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Rural water use and the environment: The role of market mechanisms

Research report

This research report was released on 25 August 2006.

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  • Key points
  • Media release
  • Contents

Markets are already making a significant contribution to increasing rural water-use efficiency. But further reform is needed to ensure that water continually moves to its highest value uses (including environmental uses).

Market mechanisms to address environmental externalities need to be targeted to location and scale — no ‘one size’ fits all. Poorly designed programs can impose high costs that may outweigh potential gains.

  • 'Saving' water via major infrastructure works is often costly compared with other options and may reduce water available for other uses.
  • Subsidies that seek to improve the uptake of particular technologies or practices solely to increase the productivity of water use are likely to be inefficient.

The Living Murray Initiative could be implemented more effectively if current efforts to source water 'permanently' are supplemented with additional water products (such as seasonal allocations, leases and options contracts). Appropriate institutional arrangements should be put in place to establish an agency specifically charged with purchasing a portfolio of water products to suit the needs of environmental management in the River Murray.

Using administrative arrangements to allocate water for environmental purposes conceals the opportunity cost of meeting environmental targets. Market mechanisms are usually a more efficient means of re-allocating resources.

Climate change, farm dams, vegetation and land-use changes, groundwater extraction, and changes to irrigation water management, have the potential to reduce stream flows substantially. In the Murray–Darling Basin, such reductions undermine efforts to achieve environmental goals and can affect the reliability of existing entitlements. Priority should be given to refining and clarifying existing property rights, undertaking further research on water systems and improving water accounting.

There are opportunities to improve entitlement regimes through unbundling of water entitlements and water-use approvals, and facilitating efficient intertemporal water use decisions. Separating delivery entitlements from water entitlements may also be beneficial where there is congestion in water delivery.

A number of impediments to water trade reduce economic efficiency and should be removed. In particular, governments should:

  • enable other participants to trade in water markets
  • open up interdistrict water entitlement trade, and remove exit fees.

According to the Productivity Commission there is scope for markets to play a greater role in improving the efficient use of water, including for environmental purposes.

In a final report released today — Rural Water Use and the Environment: The Role of Market Mechanisms — the Commission suggests that governments should give greater recognition to the integrated nature of water resources and use markets to more efficiently allocate water among competing users.

Water for environmental purposes can be obtained cost effectively through purchasing a range of water products from willing sellers on the open market, including, but not limited to, water entitlements. This can often be more cost effective than investing in new infrastructure works:

‘Saving water via major infrastructure works is often costly compared with other options and may reduce water available to other users’, said Commissioner Neil Byron.

Markets can also be used to achieve other environmental goals, such as managing salinity, but need to be targeted to location and scale — no ’one size’ fits all.

Unless accounted for, climate change, farm dams, vegetation and land-use change, groundwater extractions or changes in irrigation management have the potential to undermine efforts to achieve environmental goals and affect the reliability of existing entitlements. Governments should press ahead with the National Water Initiative, especially refining and clarifying property rights, undertaking further research on water systems and improving water accounting.

Cover, Copyright, Terms of reference, Foreword, Contents, Acknowledgments, Abbreviations and explanations, Glossary, Key points, Overview, Recommendations and findings

1 Introduction
1.1 Background
1.2 Scope of study
1.3 The Commission’s approach
1.4 Conduct of the study
1.5 Report structure

2 Key factors affecting water availability
2.1 Identifying key factors affecting water availability
2.2 How do these key factors affect water availability?
2.3 What is to be done?
2.4 Conclusion

3 Improving entitlement regimes
3.1 Simplifying water entitlements
3.2 Unbundling delivery capacity
3.3 Improving intertemporal water-use choices
3.4 Security of entitlements

4 Reducing constraints on water trade
4.1 Nonregulatory constraints
4.2 Restrictions on who can participate
4.3 Constraints on trade in seasonal allocations
4.4 Constraints on trade in water entitlements
4.5 Constraints specific to trading groundwater
4.6 Implications of freeing up water trade

5 Other factors affecting farmers’ decisions on water use and trade
5.1 Information for water-use decisions
5.2 The efficiency of rural water supply
5.3 Government policies

6 Externalities, assessment criteria and governance issues
6.1 Environmental externalities
6.2 Assessment framework
6.3 Governance framework

7 Altered river flow externalities
7.1 Environmental changes and externalities associated with altered river flows
7.2 Current and emerging approaches to addressing the effects of altered river flows
7.3 Design issues

8 Assessing market mechanisms for altered river flows
8.1 Assessment of market mechanisms to procure water and water-related products
8.2 Other market mechanisms to address externalities from altered river flows
8.3 Establishing sourcing agencies

9 Salinity externalities
9.1 Salinity
9.2 Policy context
9.3 Design issues

10 Assessing market mechanisms for irrigation salinity
10.1 Reducing the further emergence of irrigation salinity
10.2 Disposing of salt

A Consultation

B Rural water use, supply and trade
B.1 Water use in Australia
B.2 Water availability and supply
B.3 Water trade

C Water trade and exit fees
C.1 Benefits from trading water entitlements
C.2 Exit fees
C.3 Exit fees constrain trade
C.4 Exit fees reduce welfare
C.5 Sensitivity of results to water demand characteristics
C.6 Differing exit fees between exporting regions
C.7 Empirical analysis of efficiency effects of exit fees
C.8 Concluding remarks

D Effects of a tax on water use on price and quantity of water
D.1 A uniform tax on all water users
D.2 Differentiated taxes on water use
D.3 Charges on water traded out of an irrigation district