A week is a long time in Australian water

The Australian government’s proposed intervention in Murray-Darling Basin water markets should be good news for investors in terms of values – but it may come with additional scrutiny should weather conditions get drier.

Investing in Australian water entitlements has proved to be a good decision for many investors, with funds generating consistently solid and steady returns.

But the events of the past couple of weeks have served as a reminder of how politically exposed the asset class is – even if it appears unlikely to have any negative effect on returns.

If you missed it: the Australian government reached an agreement with all the states and territories that cover the Murray-Darling Basin (except Victoria) to deliver the Murray-Darling Basin Plan “in full.” The most contentious part of this has been a reaffirmation of a commitment to secure 450GL of water for the environment and an alteration of the rules to allow the government to do this by entering the market and purchasing the water (as opposed to only pursuing efficiency projects).

It doesn’t take a great leap to come to a conclusion about what effect this is likely to have on water prices. The government will reduce the consumptive pool of water that irrigators can use at the same time that demand is continuing to increase and become more permanent in nature, due to a shift in the types of commodities being grown (almond trees that require water every year, for example, versus annual crops like cotton or rice).

With less water combined with the same or higher demand, prices will surely rise, sooner or later.

The other elephant in the room is the looming presence of El Niño, which while yet to be officially declared by Australia’s Bureau of Meteorology, is set to lead to hotter and drier conditions this southern hemisphere summer.

Water storages in the MDB are at record levels after several very wet years, which may reduce the impact this summer, but a change away from wet conditions would inevitably lead to higher water prices, as the amount in the system reduces accordingly and allocations go down.

This was cited as a “nightmare scenario” by one source Agri Investor spoke to in our in-depth examination of water markets last week.

The last time Australia’s eastern states saw an extended drought and water prices shot up, investors copped a lot of flak in the media and from certain sections of the farming community, with accusations flying around that they were speculating in the market and driving up the cost of the water.

The pressure built to such an extent that the Australian Competition and Consumer Commission took a closer look, eventually producing a report that cleared investors of wrongdoing (while also calling for more market transparency, it should be said).

Then the rains came, and as usual the headlines and the breathless media coverage subsided.

It’s easy to imagine a situation where dry conditions combine with extensive intervention in the market by the government to cause a spike in prices again, perhaps to new highs – and then investors could become the unwitting scapegoats again.

It is worth remembering the words of Cullen Gunn, CEO of Kilter Rural, who last week told Agri Investor: “The only way you make money out of water is by leasing it or selling it to clients. That’s our job – to deliver water products to really good clients so we sustain their business and deliver a sustainable return to our investors. There are thresholds set around that. We’re not trying to rapaciously rip off clients, that’s not our game.”

Agri Investor has already heard from several market participants that trade in water entitlements has tightened, even if only slightly, since the government’s announcement – and they haven’t even started buying it yet.

The full effects remain to be seen, but the underlying thesis behind investing in water still looks to be very solid.