Australian water tensions increase and give investors pause for thought

With NSW threatening to tear up longstanding water-sharing agreements, institutional investors are questioning whether the headline risk that comes with water investment is worth the consistently strong returns.

Passions are running high in eastern Australia, with a group of farmers descending on Canberra last week to set up a ‘water embassy’ outside Parliament House, calling on ministers to intervene over high water prices.

The Australian Competition and Consumer Commission’s inquiry into water markets in the Murray-Darling Basin is ongoing, with public hearings taking place across four states in the last few weeks.

And in perhaps the most alarming development, divisions between the states over longstanding water-sharing agreements appear to be deepening and hardening. New South Wales Nationals leader and deputy state premier John Barilaro has repeatedly warned the state could unilaterally walk away from the Murray-Darling Basin Plan, over concerns about the amount of water that NSW has to give up to the environment relative to other states.

The Sydney Morning Herald also reported this week that the NSW government has obtained legal advice on tearing up its participation in the Murray-Darling Basin Agreement, the legislation passed in the 1980s (and incorporated into the 2007 Water Act that established today’s water market) that sets out the share of water each basin state is entitled to.

Tensions between the states are set to come to a head at a meeting of the MDB Ministerial Council next week, a body comprising state and federal water ministers that has the ability to amend the MDB Agreement – although it seems highly unlikely other states will agree to receiving less water to appease the NSW Nationals.

It’s not clear what it will look like if NSW decides to withdraw from the agreements. Some experts have argued it would have no impact at all on water availability in the short term, but it would be highly damaging to inter-state co-operation on an issue that is vital to the health of Australian agriculture.

For investors, these ugly arguments contribute further to the sense that water as an asset class, while still achieving high returns for those who have invested in it, is increasingly being weighed down by unacceptable headline and regulatory risk.

Much of the recent Australian media coverage singling out so-called ‘water barons’ has been highly unfair, with accusations of market manipulation difficult to reconcile when the amount of water held by any one company makes up only a small fraction of the overall water entitlement available.

But Agri Investor has heard anecdotal accounts of several institutional investors who have expressed unwillingness to invest in Australian water in the current climate, and we know of at least one Australian superfund that has sold out of its water holdings entirely in recent months because of the headline risk.

These negative headlines, whether asset managers think they are fair or not, have an impact on public perception – and it’s clear that this is filtering through to some institutional investors.

The pressure also increases the risk of the regulator or the federal government changing the rules on the water market.

Yes, permanent water rights belong to those who hold them in perpetuity, and it seems unlikely in the extreme that the Australian government would just look to take those back or unwind the system entirely. And it’s reasonable to argue the market is operating as it was set up to do, with water moving toward its highest-value use.

But it really isn’t outlandish to imagine changes being made to the market that make trading more difficult or that affect the value of water in other ways.

A fully transparent register of who owns what water, to give one example, would be unwelcome in some quarters and could put further investors off.

This is all cyclical, of course, and should it rain many of these arguments will be washed away until the next prolonged drought. But the evidence suggests that rain isn’t imminent, and the next prolonged drought will come sooner rather than later and last longer than it has in the past.

It may be that investors in standalone water will have to accept that heightened reputational and headline risk is part and parcel of the asset class, which is a challenge that asset managers will increasingly have to navigate.

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