A bubble in Australia’s water markets?

Prices for both water entitlements and allocations are at record levels. Investors rejoice, but cotton, rice and dairy producers are feeling the squeeze.

Dry conditions in south-eastern Australia have pushed water prices up to the extent that cotton, rice and dairy producers could suffer in the next 12 months, according to a water market expert.

Chris Olszak, director at consultant Aither, told Agri Investor that a dry fall and winter in 2018 has pushed water prices up so that there are “some concerns” for the outlook of irrigators in the south-east of the country if there is no significant rainfall in the coming months.

Water allocation prices have spiked from their average of A$100-$140 ($73-$103; €62-€88) per ML last year to above A$300 per ML now, with prices in the Murrumbidgee region hitting more than A$350 per ML in recent months.

“At that price it becomes pretty hard for cotton [producers] to make money, even with their good commodity price conditions,” Olszak said.

This could see more water ending up in the hands of permanent planters, like almond producers, who can afford to pay higher prices due to the necessity of keeping their trees alive during drought.

Olszak was speaking as Aither published its annual Water Market Report, which summarizes water trading activity and trends in the southern Murray-Darling Basin. It monitors the prices of both water entitlements and water allocations.

Water entitlements are ongoing rights to receive a share of water from a particular catchment or system, while water allocations are the volumes of water assigned to individual entitlement holders during the water year (July 1 to June 30). The entitlement market enables trade in the ongoing right to receive water allocations, while the allocation market enables the trading of physical water between parties.

High allocation prices, as are currently being seen, mean that it is harder in a given year for irrigators to secure the water they might need, as many rely on the allocation market for their water.

“We expect in 2018-19 there will be enough water available for permanent plantings, as well as some cotton and some dairy, but it’s getting tight – and if it doesn’t rain over the next couple of months, there’ll be real concerns about the next season,” Olszak said.

The entitlement market has become popular with investors in recent years and average prices there have also increased dramatically in the last 12 months, with capital values rising by around 29 percent overall and almost tripling over the last five years. This has led to a “huge influx” of investment into the entitlement market, Olszak said.

No cooling down

Yields have been relatively low, though, he added, with the ‘rental’ income from selling back allocations from entitlements averaging around 4 percent last year.

“But when combined with the huge capital growth, that’s still a fantastic result for those who’ve owned water entitlements,” Olszak said.

“The key question is whether entitlements are overvalued or will the capital growth continue? And will the annual returns of selling or leasing allocations increase up to the point where you get yields that investors are looking for?

“We think there is a natural limit on that based on the value of water in high-value irrigation. What we hear from many developers of permanent plantings, for example, is that the entitlement market is not looking very attractive to them at the moment because prices are so high – they struggle to see the value compared to leasing or buying in the spot market to meet their water requirements.

“But this could change – and this year is really important, because the allocation market has peaked to over A$350 per ML and those annual returns from selling your allocations will actually look pretty good.”

Turnover in entitlements is also low, meaning that buyers must pay high prices to prise them away from holders. “We’re not seeing any signs in the market, at all, that the entitlement market is cooling down – it’s still very hot,” Olszak said.

This could eventually lead to some producers, particularly in rice and dairy, consider making long-term adjustment decisions and selling their entitlements – but demand is such that even this is unlikely to dampen prices.

“If we don’t get rain in the next couple of months, prices will be high, and that will cause a fair bit of pain across some of the irrigators out there. On the flip side, it will be very good for investors and sellers of water, who are continuing to see entitlement markets increase,” Olszak said.

“The question is: how long can that continue for?”