Chapter 4 - Issues to do with water trading
4.1
The purpose of water trading is to allow water, through
market forces, to move to more profitable uses. Trade has occurred to some
extent for many years, but to date it has been mostly small scale temporary
trade (that is, trade of annual allocations, not the underlying entitlement).
There are still impediments to interstate trade.
4.2
The Intergovernmental Agreement on a National Water
Initiative (IGA) aims to remove impediments to trade. However all trade will
still be subject to environmental constraints. For example, if water is sold
upstream, the river flow between the selling and buying points will be reduced,
with possible environmental consequences. Exchange rates are needed to allow
for seepage and evaporation between selling and buying points. Trading rules
will be needed to control these and other situations. The IGA lists 11
principles for trading rules (Schedule G).
4.3
Interstate trade will require the categories of
entitlement in different states to be redefined so they correspond.
4.4
Most submitters to this inquiry supported water
trading. Some are quite used to buying water as needed like any other business
input, whether to top up an allocation or because they have no entitlement.
Some are looking forward to the greater flexibility, in a more mature market,
to sell their entitlement. However most stressed the need for some controls on
the market to prevent entitlements accumulating in the hands of large investors
who might gain market power.
4.5
The main concerns about water trading are discussed
below.
Who should be allowed to buy water?
4.6
This question summarises two somewhat different
concerns:
-
concerns about possible contraction of rural
economies in areas where water is sold away;
-
concerns that water entitlements may accumulate
in the hands of investors or speculators who may gain market power, to the
detriment of farmers who then need to buy the water.
4.7
These concerns overlap but conceptually they should be
distinguished. The first concern arises even if water is sold only to other
water users. The second concern is additional.
Possible contraction of local economies where water is sold away
4.8
Many witnesses, though they support water trading in
principle, were concerned that the economic benefits of water use should remain
in the local area. They were concerned that if water is sold away the community
loses the economic activity that the water created. For example:
It [trading] does need to have some parameters to govern it .
we cannot allow free trading to suddenly take all the water out of the Namoi
Valley and place it down in the
Darling somewhere and leave Gunnedah, Narrabri and Wee Waa as desert towns.[29]
4.9
Such comments imply that water should only be bought by
people who will use it in the same area (somehow defined) as the seller; or, if
there is a middleman, that the water is tagged in some way so that it can only
be resold to someone who will use it in the same area.
4.10
In such comments it seemed to be often implied that the
local area means the catchment. However in a large catchment the concern
could equally apply if water is sold from one region to another within a
catchment.
4.11
The Committee is
sympathetic to these concerns. However it must be said that to limit trade in
this way would run fundamentally counter to the IGAs policy of allowing the
freest possible trade (subject to environmental needs) so that water can move
to more profitable uses. If water moves to areas where different natural
endowments allow it to be used more profitably, this necessarily implies that
the relatively less endowed source area will lose out.
4.12
The IGA does not propose any restrictions on trade based
on socio-economic considerations. By negative implication it forbids them,
since nothing of the sort is contemplated in the principles for water trading
rules, which deal with limits on trade because of environmental requirements or
delivery constraints (Schedule G). As well, it says:
The States and Territories
agree to establish by 2007 compatible institutional and regulatory arrangements
that facilitate intra and interstate trade. including:
v) no imposition of new
barriers to trade (s60)
4.13
In the case of irrigation areas with shared
infrastructure, where there are concerns that trading out may leave stranded
assets, the IGA allows permanent trade out to be limited to 4 per cent of the
total entitlement subject to review by 2009 with a move to full and open trade
by 2014 at the latest (with certain other conditions for the southern Murray
Darling Basin - s60(iv)(b)).
Comment
4.14
The Committee accepts
that the regional adjustment problems caused by trade out could be serious
matter in some areas. The Committee suggests
that trading rules should take into account socio-economic impacts of trade.
4.15
Investment in water use efficiency measures may help
incidentally, by putting a less naturally endowed area in a better position to
use water with adequate profitability. However it is important that any public
investment in efficiencies is economically disciplined and directed with
priority to the highest returns. It should not be allowed to become a backdoor
form of structural adjustment assistance.
Concerns about possible manipulation of the market
4.16
There are concerns that water entitlements might
accumulate in the hands of major investors who might then exercise market power
at the expense of water users. For example:
Water is for the benefit of the entire region, not just for
someone who happens to be in Sydney
and is shoving a piece of paper in a drawer to constrict the market and then
leasing things out to the highest bidder under desperate circumstances.[30]
4.17
Similar concerns arise at the prospect of entitlements
being owned by non-users, whether or not there is market power:
The Victorian Farmers Federation sees no advantage in someone in
Collins Street owning water and trading it. There is no advantage for the
environment, and there are no advantages for farmers. All that it will do is
put another cost in there.[31]
4.18
A contrary view is that, assuming there are enough
buyers and sellers, the discipline of the market will prevent profiteering:
At the end of the day the water market is a bit like any other
market: it is a supply and demand situation, and you can be the biggest water
holder in the country but that water is not worth anything to you unless somebody
wants to take it up and use it.[32]
4.19
The Committee suggests
that while this may be true in the spot market for allocated water, it would be
unwise to assume it in relation to the relatively untried market for water
access entitlements. There is risk of speculation in hope of growth in the
capital value of the limited resource, not merely in relation to the current
use value of the water.
4.20
Most witnesses agreed that the possibility of
profiteering is a concern, and that the market needs to be regulated. Prof.
Cullen said: I agree with you that you
would not want an unregulated market. I would be very concerned if I thought
one or two people were going to own all the water and we were going to have
peasant farmers. I hope that we can design a market that will stop that
happening.[33]
4.21
Mr Creighton
of CSIRO argued, I do not believe we
are about a free-form economic open market here, because we are about public
good as well We are not about a willy-nilly open market; we are about some
managed trade.[34]
4.22
Prof. Young
suggested, If you wanted to stop it, you can simply require that somebody who
owns a water right has to own some land as well.[35]
4.23
Mr Dalton
of the Department of Agriculture, Fisheries and Forestry said, I think that is
an area where we would seek to have further serious analysis and investigation
done. Mr Sutherland
of the NSW Department of Infrastructure, Planning and Natural Resources noted
that There are provisions in the New South Wales
legislation whereby the minister must approve the trading regime and can take
into account any impacts that trading might have, any concerns about monopolies
et cetera. However the basic reliance would normally be on the ACCC and the
normal trading regulatory regimes.[36]
4.24
The IGA has nothing to say about this matter, beyond
the possible relevance of the following sections:
-
trading arrangements should provide adequate
protection to third-party interests. (s58(v));
-
in regard to the southern Murray-Darling Basin,
the relevant parties agree to the National Water Commission monitoring the
impacts of interstate trade and advising the relevant parties on any issues
arising (s63(vi)).
4.25
The Committee notes the
policy in the recent Victorian White Paper on water, that a limit will be
placed on the total volume of water than can be held by non-water users in each
supply system equal to 10 per cent of the systems entitlement. The White
Paper comments:
It is unlikely that this limit will be reached in the near
future. All the permanent trade that has ever taken place in the 12 years since
it began has not yet amounted to 10 per cent of entitlement. Moreover, much of
the permanent trade will continue to be from one irrigation business to
another.[37]
Comment
4.26
The behaviour of a freer water market is hard to
predict. The question is whether it will indeed become an efficient market with
many buyers and sellers, none of whom can influence the general price level.
The probability of a bad outcome is hard to estimate, and possibly low; but the
consequences if it happens could be severe. The risk should be taken seriously.
The Committee doubts that relying on the
competition provisions of the Trade Practices Act would be an adequate remedy
in practice.
4.27
The Committee regrets
that the IGA does not deal with this matter. The Committee
regrets that the IGA has not taken up the suggestion that entitlements should
only be bought by people who also own land on which they could be used. This
would solve the problem simply. It would not prevent brokers from facilitating
trade, and it would not prevent the operation of a water exchange. It would
have some administrative cost, but it should not significantly affect the
economic efficiency outcomes of trade, since traded water only participates in
economic production when it is eventually put on land by a buyer who has land.
It would only prevent middlemen from owning
the entitlement along the way.
4.28
The Committee has a
concern that leaving this matter for state level control of trading regimes may
lead to divergent policies in different states. In the Committees
view the policy on this matter should be national. The Committee
recommends that COAG should develop a policy on rules to control the water
market to prevent profiteering. This should be considered separately from the
principles for trading rules already agreed in schedule G of the IGA, as the
latter are focussed on the different matter of controlling trade to respect
environmental requirements.
Recommendation 3
4.29
COAG should develop a policy on rules to control the
water market to prevent profiteering or speculation by non-users, including
foreign interests, to the detriment of water users or the environment.
Need for structural adjustment assistance
4.30
Most comment in evidence about structural adjustment
assistance referred to the need arising from recovery of water for the
environment. The concern is that while individual farmers might be paid for
recovered water (subject to the risk sharing rules), this would not compensate
for the knock-on effects of reduced economic activity on rural communities. The
logic is that environmental goals should be paid for by the whole community,
not only by farming communities:
We are advocating the need for major structural adjustment
reform in the way we manage the landscape. We are saying that you cannot ask
farmers to bear that cost.[38]
4.31
Where a local economy contracts because of water trading
out, the moral case for assistance is not the same. It could be argued that
economies are not immutable; the chance of economic downturn is one of the
risks of life; the community has effectively benefited from a restrictive trade
practice in the past and need not be compensated for losing it.
4.32
On balance the Committee
is not inclined to argue on these
lines. In the Committees view communities
affected by water trading out have a fair claim to structural adjustment
assistance, since:
-
many of the communities concerned are
longstanding, and have developed a social infrastructure in reasonable
expectation of a stable future;
-
the need arises not from the normal evolution of
the economy, but from a deliberate, one-off government decision;
-
the economic effects of water trading and
recovering water for the environment may be hard to separate;
-
both activities serve the overarching community
goal of improving the health of rivers.
4.33
The IGA commits the parties to address adjustment
issues (s94) and the Commonwealth commits to discussing with signatories to
this Agreement assistance to affected regions on a case by case basis (s97).
There are no specific proposals.
4.34
It will take time to see the extent of the need, as the
water market matures. However the need should not be overlooked simply because
the effects may develop gradually. The Committee
notes that the Murray Darling Basin Commission is studying the socio-economic
effects of the First Step project to recover 500 gigalitres of environmental
water.[39] This
could usefully be broadened to cover the effects of water movement generally.
4.35
The Committee suggests
that COAG should commit early to a program of jointly funded structural
adjustment assistance for affected communities, of similar profile to the
Intergovernmental Agreement on addressing overallocation in the Murray
Darling Basin.
The Committee suggests that this would improve
public acceptance of water reform. The exact money involved would not need to
be decided early. It would depend on how trade develops. However it is
important to set up the framework and to start the necessary research early so
there is a baseline for comparison later.
Recommendation 4
4.36
COAG should commit to a jointly funded program of
structural adjustment assistance to communities whose economies are contracting
because of water trading, and agree to provide adequate financial support for
projects to promote environmental recovery in degraded areas.
Problem of stranded assets
4.37
Adjustment problems will probably be most serious in
some irrigation areas. This raises the problem of stranded assets: if some
farmers sell out, the burden on those remaining to pay the maintenance costs of
shared infrastructure increases.
4.38
Some irrigation area bulk suppliers have restricted
trade out of the area for this reason. For example, in the Central Irrigation
Trust (South Australia), You can
trade your water, but you are allowed to trade only two per cent out of the
system at any one time.
The reason behind that is that, if you have a massive irrigation
infrastructure, you do not want everyone trading their water at the same time.[40]
4.39
The Committee notes
the argument that shareholders of a company have every right, by majority vote,
to manage the company this way:
As a corporation, we went along to the shareholders and said: These
are the assets you own. How are we going to manage them? One of the things
they said was that as a group of shareholders and a community they do not want
to see water traded out of the area. We take that not as a barrier to trade; it
is just the shareholders who own the assets saying that they do not want to
sell them.[41]
4.40
The IGA aims to override this behaviour to ensure the
freedom of individual end users to trade. As a concession, trade out of
irrigation areas may be limited to 4 per cent of entitlement per year for the
time being, with the aim of a move to full and open trade by 2014 (s60,63).
4.41
Exit fees have been proposed as a way of maintaining
the viability of an irrigation area when water is sold out. These could be
calculated as the net present value of the stream of future levies which the
seller would have paid for maintenance of shared infrastructure.[42] The IGA has
provisions which imply a concern that exit fees could be used as a disguised
barrier to trade.[43]
4.42
The Committee draws
attention to the need to monitor this matter. The Committee
notes that imposing exit fees may have economic efficiency implications in the
longer term. At the limit it raises the possibility that many farmers who have
sold out are paying to maintain expensive infrastructure indefinitely for a few
who remain.[44]
This may be regarded as fair to those who remain, but it might not be an
efficient use of resources.
Unintended effects of trade: activating sleepers
4.43
The Committee heard
that more trade has had the effect of activating sleeper (unused) licences,
when the owner of a sleeper sells it to someone who does want to use it. This
has increased water use.[45] The
implication may be that this is a reason to limit or postpone freer trade.
4.44
Where water needs to be recovered from overallocated
systems, it is a vexed question whether sleepers should be given the same treatment
as active users, or whether sleepers should be confiscated first, by a use it
or lose it policy, on the grounds that this minimises economic dislocation.
The arguments are considered further from paragraph 5.25.
4.45
The Committee suggests
that this problem should not be a reason to limit trade. To do so for this
reason would effectively be saying: You may activate your sleeper, but you may
not trade it, because we know that in practice this makes it less likely that
it will be activated. This seems a rather ad hoc and possibly unfair approach.
4.46
The sleeper problem will need to be worked out by
catchment communities and government on a case by case basis. If the answer is
to give sleepers equal rights with active licences, increased water use caused
by trading sleepers will need to be addressed by the general procedures for
recovering overallocated water.
Need for nationally consistent regulation of trade
4.47
Schedule F of the IGA lists guidelines for water
registers, and schedule G lists 11 principles which the parties are to follow
in setting water trading rules.
4.48
If such rules are not nationally identical, they should
at least be nationally equivalent in effect. The Committee
sees a risk that without deliberate continuing oversight the rules may diverge
in different states, due to the normal vagaries of state politics subject to
differing local political pressures. As well, there is a risk that the ongoing
interpretation and application of the rules in detailed management of trade
could differ.
4.49
The Committee sees a
need for ongoing oversight of the water market to ensure national consistency.
This could presumably be a role for the National Water Commission.