Simo Tervonen,Waterfind Australia: Maturing markets the role that water markets have played in the effective utilization of a scarce resource
SIMO TERVONEN: So my name's Simo Tervonen. I'm the Manager of Trade Policy and Market Operations at Waterfind Australia.
I'm sure by now you're all wondering, where's that weird accent from? The answer is Finland. We certainly don't have water markets in Finland because our rivers are frozen for a good chunk of the year, but we certainly have water markets here in Australia.
And for those who don't know who Waterfind Australia is, just a brief introduction. We are Australia's leading water programme, and our core business is to run an online platform that facilitates both temporary and permanent trading across Australia.
So from that point of view, today I'm talking about the role that water markets have played in the effective utilisation of a scarce resource, which water, without a doubt, is in Australia, and how water markets have matured in order to make this happen. So as we all know, the climate in Australia is extremely variable, as these pictures from Lake Eildon in the Goulburn catchment in Victoria exemplify.
In a drought-prone country like Australia, it is critical that we have a price on water, which reflects its true value. The whole basic principle behind water markets is that they improve economic outcomes through supply and demand by providing price signals that allow water to flow to its highest value use and in current investment in water use efficiencies. And in general, support redistribution of water resources to areas where they will be used the most productively.
So when we're thinking about the role that water markets have played in the effective utilisation of the scarce resource, it can be stated, without a doubt, that water markets are a core component of effective water management in Australia. A prime example of that was seen during the Millennium drought.
During the drought, water markets sustained Australian irrigators through many years of record low rainfalls. Not only did markets help to preserve a financial future for many farmers, but they actually helped to maintain the value of irrigated agricultural production during the drought. As we can see here in the Murray-Darling Basin, from season 2005/2006 to '07/'08, the amount of water used by irrigators fell by 57%. However, the value of irrigated production only fell by 8%, which is simply remarkable. And it can be mostly attributed to the combination of utilising water markets and irrigation efficiencies.
There are some more recent examples as well, not just the Millennium drought. For instance, as we can see here, the water use, the water availability, dropped 25% from 2013 and '14 to '14/'15, but the irrigated production only fell by 2.4%.
And also, if we compare the production levels '14/'15 to pre-drought levels in '05/'06, we can see that the production is 26% above the pre-drought levels using 20% less water, which goes to show how much more efficient irrigators and water users have become to utilisation of water markets. And it also shows how the market has matured as water users managed their water resources throughout each season in a strategic manner.
Well, even though I said that during the Millennium drought we saw prime examples how the water markets supported irrigators, when we talk about maturing markets, we have to remember that during that time, the water markets were still fairly immature. And we have an example of that here.
The highlighted area there, that is the declared systems in Northern Victoria, zones 1 to 9, including high trading, high water use areas of the Goulburn and the [INAUDIBLE]. The blue bars on the right, they compare the net available water for the entitlements in this area at the peak of the drought, '07/'08, to 2014/'15.
As we can see, the net water availability was almost 60% less in '07/'08 compared to '14/'15. However, the yellow bars on the left, it show that actually at the peak of the drought, more water was written off at the end of the season, both in terms of absolute megaliters and also as a percentage of net available water. So more water was written off at the end of '07/'08 than '14/'15.
And by written off, I mean water that at the end of the year, it wasn't used by irrigators. It wasn't traded. It couldn't be carried over. It was just sitting on the accounts and was basically wasted.
The conclusion of this is that at that time, water right holders were not as educated to make the best decisions to manage their water assets. Who knows? They might not have even heard that water trading exists, or that water has any value.
And at that point, the value was very significant. In fact, in the Southern-connected system, it was at all-time high. It peaked at $1,200 per megaliter. And that's for temporary water. So potentially, a lot of opportunities were lost at that time, simply because the markets were still fairly immature.
So even though during the drought water markets sustained Australian irrigators through hard times, the markets were it reaches maturity. And it also goes to show that should a similar drought hit this year, next year, whenever, we will be much better prepared, and the matured model would support the farmers even better.
So what makes all of this possible? How can the markets support farmers so well? It all comes down to legislation and the reform of the water management systems in Australia. The topic of this session was adapting to a future with less water.
Well, as we can see here, from a water policy point of view, Australia has been adapting to a future with less water for quite some time. All the way from implementing the cap on extraction in the basin in 1987, National Water Initiative, '04, Water Act '07, Basin Plan 2012, without going into great detail of these major reforms.
One key consequence of them was the separation of water from land, which has been an important step in the development of markets to facilitate increasing amounts of trade. Enabled by these key policy reforms, the water markets have matured incrementally on the side as can be seen on the bottom of this figure. And the market mechanisms, they've come a long way from ad hoc, over the fence-type of training which was seen in the 1980s and '90s compared to modern online exchanges where water right holders can, for instance, buy water today to get it delivered next season, or even the season after that. As a result of these policy reforms and maturing markets, over the past decade we've witnessed the following key components of water market maturity.
Firstly, there's greater understanding around water trading, which has been utilised by irrigators to improve their annual returns. Water users are more aware of when to trade and how to capitalise on the impact of price conditions. And all in all, irrigators, they understand market drivers and they incorporate this knowledge into their annual plans and programmes.
Secondly, irrigators have seen the value of having a diversified water portfolio. So back in the day, it was very common for the irrigators just to hold a single entitlement for their whole catchment, so to speak. Just to where they divert the water directly.
However, these days, especially in the Southern-connected system, the irrigators have seen the value of managing risks via having a diversified water portfolio. Having multiple entitlements, not just your home catchment, but also in other catchments, or even in the state. So in the Southern-connected system, this is especially useful because, let's say your property is in New South Wales. You can own a South Australian entitlement, Victorian entitlement, and still get the water delivered from those entitlements to your property in New South.
And by doing that, it's possible to bypass some of the trade limits that may be in place. And all in all, mitigate risk around the market and water delivery.
Thirdly, even though Peter said, there's still room for improvement in terms of water use and irrigation efficiency. There's certainly been increased efficiency in the market in terms of water use. So usually when you place a value on something, the stakeholders become more concerned how efficiently they use that asset. And the same goes with water. This has, at least partly, resulted in improved on farm infrastructure supported by the Commonwealth on farm grants and schemes to capture more water or reduce waste. It's All in all, farmers are now more strategic in their water plants regarding timing and application rates and volumes.
And lastly, there are more and more innovative water market products available for water right holders. Not just the regular spot market, but there are instruments around forward markets, carryover, leasing, deferred delivery, and so forth. In fact, irrigators have never been better placed to act on the water marked by using these water market instruments.
As a result of increased maturity on the market side and also as a result of the policy reforms, there's been a notable change in water trade patterns. And this is strictly about temporary annual allocation trading. So while the markets were immature, the pattern looked something like this. During the first quarter, the first quarter and a half, there was little temporary trading activity. The irrigators, they bought when they needed to water in the high water use period. Not much planning in place, quite ad hoc. Buy once a year when you need to water. So the prices peaked during December/January period. And much of a water portfolio, just a single entitlement was mostly used. And also, as David said, the carryover mechanisms were still too mature. There was limited availability for carryover.
And of course, when you buy water during the peak period, the prices are higher and it's very expensive. Now, when the markets have matured, there's been a notable change in this pattern.
Well firstly, you'll see that the price peak, it's not as strong, not as obvious. It has softened. And this is because there's more strategy, more planning behind the water management. People, they don't buy just once a year. They manage risk by doing multiple purchases throughout the year, or even buy this year's water during the previous season using carryover products and so forth. So all in all, it's a more strategic way of doing things. As mentioned, irrigators use multiple entitlements in their portfolio. And also, the availability of carryover has increased.
So even though the prices still peak usually during December and January, the tail end of the season it reacts to the outlooks for the upcoming season. So usually around this time of year, the irrigation authorities, they start to publish outlooks for the next season in terms of how much water is likely to be allocated for a specific entitlement-- 1 of July when the next season starts.
So if there's a dry year on the cards, the market sentiment is that next year, there's going to be less water available. So the prices will be higher. So I'm better off buying water still during this year, using carryover or forward contracts. And that's why the demand goes higher at the tail end of the current season and so will the price. However, if there's a dry year on the cards-- no, sorry. A wet year on the cards, the market sentiment is the opposite, really. People think that next year, there's going to be a lot of water available. The prices will be cheaper. I don't need to engage with the market this year. And therefore, the demand goes down and so will the prices.
This figure, which the data is from Murray Irrigation Limited in New South Wales Murray. And their water exchanges volumes and prices. It's always the same pattern. As The markets have matured, there's a greater engagement around the market. Better awareness to trade the unused water. So there's more water traded at fairly similar prices than pre-drought conditions with less volatility. And these are all signs of maturing markets.
One fact of the matter we have to face is that the amount of water available for consumptive use, it will not increase. All major systems have been fully allocated for quite some time. So we can't just apply for a licence from the government and get x megaliters.
Well, David touched on this topic in his presentation regarding the government holding. So the Commonwealth Environmental Water Office is the single-largest water holder in Australia because they've recovered a lot of water for the environment according to the basin plan. And there have been some concerns that water recovered for the environment, it weakens the supply, constrains the supply side for the farmers. And in the long run, the prices will increase.
Well, as David mentioned, there's been some recent studies that whilst there is an impact, it's not the key driver. But it is actually the total water availability in terms of announced allocations and prevailing climatic conditions.
And this figure, it illustrates the same thing from the market size point of view. So even though we see on the green here, the Commonwealth has recovered a lot of water starting from '08/'09, it is the water availability-- the blue bars over here, which are the announced allocations in the Murray-Darling Basin that have a greater impact on the volume of the temporary water traded in the basin, which is the red line over there.
This year, however, it seems to break this pattern a bit. Even though the water availability has doubled basically, the projected amount of trade within the basin is only going to be slightly higher than last year. Well, there's a logical explanation for this.
This year, there's so much water available, not just in the Southern Basin, but also in the Northern catchments, that the demand side is simply not there. People are going to get by with their announced allocation, and they don't need to engage with the market as much. Compared to last year when the supply side was the constraining factor in terms of market size. This year, it's the demand side.
Well, so far I've talked about market maturity from the temporary market side of things, but there are clear signs of maturing in the permanent market as well. Especially in the Southern-connected system. As an example here, we have the temporary price graph for the Southern-connected system and the permanent water prices for Victoria Murray zone 7 high-reliability entitlement.
What this graphs shows that even though there's been a quite dramatic drop in temp water prices in the Southern-connected system from last year to this year-- last year, they peaked at around $300 meg. As we speak, temp water is traded in the Southern-connected basin in the Murray system at $45 per megaliter. And even lower in the Murrumbidgeethe water price below $20 per meg.
So even though there's been a dramatic drop in the temp water price, the entitlement price has-- the entitlements have kept their value. There's been little to no change at all for the big Murray zone 7 high-reliability entitlement price. No volatility at all, which is a sign of a mature market.
And what these strong prices for permanent water rights represent, it is the gains in the water productivity and the strength in the irrigation sector. And it shows that irrigators, they're adapting to water as an asset, with an increased awareness of the value of that asset, which results in better management and utilisation of that asset to greater engagement around the water markets.
Well, even though the water markets in Australia, they're a core component of effective utilisation of this scarce resource. It's not like we've reached perfection. To enable the Australian water market to further mature, Waterfind considers that there are some actions needed to, firstly, improve water market information.
At present, there is no focal, well-functioning, nationwide water market information service. I know that BOM is about to release a new product, which may be a partial solution for this issue. But as we speak, there is no well-functioning nationwide service available. Specifically, there is a lot of work to be done before the quality and transparency of Queensland water market information is brought to a level comparable to other basin states.
For instance, there is no publicly accessible, free water register in Queensland. And in fact, Waterfind is the only provider for up-to-date water prices in Queensland.
Secondly, actions are needed to remove some impediments for lending against water rights, so-called water finance. There are issues in relation to accounting standards for water and capital allocation models for lending against water that need to be resolved in order to reach the full potential of water rights as an asset class.