Water price dynamics, water derivatives and general equilibrium modelling

Abstract: The Council of Australian Government’s (COAG) water reforms of 1994 opened a new era in the irrigated agriculture market. After the separation of land and water rights, water became a tradable commodity. In the past, the value of water was significantly underestimated, which led to irrational ways of using this valuable natural resource. The water tariffs were not related to the marginal values of crops grown by irrigators, which caused unsustainable consumption of water, especially during the drought years. The major aim of the COAG reforms was to enable a proper market value for water and to re-allocate water consumption to more economically valuable crops. In 2004-2005, the total water traded in Australia was 1300 GL with 502 GL of Victoria water traded, i.e. about 10 % of overall use. Given the severity of drought conditions throughout Australia in recent years, and the uncertainty of whether this is a permanent climate change, water price and supply is a critical issue for farmers. In their present stage of development, markets offer farmers little information about long-term prices and quantities, and limited opportunity for avoiding disastrous water shortfalls or unaffordable water prices beyond the current season. Even for the current season, the present trading system still leaves farmers facing unhedgable uncertainty concerning water prices and quantities. This uncertainty appears to be increasing. For example, in the Goulburn system, managers aim to provide full allocations for 96 years out o