Aither 2017 Water Markets Report
Background
Water markets in Australia have developed significantly over the past two decades. They are now
an established part of agricultural, urban and environmental water policy and management. Water
markets help balance competing demands for scarce water resources and deliver more efficient investment, allocation and use.
Market information and robust analysis of this information supports improved understanding of
water markets. Improved understanding of market activity and trends highlights potential opportunities as well as issues and challenges to overcome. Market understanding can also help to inform decision making, such as determining if, when, or how to participate in water trade, or when it may be necessary to alter policy settings.
The Aither Water Markets Report 2016-17 provides an overview of water market activity in major water trading zones in the southern Murray-Darling Basin for the 2016-17 water year. The report also compares market outcomes with recent water years and comments on the outlook for 2017-18.
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Executive Summary
Facts at a glance (sMDB)
- Total entitlement on issue market value:
$14.5 billion - Value of Commonwealth environmental
purchases: $2.1 billion - Value of total entitlement trade:
$612 million - Aither Entitlement Index (AEI) July 2017:
141.86 points (up 4 per cent June 2016 to June 2017) - Entitlement market liquidity: 6 per cent
- Annual average entitlement returns (sale of
allocation): 2 per cent - Annual average allocation price:
$50 per ML - Percentage of total allocation trade reported
at $0: 68 per cent - Estimated value of commercial allocation
trade: $58 million (lower bound)
Summary of 2016-17
The 2016-17 water year in the southern Murray-Darling Basin (sMDB) was characterised by modest entitlement price increases, sustained price declines in allocation markets, and the emergence of more sophisticated water allocation forward and carryover lease products.
Water allocation prices opened the year at around $170 per ML and declined steadily to close at
approximately $40 per ML. The decrease in allocation prices was primarily driven by very wet climatic conditions during the 2016 winter and spring (one of the wettest on record) which resulted in high supply and reduced irrigation demand.
Entitlement prices held strong despite the low returns on the allocation market in 2016-17. The
Aither southern Murray-Darling Basin Entitlement Index (AEI) shows that major entitlement types continued to maintain and increase their value across 2016-17. However, increases were not to the same extent observed in previous years (4 per cent increase in 2016-17 compared to 46 per cent in the previous water year).
Outlook – Allocation markets
As always, the outlook for allocation prices in 2017-18 is highly dependent on climatic conditions. We know that water available for consumptive use will be high in 2017-18. We expect between 5,500 and 6,250 GL of water to be available for consumptive use across major sMDB systems (based on carryover into the current water year and conservative expectations about 2017-18 end of season allocations).
When combined with median annual rainfall in growing areas, such volumes of available water do
not support annual average sMDB allocation prices above $100 per ML (based on Aither’s annual
sMDB water allocation price model).
However, inflows to major sMDB water storages and rainfall across growing regions were well below long-term averages over June and July 2017. This, combined with a median or slightly below average 3-month rainfall outlook and the fact that cotton growers are primed for high production volumes, is currently driving sMDB allocation prices up to as high as $140 per ML.
Based on current demand for water allocations, and if it remains dry and irrigators start securing
water for 2018-19, August 2017 sMDB allocation prices ($100 to $140 per ML) may hold as the 2017-18 irrigation season develops. However, prices could equally drop below $100 per ML if high August rainfall continues into spring. At time of publication, we are seeing early signs of a softening in demand, especially in the Victorian Goulburn market.
Outlook – Entitlement markets
The growth in water entitlement prices over the last four years has been driven by long-term interest from investors and corporate agricultural enterprises, resulting from opportunities for land use change in cotton and nuts.
Aither continues to expect strong interest for all major entitlement types in 2017-18. We also expect higher allocation prices in the 2017-18 water year will increase financial returns to entitlements, and this may increase investor confidence, thereby sustaining current record high entitlement prices.
After three years of rapid price growth, the limited growth in 2016-17 reflects market sentiment, with many buyers considering higher reliability entitlements to be close to or fully valued, despite the additional horticultural development underway.
Aither’s view is that capital growth over the next few years will be modest under most scenarios but that returns to entitlement holders could increase and stabilise as large agricultural enterprises seek enhanced supply security through leases, forwards and carryover products. Our view would be more optimistic given the opportunities for further land use change but is tempered by uncertainty over the ultimate development potential for permanent plantings in the Sunraysia region.
Concluding comments
We expect the level of sophistication in approaches to water trading continue to increase with the use of forwards, leases and other bespoke water products. Looking forward, we also expect large
irrigation enterprises to increasingly deal directly with the major portfolio holders in the provision of these water solutions. At the same time, many irrigation businesses still find the water market
complex and difficult to navigate, with significant costs involved in price discovery and in obtaining insight on trade rules and market drivers.
Aither’s view is that continued investment in market fundamentals is required to maintain the
confidence of all participants, and to ensure that the flexibility and opportunity provided by water
markets is further enhanced for the benefit of all involved.
1.0. ALLOCATION MARKETS
1.1. ALLOCATION TRADE ACTIVITY
Table 1A shows total 2016-17 allocation trade across major southern Murray-Darling Basin
(sMDB) zones. The analysis suggests Vic 7 Murray and NSW Murray were both very large
net exporters of water allocations. However, Table 1A includes $0 and other non-commercial
transactions, which are substantial in volume.
Identifying commercial and non-commercial trade is important to achieve an accurate
picture of the market. Based on current public reporting practices, it is difficult to identify or
categorise these different types of allocation trade with total certainty and timeliness.
In previous years, Aither has used trades reported at $0 per ML as a rough proxy for non-commercial trade. After excluding $0 allocation trades from Table 1A, Table 1B suggests that
water allocations were primarily traded to commercial buyers in Vic 1A Greater Goulburn
and Vic 6 Murray. There are potentially two dynamics which explain this result:
- Very large volumes of water allocations were traded into Vic 1A Greater Goulburn and Vic 6 Murray for carryover purposes at reported prices greater than $0.
- Large volumes of commercial trades are being declared at $0, skewing the results.
Our view is that the latter is the more significant factor, making it difficult to estimate how water
moved across the sMDB
TABLE 1A ALLOCATION TRANSFER NUMBERS AND VOLUMES, MAJOR SOUTHERN
MURRAY-DARLING BASIN ZONES (ALL REPORTED TRADE), 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
TABLE 1B ALLOCATION TRANSFER NUMBERS AND VOLUMES, MAJOR SOUTHERN
MURRAY-DARLING BASIN ZONES (EXCLUDING $0 TRADE), 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
1.2. PROPORTION OF $0 ALLOCATION TRADES
In 2016-17, $0 allocation trades accounted for approximately 68 per cent of all reported
allocation trades by volume in major sMDB zones (Figure 1). This 68 per cent is the equivalent of almost 2,850 GL of water allocations. In 2016-17, only 1,350 GL of water allocations were traded with a reported price greater than $0.
Since 2009-10, $0 water allocation trades have consistently accounted for between 60 and 70
per cent by volume of all allocation trades reported on state registers across major sMDB
trading zones.
Where possible, state governments could significantly improve market information through real-time reporting of $0 and other non-commercial allocation trades (such as environmental water holder transfers), and stronger enforcement of price disclosure requirements.
FIGURE 1 ANNUAL VOLUME OF $0 AND NON-$0 ALLOCATION TRADE, MAJOR SOUTHERN
MURRAY-DARLING BASIN ZONES, 2004-05 TO 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
1.3 ALLOCATION TRADE PRICES
Annual water allocation volume weighted average prices (VWAP) in 2016-17 were reasonably consistent across most connected sMDB zones – around $50 per ML (Table 2). NSW Murrumbidgee and SA Murray were the exceptions to this trend, with the former trading
at a price discount and the latter trading at a price premium to the rest of the sMDB market
(for further explanation see Section 1.4).
Annual VWAPs for water allocation trade in all sMDB trading zones decreased sharply between
2015-16 and 2016-17, by around 70 to 80 per cent (Table 2).
Using allocation trades reported at $0 per ML as a rough proxy for non-commercial trade and
annual VWAPs reported in Table 2, we can estimate the total value of commercial sMDB allocation trade for 2016-17 at approximately $58 million. However, based on what we know about price disclosure issues (i.e. commercial allocation trades being reported at $0), this figure is likely to understate the total value of commercial sMDB allocation trade for 2016-17.
TABLE 2 ANNUAL VOLUME WEIGHTED AVERAGE ALLOCATION PRICES,
MAJOR SOUTHERN MURRAY-DARLING BASIN ZONES, 2014-15 TO 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
1.4 COMPARISON OF TRADE PRICES AND VOLUMES
Average sMDB allocation prices started the 2016-17 water year at approximately $170 per
ML and fell away for the remainder of the year (Figure 2). After the annual price peak in July
2016, prices again peaked at approximately $105 per ML in November 2016, before closing
at approximately $40 per ML.
Prices in the latter half of 2016-17 reached fiveyear lows (i.e. since 2011-12 to 2012-13). This
was unsurprising given the high volumes of water allocated and high rate of unused water.
In July 2017, there was a late run to secure allocations for carryover into 2017-18 and this
drove up end of season prices by around 50 per cent from the previous month. This was driven
by a deteriorating three-month rainfall and 2017-18 allocation outlook and a reopening of
the NSW Murray market which saw buyers reenter off the back of low June rainfall.
At all points in 2016-17, allocation prices reported in the NSW Murrumbidgee were at a
discount to the rest of the connected sMDB. This discounting reached a peak of 88 per cent in
June 2017. As has been observed in previous years, lower allocation prices in the NSW Murrumbidgee reflect the trade out constraint preventing market participants in the NSW
Murrumbidgee from trading surplus water into the broader connected sMDB market.
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017
FIGURE 2 MONTHLY VOLUME WEIGHTED AVERAGE ALLOCATION PRICES AND TRADE
VOLUMES, MAJOR SOUTHERN MURRAY-DARLING BASIN ZONES AND NSW
MURRUMBIDGEE, 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
FIGURE 3 MONTHLY VOLUME WEIGHTED AVERAGE ALLOCATION PRICES AND TRADE VOLUMES, MAJOR SOUTHERN MURRAY-DARLING BASIN ZONES,
2016-17
1.5 EMERGING WATER ALLOCATION FORWARD PRODUCTS
A forward allocation trade is a contract between two parties to exchange physical water
allocation at an agreed point in the future for a specified price. Forwards help provide a longerterm price signal and have the potential to play an increasingly important role in the market. Sellers can use forwards to lock in known returns while buyers can improve supply security.
While there is an active sMDB forward market for water allocation, there is limited transparency about the true volume of forward contracts or their value. This is primarily because allocation forwards are not required to be registered with state authorities until the point that delivery occurs. At the point of delivery, which could be more than a year after the original agreement was made, forwards are reported as normal allocation trades (i.e. there is no identification of these trades as being forward contracts).
Looking at the historical record of sMDB allocation trade, it is possible to identify clusters of possible forward contracts (Figure 4). The clearest cluster is allocation trades that were processed in July, August and September 2016 (see orange circle in Figure 4). These potential forwards are likely to have been agreed six or more months prior to delivery.
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
FIGURE 4 WATER ALLOCATION TRADE PRICES AND FORWARD TRADES, MAJOR SOUTHERN
MURRAY-DARLING BASIN ZONES, 2015-16 TO 2016-17
1.6 SEASONAL DRIVERS
1.6.1 WATER ALLOCATIONS MADE TO ENTITLEMENTS
In 2016-17, end of season water allocation determinations to all major sMDB entitlement types finished higher than, or equal to, 2015-16 (Figure 5). Water allocations to NSW General Security entitlements were also made much earlier in 2016-17 than in 2015-16. The timing of allocations is an important driver of allocation price because the later water is allocated the more pressure there is on water users to secure water from the market at the beginning of the irrigation season, rather than wait for allocations to their entitlements.
The total volume of allocations made to major sMDB entitlement types in 2016-17 was approximately 6,857 GL (including allocations made to entitlements held by the environment,
but not including carryover into 2016-17). This represents an increase of approximately 62 per
cent compared to the 2015-16 water year.
Aither has previously demonstrated that total water allocations are one of the prime determinants of allocation prices in each water year (Aither 2016a). High and early allocations to all entitlement types, but especially to NSW General Security entitlements (given their high proportion of total volume of entitlement in the sMDB), is likely to have been a major driver of the allocation price decrease observed during the 2016-17 water year (see Figure 6 also)
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
FIGURE 5 WATER ALLOCATIONS MADE TO MAJOR SOUTHERN MURRAY-DARLING BASIN
ENTITLEMENT TYPES, 2015-16 AND 2016-17
1.6.2 RAINFALL
Irrigation water requirements vary based on crop type, climatic conditions, soil type and irrigation management practices. Irrigators use water allocated to entitlements or obtained on the market as a controllable water supplement to in-crop rainfall.
In very wet years, the price of water allocations can be expected to drop due to both an increase in water availability (supply) and a decrease in water allocation demand (more incrop rainfall and less need to supplement with irrigation water). The opposite is the case in dry years.
In winter and spring 2016, many growing regions across the sMDB received much higher than median rainfall (Figure 6) – a reversal from 2015-16. This high rainfall, combined with high early season allocations and a positive water allocation outlook, contributed to reduced irrigation demand and downward pressure on allocation prices in most trading zones. The fact that high rainfall and flooded fields prevented many annual irrigators from maximising sowing may have also contributed to lowering demand for water allocation.
Below median rainfall in June 2017 is likely to have contributed to allocation price increases in
the final month of the 2016-17 water year as expectations for the 2017-18 water year deteriorated.
Source: Aither, 2017. Based on Bureau of Meteorology 2017.
FIGURE 6 MONTHLY OBSERVED AND MEDIAN RAINFALL ACROSS MAJOR SOUTHERN
MURRAY-DARLING BASIN REGIONS, 2016-17
1.7 LONGER-TERM COMPARISONS
1.7.1 WATER ALLOCATED TO ENTITLEMENTS
The total volume of water allocated to entitlements for consumptive use (excluding environmental water) decreased year on year from 2010-11 to 2015-16 – from 6,169 GL in 2010-11 to 3,603 GL in 2015-16 (Figure 7). The 2016-17 water year saw a return to historically high water availability, with approximately 5,882 GL allocated to consumptive users across the sMDB.
In 2016-17, approximately 14 per cent of total allocations were allocated to entitlements held
by the Commonwealth Government for the environment. Across the past five water years, this percentage has remained relatively consistent.
Carryover is not formally captured in this analysis, but is an important component to the
water availability story in each water year.
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017
FIGURE 7 TOTAL VOLUME OF WATER ALLOCATED TO MAJOR SOUTHERN MURRAY-DARLING BASIN ENTITLEMENT TYPES, 1998-99 TO 2016-17
1.7.2 WATER ALLOCATION PRICE TRENDS OVER TIME
Declining water availability, agricultural production changes and environmental purchases were significant drivers of allocation price increases across the period 2011-12 to 2015-16 (Figure 8) (Aither 2016a).
Between 2015-16 and 2016-17, annual average water allocation prices declined by over 70 per
cent in most systems. As previously noted, these declines are primarily related to the increased
volume of water allocated for consumptive use in 2016-17.
Between 2011-12 and 2014-15, reported allocation trade prices grouped closely around the monthly sMDB allocation VWAP (Figure 8). A larger distribution of prices and higher price volatility was observed in 2015-16 in comparison to previous water years.
Larger distributions have again been observed in 2016-17 (to a large extent driven by water
allocation forwards which settled in the first half of the 2016-17 water year and discounting in
the NSW Murrumbidgee).
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017
FIGURE 8 TOTAL VOLUME OF WATER ALLOCATED TO MAJOR SOUTHERN MURRAY-DARLING BASIN ENTITLEMENT TYPES AND WATER ALLOCATION PRICES, 2009-10 TO 2016-17
2.0. ENTITLEMENT MARKETS
2.1 ENTITLEMENT TRADE ACTIVITY AND PRICES
For the 11 major water entitlement types covered in this report, there was a total volume of approximately 301 GL transferred between market participants in 2016-17 (Table 3) – which
by volume is approximately 21 per cent more than was transferred in 2015-16. By volume, the
most actively traded entitlement types in 2016-17 were Vic 7 Murray (Barmah to SA) HRWS and
Vic 1A Greater Goulburn HRWS.
Annual VWAP prices reported for all entitlement types increased between 2015-16 and 2016-17
(Table 3).
While there has been an average entitlement price increase of approximately 8 per cent between 2015-16 and 2016-17, price increases of as much as 70 per cent were observed between previous years (2014-15 to 2015-16). In comparison, the highest increase in entitlement price between 2015-16 and 2016-17 was 16 per cent for Vic 7 Murray (Barmah to SA) HRWS (based on Victorian Water Register data).
In addition to the VWAP figures based on state-based register data, Aither also observed significant increases in the value of Vic LRWS in 2016-17, driven by their relatively low capital cost and favourable carryover characteristics.
TABLE 3 ANNUAL TRANSFER VOLUMES AND VOLUME WEIGHTED AVERAGE PRICES, MAJOR
SOUTHERN MURRAY-DARLING BASIN ENTITLEMENT TYPES, 2015-16 AND 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
2.2 COMPARISON OF TRADE PRICES AND VOLUMES
2.2.1 HIGHER RELIABILITY ENTITLEMENT TYPES
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
FIGURE 9 MONTHLY VOLUME WEIGHTED AVERAGE PRICES AND ENTITLEMENT TRANSFER VOLUMES, MAJOR SOUTHERN MURRAY-DARLING BASIN HIGHER RELIABILITY ENTITLEMENT TYPES, 2016-17
2.2.2 LOWER RELIABILITY ENTITLEMENT TYPES
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
FIGURE 10 MONTHLY VOLUME WEIGHTED AVERAGE PRICES AND ENTITLEMENT TRANSFER VOLUMES, MAJOR SOUTHERN MURRAY-DARLING BASIN LOWER RELIABILITY ENTITLEMENT TYPES, 2016-17
2.3 TOTAL ENTITLEMENT MARKET SIZE AND VALUE
By volume and value, the majority of the Australian water entitlement market is contained within the sMDB. The 2016-17 estimated total value of major entitlements types on issue in the sMDB is over $14.5 billion
(based on 2016-17 annual prices reported in state registers).
As per Table 4, major entitlement types held for consumptive use in the sMDB have an estimated combined value of around $12.5 billion (based on 2016-17 annual prices and excluding Commonwealth Environmental Water
Holder portfolio). Reflecting rapid price increases over the past three years, Aither estimates that the combined value of major entitlement types held for consumptive use have more than doubled since 2013-14 – when we estimated the value of combined sMDB consumptive entitlements at approximately $6.3 billion.
The estimated 2016-17 value of entitlements held by the Commonwealth Government in the sMDB as listed in Table 4 is approximately $2.1 billion. In line with the broader market, the value of this portfolio has more than doubled in value since 2013-14.
TABLE 4 ENTITLEMENTS ON ISSUE, ANNUAL PRICES AND ESTIMATES OF MARKET SIZE,
MAJOR SOUTHERN MURRAY-DARLING BASIN ENTITLEMENT TYPES, 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
2.4 ENTITLEMENT MARKET TURNOVER, LIQUIDITY AND RETURNS
In 2016-17, the market turnover value of major sMDB entitlement types was approximately $612 million – 16 per cent higher than in 2015-16. This increase has in part been driven by higher volumes of trade at higher values.
2016-17 market liquidity for major entitlement types varied from 2 to 11 per cent, with an average of 6 per cent – higher than in 2015-16. The sale of water allocations made to entitlements can deliver a financial yield or
return to entitlement holders, similar to property receiving annual rental returns. In 2016-17, average gross annual returns were between 1 and 4 per cent – or more than half that observed in 2015-16 (primarily owing to
much lower average annual allocation prices).
2016-17 returns are also low when compared to returns from leasing entitlements. Average annual returns from leasing entitlements are around 5 to 7 per cent – or 4 to 5 per cent higher than selling allocated water during 2016-17.
To address potentially low returns through allocation sales, many entitlement owners leverage carryover space leasing or the ability to structure forward products. For example, gross annual returns from leasing carryover space on
Vic LRWS at the end of 2016-17 were at or above 10 per cent (depending on cost price of asset).
TABLE 5 ENTITLEMENT MARKET TURNOVER, LIQUIDITY AND RETURNS, MAJOR SOUTHERN
MURRAY-DARLING BASIN ENTITLEMENT TYPES, 2016-17
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
2.5 AITHER ENTITLEMENT INDEX (AEI)
2.5.1 BACKGROUND
In May 2017, Aither officially published the Aither southern Murray-Darling Basin Entitlement Index (AEI) (Figure 11 over page). Like indices used in commodity and equity markets, the AEI provides a simple overall snapshot of how the major water entitlements in the sMDB are performing. Updated monthly and freely available, irrigators, investors, banks, and owners of water can use the AEI to benchmark the capital value performance of their water portfolios over time.
2.5.2 AEI VALUE
Between 2010 and 2013, the AEI (or the pooled value of major sMDB entitlements) declined by around 40 per cent (Figure 11 over page). This decline was partly driven by the breaking of the millennium drought, the Commonwealth
progressively exiting the market as a buyer for the environment, low allocation prices, and irrigators still looking to retire debt.
From a low in 2013 to the end of the 2016-17 water year, the AEI has more than doubled. This is primarily a response to drier conditions, and strong demand from irrigation industries –including the rapid development of the high value nut industry – and water funds (both water-only and water-agribusiness packages).
During 2016-17, entitlements continued to maintain and increase their value; however, the 4 per cent increase June 2016 to June 2017 was not as high as observed in previous years. Importantly, entitlement price increases during
2016-17 were despite a return to wet conditions and very low allocation prices. This highlights that buyers are seeing long-term value in the entitlements being purchased.
At the end of the 2016-17 water year, strong prices were being recorded across most sMDB water entitlement markets. Between June and July 2017, the AEI increased for the eighth month in a row – increasing by 1.79 points (1.28 per cent). The July 2017 AEI value of 141.86 represents a historical high.
2.5.3 AEI CONSTRUCTION METHOD
As part of our commitment to provide water market information in a way that improves market transparency and allows market participants to make more confident decisions, Aither has documented the method behind the
construction of the AEI in this report. We would be happy to discuss the method with our clients and all market participants.
ABOUT
The AEI tracks the performance (capital value) of a group of major water entitlement types across
the sMDB. The AEI is not an accumulation index.
SCOPE
The AEI covers the following entitlement types: NSW Murray HS; NSW Murray GS; NSW Murrumbidgee HS; NSW Murrumbidgee GS; VIC 7 Murray (Barmah to SA) HRWS; VIC 7 Murray (Barmah to SA) LRWS; VIC 1A Greater Goulburn HRWS; VIC 1A Greater Goulburn LRWS; VIC 6 Murray (Dart to Barmah) HRWS; VIC 6 Murray
(Dart to Barmah) LRWS; SA Murray (Class 3) HS.
TIMING
The AEI is calculated on a monthly basis and is indexed to 100 in July 2008. The index commenced from this date as this is when sufficiently reliable data became available.
PRICES
Historical monthly entitlement prices are calculated as volume weighted averages from state-based water register data (noting that Aither apply an algorithm to the raw database to clean data for $0 trades and other outliers).
Since June 2015, Aither has used prices based on monthly entitlement valuations that we undertake in-house (which in part are derived from register data but also broker quotes).
INDEX METHOD
The computation of the AEI uses a Tornqvist Theil Price Index method. This method requires the knowledge of both the price and volume of entitlement on issue for each entitlement type at each measurement period.
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
FIGURE 11 AITHER SOUTHERN MURRAY-DARLING BASIN ENTITLEMENT INDEX (AEI) , 2008-09 TO 2016-17
3.0. OUTLOOK FOR 2017-18
3.1 OPENING SEASON ALLOCATIONS TO ENTITLEMENTS
In 2017-18, opening season allocations were significantly higher than in 2016-17 (Table 6). The exception to this was NSW High Security and Vic LRWS entitlement types which received the same opening season allocations in 2017-18
as in 2016-17 (Table 6).
The higher 2017-18 opening season allocations are the equivalent of an additional 1,560 GL of water available to consumptive users on 1 July 2017 compared to 1 July 2016 (not including carryover). This volume of additional water
represents an approximate 200 per cent increase.
While the exact volume of 2016-17 carryover is not published at this point in time, Aither understands that from 2016-17 to 2017-18, consumptive users carried over between approximately 2,100 to 2,500 GL of water
allocations (based on broad estimates published by state governments).
This estimated volume of carryover, combined with opening season allocations, provided sMDB irrigators with between 4,400 and 4,800 GL of water in the first week of the current water year. To put this in perspective, total end of year (30 June) allocations to consumptive users in 2015-16 were only approximately 3,600 GL.
TABLE 6 OPENING SEASON WATER ALLOCATIONS TO ENTITLEMENTS, 2016-17 AND 2017-18
Source: Aither, 2017. Based on Victorian, New South Wales and South Australian water registers 2017.
3.2 ALLOCATION MARKET OUTLOOK
3.2.1 CURRENT MARKET CONDITIONS
As at mid-August 2017, water allocations across the sMDB are trading between approximately $100 and $140 per ML – with Vic 1A Greater Goulburn water allocations receiving the greatest discount due to limited trade connectivity.
Current sMDB water allocation prices are being driven by the following factors:
• Inflows to major sMDB water storages and rainfall across growing regions were well below long-term averages over June and July 2017. This, combined with a relatively dry outlook, is likely to influence future water allocation announcements, and play on the minds of both annual cropping and permanent planting irrigators.
• On the demand side, annual cropping irrigators are primed for a big season (for example estimates of between 50,000 and 70,000 ha of cotton in the Murrumbidgee). So opening allocation prices of around the $100 per ML mark were not unexpected. These irrigators are also waiting for increased certainty about 2017-18 allocations to entitlements before making final production commitments (potentially looking at 1 September allocation announcements to make a final decision).
• Some annual cropping irrigators and other owners of water allocations, including investors, are waiting and considering at what price they may become sellers – with irrigators comparing the returns from production against the value of the water, and investors trying to pick the top of the market. During July 2017, this had the effect of limiting allocation market depth.
• At allocation prices above approximately $130 to $150 per ML, some rice growers were expected to become sellers of water allocations rather than produce. As sMDB allocation prices reached this mark across August 2017, sellers have come into the market, causing the allocation market to settle.
• Off the back of record low June and July rainfall totals across much of the sMDB, rainfall over the first half of August 2017 is likely to have cooled the allocation market coming into the second half of August 2017.
• On the other hand, cotton growers (primarily in the Murrumbidgee), can still make good margins at allocation prices between $150 and $200 per ML, and will therefore still be in the market as buyers for a while to come.
• Buyer demand over the next few months will hinge on the amount of cotton production commitments with unsecured water and the needs of permanent planting enterprises to buy allocation water either to use this year
or to carryover.
• The extent to which the Vic Goulburn dairy industry can supply the connected sMDB water allocation market, which is currently restricted, will also be important as this trade is becoming increasingly vital to meet the allocation water requirements of permanent plantings in the Sunraysia Region.
3.2.2 ALLOCATION PRICE FORECAST
In previous reports, we have used our water allocation price model to estimate allocation prices for the sMDB. For this version of the report we have applied this same model to estimated 2017-18 average annual sMDB water
allocation prices.
PERFORMANCE OF MODEL FOR 2016-17
For the 2016-17 water year (last year), we estimated that under average conditions an average annual sMDB water allocation price of around $170 per ML would be expected and if wet conditions prevailed an average price of
around $135 per ML would be expected (Aither 2016b). We also estimated that if observed rainfall was substantially higher than median, an average annual price of less than $100 per ML would be expected.
An average annual price for the sMDB of around $50 per ML was observed in 2016-17, which is lower than Aither’s estimates based on outlooks available at the time. However, given the record high rainfall observed and very high allocations to entitlements, the annual average price of $50 per ML that was observed is not unexpected. Rerunning our model with observed climatic data for 2016-17, the model estimates a price of $70 per ML for that year – which is
approximately $20 per ML higher than the actual observed price.
The $20 per ML difference between the 2016-17 modelled price and observed price is likely caused by lower than expected irrigation water demand from different industries (based on the historical record). For example, lower irrigation demand based on an inability to plant annual crops due to flooded fields may not be fully captured by the model.
OUTLOOK FOR 2017-18
From a supply perspective, in 2017-18 we expect between 5,500 and 6,250 GL of water to be available for consumptive use across major sMDB systems – this is based on carryover into the current water year and conservative expectations about end of season allocations to entitlements. This volume of water available for consumptive use is high. When combined with median annual rainfall, such volumes of available water do not support annual average
sMDB allocation prices above $100 per ML (based on historical outcomes).
Based on allocation scenarios adopted from state authority outlooks (dry, average and wet), the model estimates an annual average price of approximately $50 per ML under a wet inflow and rainfall scenario (which is now an unlikely
scenario for 2017-18); $80 to $95 per ML under an average inflow and rainfall scenario; and approximately $100 to $120 per ML under a dry inflow and rainfall scenario.
Based on current demand for water allocations and if it remains dry and irrigators start securing water for 2018-19, current allocation prices ($100 to $140 per ML) may hold as the 2017-18 irrigation season develops. However, prices
could equally drop below $100 per ML if August rainfall continues into spring. At the time of publication, we are seeing early signs of a softening in demand in the allocation market, especially in the Victorian Goulburn market.
Planning for the 2018-19 water year and beyond will also become increasingly important in determining average annual allocation prices during the current water year. If large volumes of water are used in 2017-18 and storages are
not replenished, there will be concern about the availability of water in the 2018-19 water year. This scenario could cause increases in allocation prices (for carryover) and add to interest in carryover leases or the purchase of entitlements with carryover characteristics. This scenario may also further mature the allocation forward market.
3.3 ENTITLEMENT MARKET OUTLOOK
During mid-August 2017, market intermediaries are reporting a steady to slightly upward trending entitlement market – with continued strong interest in New South Wales, South Australian and Vic 7 Murray entitlement types.
The growth in water entitlement prices over the last four years has been driven by long-term interest from investors and corporate agricultural enterprises, resulting from opportunities for land use change in cotton and nuts.
Aither continues to expect strong interest for all major entitlement types in 2017-18. We also expect that higher allocation prices in the 2017-18 water year will increase financial returns to entitlements, and this may increase investor confidence thereby sustaining current entitlement prices which are at record-high levels.
After three years of rapid price growth, the limited capital growth in 2016-17 reflects market sentiment, with many buyers considering higher reliability entitlements to be close to or fully valued, despite the additional horticultural
development underway.
Aither’s view is that capital growth over the next few years will be modest under most scenarios, but that returns to entitlement holders could increase and stabilise as large agricultural enterprises seek enhanced supply security
through leases, forwards and carryover products. Our view would be more optimistic given the opportunities for further land use change, but is tempered by uncertainty over the ultimate development potential for permanent
plantings in the Sunraysia region.
3.4 BASIN PLAN UPDATE – AUGUST 2017
3.4.1 BACKGROUND
It’s been an eventful year for the implementation of the Basin Plan. However, behind all the headlines, the fundamentals have not changed and important progress has been made. We are almost there.
• Over 2,080 GL (Long Term Average Annual Yield - LTAAY) of water has been recovered for the environment.
• In June 2017, Basin states and the Commonwealth agreed to in excess of 600 GL of Sustainable Diversion Limit (SDL) offsets or adjustments, subject to a final round of assessment and modelling that may result in a total of 650 GL.
• The Northern Basin review has been completed. It resulted in some adjustments to water recovery requirements and enhanced acceptance of the Plan among many stakeholders without significantly jeopardising attainment of environmental targets.
• Together, this means that the core water recovery target of 2,750 GL (LTAAY) (about a 20 per cent reduction) can be achieved without any substantive additional water recovery including buybacks.
The recent strategic purchase of Lower Darling entitlements from Webster Ltd at Lake Tandoucontributed to the direct recovery target but was also an important enabler of a major SDL offset project at the Menindee Lakes.
Overall, progress to date with the Basin Plan represents a significant achievement in placing total extractions in the Murray-Darling Basin on a more sustainable footing. For water users, this water recovery has been undertaken without compromising the reliability or legal security of existing rights, and it provides additional certainty and confidence into the future.
Notwithstanding debate and concern over some important issues, and overall progress being slower than many would have liked, the Basin Plan is a significant reform in the management of Australia’s natural resources. While often viewed as a debate about numbers, the Basin Plan is more fundamentally an agreement for a long term adaptive
management approach aimed at enhancing the economic, social and environmental value of water resources across the Murray-Darling Basin.
The scale of this type of reform has not been contemplated elsewhere in the world. If implemented well, the Basin Plan provides an important platform for effective interjurisdictional water management. The requirement for the states to put in place accredited Water Resource Plans by 2019 further strengthens the planning, entitlement and market based framework envisaged in the National Water Initiative.
The states and the Australian government have all agreed to implement the Basin Plan requirements and there is bipartisan political support.
3.4.2 CURRENT TENSION POINTS
The Water Act (2007) provides for the recovery of an additional 450 GL of water (‘upwater’) within the Murray-Darling Basin by 2024, above and beyond the 2,750 GL to be recovered by 2019 under the Basin Plan. This water was
intended to be recovered through government investment in on-farm water efficiency measures. However, unlike the 2,750 GL, it can only be recovered if the impacts of recovery are “socio-economically neutral”. It was never a pre-determined agreement that this additional water recovery would be fully implemented. Some stakeholders want it implemented in full. Others don’t want it implemented at all. There is vigorous and important debate going on about
the merits of pursuing the upwater program.
In accordance with our role as independent advisors, Aither undertook a review of the socio-economic neutrality clause in 2017. As outlined in our recommendations, we hope that an agreement can be reached based on a
transparent assessment of the full and aggregate costs and benefits of the upwater program. Such an assessment should draw on the wealth of insights from experience generated by various stakeholders over the last two decades.
For example, there are several lessons to be learnt from previous experience with design and management of on-farm efficiency programs, concerns about the scale and extent of additional viable on-farm opportunities given
the level of work already undertaken, and concerns about the broader implications for water demand, irrigation distribution systems, and adjustment across the Murray-Darling Basin. From an environmental perspective, additional ecological benefits need to be considered in the context of system constraints and the future operating environment created by the SDL offsets projects.
3.4.3 NEXT STEPS
Looking ahead, we expect debate about the upwater program to continue into 2018, and for new challenges to emerge over the implementation of offsets and constraints management projects. We also expect states to
make progress in the development of Water Resource Plans and other requirements specified in National Partnership Agreements, in addition to effort that might be directed towards issues highlighted by recent media attention.
REFERENCES
Aither 2016a, Supply-side drivers of water allocation prices in southern Murray-Darling Basin, available at
<http://agriculture.gov.au/water/markets/supply-side-drivers>.
Aither 2016b, Aither Water Markets Report 2015-16 review and 2016-17 outlook
<http://www.aither.com.au/wpcontent/uploads/2016/08/Aither_WaterMarkets Report2015-FINAL-5Aug2016.pdf>.
Bureau of Meteorology (BoM) 2017, available at http://www.bom.gov.au>.New South Wales Water Register 2017, available at <http://www.water.nsw.gov.au/waterlicensing/registers>.
South Australia Water Register 2017, available at <https://www.waterconnect.sa.gov.au/Pages/Home.aspx>.
Victorian Water Register 2017, available at <http://waterregister.vic.gov.au>.
ABOUT AUSTRALIA’S WATER MARKETS
Australia’s water markets are comprised of two distinct but related markets – the entitlement market, and the allocation market. There is no single national market for these products, but rather a number of individual separate markets. Where hydrological connectivity exists, such as in the southern Murray-Darling Basin, trade between these markets is possible.
• Water entitlements are ongoing rights to receive a share of available water resources in a consumptive pool. They are analogous to a land property right, are generally secure and mortgageable in the same way, and have substantial value. Each catchment typically has a small number of entitlement ‘classes’, and generally all entitlements within a given class are homogenous.
• Water allocations are the volumes of water allocated to water entitlement holders during the water year (1 July to 30 June). They are a physical good analogous to a commodity and are extracted from water courses and applied as inputs to production or the environment. Their value per unit varies within and between years.
ALLOCATION MARKET
PURPOSE, USE AND OPERATION
The allocation market provides the ability to trade physical water between parties for use, further trade, or carryover. Allocation trade can generally only occur between parties that are hydrologically connected such that water can be delivered between them (or substituted by other water from a shared storage).
The water allocation market is mainly used by irrigated agricultural producers (including rice, dairy, horticulture, cotton and others), and environmental water managers. Irrigators use the market to sell water excess to requirements or buy additional water in during dry periods or when temporarily expanding production. Environmental water holders may similarly buy or sell when they have short-term surpluses or deficits.
State government regulators determine annual allocations based on entitlement characteristics (which determine priority and how much water is allocated to individuals), and market rules to manage issues such as connectivity between systems and transmission losses. State government, either directly or via their water utilities, play a key role in facilitating allocation trade, including ensuring compliance with rules and regulations, and by approving and processing trades. Parties seeking to trade allocations may utilise intermediaries such as water exchanges and brokers.
KEY DRIVERS OF MARKET OUTCOMES
The amount of water allocated to entitlement holders each year is a key driver of allocation market outcomes (including prices and volumes traded), because it strongly influences the total amount of water available for use or trade. When allocations are low, water is scarce and prices are high, and the opposite is true when allocations are high. Allocation levels reflect broader water availability, including rainfall and inflows in relevant catchments, and volumes held in storages. Other key drivers in allocation markets include conditions in markets for irrigated agricultural products, and conditions in substitute input markets.
ENTITLEMENT MARKET
PURPOSE, USE AND OPERATION
An entitlement specifies an annual volumetric share of available resources in a given catchment or water system, which the holder will receive as water allocations, subject to rainfall, inflows, water held in storage and other factors. The entitlement market enables trade in the ongoing right to receive these water allocations. Entitlements can be held by virtually any party in any location, but water use is tied to site-specific regulatory controls, and inter-valley or interstate trade is contingent upon hydrologic connectivity and other factors. The nature of entitlements differs significantly
between those catchments with large amounts of water storage infrastructure (called ‘regulated’ systems) and those without (‘unregulated’ systems).
Most entitlements within the Murray-Darling Basin are regulated. The entitlement market is also largely used by irrigated agricultural producers, but is increasingly being used by investors, water utilities (including urban suppliers) and environmental water holders. These users use the market to modify their long-term arrangements for facilitating production, or meeting environmental requirements, or urban demand. Trade in entitlement is often also driven by the need to manage risk associated with securing supply, and may also occur due to changes in business strategy or structure (such as retiring debt).
Similar to the allocation market, state government agencies govern the operation of the entitlement market, including rules and regulations regarding how and where trade can occur. Depending on the jurisdiction, other agencies (such as land titles or property registration agencies) will be involved, given entitlements’ nature as a secure property right. Third-parties (such as exchanges, brokers and conveyancers) often play a role in facilitating entitlement trade.
KEY DRIVERS OF MARKET OUTCOMES
The value (and price) of water entitlements is largely determined by their reliability characteristics, which differ between each entitlement class. Higher reliability entitlements provide greater water allocations over the long-term, and more consistently provide water allocations each year. Generally, these two characteristics are linked. Entitlements with a high reliability will typically be priced highly.
This reflects both high reliability entitlements’ increased allocations and the premium placed on water supply security by industries such as horticulture that cannot afford to experience high variability in supply. In investment terms, entitlement reliability directly influences the likelihood that yields can be achieved in the short and long-term.
Trade in entitlements is related to longer-term production decisions and the characteristics of different irrigated agricultural enterprises, including their tolerance for risk. Producers who may be expanding or contracting production drive market activity, as do investors or larger scale enterprises that may hold entitlements and facilitate new models of irrigation farming based on trading annual allocations rather than holding entitlements. Purchases of water on behalf of the environment have also driven market activity in recent years.
NOTES
DATA CLEANING METHOD
There are limitations associated with water trade information reported in the state-based registers, specifically the timeliness and accuracy of reported prices. To filter out outlier prices and generate robust statistics about market activity, Aither uses a proprietary and tested data cleaning method. Aither uses its data cleaning programs to analyse Aither’s southern Murray-Darling Basin water trade database which includes over 215,000 individual allocation and entitlement trade records.
There continues to be potential for further improvements in water markets data and in the efficient operation of water markets. In addition, state water registers remain unable to separately report transfers between environmental holdings or related parties, which complicates analysis of allocation and entitlement trade volume and price.
IRRIGATION CORPORATION TRADE DATA
Some water trade occurs within private irrigation corporations and districts, for which detailed data is not generally publicly available. Due to these data availability issues, Aither has excluded trades within irrigation corporations from all analysis within this report.
ROUNDING ERRORS
Rounding errors may result in slightly different numbers being presented in this report as can be calculated from raw data and calculations.
TABLE NOTES
Table 1A: All reported trades are included in all calculations. Total net trade calculations will not necessarily equal zero because some connected systems are not included in this analysis. Victorian data includes an adjustment for pooled accounts and reflects information available on the public Victorian Water Register.
Table 1B: Trades with a reported price greater than $0 per ML are included in all calculations. Total net trade calculations will not necessarily equal zero because some connected systems are not included in this analysis. Victorian data includes an adjustment for pooled accounts and reflects information available on the public Victorian Water Register.
Table 2: Aither has applied a cleaning methodology to remove outlier and $0 trades before calculating volume weighted average prices prices.
Table 3: Outlier entitlement trades have been excluded from price calculations. All reported trades are included in calculations of number and volumes of trade.
Table 4: Estimated environmental entitlements are based on the reported holdings of the Commonwealth Environmental Water Holder. Size of market calculations are based on total entitlement on issue minus
estimated environmental entitlements multiplied by volume weighted average price for a given entitlement type.
Table 5: All reported trades are included in calculations of number and volumes of trade. Estimated turnover value calculations are based on total volume transferred multiplied by annual volume weighted average price for a given entitlement type. Liquidity calculations exclude water allocated to entitlements held by environmental water holders (see note in Table 4). Yields are presented in gross terms; they do not account for any fees or charges associated with holding entitlements or trading allocations. In zones which received 0 per cent water allocation for the 2016-17 water year, no yields are recorded because it was not possible to trade water allocations not received (carryover water would be an exception, but this has been excluded for simplicity).
FIGURE NOTES
Figure 1: No trades are excluded on the basis of reported price. However, only ‘within’ and ‘into’ allocation trades have been included in volume calculations. ‘Out of’ allocation trades have been excluded on the basis that it would double count trades between zones. Data for Victoria included from 2007-08. Data for South Australia included from 2009-10.
Figure 2: Aither has applied a cleaning methodology to remove outlier and $0 trades before calculating volume weighted average prices. No trades are excluded on the basis of reported price from volume calculations. Only ‘within’ and ‘into’ allocation trades have been included in volume and price calculations. ‘Out of’ allocation trades have
been excluded on the basis that it would double count trades between zones.
Figure 3: Aither has applied a cleaning methodology to remove outlier and $0 trades before calculating volume weighted average prices. No trades are excluded on the basis of reported price from volume calculations. Only ‘within’ and ‘into’ allocation trades have been included in volume and price calculations. ‘Out of’ allocation trades have
been excluded on the basis that it would double count trades between zones.
Figure 4: Outlier allocation trades have been excluded from price calculations. Scatter plot data points include all reported trade.
Figure 6: Weather stations used are as follows: Albury Airport AWS 72160; Deniliquin Airport AWS 74258; Mildura Airport 76031; Renmark Irrigation 24003; Shepparton Airport 81125; and Yanco Agricultural
Institute (Leeton) 74037.
Figure 7: Water allocated to Commonwealth Government water purchases are based on announced allocations to reported holdings of the Commonwealth Environmental Water Holder.
Figure 8: Outlier allocation trades have been excluded from price calculations. Scatter plot data points include all reported trade. Water allocated to Commonwealth Government water purchases are based on announced allocations to reported holdings of the Commonwealth Environmental Water Holder.
Figure 9: Aither has applied a cleaning methodology to remove outlier and $0 trades before calculating volume weighted average prices. No trades are excluded on the basis of reported price from volume calculations.
Figure 10: Aither has applied a cleaning methodology to remove outlier and $0 trades before calculating volume weighted average prices. No trades are excluded on the basis of reported price from volume calculations
