has typically been from society to the agricultural water industry. Resource rents are still to be established in the water industry, reflecting both the path-dependency nature of the reform process and the political difficulties in introducing new charges in the water industry. The fourth potential driver of higher prices is competitive pressures. These competitive pressures may be exacerbated in some areas where water allocations need to be clawed back to meet environmental targets, although the 2004 agreement between the Commonwealth and State Governments means that governments will bear most of the costs of such clawbacks. The establishment of trading systems for water means that supply and demand intentions can be more accurately matched through the price signalling mechanism. Although these resource flows are between irrigators (rather than from irrigators to government), there is still some opposition from irrigators to competitive trading systems. This is partly because competition for water resources is likely to become more intense (water prices will increase), and because the separation of water from land titles means that land prices will be affected. Environmentalists, bureaucrats and communities Environmentalists and bureaucrats are sometimes opposed to water trading mechanisms because of the perceived loss of government control when private property rights are established. For environmentalists and community groups, there is often concern that open market trading will lead to a concentration of irrigation enterprises as scale efficiencies are exploited. This is sometimes seen as being at odds with the perceived ideal that agriculture should be comprised of the smaller-scale farming enterprises. Irrigator groups and communities are sometimes concerned about water trading mechanisms when there is potential for water to be shifted away from an area to more profitable uses elsewhere. These concerns mean that the design of new water trading mechanisms has to satisfy both economic and political criteria. Key steps in the political process are to demonstrate that there are economic gains available from water trading mechanisms, and to identify where any groups or communities may be adversely affected.

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EVIDENCE FROM QUEENSLAND ABOUT THE BENEFITS OF WATER TRADING In this section, some evidence is presented about the potential gains available from water trading, with reference to Queensland case studies. The material is presented in four parts, in line with the categorisation of the different benefits of water trading presented above. The Returns Available from Trading Between Sectors The standard case that is made for net benefits from water trading mechanisms is that trade between sectors or production activities allows higher value uses to be achieved. For example, water that is taken from low value agricultural production such as rice or cereal crops and used for industry or high value agriculture should generate higher levels of economic returns. The simplest way of depicting the gains available from shifting water to higher value activities is to summarise the returns per unit or megalitre (ML) of water. This is often done for agricultural enterprises with the aid of gross margin analysis, which identifies the net return after the direct costs of growing and selling a crop have been considered, and provides a benchmark for comparing the returns for different water uses. Here, two case studies are used to illustrate the potential gains available from transferring water between sectors. Case study 1 – Changing Agricultural Production in the Emerald Irrigation Area The Emerald Irrigation Area is an important irrigation district in the central Queensland region, serviced by the Fairbairn Dam, which is one of the largest water storages in Australia. The dam was completed in 1974, and was originally justified in economic terms for irrigating wheat and fodder crops to fatten sheep. Neither option has ever been commercially viable, but an important cotton industry developed in the late 1970s. ABS data indicates that by 2001, there were 24 000 hectares irrigated in the Emerald Shire, with a gross value of cotton production of $82.5M from 18 345 hectares. A summary gross margin exercise for cotton at Emerald is provided in Table 8.1. It shows that the average cotton crop in the region has a water application rate (for flood irrigation) of 8 ML/ha, and can be expected to yield 8 bales of cotton per hectare. The return per ML of water after all operational costs have been accounted for is estimated at $166. This return is needed to cover overheads, service debt and provide a return on capital and entrepreneurship.

130

22,408

Source:

Adapted from Donaghy (1995) and Bourne et al. (1999).

$23,830 $2,468

Picking, grading, packing, commission, levies, freight

Harvesting & marketing

1164

Gross Margin Gross Margin / ML

9 ML/ha

Irrigation and pumping

3,613

28,970

Insecticide, IPM, fungicide

Pest control

115

1,034

557

Total Variable Costs

Herbicide

Fertiliser

Fertiliser

Weed control

Pruning

Plant costs

79

52,800

Fertiliser applic, slashing, spraying

$25/case for 19kg cases, 5.5 cases/tree, 384 trees/ha

Budget$/ha

Machinery and tillage

Variable costs

Sales

Assumptions

Citrus

Table 8.1 Gross Margin Budget for Citrus and Cotton at Emerald

Harvesting, modules, transport, ginning, insurance

8 ML/ha

$1,327 $166

2,273

520

200

757

137

450

58

151

3,600

Budget$/ha

Insecticide, IPM, scouting

Herbicide and chipping

Fertiliser, growth regulant, defoliates

Seed

Cultivation and planting

8 bales per hectare at $450/bale

Assumptions

Cotton

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In the early 1990s, citrus and grape production developed at Emerald. These represent higher value crops, and substantial amounts of water have been transferred out of cotton production into these crops. An example of a gross margin analysis for citrus is also shown in Table 8.1. The analysis shows that the expected gross margin per ML of water is $2,468. By 2004, approximately 915 hectares of citrus had been established (as well as additional areas of grape production). The water that has been transferred from cotton production to those crops has generated much higher returns. After making allowances for higher security water requirements for the orchard crops, the total gross margins for citrus at Emerald is estimated at $20M, compared to $1.9M if the same water was used to grow cotton. As well, citrus and grapes require high labour inputs (pruning and harvesting), so there have been associated employment and population increases (generating other benefits for the region). A notable aspect of citrus and grape production at Emerald is that they are suited to different soils compared to cotton. Cotton is grown on the heavy clays and black soils, while citrus and grapes prefer lighter, sandy soils. When citrus and grapes were established in the region, there were no water trading mechanisms available to transfer water from the heavy soil areas to the lighter soil areas. Some citrus was grown on irrigation blocks where the lighter soils had proved uneconomic to grow cotton. In other cases, the new crops were grown on patches of poorer country on the cotton farms, or owners of multiple blocks had water rights transferred from one block where cotton was grown to another more suitable for citrus. It was fortuitous that some farms at Emerald included several soil types, and that many irrigators were large enough to own multiple blocks; otherwise water transfers may never have happened to allow citrus and grape production to start. Case study 2 A major mining company (Estrata) is developing a major new coal mine near Rolleston in central Queensland. Mine and rail construction is expected to cost approximately $600M. When the mine is commissioned in 2006, it is expected to produce 8 million tons per annum of steaming coal over a 20 year period. The mine is located in the Comet River catchment, which is a sub-catchment in the Fitzroy basin. While the coal has a low ash level and does not need to be washed before shipment, water is still needed for mine development and operations phases for items like road development and dust suppression. However, it is difficult for the mining company to gain water entitlements in the basin.

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Under the water resource planning process undertaken by the Queensland Government, total water reserves available for consumptive use in the Fitzroy basin have been capped. A number of unregulated developments have since been undertaken by landholders along the Comet River to harvest water and establish irrigation schemes, and there is now a moratorium on any further development work or capture of overland flows in the Comet system. The Comet catchment is not included in the Fitzroy Resource Operating Plan, which means that permanent water trading is not possible. The effect is that new development proponents in the catchment cannot purchase water entitlements from agricultural enterprises and establish new supply systems. The current options available are to purchase or lease agricultural enterprises and physically pump the water to the mine site. The Returns Available from Trading Within Sectors The second key benefit from water trading that was identified in Section 2 was increased returns from intra-sector trade. There are some irrigation areas that are dominated by similar value crops where the opportunities for trade between high and low value sectors are more limited. Many of the economic arguments about the benefits of water trading have focused on the higher returns available from transferring water to higher value uses (e.g. between sectors). However, there are also likely to be major benefits available from transferring water within sectors. This is because there is often substantial heterogeneity in costs at the enterprise level, which means that the more efficient operators can achieve higher returns from water inputs. 180 160

Mackay MDIA short term MDIA long term

Annual price/ML

140 120 100 80 60 40 20

Q

ua nt it

y 20 40

60 80 10 0 12 0 14 0 16 0 18 0 20 0 22 0 24 0 26 0 28 0 30 0 32 0 34 0 36 0 38 0 40 0 42 0 44 0 46 0 48 0

0

Average demands (ML)

Figure 8.5 Average Demands for Selected Farms in the Mackay and MDIA Areas

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Many farm production models average revenues and costs over a number of farms, disguising the levels of heterogeneity involved. However, the difference in returns between average and more efficient producers can be substantial. For example, in the cotton industry Boyce Chartered Accountants (2001) show that the top 20 per cent of producers perform significantly better than the average cotton producer. Across the industry, the top 20 per cent of producers had more than double the amount of net profit in 2001 ($1,042/ha) compared to the industry average ($402/ha). The more efficient producers tend to ‘set’ the market for factors of production such as land and water, but when water is tied to land, transfers are bulky and intermittent. In this situation, price signals about the most efficient use of water are substantially weaker than if water can be traded separately. Evidence about heterogeneity in farmer demands for water supplies can be gained from two stated preference experiments. These were conducted at a similar time in two irrigation areas of Queensland, and revealed low levels of demand that were very sensitive to price (Rolfe 2004). The variation in responses and sensitivity to price indicates high levels of heterogeneity in water demand between growers, suggesting that substantial efficiency gains may be possible by transferring supplies between growers. Here, those experiments are reported in more detail. Farmers in two regions were surveyed to ascertain their willingness to pay for additional water supplies. The regions surveyed were Mackay in 1998 (almost exclusively sugar cane), and the Mareeba-Dimbula Irrigation Area (MDIA) on the Atherton Tableland in 2000 (producing sugar cane, tobacco, tree crops, horticulture). Both areas have approximately 900 farms, with sugar cane as the dominant industry. In each case farmers were asked to indicate how much additional water they were prepared to purchase at various price levels. At the time the surveys were conducted, (1998 and 2000), sugar prices were low, but farmers were generally optimistic about future market conditions and were prepared to consider expansion. Information about farm details and proposed use of additional water supplies was collected to minimise any potential problems of hypothetical or strategic bias. The results reported in Rolfe (2004) are summarised in Figure 8.5. These show that demands were very sensitive to price. This was largely driven by heterogeneity between farmers, where some indicated that they were prepared to take additional water supplies at higher prices, while others were not prepared to purchase any additional supplies. This contrasts to many farm production models which tend to assume that returns from increased water use are relatively uniform and stable. The results of the stated preference experiments suggest that substantial efficiency gains could be available by transferring water between farmers within a single sector, but that only a small number of transfers would occur.

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Returns Available from Avoiding Government Failure A key advantage of competitive market systems is that they reveal information about the opportunity costs of using resources and producing outputs. Where this information is not available, it is much more difficult to assess the potential costs and benefits of alternative resource uses. There are many examples of public investments in water infrastructure development where the true costs and benefits of such developments have not been well anticipated (Smith 1998). The classic example was the development of the Ord River Dam despite the criticisms of Davidson (1965). The generation of better information about the costs and benefits of new infrastructure proposals (and policy changes) can better help to avoid government failure in terms of poor allocation of public resources. An example of how better economic information might affect investment decisions comes from the economic assessment of the Burnett River Dam in south-east Queensland, where construction began in 2003. Construction of the new dam and four new or augmented weirs on the Burnett will deliver an additional 174 000 ML of water per annum (ONECG 2001). Capital costs of the project are just over $200 million, giving a capital cost of approximately $1 150/ML. In the economic analysis performed by ONECG (2001), it is assumed that the bulk of the additional water supplies are applied to existing irrigation areas to increase application rates, particularly for sugar cane. By assuming that sugar cane growers across the region would find it profitable to increase application rates by 1–2 ML/ha, high levels of demand from agriculture were implied. The analysis indicated that the gross margin of irrigation water supplied to sugarcane was $156/megalitre, and this estimate was extrapolated across all sugar cane areas in the region (ONECG 2001). The analysis suggested that almost half of the available water, or 80 000 ML/ annum, would be used to increase sugar cane production. When these predictions are compared to the stated preference surveys for the Mackay and Mareeba-Dimbula regions reported above, significant variations emerge. The surveys were conducted at a similar time period to when ONECG was drafting its report, and were also focused on regions dominated by sugar cane production. However, the stated preference surveys showed that there would be zero (or minor) demands for additional water at the price level of $156/ML, which ONECG (2001) claimed would be the average return from increased water applications. The results suggest that the economic analysis used to justify the Burnett River Dam may be overly optimistic. If a physical market for water trading existed in the Burnett region, then the evidence about market demands and net returns for water would have been directly revealed. There would be less chance that the government could commit public funds on the basis of incomplete information about potential returns.

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The Returns Available from Fostering Innovation and Entrepreneurship The fourth area where gains are likely to be available from water trading mechanisms relate to the longer term impacts on innovation and entrepreneurship. The previous system of government allocations and tying water to land titles has minimised the choice constraints that face farmers. Economists expect that more competitive systems foster greater independence and innovation, leading to economic growth. One of the economic criticisms of providing subsidies is that it tends to reward poor performance, creating perverse incentives to maintain the status quo. Some evidence of the gains in innovation and entrepreneurship come from a comparison of irrigation areas in Queensland. The irrigation schemes at Emerald and the Atherton Tableland are approximately equivalent in size. Allocations from the Fairbairn Dam at Emerald are 189 000 ML/annum compared to 161 000 ML/annum from the Tinaroo Dam supplying the Mareeba-Dimbula Irrigation Area. However, while the Emerald irrigation area has about 100 water users, with approximately 30 major farmers, the Atherton Tableland region has over 1 000 water users and more than 900 farmers. The Emerald Irrigation Scheme was set up with nearly 100 farms, but the unviability of some crops and several downturns in the cotton market has meant that a number of original farmers were forced to sell out. Prices fell low enough for neighbours to be able to purchase additional farms, with the end result that most of the remaining farmers hold two or three farms. While the Atherton Tablelands region has also been through several slumps (especially the shrinking of the tobacco industry), there has never been the same level of consolidation. While a number of differences between the regions exist, a key one appears to be that government support programs in the Atherton Tableland (and other sugar cane regions) have reduced incentives for restructuring to occur. The restructuring that did occur in the Emerald region allowed surviving farmers to achieve larger scale efficiencies, and has generated substantial resilience and innovation. It is also possible that the differences between the regions are partly explained by the farmer characteristics. Irrigation farming at Emerald has only developed since the 1970s, so farmers may have been well aware of other opportunities and prepared to exit the area.

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CONCLUSIONS Water markets are becoming more common in Australia as competitive trading systems are being introduced to various irrigation districts. The economic arguments for allocating resources through market-like mechanisms are strong. The key advantages include an increase in net returns (surpluses) to society, better incentive structures for participants in water markets, better allocation mechanisms for scarce resources, and a transparent signalling (price) mechanism. The incentives that water markets create include better exit signals for less productive performers, as well as more flexible opportunities for new developments. There is a range of international evidence that suggests firstly that competitive market mechanisms are being more widely applied to allocate water resources in a number of countries, and secondly that substantial efficiency gains are being recognised. While there are no direct studies available in Queensland of the benefits of water trading, evidence can be presented about potential benefits in four main areas. The first reflect the advantages of shifting water between sectors, from low value use to high value use. This is the argument usually presented in favour of water markets. The second area reflects the opportunities to trade within sectors, where heterogeneity between farmers creates differences in marginal productivity. The third relates to better information revealed about opportunity costs, and the potential this has to minimise government failure problems. The fourth relates to longer term impacts, where the interface of farmers with competitive factor markets is more likely to generate innovation and entrepreneurial behaviour.

REFERENCES Archibald, S.O. and M.E. Renwick (1998), ‘Expected transaction costs and incentives for water market development’, in K.W. Easter, M.W. Rosegrant and A. Dinar (eds), Markets for Water: Potential and Performance, London: Kluwer Academic Publishers, pp. 95–117. Bauer, C.J. (2004), Siren Song: Chilean Water Law as a Model for International Reform, Washington DC: Resources for the Future. Beare, S. and A. Heaney (2002), Water Trade and the Externalities of Water Use in Australia – Interim Report, Canberra: ABARE paper for Natural Resource Management Business Unit, AFFA. Briggs-Clark, J., K. Menz, D. Collins and R. Firth (1986), A model for determining the short term demand for irrigation water, BAE Discussion Paper 86.4,Canberra: AGPS.

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Bourne, A., J. Ferguson, W. Johnston and N. MacLeod (circa 1999), Central Queensland Horticultural Crops Gross Margins 1997/98, Queensland Department of Primary Industries, Central Queensland. Boyce Chartered Accountants (2001), Australian Cotton Comparative Analysis, Narrabri, NSW: Cotton Research and Development. Crouter, J. (2003), ‘A water bank game with fishy externalities’, Review of Agricultural Economics, 25 (1), 246–258. Davidson, B. (1965), The Northern Myth: A Study of the Physical and Economic Limits to Agricultural and Pastoral Development in Northern Australia, Melbourne University Press, Melbourne. Department of Natural Resources (DNR) (1998), State Water Projects Yearbook 1997– 98, Brisbane. Department of Natural Resources (DNR) (1999), State Water Projects Yearbook 1998– 99, Brisbane. Donaghy, P. (1995), ‘Citrus production in the Central Highlands’, Information Series QI96011, Queensland Department of Primary Industries, Brisbane. Easter, K.W., M.W. Rosegrant and A. Dinar (1998), ‘Water markets: transaction costs and institutional options’, in K.W. Easter, M.W. Rosegrant and A. Dinar (eds), Markets for Water: Potential and Performance, London: Kluwer Academic Publishers, pp. 1–18. Godden, D. (1997), Agricultural and Resource Policy: Principles and Practices, Melbourne: Oxford University Press. Hearne, R.R. (1998), ‘Institutional and Organizational Arrangements for Water Markets in Chile’, in K.W. Easter, M.W. Rosegrant and A. Dinar (eds), Markets for Water: Potential and Performance, London: Kluwer Academic Publishers, pp. 141– 157. Hearne, R.R. and K.W. Easter (1998), ‘Economic and financial returns from Chile’s water markets’, in K.W. Easter, M.W. Rosegrant and A. Dinar (eds), Markets for Water: Potential and Performance, London: Kluwer Academic Publishers, pp. 159– 171 Horbulyk, T.M. and L.J. Lo (1998), ‘Welfare gains from potential water markets in Alberta, Canada’, K.W. Easter, M.W. Rosegrant and A. Dinar (eds), Markets for Water: Potential and Performance, London: Kluwer Academic Publishers, pp. 95– 117. Industry Commission (1992), Water Resources and Waste Water Disposal, IC Report Number 26, Canberra: AGPS. Lusk, J.L. and D. Hudson (2004), ‘Willingness-to-pay estimates and their relevance to agribusiness decision making’, Review of Agricultural Economics, 26 (2), 152– 169. ONECG, 2001 Indicative Economic Impacts of Additional Water Infrastructure in the Burnett Region, Report prepared for the Burnett Water Pty Ltd, Queensland Government. Available at: http://www.burnettwater.com.au/pdf/eco_report.pdf Rolfe, J.C. (1998), ‘Agricultural Demands and the Pricing of Irrigation Water’, Central Queensland Journal of Regional Development, 5 (4), 38–49. Rolfe, J.C. (2004), ‘Assessing demands for irrigation water in North Queensland’, Agribusiness Review, Vol. 12. Available at www.agrifood.info/Review/2004V12/ Rolfe.htm Roth, A.E. (2002), ‘The economist as engineer: game theory, experimentation and computation as tools for design economics’, Econometrica, 70 (4), 1341–1378. Smith, D.I. (1998), Water in Australia: Resources and Management, Melbourne: Oxford University Press.

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Tsur, Y., T. Roe, R. Doukkali and A. Dinar (2004), Pricing Irrigation Water: Principles and Cases from Developing Countries, Washington DC: Resources for the Future. Whitten, S. (2003), Water Property Rights and Water Management in the Fitzroy Basin, report prepared for Central Queensland University and the Central Highlands Regional Resource Use Planning Cooperative, Emerald. Windle, J., J. Rolfe and P. Donaghy (2004), ‘Diversification Choices in Agriculture: A Choice Modelling Case study of Sugarcane Growers’, paper presented at the 48th Annual Conference of the Australian Agricultural and Resource Economics Society, Melbourne, 11–12 February.

9.

Water Trading Instruments in Australia: Some Thoughts on Future Development of Australian Water Markets David Campbell

INTRODUCTION Despite commendable progress in the evolution of water trading markets in Australia, there remains a range of regulatory and institutional impediments to valuable evolution. Even with the removal of these constraints, it will take time for a mature market to emerge. This chapter focuses on a number of these constraints and discusses a range of instruments that are likely to find increasing use in the future. A key emphasis is on the potential role of derivative markets in providing more flexibility to deal with the high water supply volatility in Australia, and to encourage better integration of demand and supply side instruments in deriving maximum value from these markets. Other suggestions include selective separation and trading in delivery capacity rights and a measured transition to the use of tagging as opposed to exchange rate mechanisms in respect of inter-jurisdictional trading. This chapter draws heavily on a study conducted by ACIL Tasman (2003)1 for the Water Reform Working Group (WRWG). The study essentially covered current trading instruments and possible gaps and limitations in these instruments, and suggested the types of instruments that might reasonably emerge in coming years. The report extended to thoughts on the role, if any, for government in encouraging these instruments and associated trades or, perhaps more pertinently, for lowering existing barriers to their emergence. This chapter discusses a range of ideas and ways of looking at these possibilities, but is not prescriptive, beyond some emphasis on removing unnecessary barriers to the emergence, testing and, where valuable, retention and growth of some of these instruments. It is presented as a contribution to the ongoing policy debate and market evolution.

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The Evolution of Markets for Water

BACKGROUND Many stakeholders have observed the progressive development of water markets in Australia over the past two decades. To a large extent, initial thinking, amongst economists and farmers, concerned the redirection of the resource to more valuable extractive uses. This objective does, of course, remain, but in more recent years has been expanded. It came to include a desire to find least cost ways of meeting a wider range of demands, including non-extractive uses, on a resource that has been increasingly recognised by the community for its value and finiteness. The right to trade, and hence extract greater value from extractive use, has in effect become (at least in some jurisdictions) part of the basis for compensation for some attenuation of effective rights to extract. This allows greater returns to environmental flows or achievement of wider quality outcomes than might otherwise have been affordable or politically acceptable. Even more recently, the idea of active market trading as a direct means of acquiring more water for environmental flows, or for better balancing extractive and non-extractive uses to deliver greater value has been receiving greater attention, including in the most recent Council of Australian Governments’ (COAG) position (summarised in Section 3 below). Trading to date has generally been somewhat cautious, from the perspective of regulators, holders of water rights and potential buyers and lenders: • Regulators have reflected concerns for limiting transfers of extractive water rights to uses that, while possibly involving improved commercial performance, may involve ‘unacceptable’ environmental or (to a lesser extent) social consequences; • Regulators have understandably seen temporary (within season) transfers as less of a concern and this has been reflected in approvals arrangements. • Holders of rights have tended to see temporary trading as an effective way to manage their variable demand for irrigation water, rather than reassessing the best structure of their farm enterprises and the level of their water holdings, given the relaxation of a previous constraint on approved uses of the water rights. • In effect, trading (especially within irrigation) has been seen in terms of managing short-run variation in marginal demand and supply, rather than in managing enterprises and water usage patterns to maximise the longrun value of discretionary water. • Both groups have tended to express nervousness at allowing ownership in rights to pass, through trading, to intermediaries or to fundamentally different uses, including in some cases out of irrigation areas.

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• Flowing from this last point, water businesses have tended to play a regulatory role in limiting trading of water out of area and in protecting the value of local infrastructure. • Potential buyers of rights, and lenders, have had concerns with the security of the rights being traded on a permanent basis. Not surprisingly, temporary trades predominate and have reached substantial levels in a number of systems where water has real scarcity value. Some permanent trading does occur and the cumulative level of permanent trades is now reasonably significant in some systems. There have been other signs of maturing in the markets, including a growing role for intermediaries. An important issue has been the growing emphasis on the legal aspects of the title system, and the scope for registering third party interests. These matters have been the subject of other studies, including that of ACIL Tasman and Freehills outlined by Woolston in Chapter 6 of this volume. In particular, there is an inextricable linkage between a sound basis for clearly understood title, with confidence amongst traders and lenders underpinned by either indefeasibility or title insurance arrangements, and incentives for the evolution of efficient trading arrangements. This is particularly the case where these involve various forms of forward trading discussed further below.

NATIONAL WATER INITIATIVE AND COAG The June 2004 COAG meeting confirmed a National Water Initiative agenda that can be expected to flow through into a range of changes to the trading environment. Realistically, trends implied by the evolution of these arrangements should be viewed as part of the forward environment in which trading plans, the valuation of water rights and the development of new instruments should be judged. COAG has made the following commitments to the National Water Initiative: • Expansion of permanent trade in water bringing about more profitable use of water and more cost effective and flexible recovery of water to achieve environmental outcomes; • More confidence for those investing in the water industry due to more secure water access entitlements, better and more compatible registry arrangements, better monitoring, reporting and accounting of water use, and improved public access to information; • More sophisticated, transparent and comprehensive water planning that deals with key issues such as the major interception of water, the interaction

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between surface and groundwater systems, and the provision of water to meet specific environmental outcomes. Key elements of the NWI include: • Water access entitlements to generally be defined as open-ended or perpetual access to a share of the water resource that is available for consumption as specified in a water plan (recognising that there are some cases where other forms of entitlement are more appropriate). • Over-allocated water systems to be returned to sustainable levels of use in order to meet environmental outcomes, with substantial progress by 2010. • A framework that assigns the risk of future reductions in water availability as follows: • Reductions arising from natural events such as climate change, drought or bushfire to be borne by water users; • Reductions arising from bona fide improvements in knowledge about water systems’ capacity to sustain particular extraction levels to be borne by water users up to 2014. After 2014, water users to bear this risk for the first 3 per cent reduction in water allocation, State/Territory and the Australian Government would share (one-third and two-third shares respectively) the risk of reductions of between 3 per cent and 6 per cent; State/Territory and the Australian Government would share equally the risk of reductions above 6 per cent; • Reductions arising from changes in government policy not previously provided for would be borne by governments; and • Where there is voluntary agreement between relevant State or Territory Governments and key stakeholders, a different risk assignment model to the above may be implemented. • More efficient administrative arrangements to facilitate water trade in connected systems. • Removal of institutional barriers to trade in water, including a phased removal of barriers to permanent trade out of water irrigation areas in the southern Murray-Darling Basin. • National standards for water accounting, reporting and metering. • Actions to better manage the demand for water in urban areas, including a review of temporary water restrictions, minimum water efficiency standards and mandatory labelling of household appliances, and national guidelines for water sensitive urban design. In relation to the Murray-Darling Basin (MDB), COAG noted that the MDB Water Agreement signed by the Prime Minister, the Premiers of New South Wales, Victoria and South Australia and the Chief Minister of the Australian

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Capital Territory, sets out the arrangements for investing $500 million over five years commencing in 2004–05, to reduce the level of water over-allocation and to achieve specific environmental outcomes in the MDB. COAG’s position is an important part of the landscape looking forward at the evolution of the markets and associated instruments. Each of the items listed above involves commitment to changes that should encourage more active, and in many cases more sophisticated, trading, including the development of more versatile instruments. Of particular importance here are measures likely to: • Deliver firmer property rights, with greater long-term certainty, supporting greater access to debt and equity markets and a greater willingness to commit longer term trading positions: • Clearly including any implications for the confidence a buyer may have of compensation in the event that the effective rights are later clawed back for any reason – at least providing a sounder basis for market valuation of any residual risks. • Any changes that further limit effective volumes of water available for extraction, or that seek to better protect environmental access to water when water is scarcest. • The likelihood that the planned expenditures in the Murray-Darling Basin will include water-saving infrastructure, with implications for both effective volumes and for the mix of fixed/sunk and variable costs. • Indications that restrictions on permanent trading out of irrigation areas are to be relaxed. The commitment to greater permanent trading is likely to address impediments to longer term temporary and conditional trading (leasing over several years and forward sales and options) to the extent that these have been impeded by demands for greater environmental checking for non-temporary trades to take place. From the point of view of efficient resource use, the level of permanent trading that takes place in itself is not necessarily a problem. Of more potential concern is the extent of constraints on a range of forms of longer-term contracting. Each constraint has an understandable history but has a cumulative impact that is likely to be quite costly. There is also a risk that, given the intensity of government and community concerns with some aspects of current water usage, an ‘onus of proof’ requirement that falls on those wanting to move water may be counterproductive. ACIL Tasman (2003) observed that: • In many cases, restrictions on trading designed to guard against accidentally increasing damage may be having the effect of preventing trades that would reduce existing rates of damage;

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• This is likely as a result of any measure that slows or prevents trades that are subsequently deemed appropriate; • Past a certain point, impediments to trading based on well-intentioned precaution in respect of damage minimisation could prove counterproductive. • A similar effect could also occur as a result of new site usage approval processes that focus on damage at the new site without also taking into account the effects of water usage leaving the old site – looking at gross as opposed to net damage; • These comments in no way argue against sensible precaution in the context of sustainable resource management and development strategy. Current trends in favour of block approvals for transfers and the related elements in the COAG Communiqué are all positive. However, it would be a mistake to think in terms of the choices being between within-season temporary transfers and permanent transfers. There is a range of possibilities that are likely to be better suited to dealing with the particular characteristics of Australia’s water supplies and demands.

MANAGING SUPPLY AND DEMAND VOLATILITY A common observation is that water supplies in much of Australia are highly prone to chance variation, over and above normal seasonal variation. The recent drought conditions have intensified wider community appreciation of this feature, while recent prices attached to water trades have highlighted the scope for the scarcity value of water to vary dramatically as result of these conditions. Regulated supplies can, to an extent, be designed to compensate for this natural volatility. It usually implies high capacity in dams relative to average annual inflows, and has tended to encourage regulated water products with different levels of supply reliability attached. In effect, increasing supply reliability attached to an entitlement implies either an effective allocation of a larger share of capacity in storage (even where ownership of water in storage is not the basis for the property right), or the creation of greater storage. The same logic implies that the formal regulation of water products with different levels of reliability may not be necessary, even where the evolution of these products in a non-trading world is understandable. There is substantial scope for markets to manage supply reliability through trade in volume of nominal allocation. Those needing highly reliable supplies could either acquire nominal volumes that are surplus to their normal needs. They could seek to trade to others the surpluses in normal or wet years or to

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enter the markets as buyers of temporary transfers as and when supply reliability becomes a concern. Alternatively, they might seek to forward contract access to water under specified trigger conditions. The flexibility of such markets to deliver efficient outcomes is, however, constrained if there is little scope for husbanding the resource, in the sense of individual decisions to under-utilise entitlement now being reflected in individual rights to increased access to water in the future. Forward sales can be heavily constrained if it is not possible to obtain approval for conditional transfers at a future time. This is still widely the case. While some contracts for forward sales and options are being written, there is necessarily some uncertainty where the approvals can only be obtained at the time of formal transfer. Setting aside for the moment those sorts of constraints, it would be fair to say that the natural hydrology of much of Australia, the experience with climatic variation and the diversity of water uses that offer quite different and changing marginal values of water as scarcity values rise all contribute to a fairly strong conclusion that best use of our water supplies is likely to entail: • On-going demands to redirect water between uses, in response to chance variations in supply: • Trading efficiencies are not just about once and for all redirecting water to more efficient use, but rather about on-going management of tradeable assets with high volatility in their relative values in different uses at different points in time. • A mix of spot market transactions, but also involving much more active use of various forms of derivatives, including forward sales and options. • While, in theory, it should be possible to access water when needed by entering the spot market, this entails substantial price risks. Derivative instruments should allow these risks to be allocated more effectively to those best placed to accept them. • The outcome is likely to be opportunities for reduced uncertainty for both prospective buyers and prospective sellers in respect of the price environment during periods of high scarcity, feeding through to longer term investment strategy. Of related importance here is the scope for water users to modify their usage patterns so as to lower their demand for water, either generally, or at times when the opportunity cost of using the water is highest. This can include mainstream demand management instruments, from low flow shower heads through to trickle irrigation – but can extend to choices in respect of on-farm water storage (with the possibility of accessing supplies when they are cheapest for use at times of scarcity), choices in respect of permanent and annual crops

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and wider aspects of drought tolerance, tillage systems, and forward sales or options to sell livestock. Any of these could be expected to influence the incentives and willingness to trade water. ‘Optimal’ response to the new trading opportunities should involve review of the mix of demand management instruments. A key theme developed in ACIL Tasman (2003) was the concept of landowners in particular looking to trading water as a core part of their overall enterprises, and optimising product mix across traditional production and trading market opportunities. This is rather different from the view that water trading is about selling the unneeded surplus, or topping up limited supplies. This implies an input management focus rather than a whole of enterprise profitability and risk management focus. Choice of farming systems and marketing strategy have the ability to offer cost-effective ways of providing access to discretionary and tradeable water supplies at times when water is most valuable; and also offers scope for limiting exposure.

OVERVIEW OF MAJOR POSSIBILITIES The following discussion highlights the types of developments in market instruments and transactions that might seem reasonable and notes any regulatory impediments to their emergence. Many of the ideas floated here are already being used to a limited extent. The scope for using them, and the commercial incentives, can vary substantially across jurisdictions, catchments and uses. In many cases, it is likely to take time for the more sophisticated instruments to develop to an efficient level, even where there are no regulatory barriers. In other cases the regulatory impediments are substantial. The interrelated possibilities can be loosely categorised as: • those involving the ‘unbundling’ or re-definition of the primary product or entitlement, thus permitting and/or facilitating an expanded range of transactions; and • facilitative measures to enhance beneficial water trading opportunities. While some of the possibilities are presented below, the very nature of market processes suggests that new products and transactions may continue to emerge. Greater Unbundling/Re-defining of Primary Entitlements A key insight is that water access entitlements themselves comprise various bundles of (conditional) rights to access water such as:

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• • • • •

the right to take or receive water; the right to a defined quality of water; the right to have the volume and timing of water delivered; the right to use the water; the right to build, operate or have an interest in works to take and control the water; and • the right to return the water. Each of these components may have value, and that value may vary between users and uses. For example, hydro-electric generators and irrigators may place different value on the timing of releases from dams at different times. This implies that there may be merit in ‘unbundling’ the various elements so that they can be traded separately. Limited unbundling has occurred; there is a question as to what extent remaining bundling may be reducing the incentives to discover and/or use transactions based around less bundled product opportunities. This prospect needs to be weighed against what is likely to be the higher administrative or policing costs that might flow from further unbundling. ‘Full’ separation of water from land In some jurisdictions, vestiges remain of the bundling of land and water, while the water rights themselves commonly involve a bundle of services that cannot be readily traded separately. The requirement of some jurisdictions, that holders of irrigation water rights must also hold land, has an understandable history but may well impede the emergence of intermediaries in the market (as is common in many other areas) who can play a valuable role in acquiring, packaging and making available composite services in ways that add value. At the same time, it is recognised that there are significant sensitivities in respect of these matters. Some of the benefits of this unbundling could be achieved through the use of derivatives and lease instruments, without the need for fundamental ownership of entitlement to move away from the land base. The remaining restrictions may not be very severe – but they would constitute restrictions and could be expected to impede the rate of emergence of secondary markets. Perhaps the final step in completely separating land and water would be to remove the link between ‘basic’ water rights (e.g. stock and domestic riparian rights) and the land to which it attaches. In principle, allowing even these entitlements to be traded may offer an opportunity to generate value (e.g. where a landholder has unused basic entitlements in areas where there is keen competition for water).

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In practice, ‘normal’ usage of these rights is probably already factored into most assessments of sustainable levels of tradeable rights, so some caution is needed. However, there may still be some scope for individuals extracting value from their ability and willingness to alter demand for this class of water. Serious progress towards greater innovation in this area would probably require some translation, or rights to translate, riparian rights to a volume/reliability basis in order to bring it into the exchange rate (or other form of tracking transferred water) net. Delivery capacity entitlements The combination of natural hydrology of river systems and variations in flows brought about by system regulation mean that there can, at times, be points in a river or channel system that ‘fill’, thus preventing further flows passing through that point. Not surprisingly, one response to such a constraint has been to limit or prevent trading of entitlement from above to below the constraint – presumably to limit the effective attenuation of the reliability of rights below the constraint. In principle, if the limit of flow below the constraint has been reached, any attempts for an individual to access more water will need to be at the expense of someone else (or the environmental flows) below. As a result, the trade opportunity should, in principle, lie amongst entitlement holders below the constraint. However, if the market is encouraged to seek creative ways of trading in the timing of releases, and is seeking options trading opportunities designed to better allocate risk across the system, and recognises the scope for demand patterns to be adjusted to the new opportunities afforded by a changed market structure, then this logic starts to unravel. It may well be more efficient to match above-constraint to below-constraint sources of demand and supply of entitlement for the purposes of forward trading, and to address separately the delivery capacity issue through some instrument relating directly to the capacity constraint. The combination of such instruments might well allow for the identification of multilateral trade that delivers a better result for all, and that respects the system constraint. It could be expected also to post explicit information on the economic cost of the constraint in a way that might allow more efficient system infrastructure investment, including channel capacity, that could effectively relax the constraint. Congestion pricing might go some way towards meeting these objectives. However, active trade in ‘slots’ of river or channel capacity could in principle have significant advantages and would deliver its own market-based congestion prices. Not the least of these advantages would be the scope for the initial allocation of capacity rights to be used to address equity issues concerned with the rights of existing holders of downstream entitlements.

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Attaching a financial obligation to the delivery capacity entitlement (whether it is used or not) is another mechanism for addressing the concern about ‘stranded assets’ if water is traded out of an area. Restricting trades out of an area if the economics add up could impose significant costs. However, the fact that system delivery infrastructure access and charges are still commonly bundled with in-district usage rights does mean that some out-ofregion trades, while attractive to individuals, could be inefficient. This issue is discussed in more detail in ACIL Tasman (2003). However, the situation that may arise is highlighted by considering two irrigation districts, identical in all respects except that, in the first, delivery capacity rights are bundled with usage rights and in the second they are held separately. It is assumed that the delivery infrastructure is owned by the water business that is in turn owned by the water users. In the first scheme, the costs of maintaining the delivery infrastructure, and repaying the financing costs, are covered by annual charges that are proportional to water usage rights – and shares in the business are in turn proportional to water usage rights. In the latter, the charge is proportional to delivery rights, with ownership being proportional to delivery rights held – but effectively involves the same cost to users with sufficient delivery right to cover their usage demands. An entitlement holder in each district has an interested downstream buyer, willing to pay the same price for the usage rights. The seller in the first region calculates loss of earnings from sale of water rights, but sets against this the sale price and the fact that he or she will no longer need to contribute to the infrastructure maintenance in the region – and concludes that the sale makes sense. The seller in the second region does the same sums, but realises that he will be left with financial responsibilities for the delivery infrastructure, in which case the sale is uneconomic. The actual delivery system costs are unaffected – in the first case, levies on remaining water users will need to be increased to cover the shortfall, while in the latter they will not. The holder of the delivery rights will be keen to sell, but any buyer would look carefully at the deal, given that there is less water needing delivery. Prima facie, a deal that only makes sense because of the scope for shifting costs of the delivery system onto others who would not be party to the sale contract, is probably an inefficient outcome relative the second example. Of course, the market in the area that would lose the water might respond by forging an alliance to make a higher offer – justifiable because of the fact that the delivery costs are sunk. However, this involves a larger set of transaction costs and an ability, within the stakeholder group, to focus on the higher marginal value of the water given that the delivery costs are sunk. Furthermore, some water users in the area are likely to feel it is ‘unfair’ that they are needing to buy water to sustain their businesses; whether this is in fact unfair will

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depend on many aspects of the history of water usage and infrastructure development in the area, but they may well have a point in some cases. A simpler solution and one probably seen as more equitable by at least some of those involved has been for some regions and water businesses to limit rights to sell, typically in ways that do not allow market testing of whether the trade would be cost-effective. The end result of these competing pressures is likely to be a proportion of inefficient sales, or refusal of rights to sell, out of district. The nominal argument for the restricting sales out of area tends to be stated in terms of prevention of asset stranding, though this does not accurately reflect the underlying economic issue. The above diagnosis is not presented as an argument against assets being stranded. Given the inherent uncertainties, asset stranding is likely to be part of the normal efficient evolution of these markets. It is, however, an argument against asset stranding due to defects, for reasons of historical accident, in contracts that bundle access and delivery rights. A strong case can be made against the use of blunt regulatory and water business commercial instruments for preventing the discovery of opportunities for cost-effective trades, even where these would result in stranded assets. In reality, these assets will not usually be stranded, though a steady loss of water from an area could ultimately have this effect. The costs of sustaining the assets will, however, be spread over a smaller base of water usage, and this will detract from the effective value of water in that area. Fundamentally, this is an issue about the efficient definition of property rights, and removal of artificial constraints on unbundling and trading. If the downstream buyer of the water were prepared to assume responsibility for the upstream water usage charges (either explicitly, or via a premium on the price paid for the water) then the deal should proceed. The issue is then a question of equity. The desirability of establishing tradeable entitlements in delivery capacity is likely to vary across systems. Where capacity constraints in a channel affect only a few entitlement holders, establishing a formal market is unlikely to be cost-effective. In situations where capacity constraints affect a large number of users, or where the capacity constraint in fact has some flexibility for relaxation, timing shift etc, the benefits could be substantial. If the unbundling is not to occur, then it would seem desirable to ensure that other aspects of the trading rights environment, including contractual commitments, do not post trading incentives that are distorted excessively by the bundling. Timing of release Hydro-electric generation represents one of the key uses of Australian water systems. The Snowy Mountains Hydro Electricity Scheme (Snowy Hydro) provides approximately 8 per cent of the generation in the National Electricity

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Market. It is a key supplier of options to the market to cover the risks of price spikes or loss of system integrity and interacts strongly with the hydrology of the Murrumbidgee and Murray River (not to mention the Snowy) systems. The value of the Snowy Hydro’s options lies in the flexibility it has to influence the timing of releases from the dams feeding through its generators. Within the constraints under which it operates, its incentives are to maximise the value it produces through these resource husbanding practices – assessed solely within the context of its electricity business. It faces no effective commercial incentives to maximise value over the combination of generation and all potential downstream demands for changes in the timing of its releases. Non-electricity demand normally only enters the strategy via regulated release requirements and, occasionally, negotiated modifications to strategy, typically on a ‘no net-cost’ basis. These considerations strongly suggest that there may be value in tradeable entitlements to the resource ‘husbanding’ activities undertaken in regulated systems, allowing release timing to be varied to minimise net costs across electricity and other downstream demands. Analogous considerations also apply to other resources where there is a ‘husbanding’ option – including many groundwater sources. Present entitlements tend to involve a ‘use it or lose it’ approach to resource access, in the sense that water not used this year is unavailable for use next year. The effect of opening up these incentives could be expected to range quite widely. If owners of downstream delivery entitlements faced strong financial inducements to consider a variation in the timing of their extraction options, it could reveal economic incentives to consider alternative farm water storage investments, or otherwise to explore enterprise structures more suited to access that value. In terms of release, and which river system water travels down, Snowy Hydro has substantial theoretical flexibility. It is more constrained by the flow requirements it faces and the associated variable level of discretionary water. Discretionary water is the key asset on which it can base its engagement in secondary markets, its role in providing a range of products designed to deliver system integrity to electricity generation and recover its costs. In effect, it is possible to envisage a move towards a situation in which downstream holders of water entitlements, including delivery entitlements that could be tradeable with values that vary with timing, engage actively in extracting maximum combined value from their use of water, from their sale of water to other uses and from their willingness to vary delivery times to underpin a more effective whole-of-system outcome. This is unlikely to be based on a raft of bilateral arrangements between individual irrigators and Snowy Hydro, but attractive portfolio products could well emerge that would have this type of effect.

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Capacity share entitlements At present most end-user entitlements are specified to entitle the holder to defined volumes of water at a specified off-take point over a certain timeframe. This makes them dependent on the actions of others (i.e, storage management decisions made by the storage operator). It also means that, unless carry-over is permitted, an entitlement holder may not reap the full benefits from conserving water. While an entitlement holder may be able to sell excess water in the temporary market, it may be that the water would have more value (to the entitlement holder or someone else) being held in storage. However, a delivery entitlement provides no incentive to do this, since any entitlement not used or sold is effectively lost. In theory, a capacity share entitlement (that defines the access entitlement as a share of the available inflows, storage capacity and off-take capacity) represents a more efficient form of entitlement, but may entail high costs and inefficiencies in coordinating storage management and release decisions. However, in some situations, there may be merit in exploring the possibility of specifying entitlements in this form. Capacity shares, possibly combined with other derivatives or an explicit swap, offer a theoretically clean approach to dealing with trading in release timing as discussed above. The approach adopted in the St George Water Supply Scheme in the Condamine-Balonne Basin in south-west Queensland, explained by Ryan et al. (2002), provides an interesting example of capacity sharing. In response to demands by users for more control over allocation decisions, the St George Water Supply Scheme is now operated as a capacity share scheme. Under the arrangements, the four scheme storages (as a whole) are conceptually partitioned into vertical shares. The shares distinguish between Individual Capacity Shares (ICS) and the Bulk Share (BS). Individual users who have chosen to hold individual capacity shares effectively manage these shares independently by issuing instructions to the storage operator. Other users continue to be supplied by SunWater out of the Bulk Share, according to traditional allocation processes based on the scheme operator’s assessments of future demands and supply. A system of water accounting keeps track of the volume in each individual user’s share, and the Bulk Share in accordance with defined rules for measuring inflows, releases, evaporation, seepage and transmission losses etc. There is also scope to shift between the two capacity share types within defined rules. The introduction of capacity shares has had significant impact on behaviours, with individual users who are able to do so making much greater use of on-farm storages rather than keeping water in Beardmore Dam and incurring higher evaporation losses. This is almost a reversal of the approach under announced allocations managed by the operator, where water harvesting

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was used in preference to water in bulk storage. This reflects the incentives for managing the system to maximise overall yields under individual capacity shares. Against this, however, the system involves higher administrative costs in managing the water accounts (one full-time staff position) and compliance costs in reconciling water ordered and used. These costs could be expected to increase for more complex systems (the St George system supplies around 120 users and there are no tributary inflows between storages). As a fallback, establishment of water accounting with carry-overs and under-draws represents a step in the direction of capacity share entitlements that may be easier to implement. The same principle applies quite explicitly in the case of groundwater sources where supply is constrained by recharge rate. In effect, the move would parallel the shift from the use of input controls to catch quota as a device for managing a fishery – again engendering incentives to husband the resource by redressing an externality. Drainage rights The use of water under a water entitlement may have adverse impact on third parties or on the environment (e.g. adverse salinity or drainage impacts). Indeed, a prime rationale for the current trade approval processes is to prevent such external impacts. The issue then becomes one of ensuring that the regulatory intervention represents the most efficient way of addressing the concern, and that it does so without unanticipated side-effects. Since these adverse external impacts reflect the absence of clearly defined rights (e.g. to pollute the environment), an alternative solution in some circumstances may be to establish a new product (i.e. drainage diversion rights) in the market. Well-based and tradeable drainage rights may have substantial advantages over attempts at direct externality pricing, provided that the basis for determining the aggregate block of rights is sound. At present, irrigators typically have implicit rights to return flows and are able to trade without consideration of the downstream impacts (e.g. salinity). These impacts are meant to be addressed through the regulatory approval processes and rules. A system of tradeable pollution rights (e.g. salt credits) represents a market-based mechanism that may enable these external impacts to be addressed at lower economic cost. In theory, efficient outcomes require spatially differentiated property rights that reflect site-specific differences between external cost of water use at the source and receiving locations. In practice, a partially differentiated system (e.g. defining salt credits at irrigation area level rather than individual site level) may represent an effective second best solution (Beare and Heaney 2002). A system of trading in salt credits is being considered for potential application in the Murray-Darling Basin.

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Expanded Transaction Range Leasing Leasing is the transfer to another person of some or all of the water that may be taken under a water entitlement for a defined period (typically a number of years), but with the ownership of the entitlement remaining with the original holder. In effect, it involves an extension of temporary transfers, though formally it involves a different instrument. Leasing of entitlements is permitted in some States but not in others. It is difficult to see why legal restrictions on leasing should not be removed in those jurisdictions where they remain. Certainly in circumstances where the permanent transfer of the rights would be approved, and where by default the non-transfer of the rights is approved, it is difficult to see how the temporary leasing of the rights for a number of years would weaken controls over adverse impacts. Secondary markets To date, most of the development of water trading has been directed at primary trading – the permanent or temporary transfer entitlement from one user/use to another. This is understandable. However, the processes and institutional changes that have allowed such trades appear to have been predicated almost entirely on the notion of facilitating these forms of trade. Some secondary market products have begun to emerge, and more advanced secondary markets have developed overseas. Secondary markets, especially a range of forward price-based options, have features that could, in principle bring a substantial increase in flexibility to the market, and that could encourage significant shifts in the patterns of water usage. As has already been discussed, important synergies could be expected to lie between different forms of irrigated agriculture, with different vulnerabilities to drought, and with hydro-generation and other uses. Options have the potential: • to offer alternative or expanded mechanisms for individuals pursuing supply reliability and manageable price risk; • to reduce the need for regulators to manage different classes of supply reliability; • to insert into existing entitlement structures some of the features of entitlement based on volumes in storage, with the associated incentives for resource husbanding across seasons; • to encourage a more coordinated strategy across irrigation regions, involving changes in enterprise mix and an expansion in designing farm systems for their value in backing flexible water trading over time as well as for the value of production.

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Such a market would attach greater value to the flexibility to substantially reduce demands for water in times of drought. In the case of irrigated agriculture, the opportunity for better matching pastures and annual crops against perennial crops, for example, suggests valuable opportunities that are likely to be only partially satisfied through different classes of water reliability. In a sense, such market instruments could eliminate the need for and value in multiple classes of water reliability – because these price capping products would allow users to blend entitlement and differently configured caps to meet their own risk profiles. Secondary markets face substantial hurdles in becoming a more important feature of the market. These markets will probably always be significantly ‘thinner’ than markets in financial or energy derivatives. In many cases, the entitlements have been designed in a way that effectively prevents the forward sale of a wide range of options that entail contracted willingness to deliver water at some time in the future under prescribed trigger conditions. This is despite the fact that, prima facie, such transactions could extract significant value from the resource. Were the role of environmental traders to emerge, then access to an effective market in options could be of substantial interest to such traders. As new information emerged regarding dynamic requirements of the rivers for flows, and of the implications of variations in these flows, then options markets could provide powerful instruments for modifying effective flow regimes cost effectively and for establishing a source of revenue for such activities. In some other sectors such as energy, secondary markets have become the dominant trading instrument – and the ability to sell or purchase options is shaping demand patterns in significant ways designed to increase overall market efficiency. This market has resulted in some interesting multi-party price cap products that still seek to share some of the risks of extreme demands (on hydro-generation capability) across contract participants. While a comparable level of derivatives trading in water may be unlikely to emerge, it nevertheless has a potentially important role to play. However, some significant changes are needed in the institutional environment if this is to occur. These relate especially to the nature and duration of approvals for transfers, to the scope for active trading between hydro and downstream activities, and with urban demand. This may suggest a longer term move to greater use of water tagging as an alternative to the exchange rates now being implemented. It is against this background that a move to allow, in all jurisdictions, approvals for temporary transfer of water for periods spanning more than one year, or for shorter period may make sense (see ACIL Tasman (2003). Such approvals could be on a conditional basis at a point in time in the future that is defined by a trigger (water price, allocation level, commodity price index

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etc) that implies uncertainty as to timing. This could include removal of any arbitrary time limits on whether and when a transfer needs to be effected, once approval is granted. A range of secondary market products and transactions might reasonably be expected to emerge in time, in the absence of market constraints. Some are already present in Australia, while others have arisen in overseas markets. Some generic types of instrument with good prospects for application to water markets are outlined below, following ACIL Tasman (2003). Futures contracts allow forward sale/purchase of access to water at an agreed price. They involve a commitment to a trade at agreed price at a nominated time in the future. For example a right holder could forward sell water 5 years out, to coincide with planned fallow rotation as is occurring in Colorado, or forward purchase tranches of water, at a known price, over several years to coincide with expected patterns of demand as a farm development matures. The latter allows the developer to lock in costs of a key input. Buyers could source futures contracts from a range of sources to produce a portfolio with significant stability over time, or with a specified supply profile suited to needs. For instance, Colorado utilities can compile a stable increment to town supply via a series of futures based around different phases of farm rotation patterns. In return for both price and volume security, a fee would typically be paid, up-front, to the seller of the water, allowing holders of water to bring forward some of the benefits of the water at a future time, at the cost of some loss of flexibility. Depending on the price struck for the contract, payments could be structured to flow the other way, with the seller of the water paying to lock in a future price. Call options allow the forward sale to a buyer of the right to acquire access to water on an agreed basis, if the buyer wants to exercise the option at the time. The holder of a water entitlement sells to another party the right to acquire water at a nominated time, or under nominated conditions, if the buyer of the option wishes to proceed with the sale. The seller of the option is committed to supplying the water if wanted by the buyer; but, the buyer of the option has the right not to exercise the option. The conditions could be linked to drought declarations, rainfall, commodity price indexes etc, or might simply nominate a price that would normally be unattractively high to the buyer of the option, but that might become attractive in the event of a drought. For example, call options could be used to provide a price ceiling to buyers of the option, in return for up-front payment of an option fee. Alternatively they could allow the sellers of the option access to option fee income and allow enterprise planning based on reduced access to water when the price is very high. Put options provide the holder of water entitlements with the right to sell access on agreed terms, at a time in the future, should the water holder want to exercise the option at the time. An enterprise might sell to the holder of water entitlement the right to require the enterprise to purchase access to a

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volume of water, at a nominated time, or under nominated conditions, if the buyer of the option wishes to proceed with the sale. The seller of the option is committed to supplying the water if wanted by the buyer; but the buyer of the option has the right not to exercise the option. Again the conditions could be linked to rainfall, commodity price indexes etc – or might simply reflect periodic or temporary surplus of water in the enterprise holding the entitlement. Put options could be used to secure a guaranteed market for water that is surplus to needs. They could also provide the sellers of the option access to option fee income and access to water on known terms around which to plan opportunistic usage including cash crops, on-farm storage for later use and storage in dam for later hydro or other use. Swaps contracts are designed to allow trading in the release pattern of water in a manner paralleling financial market uses. Swaps are normally financial derivatives used in relation to interest rate or currency risks. A common application of an interest rate swap is to allow two parties to convert the nature of the interest payments they face. For example, they might swap a fixed interest schedule for a variable interest schedule, without changing the underlying principal. If an underlying water entitlement is viewed as the principal, compulsory release requirements on dam operators as fixed interest payments and discretionary releases as variable interest payments, then there is an interesting analogy. A swaption is simply the option to require another party to enter into a swap contract. Swaptions could add to the flexibility of swaps instruments for use in time shifting and could be structured to provide additional hedge cover in respect of other options being sold. The right to exercise a swaption could be held by parties upstream or downstream from the other contracting party – or conceivably in another catchment. Composite instruments, including tranches of options that become exercisable under different conditions and ‘swaptions’, increase the flexibility to match buyer and seller demands and physical alternative strategy for managing supply volatility over time. Most of these instruments can be effected through secondary contracts, between supplier and user or, more commonly, via a water trading market intermediary able to package portfolio products, manage a range of risks and access size economies. They could be based around the types of primary instruments now in place – though the flexibility of these instruments would be improved through further progress on removing rigidities and uncertainties from the primary instruments. In some cases, these instruments might be used to allow markets to develop ‘work arounds’ in respect of some constraints on the primary instruments, though this may well be seen as less than ideal from a regulator’s perspective. Conversely, however, this facility could be used to

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maintain pressure on regulators to review the economic cost of their constraints – and provide them with market-based shadow pricing in some cases. More trading across uses/sectors Under existing arrangements, there remain limitations on the ability of water users to trade entitlements across certain uses, particularly when such a trade would involve water moving from, say, agriculture to another sector. While the majority of trades to date have been, and are likely to continue to involve, trades between irrigators, relaxing such restrictions may open up even more opportunities to generate value through an even wider range of divergence in the value of water entitlement between different uses and/or users at different times. Wider opportunities for trade across uses and sectors finding complementary trades would favour the use of secondary market instruments. Overseas, and limited domestic, experience points to the scope for futures and options being beneficially traded between irrigation and urban usage, while trades between hydro power and irrigation or urban usage could add greatly to the depth of these secondary markets. Trading in groundwater Comment was made earlier on the question of managing groundwater, possibly through entitlement based on water in-storage. Such an arrangement would need to be based on a system of groundwater source water accounting, inclusive of recharge monitoring or modelling and extractions. Options trades, as well as temporary and permanent transfers amongst extractors from a single groundwater source, could facilitate efficient allocation of the resource, again accompanied by incentives to look to changes in demand patterns to deliver trading flexibility. Such arrangements could facilitate better husbandry of the resource, including across seasons. Inter-jurisdictional trading Considerable attention has been focused on the issue of interstate trading, with concerns in some quarters that this market has been slow to develop. The major area of interest has, for reasons of integrated hydrology and demand, been the Murray-Darling Basin and, in particular, trade between NSW, Victoria and South Australia. Different jurisdictions have developed their water supplies at different times and using different philosophies in respect of levels of allocation and the nature of reliability management. This has resulted in significant differences in the character of water rights, even in regard to opposite sides of the same river. The reasons for these differences are historical, but they now represent an opportunity for water users to blend a more diverse set of rights to better meet

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demand needs by looking to trade into a market where the special characteristics of the available water may have greater value. These differences however may also be an obstacle to trade because of the complications involved in moving water into areas where the normal rights are differently configured. There are, of course, the same concerns that arise with moving water between areas within jurisdictions, possibly complicated by the involvement of additional regulators. The Murray-Darling Basin Commission (MDBC) offers some scope for consolidating these planning processes in respect of the Basin and has been very active in developing the rules that apply to markets across borders within the Basin. While there are numerous relevant underlying factors, one concern is that the large number of different types of entitlements that exist might itself be an impediment to trade. Alternative ways of dealing with this issue include: attempting to get uniformity in entitlement definition; use of exchange rates to enable trade between entitlements in different locations and/or of different inherent and policy-induced reliability; and ‘tagging’ of water. Achieving uniformity is infeasible: water comes from different sources with different reliability characteristics reflecting both physical and storage management variations. In any event, uniformity is not a pre-requisite for trade. All that is required for trade to occur is the ability to convert one entitlement to another or to retain the entitlement in its original form, with all the associated features. Indeed, lack of uniformity is one of the reasons why trade can be expected to deliver benefits. Care should be taken to ensure that the market rules that are developed do not, in the interests of administrative efficiency, destroy one of the main reasons why a cross-border trade makes economic sense. The approach to date has involved the use of exchange rates where there is a need to reflect different reliabilities and system losses. However, with around 14 different types of entitlement in the Murray-Darling Basin, there is an understandable concern that an exchange rate system will get very complicated. They will almost necessarily require on-going monitoring and fine-tuning. Similar issues albeit on a lesser scale, arise in relation to the trade of entitlements between Queensland and New South Wales in the Border Rivers Catchment. An alternative and possibly less complex solution is to avoid the need for exchange rates by permitting entitlement holders in one State to hold water entitlements issued in another. In effect, a user could hold a portfolio of entitlements (e.g. relatively high security Victorian entitlements and lower security NSW entitlements) to suit their risk preferences and needs. This would require a system of ‘tagging’ water so that at any point in time it could be determined whether a user was using, say, their Victorian or NSW entitlement. While there are some administrative and financial issues to resolve in

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establishing such a system, these would not seem to be necessarily more onerous than those in a system of exchange rates. However, they are likely to be loaded more heavily towards the implementation end of tagging relative to exchange rates that will fall as an ongoing cost. In effect, if low volumes of trade are likely, these costs might favour the exchange rate mechanism. Expectations of growing and extensive trading, whether temporary, permanent or through derivatives, would make the administrative costs of tagging relatively more attractive. In principle, having the ability to accumulate water from different sources, with different characteristics, adds to the flexibility users have to sculpt a mix of entitlements, and their demand patterns, to deliver a cost-effective outcome. In practice, tagging would involve added complexity at the user end. Such complexity that might be avoided through the activities of intermediaries seeking access to the same range of sources, but using size economies to allow delivery of a mix of products with different features and allowing the spreading of costs of information management. Tagging could conceivably evolve towards wider application of entitlements based on water in storage, and could complement development of stronger water accounts and water bank concepts. In the case of MDBC, current policy development is predicated on the use of exchange rates. A medium term move towards tagging, coupled possibly with some of these other elements, all of which could underpin sounder water trading, would make sense. Conceptually at least, transition from exchange rates to tagging should be relatively straightforward and evolutionary in nature. Most of the information gathered to allow the determination of exchange rates would remain valuable to a market in tagged product. Active trading in environmental entitlements The externality cost of affecting river flows as a result of extractive use is being addressed through the implementation of environmental flow regimes, typically in the form of prescribed river flow requirements. An alternative or complement to such an arrangement could be the introduction of active trade in these flow entitlements, either absolutely or above some specified base regime. This could permit a resource manager the flexibility to adapt the flow regime to changing information and hydrology conditions and to effectively transfer flows from one river system to another unlinked system through complementary sale and purchase. In doing so, such an agent would be explicitly attributing and posting a marginal value to environmental flows in a way that could add significantly to the quality of the information available to the market. This could encourage more efficient trades amongst extractive users, as well as between extractive users and environmental demands.

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The scope for an environmental trader2 to build the aggregate value of environmental flows through cross-system and through-time trades in actual river flows could be considerable. Such a system would allow differentials to be reflected in the marginal value of flows in different parts of the system at different points in time and in variations in the commercial value of the same water. In principle, such activity could be possible on a ‘self-funding basis’, with a requirement that sales match purchases. Alternatively, there would be scope for various forms of additional funding to be used over time to grow the total pool of environmental flows. The case of the Oregon Water Trust (OWT) provides some insight with regard to the emergence of environmental water traders. It was founded in 1993 by a coalition of agricultural, environmental, legal and tribal interests. It is a not-for-profit organisation that purchases water on the market for in-stream flow purposes, primarily for fish habitat. Its mission is to acquire water rights ‘through gift, lease or purchase and commit these rights under Oregon law to in-stream flows in order to conserve fisheries and aquatic habitat and to enhance the recreational values and ecological health of watercourses’. The ability of OWT to become a participant in the market was only made possible by a change in the legislative definition of ‘beneficial use’ under Oregon’s water code in 1987 to include leaving water in-stream. This change reflected concerns about the impacts on salmon and trout populations of insufficient in-stream flows. Previously only extractive uses such as irrigation, mining or domestic use were included within the definition. However, in-stream flow rights were defined to be held in trust by the Water Resources Department. The OWT has negotiated over 50 temporary and permanent transfers since its inception and protected flow in over 450 river miles throughout Oregon. It has focused attention on basins that have historically supported significant fisheries where low flows are affecting a significant aquatic resource, where there is a high likelihood of ecological benefit, and where it can measure, monitor and enforce its rights. Within each basin OWT identifies priority streams for which stream flow is a limiting factor for fish habitat and water quality and there is potential for acquiring water rights to convert to in-stream use to enhance flows. Although on several occasions legislators have proposed prohibiting the transfer of agricultural water to any other use, these have been rejected. One change that has occurred, however, is that in-stream flow rights may now be held directly by private organisations.

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Facilitative Measures A number of measures can be identified that would indirectly facilitate the development of new products and transactions in the water market. Approvals In terms of direct facilitation, especially of derivatives markets, the earlier discussion of the need to address aspects of the approvals process, especially in relation to rights to contract for conditional trades at a future time, is highly relevant. Should the recent COAG commitment flow through to expand the scope for permanent transfers, there should be no remaining impediments to conditional transfers on any such water. More generally, there should be scope for safely approving some forms of conditional transfer, even where the risks in allowing a permanent transfer are judged to be too great. For example, a 10-year options contract could be agreed that limits the total transfer allowed across this period to, say, 20 per cent of entitlement. The challenge would then be to get the timing/option exercise arrangements right to extract maximum value from that 20 per cent. The US experience with urban utilities acquiring a portfolio of forward sale contracts matched to cropping fallow years may have less application in Australia but is another case of contracts that place a cap on volumes transferred, but over a rolling 5-year period – thus providing greater confidence for all parties in their forward planning and investment. A related issue is that of ‘onus of proof’ in relation to adverse impacts of transfers. Clearly some process will be demanded, and is appropriate, but should also recognise: • the costs associated in delaying approval of what will prove to be beneficial transfers; • the environmental benefits that might occur in response to lower extractive demand at the seller’s site; • the environmental benefits associated with greater river and channel flows where the sale is to a user downstream; and • a requirement for case-by-case establishment of net benefits may involve net costs because of the associated delays and beneficial transfers that fail to occur – especially given the starting point in many areas of a system that is heavily stressed by current usage patterns. The default in the event of nontransfer will, in many cases, not be environmentally benign. These last considerations feed into the next point – the use of pricing instead of, or as well as, regulation to address external impacts.

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Attribution of externality costs There is nothing original in stressing the value in improving pricing and/or other instruments to reduce the severity of any externalities by bringing users to account better for the impacts of their demands on the resource in allowing more efficient trading. There are two dimensions to this: • unlimited freedom to trade can be quite counterproductive where there are major externalities – unpriced or underpriced impacts on other stakeholders, with inadequate facilities for the affected parties to resolve the problem by entering the market; and • the presence of substantial pricing limitations has been used as an argument for slowing the creation of more flexible trading instruments – restriction on trade has been seen as an instrument for managing externalities. More generally, it has probably produced distorted signals as to where the important pressures for improved specification lie. Externality pricing represents the textbook solution to the problem of externalities, but clearly feasibility and cost effectiveness have been major problems. There have also been concerns with the equity consequences of its introduction into an existing set of allocations and approvals. Accurate externality pricing is not currently feasible in respect of many impacts. There has been a lot of emphasis in post-COAG reform processes in moving to cost-reflective pricing. An issue that has received relatively little attention has been that of getting the marginal cost of water to the point where it reasonably reflects the costs the system saves as a result of reduced usage: the incremental (and avoidable) cost of marginal water usage. These are the costs that should underpin trading.

NOTES 1. This report, is publicly available and is downloadable at http://www.aciltasman.com.au/ pdf/WRTG%2030%20June%202003.pdf 2. The prospects for such a trader to emerge in Australian water markets is assessed by Bennett in Chapter 10 of this volume.

REFERENCES ACIL Tasman (2003), Water Trading in Australia – Current and Prospective Products, Report to the Water Reform Working Group, downloadable at http://www. aciltasman.com.au/pdf/WRTG%2030%20June%202003.pdf Beare S. and A. Heaney (2002), ‘Externalities and water trading in the Murray-Darling Basin, Australia’, Paper for the Australian Conference of Economists, Adelaide, 30 September – 3 October 2002, ABARE Conference Paper 02.19.

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COAG (2004), Council of Australian Governments’ Meeting, 25 June 2004, http:// www.coag.gov.au/meetings/250604/ Ryan I., R. Keogh, N. Fernando and P. Boettcher (2002), ‘Capacity Sharing – A New Water Management System for the St.George Water Supply Scheme’, Paper presented to ANCID 2000 Conference, Interim Resource Operations Licence for St George Water Supply Scheme, Issued to SunWater.

10. Realising Environmental Demands in Water Markets Jeff Bennett1 INTRODUCTION To achieve Pareto efficiency through market allocation, property rights over resources must be comprehensively defined and defended. This ensures that the full range of benefits and costs arising from their use are assigned and enforced. Competition between those with interests in a resource ensures that allocation is to the highest marginal net value use (Kasper 1998). The difference between the marginal net values of a resource prior to and subsequent to market place reallocations is known as the gains from trade. These gains from trade provide a powerful rationale for society to ensure the definition and defence of property rights. A complication to this logic arises when it is recognised that the definition and defence of property rights and their subsequent reallocation by trading in markets are costly activities in themselves. The existence of these so-called transaction costs limits the extent of gains from trade. Indeed if the transaction costs involved are greater than the potential gains from trade, then trade in a resource may prove unproductive for society. Put simply, in those circumstances, the costs involved in establishing and implementing trade are greater than the benefits that would result (Demsetz 1967). Such a situation can arise when a resource can be used to provide benefits that are ‘non-excludable’: that is, when the identification of beneficiaries is problematic (rights definition) and/or where beneficiaries cannot be precluded from use (rights defence). For example, if an ecosystem provides existence benefits to people – that is, the enjoyment experienced from the knowledge that ecosystem remains intact – identifying which individuals are enjoying the benefits and then securing exclusive use is at best expensive and at worst impossible. Hence, where some alternative uses of a resource are associated with rights that are readily defined and defended whilst others suffer from transaction costs that are high relative to their net marginal values, it can be confidently 165

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predicted that market allocation will favour the former uses. In the ecosystem example above, the likely outcome is that uses involving the production of ‘excludable’ goods such as food, fibre and minerals will prevail over ‘nonexcludable’ goods such as existence benefits. This gives rise to concerns that the market allocation process results in a ‘misallocation’ of resources. The consequential ‘inefficiency’ is deemed to be a failure of market allocation. But is this ‘inefficient’? If the transaction costs exceed the potential gains from trade in the ‘non-excludable’ goods, then society is better off without the trade taking place. However, that conclusion is based on all the transaction costs being born by the individuals with interests in a resource. That is not the case for the majority of resources, even in the most laissez-faire of economies. Governments act to take advantage of economies of scale in performing many of the tasks associated with the definition and defence of property rights. Parliamentary legislation codifies rights. Legal precedent clarifies rights in an evolutionary context. Police, the courts and the penal system target enforcement. In all of these cases, transaction costs are borne by society at large, rather than by individuals, with consequential cost savings. Taking the logic further, governments can take a more interventionist stand by either directly or indirectly controlling resources that provide ‘nonexcludable’ benefits to people. For example, governments set aside areas of land as National Parks and require minimum flow levels in rivers to be secure from extraction. Such intervention avoids the transaction costs associated with market allocation processes. The temptation then is to conclude that so long as the marginal benefits of intervention are greater than the marginal costs then government action is justified. This conclusion is flawed, however, if the transaction costs associated with the process of government intervention are ignored in the calculation of the marginal costs of intervention. Government actions – including the taxation process used to fund intervention – involve costs. Furthermore, the incentives associated with government action induce inefficiencies. Rent-seeking behaviour by parties interested in both the excludable and non-excludable alternative resource uses can drive a wedge between political outcomes and economic efficiency. What this means is that neither a laissez-faire market-based system nor a command and control government regulated system of allocation is likely to deliver Pareto efficient resource allocation. Nor is one system guaranteed to deliver Pareto superior outcomes relative to the other. A key goal of policy is thus to determine the appropriate balance between the two systems. In the case of many environmental resources, past policy in Australia has focused on the regulatory approach. Specifically in the case of the water resource, environmental flows have been mandated and extractions allocated largely via government issued licences.

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There has been a growing recognition of the potential efficiency advantages offered by market allocation with technological advances in information processing reducing transaction costs. In addition, there has been a realisation, internationally, of the extent of the transaction costs involved with government allocation and a better understanding of the significance of rent-seeking behaviour. These factors have induced more policy makers to turn their attention to markets and market-based instruments of natural resource management. One expression of this shift has been the effort to establish water markets in Australia. Fundamentally, this has taken the form of the more complete definition of rights to extract water for irrigation purposes – including the capping of volumes extracted – and the separation of water rights from land titles to facilitate trade. Rolfe’s chapter in this book demonstrates that the shift toward towards market-based water management has created potential for improved efficiency in the use of water for consumptive purposes as have Young et al. (2000). However, questions remain regarding the efficiency of the outcome with respect to non-consumptive, non-market, environmental uses of water. Fundamentally, allocation to these uses remains a function of government regulation because the decision as to the positioning of the ‘split’ between extractive and non-consumptive uses of water – that is, how much water should remain as ‘environmental flows’ – rests with state government agencies, albeit more recently with the inputs of advisory groups comprising local people, scientists and representatives of vested interest groups. The issue of allocating water to environmental purposes is addressed in this chapter. Two specific questions are addressed: 1. Are governments and their agencies setting environmental flows at economically efficient levels; and 2. Can markets play a larger role in determining the allocation of water for environmental protection purposes? The chapter is structured around these two questions. In the next section, the processes of establishing environmental flow levels in a regulatory setting are considered. Included is a review of some studies conducted to estimate the community’s level of demand for environmental flows. In Section 3, the potential for private sector conservation enterprises (PSCEs) to act in water markets to represent the community’s demands for environmental flows is assessed. This is done by considering the evidence of such organisations working to secure the supply of environmental protection benefits from landbased ecosystems. Some conclusions are drawn in Section 4.

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REGULATORY SETTING OF ENVIRONMENTAL FLOWS For governments to set the level of environmental flows in rivers at efficient levels, they must be able to identify the marginal benefits of environmental flows. This would enable the flow level to be set so that the marginal values of alternative uses of water can be equilibrated. In other words, the marginal benefit of water allocated as an environmental flow needs to be equal to the marginal benefit arising from the next best alternative use of the water, presumably the most valuable extractive use. This is the familiar equi-marginal principle that underpins conventional cost benefit analysis. Additional to the foregone benefits, account should also be made of the transaction costs inherent in the policy process and its implementation. Hence, for governments to implement the equi-marginal principle, knowledge of the values placed by the community on all potential uses of the water should be acquired. This includes information on the non-marketed values associated with environmental flows. Whilst well-functioning markets are good sources of information regarding the values of people for the extractive uses of water, value information regarding the non-marketed environmental values is more problematic. Some attempts have been made to estimate these non-market values in the context of water allocations. For instance, as part of the process used to develop water management plans for the rivers of NSW, Bennett and Morrison (2001) used choice modelling to estimate the values associated with river attributes that would be advantaged by greater environmental flows. These included riverside vegetation health, and the number of fish and bird species relying on the river habitat. Choice modelling is a non-market valuation technique that presents respondents in a survey with a sequence of potential future water management arrangements and outcomes. Respondents’ choices between these alternatives are used to infer the values of environmental attributes, in monetary terms, given that one of the impacts of changed water management conditions is a directly felt monetary impost. A selection of the Bennett and Morrison (2001) results is provided in Table 10.1. The units of measurement of the attribute value estimates displayed in Table 10.1 are dollars per unit of each attribute. For instance, from the Bega River survey, the Fish Specie attribute value can be interpreted as: On average, respondent households in the Bega Valley value the presence of an additional fish specie in the river at $7.37 per household. Similarly, Rolfe et al. (2002) have undertaken choice modelling studies of the environmental values of water in the Fitzroy Basin of Central Queensland. They asked various samples of people resident in Rockhampton, Emerald and Brisbane to choose between alternative water management regimes for rivers

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Table 10.1 Attribute Value Estimates ($ per household) River

Vegetation

Bega Clarence Georges Murrumbidgee Gwydir

$2.32 $2.02 $1.51 $1.45 $1.49

Fish

Birds

$7.37 $0.08* $2.11 $2.58 $2.36

$0.92 $1.86 $0.67* $1.59 $1.89

* Insignificant coefficients in model at the 5 per cent level. Source:

Bennett and Morrison (2001).

in the Fitzroy. One of the attributes used to describe the outcomes of those strategies was the number of kilometres of waterways in the catchment that remain in good health. Estimates of the value of this attribute were calculated for the different groups of respondents and for different sub-catchments. Values in the order of 2 to 10 cents per annum over a 20-year period per kilometre were reported. van Bueren et al. (2004) provide estimates of the environmental values of rivers that were calculated as a component of the National Land and Water Resources Audit. This work used the context of a river restoration programme in contrast to the Rolfe et al. study where river protection was the focus. It also used a nation-wide context. An estimate of 8 cents per annum over a 20-year period per household per 10km stretch of restored river was reported. Whilst some environmental valuation studies have been attempted, their use in the policy process of determining environmental flows has been limited. For instance, the Bennett and Morrison results have yet to be sanctioned for release by NSW Government agencies. A number of points arise from this observation. First, the limited use made of the studies can be attributed to their controversial nature. Techniques for estimating non-market values such as choice modelling rely on peoples’ responses to questions that are essentially hypothetical. People provide answers that are expectations rather than revelations of actual behaviour. This has lead to a debate in Australia regarding the accuracy of estimates so derived that goes back to the controversial use of a related technique, contingent valuation, to estimate the environmental protection values associated with Coronation Hill in the Northern Territory (Moran 1991). However Bennett and Morrison argue that their estimates are reliable due to the strength of the models on which they are based. Those models explained a relatively large proportion of the total variability evident in the choice data,2 the environmental attribute coefficients were consistently

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found to be significant and respondents’ age and income were both significant and consistent with a priori expectations. Second, the limited number of environmental valuation studies can be attributed to their cost. The collection of primary data through surveys is expensive and it can be expected that there is a positive relationship between the cost of non-market valuation exercises and the reliability of their results. Put simply, cost-saving short cuts in such exercises are likely to be detrimental to the quality of their outputs. The high cost of non-market value information should come as no surprise when it is recognised that the transaction costs of markets generating such information are sufficiently high to preclude their formation. None the less, these transaction costs of governments acting to ensure efficiency are a barrier to the information being collected. An alternative to expending resources on information collection is to rely on the judgements of elected representatives to determine the efficient allocation of water between consumptive and non-consumptive uses. This is the most widely applied process of determining environmental flow levels in the Australian context. Whilst this approach does reduce the transaction cost burden on society, its ability to deliver the most efficient allocation must be questioned on rent seeking grounds. The political process that drives the allocation decision is driven by the incentive for re-election. In the Australian case, this centres on the search by politicians for the votes of those in marginal electorates who can sway an election result one way or the other. This is unlikely to deliver an outcome that provides outcomes that are in the best interests of society at large. The decision regarding the extent of environmental flows to be provided for the Snowy River is a case at point. There, the results of a Commission of Inquiry were largely ignored when the decision on flows was taken in order to secure the support of the independent local member in the Victorian Parliament. It can be argued that decision makers prefer a situation where information regarding the relative marginal values of non-marketed environmental uses of water is not available. If the voters are ignorant of value information, it is easier for their representatives to make decisions that favour their re-election prospects even if those decisions have net costs to society. This argument can also help to explain the reluctance of decision makers to commission and/or use nonmarket valuation studies, a point raised by Gillespie et al. (2003) in detailing the curtailment of such a study into the value of environmental flows under the Living Murray programme of the Murray-Darling Basin Commission. The resultant picture is one in which the operation of governments to set environmental flow levels is confounded by costly information and incentives that are likely to lead to inefficient allocations. However, the studies performed to estimate the extent of values society enjoys from environmental flows in Australian rivers show that that these values are significant and warrant

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consideration in the resource allocation process. Given the weaknesses inherent in the regulatory approach, are there better prospects for a market solution?

MARKET DEMANDS FOR ENVIRONMENTAL FLOWS The non-excludability of some of the environmental benefits arising from environmental flows in rivers has been argued to result from the high transaction costs of defining and defending exclusive rights to those benefits. Yet there are some environmental flow benefits that are excludable. These mostly relate to uses that rely on direct contact with the water. For instance, environmental flows can improve peoples’ recreational enjoyment from a river – fishing, swimming and boating. Such uses can be excludable. For example, a kayak tour or houseboat operator reliant on a particular level of flow for their clients’ satisfaction may purchase water to secure that flow. With the profit motive providing the incentive for non-consumptive purchases of water, some non-excludable benefits may be provided as a positive externality (Anderson 2004). This can arise because there is joint production of excludable and nonexcludable benefits through the supply of environmental flows. Similarly, a group of anglers may form to purchase environmental flows to ensure an ecologically healthy habitat for spawning fish. In this case, the costs associated with overcoming the free-rider problem within a group may be low enough not to overwhelm the potential benefits of improved fish catch probabilities. Again it is the prospect of a direct use benefit being enjoyed that could motivate purchase. That benefit – the catching and consumption of a fish – is excludable and exclusion from a length of a river to all who are not members of the angling group is also possible. However, along with the excludable good, non-excludable benefits such as the protection of other species of flora and fauna may be supplied. Anderson and Leal (1991) cite cases in the UK and the USA where the protection of environmental assets has been successful due to the purchase of use rights by groups seeking hunting and fishing opportunities. Similarly, documentation of the revitalisation of the African Elephant population in Zimbabwe (Sanera and Shaw 1996) demonstrates the significance of hunting property rights. Thus, by securing use rights to resources, people interested in types of uses that are consistent with non-use benefit provision, effectively provide the wider public good. In a sense, the use benefits for which rights can be defined and defended ‘piggy back’ the non-use benefits where property rights are more problematic. These two classes of example illustrate the possibility of private sector interests buying water in markets for non-consumptive use values. It is also possible that entities could be established specifically to purchase

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environmental flows for non-excludable benefits. Motivations for such actions include philanthropy. In this case, people provide funds either as individuals or coordinated in some group structure, to buy water in order to supply nonexcludable goods such as existence values. They will enjoy these benefits but so will all other members of the community. Such an action contradicts the free-rider incentive by which people are hypothesised not to spend money in this way, hoping that others will pay enough so that the good is supplied and then enjoyed at no personal cost to the free-rider. For groups to form to raise funds to purchase non-excludable water use benefits, they must confront the free-rider incentive. This in itself can be an exercise ladened with transaction costs. It involves seeking out people who value the benefits being provided and then convincing them of the merits of paying. These transaction costs are essentially being born to mimic the exclusion process required for efficient market provision. The formation of groups of people with high marginal values for the non-excludable benefit means that the surplus they enjoy from having the good provided is sufficient to yield a surplus large enough to be redeployed in meeting some of these transaction costs. Water markets in Australia are, perhaps as yet, too young to expect such private purchases of water for environmental flows to have emerged. To date only one purchase of water to create an environmental flow by a private sector entity is known to the author and that was funded by a grant from government. A wide range of private sector entities is potentially capable of forming to see the provision of environmental flow benefits. Profit maximisers, not-forprofits, clubs and societies all may arise. Whether they will develop or not as the market matures remains conjectural. The Australian context of large areas with relatively sparse population is very different from the European and United States settings. Similarly, Australian rivers do not support populations of ‘charismatic mega fauna’ that are likely to either support large-scale tourist or hunting demands. 3 Furthermore, there are potential issues surrounding the suitability of flows purchased for some river recreational activities to support the ecological functioning of a riparian system. For example, flows purchased to support the houseboat industry may be made in the summer when the ecology of inland rivers is adapted to low flow levels. One way to assess the likelihood of the private sector realising the community’s demands for environmental flows is to consider the evidence offered by conservation initiatives undertaken on the land resource by private sector conservation enterprises. Before proceeding, however, it is worth noting that the emergence of private buyers of water – and of land – for environmental conservation purposes in Australia is – or will be – occurring in a context of government intervention. In the land case, governments across Australia have already established large-

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scale estates of national parks and nature reserves. For water, as has been noted, environmental flows have been regulated. The emergence of private, conservation motivated, buyers in land and water markets will thus reflect demands at the margin net of the transaction costs associated with overcoming the free rider problem. In a survey of 174 Australian PSCEs, Bennett and Usher (2004) found that the sector is involved in numerous direct conservation4 activities. These include: • ownership of natural areas; • management of natural areas including on-ground works that maintain, restore or enhance biodiversity; and • use of private funds to conserve native wildlife and habitat through establishment and management of reserves and sanctuaries. In addition, activities undertaken by these organisations that facilitate nature conservation activities include: • administration of conservation covenants and/or revolving funds that facilitate land purchases; and • administration of devolved grant schemes; and • brokering between groups that undertake on-ground works and those seeking to achieve nature conservation goals. The distribution of these activities across groups is shown in Table 10.2. Table 10.2 Direct Conservation Activities Activity

Ownership of natural areas Management of natural areas Administration of covenants Administration of devolved grants Brokering conservation activities Technical advice/support

Respondent PSCEs involved

Percentage of respondent PSCEs

27 156 32 93 45 101

16 90 18 53 26 58

Source: Bennett and Usher (2004).

The evidence from the survey shows that PSCEs are active in the Australian conservation scene in every state and territory:

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• • • •

fifteen of the PSCEs responding had per annum revenue of over $1m. total annual revenues across the PSCEs surveyed are in the order of $99m. total average value of responding PSCEs’ assets exceeded $112m. in the 2002/03 financial year around 31 000 volunteers worked with the surveyed PSCEs, representing the equivalent of over 1600 full time equivalent workers. • in the same year, over 800 paid employees worked for the responding PSCEs.

Bennett and Usher found that the activities of the PSCEs responding to the survey were largely independent of their location. However the geographic focus of PSCEs was found to give rise to different concentrations of activity. Owning natural areas was more frequently observed in national or state focused PSCEs than those with a regional and local site focus.5 For example, 30 per cent of the national PSCEs and 39 per cent of state focused PSCEs surveyed owned natural areas, compared with 7 per cent for regional and 15 per cent for local site focused PSCEs. PSCE with a national focus were also found to be more likely (50 per cent) to act as a broker between PSCEs undertaking on-ground works and those wanting them. In contrast to the trend observed for ownership of natural areas, the next most likely PSCEs to act as brokers were those with a regional focus (34 per cent) rather than state focused PSCEs (26 per cent).6 However, state focused PSCEs were more likely to be involved in both the administration of covenants7 and provision of technical advice/support8 than other PSCEs. Table 10.3 displays the data collected on activity differences. Table 10.3 PSCE Activities by Focus of Operations % of PSCE, separated by focus of operations, undertaking an activity

Focus\ Activity National State Regional Local Chi square Significance level

Own

Manage

Covenant

Broker

%

Devolved Grants %

%

Tech. advice %

%

%

30 39 7 15

80 78 90 94

10 30 23 10

30 48 63 49

50 26 34 13

70 87 64 40

13.9 0.00

5.1 0.17

7.0 0.07

5.9 0.12

11.7 0.01

20.2 0.00

Source: Bennett and Usher (2004).

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Other differences across PSCEs were observed to be less marked. For instance, activities carried out were generally invariant across the scales of PSCEs, as indicated by revenue. The exception was PSCEs with larger revenue flows, which were more likely to be involved in the provision of technical advice and support.9 Similarly, activities were independent of PSCE structure, with the exception that public corporations with elected boards were more likely to be involved in the ownership of natural areas.10 The Bennett and Usher study shows that PSCEs are active participants in the protection of natural ecosystems in Australia. The activities undertaken by these groups are broad ranging, but most of the PSCEs surveyed were involved with the on-ground management of nature protection areas. PSCE were shown to be responsible for significant funds being invested and considerable labour resources being mobilised for the achievement of nature conservation objectives. An important consideration in determining the prospects of PSCEs in mobilising demand for non-excludable environmental benefits is their sources of funds. Whilst a wide range of funding sources were accessed, nearly all the PSCEs responding to the Bennett and Usher survey received government grants as one source of revenue. Table 10.4 sets out information on revenue sources for responding PSCEs. Table 10.4 PSCE Revenue Sources Sources of revenue

Respondent PSCEs in receipt

Government grants Philanthropic grants Sponsorships Donations Membership dues Merchandising Events Tourism

156 32 53 116 138 45 42 23

Percentage of respondent PSCEs 90 18 31 67 80 26 24 13

Source: Bennett and Usher (2004).

The strength of the devolved grant activity in the sector may also be a reflection of government funding policy, that is, to channel public funds through PSCEs at a regional or local level so as to ensure that a ‘grass roots’ approach is secured. Notwithstanding the prevalence of government derived funding, donations and membership fees were also shown to be important sources of funding for the survey PSCEs. Furthermore, the success of this

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sector in leveraging non-cash private sector resources is significant. Of particular importance is the labour input; the volunteer labour force in the sector is substantial. The prevalence of government grants as a revenue source within the PSCE sector may indicate that significant barriers confront these organisations in the raising of private sector revenue streams. One explanation of this is that the free-rider hypothesis is verified by the survey. Alternatively, it may be evidence of structural impediments to PSCEs that are the result of government policies. For instance, bans on the ownership of native species could prevent the formation of profitable enterprises based on the protection of natural ecosystems for the breeding of species for sale to collectors. However, it may also signal that the level of supply offered through public sector provision is sufficient for most people. Hence it may only be a small minority in the community that is sufficiently dissatisfied by government provision that they seek private alternatives. The results call into question the long-term sustainability of many PSCEs if a change in government policy led to either, less funds being available to PSCEs for leveraging other resources, or a greater channelling of public funds for the environment to public sector agencies. However, Bennett and Usher admit that the data collected do not enable an analysis of the degree to which PSCEs are dependent on government funding. It may be the case that whilst many PSCEs receive some form of government funding, their primary source of funds is the private sector.

CONCLUSIONS Defining, defending and then trading property rights in water is being advanced as a means of improving the efficiency with which the Australian community uses this frequently scarce resource. The gains from trade that this policy approach offers need to be considered in the light of the transaction costs involved. It is argued in this chapter that the transaction costs involved in defining, defending and trading the rights associated with some aspects of water may be sufficiently high to offset completely the gains from trade that may be available. These aspects are characterised by ‘non-excludability’ and include many of the environmental benefits supplied by riparian ecosystems. The conventional approach to securing the supply of these environmental benefits has been for governments to circumvent the market transaction costs by regulating peoples’ behaviour. In the case of water, this has usually been done through the setting of caps on extractions from rivers or minimum required flow levels – known as environmental flows. This approach is called into question for three reasons.

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First, governments incur transaction costs themselves in the determination of the appropriate level the environmental flows should take and then the implementation and monitoring of the regulation. These costs may well be greater than the net benefits generated by the flow. Second, the process by which governments determine environmental flows may be compromised in terms of achieving greater efficiency in resource allocation (and hence greater net social well-being) because of rent seeking behaviour. The resource use outcomes derived through the political process can be more about securing the votes of vested interest groups than achieving efficiency. Third, the transaction costs associated with dealing with free-rider behaviour may not always be so large as to negate gains from trade in water for the non-excludable uses. This can occur because of altruism or philanthropy, motivations that are independent of free-rider response. It may also occur because of the joint production of excludable and non-excludable water-derived benefits. Technological advances may also make inroads into transaction costs. New and cost-effective ways to exclude users may be developed. These issues have been explored in this chapter from two angles. First the use of non-market valuation techniques to estimate the benefits arising from environmental flows was considered. It was shown that whilst some such studies have been undertaken they have not as yet seen wide application in the regulatory policy process of setting environmental flow levels. This provides some evidence of the high transaction costs associated with government regulatory behaviour but also may indicate the presence of rent seeking in that decision-making process. The second angle involved the analysis of PSCEs in Australia. These organisations have made a significant contribution to the conservation of landbased ecosystems in Australia and this evidence supports the hypothesis that similar efforts to protect water-based ecosystems would also be successful once water markets become better established and more widely recognised as vehicles by which nature conservation benefits may be secured. Hence two key conclusions are that government regulatory processes to determine and implement environmental flows are both costly and incentive incompatible and that PSCEs do hold some promise as environmental flow suppliers. Does this inevitably lead to the conclusion that governments should simply exploit their economies of scale in defining and defending water rights and leave individual, corporate and group interests to determine allocations through trade? Certainly under such a scenario, there would be no need for non-market valuation studies as the market would be the venue whereby entities revealed their values. And the prospects of rent-seeking behaviour would be minimised.

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However, it is dubious to think that free-riding would not emerge, at least to some degree, given the degree of non-excludability associated with benefits such as existence demand. Similarly, equity issues – especially those associated with intergenerational equity and the prospect of irreversible outcomes such as species extinction arising from the actions of the current generation – are unlikely to be incorporated in purely market-based processes. One option that could be seen as a potential middle ground between markets and regulation is for a staged approach to the allocation of water to environmental flows. In the first stage, governments – using scientific research and non-market valuation techniques as guides – determine what could be described as ‘safe minimum standards’ (Bishop 1978) of environmental flows. These would be set to ensure the avoidance of irreversible environmental outcomes as well as to reflect the base levels of benefits the current generation enjoys from river ecosystems. Once announced, these levels would be held immune from political manipulation. That would send the signal to those who value environmental flows more highly that the only way they will see more supplied is through their individual or group actions in water markets. Hence, governments could not ‘crowd-out’ the endeavours of PSCEs nor could individuals hope for a return from lobbying governments for a change in the level of flows. Furthermore, governments may use PSCEs as management agents for environmental flows. This would involve PSCEs competing to be allocated the environmental flows mandated by government. Under contracts specifying the environmental goals to be achieved, PSCEs could manage the water under their control to achieve those environmental goals and perhaps more. For instance, allocated environmental flow volumes could be sold in water markets at times of greater scarcity (summer) and bought in winter when they would be both less expensive and more environmental advantageous. In other words, seasonal marginal value difference between extractive and nonconsumptive uses of water could be exploited to achieve gains from trade for all parties and profits for the contracting PSCE that could be used to pursue further environmental improvements.

NOTES 1. The contribution of Georgina Usher in the preparation of this chapter is gratefully acknowledged. Errors and omissions remain the responsibility of the author. 2. Adjusted rho squared statistics for the models ranged from 0.21 to 0.41, with values greater than 0.2 being regarded as robust. 3. An exemption maybe the crocodile in northern Australia, but there, most habitat is found in unregulated river systems. 4. Indirect conservation activities include lobbying the government for changes to biodiversity conservation policies and programmes of community education activities. 5. Significant at the 1 per cent level, however there is a caveat relating to this result due to the small numbers of observations in some categories.

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6. Significant at the 1 per cent level. 7. Significant at the 10 per cent level, however there is a caveat relating to this result due to the small numbers of observations in some categories. 8. Significant at the 1 per cent level. 9. The difference is significance at the 1 per cent level. 10. Significant at the 5 per cent level. This result however goes with a caveat relating to the small numbers of observations in these categories.

REFERENCES Anderson, T. (2004), Donning Coase-Coloured Glasses: A Property Rights View of Natural Resource Economics. Paper presented to the Australian Agricultural and Resource Economics Society Conference, Melbourne, 13 February. Anderson T. and D. Leale (1991), Free Market Environmentalism, San Francisco: Pacific Research Institute for Public Policy. Bennett, J. and M. Morrison (2001), ‘Estimating the Environmental Values of New South Wales Rivers’, Proceedings of the Third Annual Stream Management Conference: The Value of Healthy Streams, Brisbane, August, 1, 29–34. Bennett, J. and G. Usher (2004), Private Sector Conservation Enterprises in Australia, paper presented at the 79 th Annual Conference of the Western Economic Association, Vancouver Canada, 29 June–3 July 2004. Bishop, R. (1978), ‘Endangered Species and Uncertainty: The Economics of a Safe Minimum Standard’, American Journal of Agricultural Economics, 60, 10–18. Demsetz, H. (1967), ‘Toward a Theory of Property Rights’, American Economic Review: Papers and Proceedings, 57 (2): 347–59. Gillespie, R and J. Bennett (2003), ‘Linking Science, Community Consultation and Economics: The Living Murray Project’, Paper presented to The Economic Value of Biodiversity National Workshop 22–23 October, 2003. Kasper, W. (1998), Property Rights and Competition: An essay on the constitution of Capitalism, Policy Monograph 41, Sydney: Centre for Independent Studies. Moran, A. (1991), Valuing the Kakadu Conservation Zone. Occasional Paper No. 139, Melbourne: Tasman Institute. Rolfe, J., A. Loch and J. Bennett (2002), Tests of Benefit Transfer across Sites and Population in the Fitzroy Basin. Research report No. 4, Floodplain Development Research Reports, Faculty of Business and Law, Central Queensland University, Emerald. Sanera M. and J. Shaw (1996), Facts, Not Fear: A Parent’s Guide to Teaching Children about the Environment, Washington, DC: Regnery. van Bueren, M. and J. Bennett (2004), ‘Toward the Development of a Transferable set of Value Estimates for Environmental Attributes’, Australian Journal of Agricultural and Resource Economics, 48 (1), 1–32. Young, M., D. MacDonald, R. Stinger and H. Bjorlund (2000), Inter-state Water Trading: a Two-Year Review, Canberra: CSIRO Division of Land and Water.

Index Abel, Nick 6 aboriginal people 1 access 43, 57, 62 entitlements 82–4, 89–90 rights 100 accounting systems 86, 152, 153 ACIL Tasman 139, 143–4, 146, 149 acquisition limits 27–8 Acton v Blundell 31 Adelaide, water demand 20 agricultural production, changes in 129–31 usage 100, 108–11, 122, 125, 154–5 alienation rights 102 allocation effectiveness 144–5 efficiency in 9–10, 121–2 environmental flows 16–17 history of 10–12 improvements 18–19 market-based 77–8 mechanisms 122–5 property rights 15–16 state control of 76–7 approvals process 144, 162 aquifers 97, 103 Argus, The 46 assignability 67 Atherton Tableland 133, 135 Australia entitlements in 106–14 water in 95–100 availability of water 98–9 Beardmore Dam 152–3 Bega River 168 benchmarking, registration systems 87 ‘beneficial use’ 161 Bennett, Jeff 6 biodiversity 16–17 Blackstone, W. 25

Brazil, water markets 60 Bulk Shares (BS) 152 bundling of land and water 147 bureaucrats 128 Burnett River Dam 134 California 59 call options, forward trading 156 Campbell, David 6 capacity share entitlements 152–3 capping commercial uses 20 extractions 83, 176–7 volumes 162 water harvesting 111–12 case studies, inter-sector trading 129–32 centralised allocation, Victoria 51–3 Chaffey brothers 1 Chile, water markets 60, 124 choice modelling 168–70 Coase theorem 15 Coffin v The Left Hand Ditch Co. 35–6 Coggan, Anthea 6 collective action approach, property rights 40 in-stream uses 26 Colorado 34, 35–6, 59, 61, 156 Comet River 131–2 commercial uses, capping 20 common law concept of property 66–7 custom 24–5, 26, 33 second-best allocations 27–30 see also English common law common pool problems 31 resource 102–3, 112 ‘common property’ 61–2 communal property rights 57 community groups 128 ‘community of the river’ 42–3 180

Index compensation 32, 33 competitive pressures 128 water markets 9 complete entitlements 115 compulsory charging, Victoria 51 Condamine-Balonne Basin 152 conditional trading 143 transfers 162 congestion pricing 148 conservation initiatives 172–8 consumptive uses 170 Coronation Hill 169–70 cost-reflective pricing 163 costs components 17–18 pollution 14–15 production 12–13 cotton industry 129–31, 133, 135 Council of Australian Governments (COAG) agreement (1994) 78, 82, 119–20, 127 commitments 13, 140, 141–4, 162 property framework 62–4 statements 8–9, 11 strategies 15, 19–21 courts as policymakers 69 customary foundations of water rights 24–5 dams construction of 32, 33–4, 99 timing of release 150–51 Deakin, Alfred 48, 77 delivery capacity entitlements 148–50 rights 14 demand changes in 18 and groundwater rights 30–31 volatility, management of 144–6 Department of Natural Resources and Mines (DNR&M) 86 derivatives/options contracts 86 markets 162 disputes, water access 43 downstream entitlements 16, 151

181

users 42–3, 97, 103–4, 111, 114 water yields 109 ‘dozer’ rights 16 drainage rights 153 drought (1877–1881) 45–6 ecologically sustainable usage 79 economic issues, water trading 121–8 usage 100 Emerald Irrigation Area 129–31, 135 end-user entitlements 152 English allocation in 27–9 common law 39, 42, 57, 62, 69, 76 groundwater rights 30 markets 24, 25, 26 natural user system 32, 34, 35 entitlements cancellation of 89 as collateral for loans 87 defensibility of 106–14 definitions, uniformity in 159 irrigation 114 National Water Initiative 58 nature of 83–5 security and defensibility 100–105 strategies 13–16 unbundling of 85, 86 entrepreneurship, returns from 135 environmental entitlements, active trading in 160–61 traders 155, 161 environmental flows 16–17, 167 investment in 20–21 market demands for 171–6 regulatory setting of 168–71 and titling systems 90–91 environmentalists 128 Epstein, Richard A. 5 ‘equi-marginal principle’ 4, 168 equity criteria, water trading 19 ‘equivalent right’ model 91 Essential Services Commission 14 European legal systems 62 settlers 1 evapotranspiration 108, 109, 112, 113 evolutionary nature of property rights 41 exchange rates 159–60

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excludable benefits 171 exclusion rights 102 exclusive rights, land 25–6 experimental economic procedures 127 explicit rights 102, 104 external costs 9–10, 163 extractive uses 140–41 Fairbairn Dam 129, 135 farm boundaries, water within 108–12 dams 99, 111 production models 126, 133 farmers price rises 127–8 water rights 11–12 first possession rule 35 fish habitats 161 Fitzroy Basin 131–2, 168–9 flooding 33 flows 103–4 forests 108–9, 110 forward trading 145, 148 free-rider incentives 172, 173, 176, 177, 178 Freebairn, John 4 French legal system 62 fruit growing 131 funding for conservation 175–6 futures contracts 156 Gold Fields Act (1857) 44 gold mining, Victoria 44 government failure 125, 134 intervention 10, 41, 48–9, 166 land departments 15 ownership of water rights 52–3 policy 10–12, 19–21 reforms 56–9, 78, 92–3 Goyder line 1 grandfather arrangements 11–12, 19 groundwater percolation 108 rights 30–31 trading in 158 volume 99 H Jones v Kingsborough Corporation 65

Harris, Edwyna 5 harvesting of water 111–12 Hawai’i 68 Head v Amoskeog Mfg. Co. 33 holders of rights 140–41 Holmes and Sinclair Relationship (HSR) 109 horticultural regions 113 human influences on hydrological cycle 95–7 Hunter Walter Corporation 108 hydro-electric generation 150–51 hydrological cycle, human influences on 95–7 imperative necessity 34–6 implicit rights 102, 104 in-district usage rights 149–50 in-stream flow rights 161 uses 26, 31–6 incentive structures, politicians 3–4 incomplete entitlements 115 indefeasibility, water titles 88–9 Individual Capital Shares (ICS) 152 industrial users 121–2 infrastructure failure 49 innovation, returns from 135 institutional frameworks, rigidity in 51–2 inter-jurisdictional trading 158–60 inter-sectoral trade 125, 129–32 interstate trading 158–60 intra-sectoral trade 132–3 investments environmental flows 20 incentives for 80 infrastructure 134 water markets 19 irrigation districts 1 efficiency 113–14 schemes 135 Victoria 41, 45–51, 52 Irrigation Act (1886) 46, 48, 50 irrigators 97, 127–8 Islamic law 62 Kaldor-Hicks improvements 36 standard of social welfare 32

Index land ownership 43, 44–5 rights 25–6 separation from water 82, 147–8 use/change 108–11 landowners groundwater rights 30 trading of water 146 leases 86, 154 legal environment property regimes 61–2 water rights 24–5 legislation, objectives of 57–9 licences, water use 15, 17–18 licensing systems 77 Limari water market, Chile 60 ‘live and let live’ regimes 26 loans, collateral for 87 location-specific flows 103–4 Locke, John 24–5, 27, 35 long-term entitlements 103 Mackay region 134 Major’s line, Victoria 42 management rights 100, 102 rules, environmental allocations 91 Mareeba-Dimbula Irrigation Area (MDIA) 133, 134, 135 marginal social benefits, environmental flows 17 market contracting 40–41 demands for environmental flows 171–6 models 59–61 valuation studies 170–71 market-based allocation 77–8 mature water economy stage 10–11 Mean Annual Run-off (MAR) 99 Meering and Leaghur Irrigation Company 41 Melbourne, demand in 12, 20 Middle Eastern legal systems 62 Mildura 1 Mill Act cases, US 33 mills, construction of 32, 33–4 Mining Act (1865) 46 Mining Boards/Committees, Victoria 44 mining industry 131–2

183

Mississippi River 31 mortgage arrangements, protection of 88 multiple system of water rights 35–6 Murray River 114, 151 Murray Wetlands Working Group (MWWG) 112 Murray-Darling Basin 109, 142–3, 153, 158–9 Murray-Darling Basin Commission (MDBC) 78, 79, 142–3, 160, 170 National Land and Water Resources Audit (NLWRA) 99, 169 National Parks 166 National Provincial Bank v Ainsworth 66 National Water Initiative (NWI) access entitlements 83 agenda 141–4 common principles 92–3 drivers 79 strategies 58–9 natural resource property rights 41 user system of rights 32 ‘navigation servitude’, US 34 negative externalities, irrigation 127 New South Wales (NSW) allocations 85, 86, 106 irrigation 39, 114 titling system 92 trading 158, 159 ‘vesting’ formula 65 water harvesting 111–12 New South Wales Farmers Federation 111–12 non-consumptive uses 170, 171–2 non-excludable benefits 165–6, 171, 176–7 non-extractive uses 140–41 non-market values 168–71, 178 Northern Territory 64 ‘old title’ system 81 ‘onus of proof’ requirement 143–4, 162 opportunity costs 134 options contracts 162 Ord River Dam 134 Oregon Water Trust (OWT) 161 out-of-region trades 149–50

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The Evolution of Markets for Water

out-of-stream uses, US 35 over-use, prevention of 40 ownership rights, definition of 2–3 Pareto efficiency 166 exchange 19 improvements 26, 32, 36 partial equilibrium analysis 126 percolation losses 112 permanent trades/trading 85, 86, 141, 143 perpetuity characteristics, entitlements 13, 15–16 Pigovian tax 127 policy initiatives 10–12, 19–21 political economy issues, water trading 127–8 politicians, incentive structures 3–4 pollution costs 14–15 rights 153 Port Philip District, Victoria 42, 43 Portland, Victoria 42 Pratt Walter Group 112 price rises, farmers 127–8 price sensitive demand 133 primary entitlements 146–53 prior appropriation 34–6 entitlements 104 ‘prior right model’ 91 private in-stream uses, allocation of 27–9 irrigation schemes 46–8 private sector conservation enterprises (PSCEs) 167, 173–8 pro-rata allocation 28–9 product prices 18 production costs 12–13 property framework, water markets 56–7, 61–7 background 57–9 market models 59–61 water as public property 67–9 property regimes 61–2 property rights allocation of 15–16 nature of 39–41 re-definition of 66–7

security/enforceability of 80 public accessibility, entitlement registers 89–90 trust doctrine 67–9 public funded investment projects 20–21, 134 irrigation schemes 49–50 public rights embodiment of public values 63–4 protection of 61, 69 put options, futures trading 156–7 ‘quality of title’ provision 86–8 Quebec 30–31 Queensland allocations 85 benefits of water trading 129–35 titling system 92 trading 86, 159 ‘vesting’ formula 65 water harvesting 111 Queensland Resource Registry (QRR) 86, 90 R v Toohey; Ex parte Meneling Station P/L 66–7 rainfall variation 42, 43–4 reafforestation 110 reasonable user system of rights 32, 35 recording systems 81 recreational usage 171–2 redistribution of property rights 40–41 registered interests, protection of 86–8 registers of deeds 81 registration systems reforms of 92–3 role of 80–81 registry of information, entitlements 15, 90 regulation 64–6 regulators, concerns of 140 rent-seeking behaviour 166–7, 170, 177 residual entitlements 104 resource management 77–8 rents 128 return flows 97, 114 rights bundles of 53

Index to extract 140–41 levels of 100, 102 to sell, limitation of 150 riparian rights 42–5, 48–9, 57, 64 systems 29–30 rivers property rights 63 topography 31–2, 34–5 Rolfe, John 6 Roman law 24–5, 62, 68 Royal Commission (1884) 48 runoff 108–10 rural users, sales to urban users 20 Rural Water Commission (RWC) 52 ‘safe’ farming 1 scarcity, living with 1–2 Scottish law 62 seasonal allocations 85 second-best allocations at common law 27–30 secondary markets 154–8 sectors, trading across 158 security of entitlements 100–105 of supply, settlers 45 sequential allocation problem 104 settlement expansion 42–5 short-term entitlements 103 single share product 13 ‘sleeper’ rights 16 Smith, Adam 2–3 Snowy Mountains Hydroelectricity Scheme 1, 150–51 Snowy River 170 social improvements, compensation for 32, 33–4 infrastructure for common law rights 29–30 South Australia (SA) allocations 85 irrigation 113, 114 titling system 92 trading 158 water harvesting 111 Spain legal system 62 water markets 60, 61

185

spatial alienability of entitlements 103 squatters’ water rights 42–5 St George Water Supply Scheme 152, 153 state control of allocation 76–7 guarantee of title 89 management resources 57–8 State Rivers and Water Supply Commission (SRWSC) 39, 50–52 stated preference techniques 126–7, 134 statutory framework, gaps in 66–7 stored water 99, 122–3 stranded assets 14, 149, 150 substitutability of water sources 103–4 sugar cane industry 133, 135 SunWater 152 supply volatility, management of 144–6 surface water 99 swaps contracts/swaptions 157 Sydney Water Corporation 108 ‘tagging’ of water 159–60 Tan, Poh-Ling 5 Tasmania 58 technology, investments in 19 temporary trades/trading 85, 86, 141, 143 transfers of water 155–6 theoretical foundations of water rights 24–5 third party interests, protection of 86–8 Tinaroo Dam 135 titling regimes background 81–2 environmental flows 90–91 indefeasibility 88–9 nature of entitlements 83–5 nature of transactions 85–6 protection of registered interests 86–8 public accessibility 89–90 transition issues 91–2 titling systems legal aspects of 141 role of 80–81 topography 31–2, 34–5 Torrens titling system 81, 82, 86–9, 91, 92 tradeable entitlements, value in 151

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The Evolution of Markets for Water

property rights, establishment of 78–9 trading across users/sectors 158 in environmental entitlements 160–61 in groundwater 158 inter-jurisdictional 158–60 limitations of 148 rights to property 2–4 trading systems, need for improvements 79 transaction costs 104–5, 109–11, 115, 165–7 transactions nature of 85–6 range 154–61 restrictions on 20 transfers adverse impacts 162 block approvals 144 of rights 29–30, 35 of title 90 transition issues, entitlement systems 91–2 transmission losses 112 trusteeship 67–9 two entitlement model 13

usage patterns, modification of 145–6 rights 171 users, trading across 158 usufruct 62, 69

UK, environmental protection 171 un-allocated transmission losses 112 unbundling of primary entitlements 146–53 uni-directional flows 103–4 upstream entitlements 16 users 97, 103–4, 109–11, 114 urban users demand levels 121–2 purchase from rural users 20 urban water market, demand in 12 US Constitution 33–4 environmental protection 171 forward sales 162 prior appropriation and imperative necessity 34–6 state ownership of water 67–9 water access 43 water markets 24, 56, 59–60 water rights 31–2, 36–7, 62

water availability 98–9 characteristics 3 cost components 17–18 law, evolution of 63–4 losses 13–14 as public property 67–9 separation from land 82, 147–8 use 100 Water (Central Management Restructuring) Act (1984) 52 Water Act (1905) 49, 51 Water Act (1989) 52, 64–5 Water Allocation Register, Queensland 90 Water Conservancy Board (WCB) 46 Water Conservation Act (1881) 46 Water Conservation Act (1883) 47 Water Management Act (2000) 65–6, 69, 106, 108 water markets development of 56–7

value information 168–71 verification of title 89–90 ‘vesting’ formula 64–6 Victoria allocation 97 availability of water 98 evapotranspiration 109 harvesting of water 111 horticulture 113 interstate trading 158 irrigation 45–51, 88, 114 move to centralised allocation 51–3 property rights 39–41 riparian rights 42–5 titling system 92 unbundling of entitlements 85 use of ‘vesting’ formula 64 Victoria Government Green Paper (2003) 11–12 White Paper (2004) 8–9, 11–14, 15–16, 19–21, 92

Index effective operation of 17–19 future development 140–41 need for establishment of rights 38–9 setting up of 59 Water Reform Working Group (WRWG) 139 water rights 12–16 farmers 11–12 groundwater 30–32 history of 26 theoretical and customary foundations 24–5 water trading benefits of 129–35 economic issues 121–8 evolution of 76–9 water trading instruments study background 140–41 managing volatility 144–6 NWI/COAG 141–4

overview of possibilities 146–63 water use licences 15 Waterworks Trusts 46, 47–50 wealth generating exchanges 40–41 wells 44 Western Australia 58 Western Mining Corporation Ltd v Commonwealth 67 Wetland Care Australia (WCA) 112 Whitten, Stuart 6 Wilberforce, Lord 66 WILMA titling system 92 withdrawal rights 100, 102 Woolston, Michael 5–6 World Bank 60, 61 Yanner v Eaton 65 Yass River 111 Zimbabwe 171

187