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

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 Marketsfor WaterTheory 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

Edward ElgarCheltenham, UK • Northampton, MA, USA

NEW HORIZONS IN ENVIRONMENTAL ECONOMICS

© 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. Water- supply–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

v

Contents

Figures vi

Tables vii

About the Authors viii

Acknowledgements xi

Preface by Alan Moran xii

1. Markets and Government – An Evolving Balance 1

Jeff Bennett

2. Principles and Issues for Effective Australian

Water Markets 8

John Freebairn

3. The Historical Variation in Water Rights 24

Richard A. Epstein

4. State Administration versus Private Innovation: The Evolution

of Property Rights to Water in Victoria, Australia 38

Edwyna Harris

5. A Property Framework for Water Markets: The Role of Law 56

Poh-Ling Tan

6. Registration of Water Titles: Key Issues in Developing Systems

to Underpin Market Development 76

Michael Woolston

7. Accounting for Water Flows: Are Entitlements to Water

Complete and Defensible and Does this Matter? 94

Anthea Coggan, Stuart Whitten and Nick Abel

8. Potential Efficiency Gains from Water Trading in Queensland 119

John Rolfe

9. Water Trading Instruments in Australia: Some Thoughts on

Future Development of Australian Water Markets 139

David Campbell

10. Realising Environmental Demands in Water Markets 165

Jeff Bennett

Index 180

vi

Figures

6.1 Water Rights, Trading and Titling Systems 84

7.1 Human Influences on the Hydrological Cycle 96

7.2 Precipitation to Water Resources in Victoria 98

7.3 Water Supply and Use in the Australian Economy 2000–01 1017.4 Relationship Between Land Cover, Mean Annual

Rainfall and Mean Annual Evapotranspiration 1108.1 Surpluses from Water Use by Different Industries 122

8.2 Planning for Water Shortages 123

8.3 How Additional Dams Have Been Planned 123

8.4 The Market Mechanism and Additional Demands 124

8.5 Average Demands for Selected Farms in the

Mackay and MDIA Areas 132

vii

Tables

4.1 Number of Squatting Runs in Victoria, Various Years 43

4.2 Victorian Population by Location, 1860–1880 45

4.3 Amount of Land Claimed to be Irrigable and Amounts

Actually Irrigated 50

7.1 Water Entitlements in NSW, Victoria, South Australia

and Queensland 107

7.2 Land Use and Runoff 109

7.3 Irrigation Water to Evapotranspiration and Groundwater

Percolation 113

8.1 Gross Margin Budget for Citrus and Cotton at Emerald 130

10.1 Attribute Value Estimates ($ per household) 169

10.2 Direct Conservation Activities 173

10.3 PSCE Activities by Focus of Operations 174

10.4 PSCE Revenue Sources 175

viii

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

About the Authors ix

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 micro-

economics.

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

x The Evolution of Markets for Water

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.

xi

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

xii

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

Preface xiii

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

xiv The Evolution of Markets for Water

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

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

2 The Evolution of Markets for Water

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.


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 concept-

ual 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.


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


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.


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.

8

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

Principles and Issues for Effective Australian Water Markets 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


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 charac-

teristics 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 non-

rival 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-first-

served 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 so-

called 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,


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 over-

allocations, 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


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 non-

household 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


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


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


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


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


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


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 inter-

connection 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 non-

commercial reasons, but over a number of years most mutually advantaged

trades will occur as the true opportunity value of water becomes known.


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.


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


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.


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 non-water input. Further, the marginal value of water will be a declining value of the amountused for each use. The marginal value of water does not necessarily correlate with thecommonly reported dollars per megalitre of water, namely P / Xw, where P is output priceand Xw is water per unit of product.

6. Note that for most rivers and canals with a continuous flow, for marginal changes in riverand 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 ofthese 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 Bendigoand Castlemaine.

11. I am grateful to Alistair Watson for alerting me to this issue. For a related point, on economicgrounds there seems no rationale for the proposed three-step block pricing scheme for urbanwater. In terms of opportunity costs and allocative efficiency, water is water whether itcomes in small or large quantities suggesting a single price. Equity concerns are alreadylargely 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 Groupon Water Resources Policy: Communique’, February.

Council of Australian Governments (COAG) (2002), ‘National Water Initiative:Communique’, 6 December.

Council of Australian Governments (COAG) (2004), ‘Intergovernmental Agreementon 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’, AustralianEconomic Review, 36 (2), 203–212.

Freebairn, J. (2004), ‘Water Rights for Variable Supplies’, paper presented toAustralian Agricultural and Resource Economics Society Annual Meeting,Melbourne.

Godden, L. (2003), ‘Perception of Water in Australian Law: Re-examining Rights andResponsibilities’, paper presented at Australian Academy of Technological Sciencesand Engineering, Melbourne.


Marohasy, J. (2004), ‘Myth & the Murray: Measuring the Real State of the RiverEnvironment’, 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 WaterEntitlement System for Australia’, Australian Economic Review, 36 (2), 225–234.

24

3. The Historical Variation in Water Rights

Richard A. Epstein

THE THEORETICAL AND CUSTOMARY FOUNDATIONSOF 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

The Historical Variation in Water Rights 25

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.


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.


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


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 equi-

marginal 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


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


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 well-

established 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


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.


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 in-

stream 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.


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


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


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,


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


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 mostinsightful 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: ClarendonPress.

Demsetz, H. (1967), ‘Toward a Theory of Property Rights’, American EconomicReview, Papers and Proceedings, 57 (2), 347–359.

Epstein, R. (1995), Simple Rules for a Complex World, Cambridge MA: HarvardUniversity Press.

Getzler, J. (2004), A History of Water Rights at Common Law, Oxford: OxfordUniversity 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.

38

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

State Administration versus Private Innovation 39

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


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


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, right-

of-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.


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


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 1840 192

Bourke (Melbourne) 1843 69

Gippsland 1843 44

Grant (Geelong) 1843 72

Murray 1843 149

Normanby (Portland) 1843 72

Portland Bay 1843 282

Wimmera 1846 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 theiroccupation is sketchy at best. As a result, this is the best information available as to the extent ofsquatter 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


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


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

Capital City (Melbourne) Other urban* Rural

1861 123 061 112 249 303 357

1871 191 449 182 701 357 378

1881 262 389 173 054 426 903

* 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: THEINTRODUCTION 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, butnow thousands of small farmers and their families were in dire distress, withonly 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


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, butrather so to lay out the works that they be gradually developed as the demandfor 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


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


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


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


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

Trust (acres) 1891 1892 1893 1894 1895

Bacchus Marsh 750 8.00 21.33 16.67 19.47 42.40Benjeroop and Murrabit 10 000 5.50 14.34 18.74 8.58 39.03Cohuna 96 771 0.53 5.48 7.60 5.49 24.48

Dry Lake 1 513 0.00 6.68 16.46 39.39 27.96

East Boort 10 796 4.87 4.81 5.24 9.07 29.26

Emu Valley 1 000 0.00 0.00 0.00 8.00 0.00

Harcourt 500 0.00 8.40 9.40 8.40 10.00

Kerang East 16 000 0.00 12.69 16.63 24.58 66.26

Koondrook 6 500 6.42 6.35 5.00 0.45 15.12

Leaghur and Meering 10 300 6.79 6.87 13.30 15.17 21.14

Marquis Hill 9 500 0.00 0.00 11.13 26.63 82.08

Myall 4 000 0.00 6.95 25.85 2.95 12.05

North Boort 10 000 0.20 0.20 0.20 0.06 0.00

Rodney 230 616 0.13 0.81 1.17 1.63 5.30

Swan Hill 13 500 12.25 9.16 13.48 8.22 19.77

Tragowel 192 000 5.86 4.50 7.29 6.54 13.23

Twelve Mile 8 830 10.05 15.89 36.46 14.76 38.70

Wandella 16 000 6.60 4.39 20.72 16.87 59.40

Western Wimmera 900 000 0.05 0.06 0.08 0.06 0.09

Yatchaw 6 753 0.00 0.00 22.21 44.42 14.81

Source: 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


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,


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 large-

scale 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 Restruc-

turing) 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


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.


NOTES

1. The Port Phillip District was the name given to the geographical boundaries that definemodern day Victoria. This district became known as Victoria on its separation from NewSouth Wales in 1851. The Major’s line was the path established by Major John Mitchell’ssuccessful expedition over the Great Dividing Range in 1836 and became the controllingaccess for pastoral expansion in Victoria becoming a kind of internal boundary for thecolony (Roberts 1924, p. 175). Squatters runs were defined according to their location inrelation to this line for example, a run of 1841 was described as being ‘situated on theMajor’s Line about 70 miles from Melbourne’ (ibid., p. 175).

2. Dominance of sheep grazing over more permanent forms of agriculture was also reinforcedby the increasing value of Australian wool on British markets during the period (seeVanplew 1987, p. 109).

3. This statement is also supported by evidence from newspapers later in the nineteenthcentury for example, a letter relating to experimental irrigation by R. Officer in Swan Hillduring the 1880s published in The Australasian has the author stating quite clearly thatOfficer 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’, TheAustralasian, 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) indicatedthey would apply the riparian doctrine in the absence of relevant case law in Victoria, thesefindings 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 caseof 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 WaterSupply 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 of13 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 thewestern 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 DrainageInvestigations Bureau, a division of the US Department of Agriculture and later came toVictoria as Chairman of the SRWSC (1907 to 1915). Mead was bitterly opposed to privateownership of water resources claiming it led to wasteful exploitation and speculation as hadbeen experienced in the western states of the United States due to the prior appropriationdoctrine. Deakin became convinced such problems would occur in Victoria should privateownership be permitted.

9. The inclusion of efforts to remove further acquisition of riparian rights within the colonywithin this legislation indicates that the government believed, regardless of the absence ofcase 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), 21June.


Agricultural Reporter (1885), ‘Irrigation at Kerang’, The Australasian, 39 (1009), 1August.

Agricultural Reporter (1885), ‘Among the Irrigators’, The Australasian, 39 (1041), 5September.

Anderson, A., W. Grattan, T. Langdon and J.S. White (1896), ‘Report of the RoyalCommission on Water Supply’, VPP, Paper Number 80.

Anderson, T. L. and P.J. Hill, (2004), The not so Wild, Wild West: Property Rights onthe 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, Twoand Three, Thesis Submitted as part of the requirements for the Degree of Doctorof Juridical Science, University of Wisconsin, USA.

East, L.R. (1962), ‘Pioneers of Irrigation in Victoria,’ Aqua: The Official Journal ofthe 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, TheUniversity 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 forCollective 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 inVictoria 1834–1988, Sydney: Allen and Unwin.

Roberts, Sir S. (1924), History of Australian Land Settlement, Melbourne: MacmillanPress.

Roberts, S.H. (Reprint 1964), The Squatting Age in Australia, Melbourne: MelbourneUniversity Press.

Rutherford, J. (1964), ‘Interplay of American and Australian Ideas for the Developmentof Water Projects in Northern Victoria’, Annals of the Association of AustralianGeographers, 54, 88–106.

Scott, A. and G. Coustalin, (1995), ‘The Evolution of Water Rights’, Natural ResourceJournal, 35, 821–943.

Umbeck, R. (1981), A Theory of Property Rights: with application to the Californiangold rush, Iowa State University Press, USA.

Vamplew, W. (ed.) (1987), Australian Historical Statistics, Melbourne: Fairfax, Symeand Weldon.

56

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

A Property Framework for Water Markets 57

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 over-

allocated, 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.


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


• 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–


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;


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 privatecommodities in such broad and unconditional terms that there is no effective wayto assert or defend public rights and interests – whether these public interests areeconomic, social or environmental.… Legislation should be drafted to clarify therules governing the exercise of non-consumptive versus other water rights inmanaging 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


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 property14 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


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 caseswhere 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 heldin common, further improvement is possible if some limited conversion of waterfor private use is tolerated . . . The underlying instinct shows the importance ofmaking marginal adjustments to fundamental institutions. In principle, theformal problem to be solved (although Justinian and the Romans would scarcelyhave put it this way) is how to take a body of water, which has value in multipleuses simultaneously, and devise a system of rights that maximises the value fromthe sum of its common and private uses.

The Romans had a intuitive sense of the relative values at stake because they infact adopted an intermediate solution that left the commons dominant, butallowed some diversion from it . . . It was routinely held that each of theriparians had a ‘usufructuary’ interest in the water which allowed them to makelimited 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,


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 outits objects, it would be preferable to settle for a system of regulative interventionrather than to invoke conceptual confusion by introducing superfluous notionsof 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


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 integratedmanagement of the water sources of the State for the benefit of both present andfuture 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 theState 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 andrecreation, 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, inresolving issues relating to the management of water sources,(e) to provide for the orderly, efficient and equitable sharing of water from watersources,


(f) to integrate the management of water sources with the management of otheraspects of the environment, including the land, its soil, its native vegetation andits native fauna,(g) to encourage the sharing of responsibility for the sustainable and efficientuse 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 . . . itmust be definable, identifiable by third parties, capable in its nature ofassumption 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


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


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 prerogativesrespecting water constituted much more than restatement of police powers,rather we find that it retained on behalf of the people an interest on the watersof the kingdom which the State has an obligation to enforce, and whichnecessarily 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


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.


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 greaterthan 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 shrinkingbase, 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 withinChile.

11. Bauer (2004) refers to inter basin transfers where there were conflicts between irrigators andelectric companies over how to operate dual purpose reservoirs and environmental impactson 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 thethirteenth century, considered rivers as public property. French law has since 1669 treatednavigable and floatable rivers as destined for public use and not susceptible to private


ownership. Iranian laws which bear the imprint of many ancient legal systems, treat allwaters in their natural state, whether on private or public land, as in the public domain.

13. Although the exact formulation differs, several western constitutions declare that water isthe property of the state, for example the Colorado Constitution Art XVI, § 5; MontanaConstitution Art IX, § 3, New Mexico Constitution Art XVI § 3: see Blumm (1989) pp. 583,576 note 12.

14. Small rivers are predominantly for riparian use. Nanda (1977) p. 43.15. For example water contained in a cistern, or in ownership with others who built an artificial

channel for water: see Nanda (1977) p. 42.16. There is extensive literature on common property institutional arrangements. For example

see Williamson, Brunckhorst and Kelly (2003), Bromley (1992) and Ostrom (1990).17. Working Group on Water Resources (1994) and Working Group on Water Resources

(1995). None of the submissions received by COAG disputed that environmentalrequirements of water bodies should be determined: Second Report, 6.

18. See for example Howe, Schurmeier and Shaw (1986) and Mäler (1984).19. See for example, MacDougall (1996), Butler (1985) and Day (1996).20. 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.

21. 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, throughnumerous disputes that courts adjudicated, changed to a new system that allowed moreextensive private use of water. The new position had the same generic feature of the oldsystem but struck the balance in a different way.

22. For example, see Challen (2000).23. Irrigation Bill 1886 cl 4. See discussion in Clark and Meyers (1969).24. Clark and Meyers (1969) pp. 247 and 256, referring to Cutler (1965).25. Water Act 1989 (Vic) s 7.26. Water Management Act 2000 (NSW) s 392, and Water Act 2000 (Qld) s 19.27. Coverdale v Charlton (1878) 4 QBD 104 per Brett LJ, 120.28. Fisher, Water Law, LBC, Sydney, 2000, 91. See also chapter 5 particularly at 94, 103-116.29. 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 authoritywhich serve a definite public purpose have received a construction according to which theauthority takes less than the full property in the site. The same sort of construction appearedappropriate 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 definedboundaries therefore the purpose is limited.

30. Yanner v Eaton (1999) 73 AJLR 1518.31. Yanner v Eaton (1999) 73 AJLR 1518, 1525 per Gleeson CJ, Gaudron, Kirby and Hayne JJ.32. 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.

33. Yanner v Eaton (1999) 73 AJLR 1518, 1539.34. Yanner v Eaton (1999) 73 AJLR 1518, 1525.35. See for example, Martin and Verbeek (2002).36. 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) inreal or personal property of any description, including money, and includes things in action’.

37. Many property texts deal with the theoretical arguments justifying the idea of property forexample see Penner (1997) and Waldron (1988).

38. See Underkuffler (1990). One school of thought sees that the concept has been subject to ashifting of the balance from individual rights towards a greater emphasis on the collectivesocial interest: Cribbet (1986).


39. [1965] AC 1175, at pp. 1247-8. That statement, made in 1965 the context of a matrimonialdispute over assets, is often taken as an authoritative pronouncement of the essentialelements 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 forpetroleum 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 seeTan (2003).

45. Sax (1970) p. 113, 645 citing the decision of Ivanhoe Irrigation District v All Parties 47 Cal2d 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 marginof the seas and lakes, the waters over those lands, waters within rivers and streams of anyconsequence, and parklands.

47. When it was in the public interest to promote industrialisation, the Supreme Court ofPennsylvania in ruling that the downstream landowner’s riparian rights to have a flow ofwater unchanged in quality and quantity had to yield to an upstream coal company’s actionsof 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 navigablewaters of is Illinois Central Railroad v Illinois (1892) 146 US 387. The celebratedCalifornia Supreme Court case of National Audubon Society v Superior Court of AlpineCounty (1983) 658 P 2d 709, Cal. (the Mono Lake case) applied the public trust doctrine towater resources.

49. See for example the Hawai’ian Constitution, s 7. See also section 1 which states: ‘for thebenefit of present and future generations, the State . . . shall conserve and protect Hawaii’snatural beauty and all natural resources, including land, water, air . . . and shall promote thedevelopment and utilization of these resources in a manner consistent with theirconservation 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 FlowStandard Amendments, and Petitions for Water Reservations for the Waiahole ditchCombined 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 sellingAlbert Park for development of housing, and the NSW government’s 1895 attempt to grantpart 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; andWorimi Local Aboriginal Land Council v Minister (1991) 72 LGRA 149, 161 both of whichacknowledge the existence of a public right to navigation and anchorage over tidal navigablerivers. See also Stein (1996).

54. The public trust doctrine is seen as an adjunct to legislative schemes especially where thoseschemes are weak: see Stein (1996).

55. Application of the doctrine has been criticised on four main grounds: that the doctrine isvague and indeterminate; that the statements of Roman law on which it is based is ofundeserved authority because they were meant as mere introductory comments, ornormative statements of what the Emperor wished the law to be; that enactment ofenvironmental legislation has rendered the doctrine obsolete; that the doctrine results inoverturning of serious legal processes, and conflicts with fundamental legal institutionssuch 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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76

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.

Registration of Water Titles 77

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


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.


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.


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;


• 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 FORWATER

Background

In the past, water licence registers maintained by responsible authorities

constituted simply a record of licences. Such registers provided an appropriate


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.


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 off-

take 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.

84

Fig

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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.


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).


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.


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 well-

informed 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


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


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 consi-

deration 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.


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 environ-

mental 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 implement-

ation 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


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 day-

to-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


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 withFreehills for Land and Water Australia and the Australian Government Department ofAgriculture, Fisheries and Forestry (ACIL Tasman and Freehills 2004) as well as on workundertaken 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.htm4. 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 details6. 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 alteredin any way which may either reduce the right of the bank under its mortgage or the value ofthe asset than what is stated on the details provided to the bank by the client or registrationoffice.

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 PropertyTitles. Report to The Australian Government Department of Agriculture, Fisheriesand 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 transportableproperty 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 genericframework to simplify registration and trading of interests in natural resources,CSIRO Land and Water, September.

94

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 co-

ordination 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

Accounting for Water Flows 95

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


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;

Aquifer 1

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

Evapotranspiration

Percolation to groundwater

Precipitation1

Irrigation

Transmission losses

Irrigationefficiency

Aquifer 2

Rivers, Streams andLarge Storages

2

3 4

Runoff& sub

surfacelateralflow

Percolation togroundwater

Return flows

Environmental Allocation

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 furtherdown the system. The link between return flows and the surface water system is not demonstratedin Figure 7.1.

Figure 7.1 Human Influences on the Hydrological Cycle


• 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.


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.

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.

Source: Victorian Government Department of Sustainability and Environment

Figure 7.2 Precipitation to Water Resources in Victoria

22.5 million ML(15%)

1.5 million ML(1%)

126 million ML(84%)

123123123123

evaporation andtranspiration byvegetation

surface runoffand streamflow

percolates togroundwater

Total annualaverageprecipitation:150 million ML


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 over-

used 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.


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

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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


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


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:


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.


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

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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 evapo-

transpiration) 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


Table 7.2 Land Use and Runoff

Site Treatment Runoff as a proportion of

total rainfall (%)

Wheat Stubble Heavy grazing 57–81%

Ungrazed 4–42%

Pasture Heavy grazing in summer 45–48%

No grazing and pasture retained

from previous 2 years 15%

No grazing but pasture removed 30–60%

Source: 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 evapo-

transpiration 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:


• 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.

Source: Holmes and Sinclair (1986) in Keenan et al. 2004.

Figure 7.4 Relationship Between Land Cover, Mean Annual Rainfall andMean Annual Evapotranspiration

Mean annual rainfall (mm)

500 1000 1500 2000

1600

1200

400

800

HSR

Forest

Grass

Me

an

an

nu

al

ev

ap

otr

an

sp

ira

tio

n(m

m)


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


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.


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 Irrigated Water Et Recharge

area activities allocation fractiona fractionb

Murray Tributary

(GL) (GL) (%) (%)

Goulburn Pasture, 320 853 65 50Broken cropping,

horticulture

Campaspe Pasture, 207 75 50 60cropping

NSW Murray Pasture, 2 464 0 65 75cropping

Loddon Barr Pasture, 163 0 65 75Creek cropping

Loddon Pasture, 455 0 55 75Cohuna cropping

Loddon Pasture, 455 0 55 75Tragowel cropping

Murrumbidgee Pasture, 0 2 045 65 80cropping,horticulture

Robinvale Horticulture 31 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).


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


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 EstablishingAustralian Water Markets in Melbourne, Australia, 9 August 2004. We are grateful forcomments from Jeff Bennett (The Australian National University) and Russell Gorddard(CSIRO Sustainable Ecosystems). Naturally all errors remain the responsibility of theauthors.

2. Water supply in Australia is either regulated or unregulated. Regulated water supply is thatwhich is released from large storages operated by the State, unregulated supply is that waterin rivers and streams not regulated by any storage.

3. Other agents may also influence the amount of water that reaches the ground through cloudseeding. This is not discussed here.


4. As demonstrated in Figure 7.3, water providers are defined by the ABS as primarily thewater supply, sewerage and drainage service industry. This water is extracted and providedto users through a network of infrastructure such as channels and pipes and is supplied tousers for a fee.

5. Defined by the ABS as water extracted from the environment and includes water fromrivers, lakes, farm dams and other water bodies.

6. Regulated discharge refers to water discharged after use where that discharge does notmatch the natural flow regime of the receiving water body. For example, wastewaterdischarged into a river, ocean or land outfall by a sewerage service provider is considered aregulated discharge. Many irrigation water providers were unable to quantify the volume ofdrainage water discharged and it is likely that this volume is larger than indicated in the flowtables. 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 someattributes differ. For example, water entitlements are generally time limited rather thanallocated in perpetuity.

8. Transaction costs may be so high that no entitlements are allocated or alternatively no tradestake place, even under the most efficient frameworks. In this case the optimal outcome willbe to do nothing and allow the market or government failure to continue because no netbenefit can be created by allocation or trading.

9. The National Water Initiative is currently considering a framework to address uncontrolledand significant interceptions of water from land use activities (Australian GovernmentDepartment of Prime Minister and Cabinet).

10. The Yanco Creek anabranch south off the Murrumbidgee is reported to have losses of over200 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 waterpolicy 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 AustralianThinking, CSIRO Land and Water.

Department of Infrastructure, Planning and Natural Resources (2001), Water AccessInformation Sheet Number Seven. The Water Management Act 2000, What it Meansfor Town Water.

Department of Sustainability and Environment (2004), Securing Our Water FutureTogether; Victorian Government White Paper.

Dunlop, M., N. Hall, B. Watson, L. Gordon and B. Foran (2001), Water Use inAustralia, Report 1 of 4 in a series on Australian Water Futures, Working PaperSeries 01/02, CSIRO.

Grafton, R.Q., L.H. Pendleton and H.W. Nelson (2001), A Dictionary of EnvironmentalEconomics, Science, and Policy, Cheltenham, UK and Northampton, MA, USA:Edward Elgar.

Heany, A. and S. Beare (2001), ‘Water Trade and Irrigation, defining propertyentitlements to return flows’, Australian Commodities, 8 (2), June quarter 2001,Canberra: Australian Bureau of Agriculture and Resource Economics.


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 andWood Products Research and Development Corporation, Project NumberPN04.4005, Australian Government.

National Land and Water Resources Audit (NLWRA) (2001), Australian WaterResources Assessment 2000, Natural Heritage Trust, Australian CommonwealthGovernment.

National Competition Council (2001a), Assessment of Governments Progress inImplementing the National Competition Policy and Relate Reforms: New SouthWales reform, June 2001, Canberra: Ausinfo.

National Competition Council (2001b), Assessment of Governments Progress inImplementing the National Competition Policy and Relate Reforms: Victoriareform, June 2001, Canberra: Ausinfo.

National Competition Council (2001c), Assessment of Governments Progress inImplementing the National Competition Policy and Relate Reforms: Queenslandreform, June 2001, Canberra: Ausinfo.

National Competition Council (2001d), Assessment of Governments Progress inImplementing the National Competition Policy and Relate Reforms: South Australiareform, June 2001, Canberra: Ausinfo.

Neal, B., R. Nathan, S. Schreider and A. Jakeman (2002), ‘Identifying the SeparateImpact of Farm Dams and Land Use Changes on Catchment Yield’, AustralianJournal of Water Resources, 5 (2), 165–176.

Ostrom, E. and E. Schlager (1996), The Formation of Property Rights, WashingtonDC: Island Press.

Perman, R., Y. Ma and J. McGilvray (1996), Natural Resource and EnvironmentalEconomics, London and New York: Longman.

Productivity Commission (2003a), Water Entitlements Arrangements in Australia andOverseas, Melbourne: Commission Research Paper, Productivity Commission.

Productivity Commission (2003b), Water Entitlements Arrangements in Australia andOverseas: Annex B, New South Wales, Melbourne: Commission Research Paper,Productivity Commission.

Productivity Commission (2003c), Water Entitlements Arrangements in Australia andOverseas: Annex C, Victoria, Melbourne: Commission Research Paper,Productivity Commission.

Productivity Commission (2003d), Water Entitlements Arrangements in Australia andOverseas: Annex D, Queensland, Melbourne: Commission Research Paper,Productivity Commission.

Productivity Commission (2003e), Water Entitlements Arrangements in Australia andOverseas: Annex E, South Australia, Melbourne: Commission Research Paper,Productivity Commission.

Sjasstad, E. and D.W. Bromley (2000), ‘The prejudices of Property Entitlements: OnIndividualism, Specificity, and Security Property Regimes’, Development PolicyReview, 18 (4), 365–389.

Tan, P. (2002), Legal issues relating to water use. Property Entitlements andResponsibilities: 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 andSalinity Issues in Agroforestry No. 7 Rural Industries Research and DevelopmentCorporation, Publication No. 01/20.


Whitten, S.M. (2003), Water Property Entitlements and Water Management in theFitzroy Basin, report prepared for the Central Queensland University and theCentral Highlands Regional Resource Planning Cooperative.

Wills, I. (1997), Economics and the Environment, A signalling and incentivesapproach, Sydney: Allen and Unwin.

Young, M.D. and J.C. McColl (2002), Robust Separation: A generic framework tosimplify registration and trading of interests in natural resources, CSIRO Land andWater.

Young, M.D. and J.C. McColl (2003), Robust Reform Implementing robust institutionalarrangements to achieve efficient water use in Australia, CSIRO Land and Water.

INTERNET REFERENCES

Australian Bureau of Meteorology: http://www.bom.gov.auAustralian Government Department of Prime Minister and Cabinet: http://

www.pmc.gov.auNLWRA: http://www.nlwra.gov.au/Victorian Government Department of Sustainability and Environment: http://

www.dse.vic.gov.auSydney Morning Herald ‘Greens pour cold water on push for bigger dams’

www.smh.com.au

119

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.


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.

Potential Efficiency Gains from Water Trading in Queensland 121

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,


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

CDB.

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.

$

Demand

Demand from industry

Demand from agriculture

A

B

C

D

Q1


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

$

QuantityIndustry demand Agricultural demand

Water storagecapacity

Figure 8.2 Planning for Water Shortages

Newindustrydemand Extra agriculture

Demand

Limit of existing storagecapacity

New dam needed

Quantity

$

Figure 8.3 How Additional Dams Have Been Planned


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 P

2. 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.

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

Old demand curve

New demand curve

ExistingSupply

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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.


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 environ-

mental 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


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, environ-

mentalists, 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).


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.


EVIDENCE FROM QUEENSLAND ABOUT THE BENEFITSOF 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.

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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.


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.

0

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Average demands (ML)

Annu

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Mackay

MDIA short term

MDIA long term

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


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.


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.


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 entrepre-

neurship. 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.


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.

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139

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.


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 arrange-

ments.

• 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 long-

run 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.

Water Trading Instruments in Australia 141

• 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


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


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 counter-

productive. 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;


• 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 counter-

productive.

• 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


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


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:


• 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).


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.


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-of-

region 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


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


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.


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


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.


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.


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


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


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


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 comple-

mentary 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


demand needs by looking to trade into a market where the special charac-

teristics 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


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.


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.


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 non-

transfer 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.


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 Bennettin 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-DarlingBasin, Australia’, Paper for the Australian Conference of Economists, Adelaide, 30September – 3 October 2002, ABARE Conference Paper 02.19.


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 NewWater Management System for the St.George Water Supply Scheme’, Paperpresented to ANCID 2000 Conference, Interim Resource Operations Licence for StGeorge Water Supply Scheme, Issued to SunWater.

165

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 circum-

stances, 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


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 ‘non-

excludable’ 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 ‘non-

excludable’ 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.

Realising Environmental Demands in Water Markets 167

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 land-

based ecosystems. Some conclusions are drawn in Section 4.


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


Table 10.1 Attribute Value Estimates ($ per household)

River Vegetation Fish Birds

Bega $2.32 $7.37 $0.92

Clarence $2.02 $0.08* $1.86

Georges $1.51 $2.11 $0.67*

Murrumbidgee $1.45 $2.58 $1.59

Gwydir $1.49 $2.36 $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


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 non-

market 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


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 non-

excludable 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


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 non-

excludable 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-for-

profits, 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-


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 Respondent Percentage of

PSCEs involved respondent PSCEs

Ownership of natural areas 27 16

Management of natural areas 156 90

Administration of covenants 32 18

Administration of devolved grants 93 53

Brokering conservation activities 45 26

Technical advice/support 101 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:


• 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\ Own Manage Covenant Devolved Broker Tech.Activity Grants advice

% % % % % %

National 30 80 10 30 50 70

State 39 78 30 48 26 87

Regional 7 90 23 63 34 64

Local 15 94 10 49 13 40

Chi square 13.9 5.1 7.0 5.9 11.7 20.2

Significance 0.00 0.17 0.07 0.12 0.01 0.00

level



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 Percentage of in receipt respondent PSCEs

Government grants 156 90

Philanthropic grants 32 18

Sponsorships 53 31

Donations 116 67

Membership dues 138 80

Merchandising 45 26

Events 42 24

Tourism 23 13


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


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.


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 land-

based 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.


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 non-

consumptive 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 gratefullyacknowledged. 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 greaterthan 0.2 being regarded as robust.

3. An exemption maybe the crocodile in northern Australia, but there, most habitat is found inunregulated river systems.

4. Indirect conservation activities include lobbying the government for changes to biodiversityconservation 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 thesmall numbers of observations in some categories.


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 smallnumbers of observations in these categories.

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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 NewSouth Wales Rivers’, Proceedings of the Third Annual Stream ManagementConference: 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 EconomicAssociation, Vancouver Canada, 29 June–3 July 2004.

Bishop, R. (1978), ‘Endangered Species and Uncertainty: The Economics of a SafeMinimum Standard’, American Journal of Agricultural Economics, 60, 10–18.

Demsetz, H. (1967), ‘Toward a Theory of Property Rights’, American EconomicReview: Papers and Proceedings, 57 (2): 347–59.

Gillespie, R and J. Bennett (2003), ‘Linking Science, Community Consultation andEconomics: The Living Murray Project’, Paper presented to The Economic Valueof Biodiversity National Workshop 22–23 October, 2003.

Kasper, W. (1998), Property Rights and Competition: An essay on the constitution ofCapitalism, 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 andPopulation in the Fitzroy Basin. Research report No. 4, Floodplain DevelopmentResearch Reports, Faculty of Business and Law, Central Queensland University,Emerald.

Sanera M. and J. Shaw (1996), Facts, Not Fear: A Parent’s Guide to TeachingChildren about the Environment, Washington, DC: Regnery.

van Bueren, M. and J. Bennett (2004), ‘Toward the Development of a Transferable setof Value Estimates for Environmental Attributes’, Australian Journal ofAgricultural and Resource Economics, 48 (1), 1–32.

Young, M., D. MacDonald, R. Stinger and H. Bjorlund (2000), Inter-state WaterTrading: a Two-Year Review, Canberra: CSIRO Division of Land and Water.

Abel, Nick 6aboriginal people 1access 43, 57, 62entitlements 82–4, 89–90rights 100

accounting systems 86, 152, 153ACIL Tasman 139, 143–4, 146, 149acquisition limits 27–8Acton v Blundell 31Adelaide, water demand 20agriculturalproduction, changes in 129–31usage 100, 108–11, 122, 125, 154–5

alienation rights 102allocationeffectiveness 144–5efficiency in 9–10, 121–2environmental flows 16–17history of 10–12improvements 18–19market-based 77–8mechanisms 122–5property rights 15–16state control of 76–7

approvals process 144, 162aquifers 97, 103Argus, The 46assignability 67Atherton Tableland 133, 135Australiaentitlements in 106–14water in 95–100

availability of water 98–9Beardmore Dam 152–3Bega River 168benchmarking, registration systems 87‘beneficial use’ 161Bennett, Jeff 6biodiversity 16–17Blackstone, W. 25

Brazil, water markets 60Bulk Shares (BS) 152bundling of land and water 147bureaucrats 128Burnett River Dam 134California 59call options, forward trading 156Campbell, David 6capacity share entitlements 152–3cappingcommercial uses 20extractions 83, 176–7volumes 162water harvesting 111–12

case studies, inter-sector trading 129–32centralised allocation, Victoria 51–3Chaffey brothers 1Chile, water markets 60, 124choice modelling 168–70Coase theorem 15Coffin v The Left Hand Ditch Co. 35–6Coggan, Anthea 6collectiveaction approach, property rights 40in-stream uses 26

Colorado 34, 35–6, 59, 61, 156Comet River 131–2commercial uses, capping 20common law concept of property 66–7custom 24–5, 26, 33second-best allocations 27–30see also English common law

common poolproblems 31resource 102–3, 112

‘common property’ 61–2communal property rights 57community groups 128‘community of the river’ 42–3

180

Index

compensation 32, 33competitivepressures 128water markets 9

complete entitlements 115compulsory charging, Victoria 51Condamine-Balonne Basin 152conditionaltrading 143transfers 162

congestion pricing 148conservation initiatives 172–8consumptive uses 170Coronation Hill 169–70cost-reflective pricing 163costscomponents 17–18pollution 14–15production 12–13

cotton industry 129–31, 133, 135Council of Australian Governments

(COAG)agreement (1994) 78, 82, 119–20, 127commitments 13, 140, 141–4, 162property framework 62–4statements 8–9, 11strategies 15, 19–21

courts as policymakers 69customary foundations of water rights

24–5damsconstruction of 32, 33–4, 99timing of release 150–51

Deakin, Alfred 48, 77deliverycapacity entitlements 148–50rights 14

demandchanges in 18and groundwater rights 30–31volatility, management of 144–6

Department of Natural Resources andMines (DNR&M) 86

derivatives/optionscontracts 86markets 162

disputes, water access 43downstreamentitlements 16, 151

users 42–3, 97, 103–4, 111, 114water yields 109

‘dozer’ rights 16drainage rights 153drought (1877–1881) 45–6ecologically sustainable usage 79economicissues, water trading 121–8usage 100

Emerald Irrigation Area 129–31, 135end-user entitlements 152English allocation in 27–9common law 39, 42, 57, 62, 69, 76groundwater rights 30markets 24, 25, 26natural user system 32, 34, 35

entitlementscancellation of 89as collateral for loans 87defensibility of 106–14definitions, uniformity in 159irrigation 114National Water Initiative 58nature of 83–5security and defensibility 100–105strategies 13–16unbundling of 85, 86

entrepreneurship, returns from 135environmentalentitlements, active trading in 160–61traders 155, 161

environmental flows 16–17, 167investment in 20–21market demands for 171–6regulatory setting of 168–71and titling systems 90–91

environmentalists 128Epstein, Richard A. 5‘equi-marginal principle’ 4, 168equity criteria, water trading 19‘equivalent right’ model 91Essential Services Commission 14Europeanlegal systems 62settlers 1

evapotranspiration 108, 109, 112, 113evolutionary nature of property rights 41exchange rates 159–60

Index 181

excludable benefits 171exclusion rights 102exclusive rights, land 25–6experimental economic procedures 127explicit rights 102, 104external costs 9–10, 163extractive uses 140–41Fairbairn Dam 129, 135farmboundaries, water within 108–12dams 99, 111production models 126, 133

farmersprice rises 127–8water rights 11–12

first possession rule 35fish habitats 161Fitzroy Basin 131–2, 168–9flooding 33flows 103–4forests 108–9, 110forward trading 145, 148free-rider incentives 172, 173, 176, 177,

178Freebairn, John 4French legal system 62fruit growing 131funding for conservation 175–6futures contracts 156Gold Fields Act (1857) 44gold mining, Victoria 44governmentfailure 125, 134intervention 10, 41, 48–9, 166land departments 15ownership of water rights 52–3policy 10–12, 19–21reforms 56–9, 78, 92–3

Goyder line 1grandfather arrangements 11–12, 19groundwaterpercolation 108rights 30–31trading in 158volume 99

H Jones v Kingsborough Corporation 65

Harris, Edwyna 5harvesting of water 111–12Hawai’i 68Head v Amoskeog Mfg. Co. 33holders of rights 140–41Holmes and Sinclair Relationship (HSR)

109horticultural regions 113human influences on hydrological cycle

95–7Hunter Walter Corporation 108hydro-electric generation 150–51hydrological cycle, human influences on

95–7imperative necessity 34–6implicit rights 102, 104in-district usage rights 149–50in-streamflow rights 161uses 26, 31–6

incentive structures, politicians 3–4incomplete entitlements 115indefeasibility, water titles 88–9Individual Capital Shares (ICS) 152industrial users 121–2infrastructure failure 49innovation, returns from 135institutional frameworks, rigidity in 51–2inter-jurisdictional trading 158–60inter-sectoral trade 125, 129–32interstate trading 158–60intra-sectoral trade 132–3investmentsenvironmental flows 20incentives for 80infrastructure 134water markets 19

irrigationdistricts 1efficiency 113–14schemes 135Victoria 41, 45–51, 52

Irrigation Act (1886) 46, 48, 50irrigators 97, 127–8Islamic law 62Kaldor-Hicksimprovements 36standard of social welfare 32

The Evolution of Markets for Water182

landownership 43, 44–5rights 25–6separation from water 82, 147–8use/change 108–11

landownersgroundwater rights 30trading of water 146

leases 86, 154legal environmentproperty regimes 61–2water rights 24–5

legislation, objectives of 57–9licences, water use 15, 17–18licensing systems 77Limari water market, Chile 60‘live and let live’ regimes 26loans, collateral for 87location-specific flows 103–4Locke, John 24–5, 27, 35long-term entitlements 103Mackay region 134Major’s line, Victoria 42managementrights 100, 102rules, environmental allocations 91

Mareeba-Dimbula Irrigation Area(MDIA) 133, 134, 135

marginal social benefits, environmentalflows 17

marketcontracting 40–41demands for environmental flows

171–6models 59–61valuation studies 170–71

market-based allocation 77–8mature water economy stage 10–11Mean Annual Run-off (MAR) 99Meering and Leaghur Irrigation

Company 41Melbourne, demand in 12, 20Middle Eastern legal systems 62Mildura 1Mill Act cases, US 33mills, construction of 32, 33–4Mining Act (1865) 46Mining Boards/Committees, Victoria 44mining industry 131–2

Mississippi River 31mortgage arrangements, protection of 88multiple system of water rights 35–6Murray River 114, 151Murray Wetlands Working Group

(MWWG) 112Murray-Darling Basin 109, 142–3, 153,

158–9Murray-Darling Basin Commission

(MDBC) 78, 79, 142–3, 160, 170National Land and Water Resources

Audit (NLWRA) 99, 169National Parks 166National Provincial Bank v Ainsworth

66National Water Initiative (NWI)access entitlements 83agenda 141–4common principles 92–3drivers 79strategies 58–9

naturalresource property rights 41user system of rights 32

‘navigation servitude’, US 34negative externalities, irrigation 127New South Wales (NSW)allocations 85, 86, 106irrigation 39, 114titling system 92trading 158, 159‘vesting’ formula 65water harvesting 111–12

New South Wales Farmers Federation111–12

non-consumptive uses 170, 171–2non-excludable benefits 165–6, 171,

176–7non-extractive uses 140–41non-market values 168–71, 178Northern Territory 64‘old title’ system 81‘onus of proof’ requirement 143–4, 162opportunity costs 134options contracts 162Ord River Dam 134Oregon Water Trust (OWT) 161out-of-region trades 149–50

Index 183

out-of-stream uses, US 35over-use, prevention of 40ownership rights, definition of 2–3Paretoefficiency 166exchange 19improvements 26, 32, 36

partial equilibrium analysis 126percolation losses 112permanent trades/trading 85, 86, 141,

143perpetuity characteristics, entitlements

13, 15–16Pigovian tax 127policy initiatives 10–12, 19–21political economy issues, water trading

127–8politicians, incentive structures 3–4pollutioncosts 14–15rights 153

Port Philip District, Victoria 42, 43Portland, Victoria 42Pratt Walter Group 112price rises, farmers 127–8price sensitive demand 133primary entitlements 146–53priorappropriation 34–6entitlements 104

‘prior right model’ 91privatein-stream uses, allocation of 27–9irrigation schemes 46–8

private sector conservation enterprises(PSCEs) 167, 173–8

pro-rata allocation 28–9product prices 18production costs 12–13property framework, water markets

56–7, 61–7background 57–9market models 59–61water as public property 67–9

property regimes 61–2property rightsallocation of 15–16nature of 39–41re-definition of 66–7

security/enforceability of 80publicaccessibility, entitlement registers89–90

trust doctrine 67–9public fundedinvestment projects 20–21, 134irrigation schemes 49–50

public rightsembodiment of public values 63–4protection of 61, 69

put options, futures trading 156–7‘quality of title’ provision 86–8Quebec 30–31Queenslandallocations 85benefits of water trading 129–35titling system 92trading 86, 159‘vesting’ formula 65water harvesting 111

Queensland Resource Registry (QRR)86, 90

R v Toohey; Ex parte Meneling StationP/L 66–7

rainfall variation 42, 43–4reafforestation 110reasonable user system of rights 32, 35recording systems 81recreational usage 171–2redistribution of property rights 40–41registered interests, protection of 86–8registers of deeds 81registration systemsreforms of 92–3role of 80–81

registry of information, entitlements 15,90

regulation 64–6regulators, concerns of 140rent-seeking behaviour 166–7, 170, 177residual entitlements 104resourcemanagement 77–8rents 128

return flows 97, 114rightsbundles of 53


to extract 140–41levels of 100, 102to sell, limitation of 150

riparianrights 42–5, 48–9, 57, 64systems 29–30

riversproperty rights 63topography 31–2, 34–5

Rolfe, John 6Roman law 24–5, 62, 68Royal Commission (1884) 48runoff 108–10rural users, sales to urban users 20Rural Water Commission (RWC) 52‘safe’ farming 1scarcity, living with 1–2Scottish law 62seasonal allocations 85second-best allocations at common law

27–30secondary markets 154–8sectors, trading across 158securityof entitlements 100–105of supply, settlers 45

sequential allocation problem 104settlement expansion 42–5short-term entitlements 103single share product 13‘sleeper’ rights 16Smith, Adam 2–3Snowy Mountains Hydroelectricity

Scheme 1, 150–51Snowy River 170social improvements, compensation for 32,

33–4infrastructure for common law rights

29–30South Australia (SA)allocations 85irrigation 113, 114titling system 92trading 158water harvesting 111

Spainlegal system 62water markets 60, 61

spatial alienability of entitlements 103squatters’ water rights 42–5St George Water Supply Scheme 152,

153statecontrol of allocation 76–7guarantee of title 89management resources 57–8

State Rivers and Water SupplyCommission (SRWSC) 39, 50–52

stated preference techniques 126–7, 134statutory framework, gaps in 66–7stored water 99, 122–3stranded assets 14, 149, 150substitutability of water sources 103–4sugar cane industry 133, 135SunWater 152supply volatility, management of 144–6surface water 99swaps contracts/swaptions 157Sydney Water Corporation 108‘tagging’ of water 159–60Tan, Poh-Ling 5Tasmania 58technology, investments in 19temporarytrades/trading 85, 86, 141, 143transfers of water 155–6

theoretical foundations of water rights24–5

third party interests, protection of 86–8Tinaroo Dam 135titling regimesbackground 81–2environmental flows 90–91indefeasibility 88–9nature of entitlements 83–5nature of transactions 85–6protection of registered interests 86–8public accessibility 89–90transition issues 91–2

titling systemslegal aspects of 141role of 80–81

topography 31–2, 34–5Torrens titling system 81, 82, 86–9, 91,

92tradeableentitlements, value in 151

Index 185

property rights, establishment of 78–9

tradingacross users/sectors 158in environmental entitlements 160–61in groundwater 158inter-jurisdictional 158–60limitations of 148rights to property 2–4

trading systems, need for improvements79

transaction costs 104–5, 109–11, 115,165–7

transactionsnature of 85–6range 154–61restrictions on 20

transfersadverse impacts 162block approvals 144of rights 29–30, 35of title 90

transition issues, entitlement systems91–2

transmission losses 112trusteeship 67–9two entitlement model 13UK, environmental protection 171un-allocated transmission losses 112unbundling of primary entitlements

146–53uni-directional flows 103–4upstreamentitlements 16users 97, 103–4, 109–11, 114

urban usersdemand levels 121–2purchase from rural users 20

urban water market, demand in 12USConstitution 33–4environmental protection 171forward sales 162prior appropriation and imperative

necessity 34–6state ownership of water 67–9water access 43water markets 24, 56, 59–60water rights 31–2, 36–7, 62

usagepatterns, modification of 145–6rights 171

users, trading across 158usufruct 62, 69value information 168–71verification of title 89–90‘vesting’ formula 64–6Victoriaallocation 97availability of water 98evapotranspiration 109harvesting of water 111horticulture 113interstate trading 158irrigation 45–51, 88, 114move to centralised allocation 51–3property rights 39–41riparian rights 42–5titling system 92unbundling of entitlements 85use of ‘vesting’ formula 64

Victoria GovernmentGreen Paper (2003) 11–12White Paper (2004) 8–9, 11–14,

15–16, 19–21, 92wateravailability 98–9characteristics 3cost components 17–18law, evolution of 63–4losses 13–14as public property 67–9separation from land 82, 147–8use 100

Water (Central ManagementRestructuring) Act (1984) 52

Water Act (1905) 49, 51Water Act (1989) 52, 64–5Water Allocation Register, Queensland

90Water Conservancy Board (WCB) 46Water Conservation Act (1881) 46Water Conservation Act (1883) 47Water Management Act (2000) 65–6, 69,

106, 108water marketsdevelopment of 56–7


effective operation of 17–19future development 140–41need for establishment of rights 38–9setting up of 59

Water Reform Working Group (WRWG)139

water rights 12–16farmers 11–12groundwater 30–32history of 26theoretical and customary foundations

24–5water tradingbenefits of 129–35economic issues 121–8evolution of 76–9

water trading instruments studybackground 140–41managing volatility 144–6NWI/COAG 141–4

overview of possibilities 146–63water use licences 15Waterworks Trusts 46, 47–50wealth generating exchanges 40–41wells 44Western Australia 58Western Mining Corporation Ltd v

Commonwealth 67Wetland Care Australia (WCA) 112Whitten, Stuart 6Wilberforce, Lord 66WILMA titling system 92withdrawal rights 100, 102Woolston, Michael 5–6World Bank 60, 61Yanner v Eaton 65Yass River 111Zimbabwe 171

Index 187

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