Water Markets - Economic Instruments to Manage Scarcity

Australia has aggressively pursued water markets as an integral part of water policy reforms. Compared to most other countries, relatively active water markets have therefore emerged. Consequently, Australia provides an unique opportunity to study how markets have been introduced and adopted and their role in managing demand and scarcity. This paper discusses: a) how water markets have evolved in Australia, b) 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 in order 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. Once the region is out of this period of drought further research should be conducted to establish the water price/commodity price relationship during periods of more normal supply.