1 Tradable permits- instruments to manage water scarcity? Some Australian experiences

The use of tradable permits to manage scarce supply of natural and environmental resources emerged during the 1970s especially in the United State. Since the 1990s, permit systems have been more widely adopted within water, fisheries and air pollution and more active markets have therefore developed. Water scarcity has been a growing and escalating problem in Australia and water markets have therefore been aggressively pursued as an integral part of water policy reforms. Compared to most other countries, relatively active water markets have therefore emerged. Consequently, Australia provides a unique opportunity to study how markets have been introduced and adopted and their role in managing scarcity. This paper discusses: a) how water markets have evolved in Australia, b) factors influencing prices paid and volumes traded in water markets, and c) the increase in market participation. During periods of drought, scarcity is the main driver of price and market participation. Irrigators do not buy water to maximize their profits due to good commodity prices. Farmers with significant investments in long-term assets purchase water to protect their assets against long-term losses due to inadequate watering. This behavior drives prices to levels where no other agricultural users can compete. The price of water entitlements fluctuates with the price of water allocations, but irrigators do not capitalize scarcity-driven short-term increases in allocation prices into the price of entitlements. There is evidence to suggest that water markets have had a significant impact on the ability of irrigators to cope with scarcity