Water, sustainability & entitlement

The formation of water markets has enabled users to reveal the value of water, respond to different drivers over time and for water to be allocated to those who value it most. 

"Australia’s [water] system is not perfect but provides a clear competitive advantage.”

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The blueprint called for governments to commit to 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.

When we look at water management frameworks in other countries Australia’s system is not perfect but provides a clear competitive advantage.

The level of new investment - particularly in the southern Murray-Darling Basin (MDB - has been astonishing. All the main irrigation industries are doing well and the response in water asset prices has been remarkable.

However this is creating some uncertainty and many agribusinesses are now looking for ways to appropriately value water as a component of their investments or operations. 

With water ownership restrictions lifted progressively it is now possible for basically any individual or firm to hold water entitlements and trade allocations to them on a daily basis.

 Unbundling & trade

About 90 per cent of Australia’s water trading occurs in the southern MDB. The outcomes of reforms are positive for investment in Australian irrigated agriculture with potential application and benefit globally in dealing with one of the world’s biggest challenges – water scarcity.

Water planning, entitlement and market reforms which have been undertaken in Australia have enabled the irrigated agriculture sector to withstand the stress test of a one-in-1000 year drought sequence and proven to be resilient. Whilst the millennium drought no doubt caused significant pain major government intervention was not required.

Essentiality the industries with flexible water use requirement such as annual crops (rice) and dairy were able to reduce water use and thus production and the water they owned was able to be traded to wine grapes, nuts and other permanent plantings with fixed water requirements. Through trade both parties were better off.

Importantly during the millennium drought it wasn’t a case of would I be able to get access to water - it was an economic question of ‘how much are am I willing to pay?’

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Real risks & opportunities

The latest investment boom has brought with it both risks and opportunities. Even if you own water entitlements there is no guarantee water will be delivered to your pump on the river when you need it.

There are real physical constraints, particularly in the Murray system, around how much water can get below the Barmah Choke to the Sunraysia and Lower Murray region and this will be pushed when newly planted almond trees reach maturity.

The second risk is around price. With significantly increased demand the price of water entitlements has gone up to the point where many are starting to question the value in owning entitlements. In addition those which want to purchase entitlements are finding them very hard to come by.

There’s lots of capital at risk, expensive trees at risk and reputations at risk. There’s risk associated with upfront asset purchases and then through the investment life cycle.

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The best way to deal with these types of risk and uncertainty is through a rigorous, well-governed and well-informed approach to water risk management. Small improvements can make a big different to overall returns, risk exposure and the comfort of managers, investors and banks.

This must be tackled from several angles including risks which sit around a water portfolio strategy including market risk, deliverability risk and regulatory risk.

Returns in unbundled world

There are a couple of possible explanations for high water entitlement prices which are open to debate but one factor is very important and that is the expected rate of return for the asset class based on its characteristics. This obviously makes a very big difference to your valuation.

With water, land and operations increasingly separated it’s important to come to a view on the risk weighted desired return for each of them and decide what you want to be.

With water entitlements, buyers are increasingly seeing them as a relatively low risk asset class akin to land. Many buyers are either satisfied with lower returns or banking on further capital growth.

So, water is likely to progressively move to this type of investor - and this movement has been occurring in the process of entitlement assets appreciating.

Chris Olszak is a Director at Aither, an economics, policy and strategic advisory firm with primary expertise in water policy and reform, water infrastructure, floods, natural resource management and the environment.