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'buybacks' and their use to secure environmental flows - National ...

'buybacks' and their use to secure environmental flows - National ...

Box 1: An overview of

Box 1: An overview of the ABARE analysis of the use of options in the Murrumbidgee River (Hearney, Beare and Hafi 2004) ABARE used the Murrumbidgee River as a case study to assess the effectiveness of using options contracts to meet the environmental objective of recreating floodplain floods in winter and early spring. The options contract was designed around irrigators selling that part of their water allocation that was in excess of a specified level. For example, an irrigator with 100 ML could write an options contract to sell any water above 90 ML. In years with limited water, this threshold would not be reached, but in wet years, 10 ML would be sold. The timing of the option also needs to be considered. ABARE indicate that an option that was exercised early in the season could be used immediately whereas an option exercised late in the season could be carried over in storage for use later in the year. In this sense, the option takes the form of a volume trigger and specifies a point in time that it would be exercised. An option fee and price need to be established. An option fee is paid regardless of whether the option is exercised. The option price represents the opportunity cost of forgoing the water from agricultural use. ABARE developed the Murrumbidgee River Options Model, a model of the hydrological system, storage and delivery of water and the associated agricultural production in order to assess how the timing of a contract affects the volume and cost of the water transfer. The contract that was analysed was a 1 August water allocation of above 80, 82.5, 85 and 87.5 per cent of an irrigator’s licensed entitlement. For an option written against 85 per cent of water allocation, the results indicate that the option would be exercised on average 3 in 10 years. ABARE conclude that apart from being more cost effective than the purchase of permanent entitlements, using options contracts has the advantage of allowing irrigators to keep their permanent entitlement as a hedge against the risk that the pool of water resources available to irrigators will decline in the future. English et al (2004) found that if counter cyclical trading was used to manage the objectives of the Barmah-Millewa environmental allocation, the cost could be as low as 18 per cent of the value of the permanent entitlement. That is, it is more cost effective to sell water allocations under a small holding of environmental entitlement in years when it is not needed, and to purchase additional water in years when it is required, rather than to hold a larger number of entitlements without trading. An illustration of this temporal variability of demand was prepared by the MDBC through a simulation of how 500 GL could be used to water four Living Murray icon sites over an eight-year period (see BDA Group 2006). The results of the simulation are shown in Figure 1. This simulation showed that in excess of twice the long term average of 500 GL may be required in some years, whereas relatively little was required in others. Natural resource ‘buybacks’ and their use to secure environmental flows BDA Group 16

Figure 1: Simulation of use of environment water over 8 years across four icon sites. Lower Lakes, Coorong and Murray Mouth Chowilla Floodplain New environmental water used (GL) 1400 1200 1000 800 600 400 200 0 Gunbower Koondrook-Perricoota Forest Barmah-Millewa Forest 500 GL of high reliability water 95/96 96/97 97/98 98/99 99/00 00/01 01/02 02/03 Year An analysis using water price data from the Murray Irrigation Limited irrigation area indicated that the cost of meeting this environmental need through permanent entitlement purchase would be four times as much as the cost of purchasing water (seasonal allocations) only in years when it was required. 2.2 International studies and experience with water buybacks It is common in some western states of the United States and in South and Central America for water managers to utilize the market to achieve both environmental flow objectives and meet urban demands. This is both through permanent purchase, and more recently through a range of derivatives products. Some western States of America have a long tradition of using markets to exchange water between irrigators and urban areas. Many of these exchanges have been focused on the permanent purchase of rights. For example, the city of Denver in the State of Colorado began purchasing water in 1925 (Hartman and Seastone 1970). Hartman and Seastone (1970), however, indicate that the regulatory structure in some states prohibited larger volumes being exchanged. For example, in Colorado, applications to transfer needed to go through the court system to ensure that a change in diversion would not be to the detriment of established water rights. This involves taking into account the difference in return flows (ie, only consumptive use can be exchanged) and ensuring that the change in the point of diversion does not impact on other users. Wiley (1992) writing more than a decade ago indicated that some transfers were beginning in the US between irrigation and environmental users. A number of trusts have been established with environmental objectives. For example, the Oregon Water Trust is a not for profit organisation that purchases water on the open market to use for instream flow purposes (mainly the maintenance of fish habitats). The Nature Conservancy of Colorado is a public trust that purchases water for in-stream uses (Crouter 2003). In Nervada, legislation was enacted to acquire water rights for wetlands and fisheries (Wiley 1992) during the early 1990’s. In California, legislation was enacted to obtain water supplies for wetlands and in the Pacific Northwest, short term leases have been used to protect the migratory habitats for salmon. Washington and Montana also have trusts focused on environmental objectives (ACIL Tasman 2003). Natural resource ‘buybacks’ and their use to secure environmental flows BDA Group 17

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