The Role of the Government and Markets in Water Reform: Learning from Australia University of Arizona, January 2009 Prof Mike Young, Executive Director Research Chair, Water Economics and Management The Environment Institute The University of Adelaide

River Murray Inflows (GL) In 2006/07, we broke the month by month inflow record for 11 months Inflows have been well below evaporative losses Managed by running down stocks and reducing evaporation by closing off wetlands and not replenishing lakes

Symptoms - The River Murray Over-allocation –Dredges in its mouth since Oct 2002 –Level below the sea –Rising salinity –Serious acid- sulphate soil problems –Bottom in strife! –High security allocations in SA on 18%

Natural resource management policy 101 The Key Question How, at every location, do we get –the right set of interventions –at the least cost so as to facilitate the emergence of –Socially optimal land use change –Socially optimal land and water use in an ever changing world of –Varying prices, climates and technology full of people who behave differently from one another

Which future is best? –One that gets the fundamentals right, now? A system that can be confidently explained as able to cope -- whatever future arrives One that facilitates autonomous adjustment and change One that creates opportunity –One that commits all to more decades of reform and uncertainty? Incremental progress with lots of impediments to change No guarantee of resolution of current problems

Robustness Robust (adj.) Said of a system that has demonstrated an ability to recover gracefully from the whole range of exceptional inputs and situations in a given environment. One step below bulletproof. Carries the additional connotation of elegance in addition to just careful attention to detail. Compare smart, oppose brittle. Robust systems Endure without the need to change their foundations. They last for centuries. Inspire confidence. Produce efficient and politically acceptable outcomes in an ever changing world.

Theoretical Design Foundations Tinbergen Principle (NP in 1969) –For dynamic efficiency => One instrument per objective Mundell’s Assignment Principle (NP in 1999) For dynamic stability => Pair instruments and objectives for greatest leverage Coase Theorem (NP in 1991) –To minimise adverse effects of entitlement mis-allocation on economic activity => Ensure very low transaction costs

High level water reform agenda YearMajor Australian policy initiative 1994COAG Water Reform Framework within National Competition Policy 1995a 1995b MDB Cap introduced Water reform implementation linked to competition payments 1998MDBC commenced Pilot Interstate Water Trading Trial 2001National Action Plan for Salinity and Water Quality 2002MDBMC started Living Murray process 2003COAG agreed, in principle, to implement a NWI 2004COAG finalised NWI Water for the Future (Formerly National Plan for Water Security)

National Water Initiative Full implementation of this Agreement will result in a nationally-compatible, market, regulatory and planning based system of managing surface and groundwater resources for rural and urban use that optimises economic, social and environmental outcomes by achieving the following: 1.clear and nationally-compatible characteristics for secure water access entitlements; 2.transparent, statutory-based water planning; 3.statutory provision for environmental and other public benefit outcomes, and improved environmental management practices; 4.complete the return of all currently over-allocated or overused systems to environmentally-sustainable levels of extraction; 5.progressive removal of barriers to trade in water and meeting other requirements to facilitate the broadening and deepening of the water market, with an open trading market to be in place; 6.clarity around the assignment of risk arising from future changes in the availability of water for the consumptive pool; 7.water accounting which is able to meet the information needs of different water systems in respect to planning, monitoring, trading, environmental management and on-farm management; 8.policy settings which facilitate water use efficiency and innovation in urban and rural areas; 9.addressing future adjustment issues that may impact on water users and communities; and 10.recognition of the connectivity between surface and groundwater resources and connected systems managed as a single resource.

Long drys DRY WET Total River Murray System Inflows (including Darling River) 8 yrs 12 yrs 52 yrs

Insufficient planning for less water - 1% - 3%

With half as much water Users Environment River Flow Environment River Flow Users

With half as much water Users Environment River Flow Environment River Flow Users River Flow Environment Users

Volume of Water in the System Indicative template for sharing and allocating water

Water Reform - Entitlements Water Tradable Licence Price Land Single Title to Land with a Water Licence Entitlement Shares in Perpetuity Bank-like Allocations Use licences with limits & obligations Delivery Capacity Shares Delivery Capacity Allocations Salinity Shares Salinity Allocations National Competition Policy 1993/94 Plus Cap National Water Initiative 2004 Now trying to fix the problems created by the naive introduction of markets bolted onto an entitlement regimes that lacked hydrological, environmental & economic integrity

Scarcity and Trading  Source: Murray Darling Basin Commission, Trading has enabled adoption of new technology and “greenfield” development

What have been the outcomes Many more irrigators survived the drought Considerable innovation and wealth creation Movement of water out of areas with local environmental problems Facilitate considerable greenfields development Facilitated considerable change without government intervention

Benefits of trading Psi-Delta 2007 Bjornlund and Rossini 2007

Entitlements Shares of a pool of water –Unit shares not percentage shares How many pools? –One if trading costs extremely low –Two enables individual risk profile management –Three if already exists in old system Define pool size to shift with longtime water availability –High security = 30% of 10 year moving average of total annual allocation to system

Entitlement registers 1.Issue shares of a pool not volumetric entitlements 2.Units based on current volume 3.Validate registers early 4.Ensure register compatibility 5.Register (not paper) defines ownership

Periodic Allocations & Trading

What we got right 1.Installing meters 2.Enforcing compliance with licensed volume 3.Defining entitlements as shares 4.Pools of differing reliability 5.Unbundling to get control and transaction costs down 6.Allocation announcement discipline

Mistakes we made 1.Regime arrangements 1.System connectivity – manage GW and SW as one 2.Capped the wrong thing – cap entitlement potential not use 3.Return flows – account for them 4.Unmetered uses – include them 5.Climate change – plan for an adverse shift 6.The environment’s share – define it and allocate to it 7.Storage Management – include in trading regime 2.Individual licence arrangements 1.Registers – validate them early 2.Entitlements - define entitlements as shares 3.Trading – forgot to get the costs and time to settle down 4.Not enough instruments – needed to unbundle 5.Inter-seasonal risk management – allow markets to optimize carry forward 6.Exit fees – Need to allocate to individuals or allow trade out of districts 7.Trading risk – develop tagged trading

Governance Power of veto for each state restricted progress Too many people at the table States have now referred planning powers to Independent Murray Darling Basin Authority –6 people expertise-based –Ministerial Council has power to accept plan or refer back –If referred back goes to Federal Minister

Recent water reform initiatives Driven by political realization about the importance of getting water right New Authority Buying water entitlements for the Environment Investing in water efficiency Trying to remove remaining barriers to trade Taking climate change risk seriously

CSIRO Sustainable Yield Project, 2008

Emerging guidelines Hydrological Integrity (Debit & credit) –Return flows –Connectivity –Unmetered water use Economic Integrity –Trading at low cost –Facilitate individual risk management Equity –Full specification of right –Allocate licence to the environment

An Australian style reform sequence 1.Cap Groundwater Systems and issue rights to a share of recharge 2.Meter all use and establish a robust and transparent accounting system 3.Unbundle rights and establish centralised share registers and individual accounts 4.Trial voluntary conversion from current seniority to 3 pool share allocation system –Pre-1950 ??? –1950 to 1980 ???? –Post 1980 ???? 5.Issue environmental trusts with shares and responsibility for deciding how best to use the available water 6.Change legislation so that courts are no longer involved in allocation decisions 7.Establish allocation announcement and trading protocols that allow inter-system trading. 8.Set rules for district exit fee payments. 9.Guarantee to compensate if value of new shares is less than value of old system and consider abandoning trial. If more valuable, confirm new system

Contact: Prof Mike Young Water Economics and Management Phone: Mobile: Download our reports and subscribe to Jim McColl and my droplets at