Australia’s water minister Tanya Plibersek made an announcement with more than a little fanfare last week: her government had reached an agreement to extend the delivery deadline of the Murray-Darling Basin Plan.

But the new agreement has been received with concern by some of those involved in Australia’s water markets, whether they manage water funds or use water for irrigation.

To understand why, it is important to look at the background.

The MDB Plan is a landmark bipartisan agreement between the Australian Commonwealth government and all the states and territories that cover the MDB: New South Wales, Queensland, Victoria, South Australia and the Australian Capital Territory.

Passed by the Australian Parliament in 2012, the plan essentially restricts the amount of water that can be taken from the river systems of the MDB each year, setting aside a certain amount for the environment while balancing this with the socioeconomic health of communities in the region.

The plan initially set a target of 2,750GL for environmental water recovery, to be achieved through direct means such as the Commonwealth government entering the market and purchasing water entitlements, as well as efficiency measures and water resource plans. This was later reduced to reduced by 70GL to 2,680GL following a review – a reduction that the South Australian government, on whose territory the Murray River meets the sea, agreed to in exchange of adding a target of recovering a further 450GL for the environment.

When Anthony Albanese’s government won power in 2022, included in its policy platform was a pledge to deliver the MDB Plan “in full”, which included the extra 450GL for the environment.

In July 2023, the Murray-Darling Basin Authority, the independent statutory agency responsible for water resource planning and management across the MDB, said the legislated deadline for its delivery of June 30 2024 would be missed. Part (although admittedly not all) of the reason for this was the challenge in securing this last 450GL for the environment.

This brings us to last week’s announcement, where Plibersek struck what she described as “an historic agreement” with the MDB Basin states and territories, except Victoria, that will see the MDB Plan delivered “in full”, as she had promised.

The agreement includes a tweak to the Commonwealth government’s powers around how it can secure the last 450GL it needs. Under the current settings prior to the reworked agreement, the 450GL had to be recovered through what are known as efficiency measures: projects that reduce water lost through irrigation, commercial use or other public supply infrastructure, while maintaining or increasing productivity and ensuring neutral or positive socioeconomic impacts on communities in the MDB.

The new agreement changes this, with “all options on the table” to recover the 450GL, as its text puts it.

This includes a return of the often-controversial water buybacks made by the Commonwealth government, which if pursued to its full extent will represent a major divergence from previous policy, likely to materially affect both communities in the MDB and the long-term value of water.

The cost of buybacks

Agri Investor has heard from several water market participants that the Commonwealth government has been in listening mode since coming to power, gauging whether it would be possible to secure the 450GL through buybacks (if even only a portion of it).

The answer the government has received has generally been the same: theoretically, yes. But at what cost?

“We’re now dealing with an irrational buyer in the market, with a very big checkbook,” says Rob Brooks, chief investment officer of goFARM Australia, speaking in a personal capacity.

“They are driven by political outcomes, not commercial or agricultural outcomes. They might have some idea about the cost, but they might have to spend somewhere in the range of A$15 billion ($9.6 billion; €8.9 billion) to A$20 billion to finish this off [through buybacks]. Those are insane numbers to spend on the recovery of water,” Brooks says, pointing to the fact that the MDB Plan’s original budget for its entire implementation, including buybacks, efficiency projects and everything else, was A$13 billion.

Another asset manager with extensive experience in water markets, who does not wish to be named, echoes this and questions whether this will be the best use of public money: “They haven’t said how much they are going to be spending – it’s an unknown amount.”

This asset manager points out it is not as simple as calculating the cost of water and multiplying that by 450GL, pointing to what they believe is a precedent set in 2017, when the Commonwealth purchased almost 22GL of water entitlement from Webster Limited at roughly twice the rate it was recommended to pay by the Australian Bureau of Agricultural and Resource Economics and Sciences. Webster had used the water to grow cotton; after the sale, it used the farm as a feedlot.

“There was a hullabaloo at the time because many felt they had paid too much for the water. But they had to pay it because Webster wanted compensation for shutting down their operation. That’s what irrigation farmers will contemplate. It’s not just selling water rights – it’s switching off parts of their farm businesses that they may never be able to pursue again,” the fund manager says.

And Brooks points out another issue: the government will likely need to purchase more than the headline 450GL figure.

“It’s not entitlements [they need] – it’s long-term reliability. You might have 450GL to get back, but it must be ‘wet water’ recovery. You might end up needing to buy, say, 600GL of water to get 450GL of ‘wet water’,” he says.

“Even if it were just 500GL they have to buy, to put that in perspective: that is all the water that South Australia is allocated for agriculture every year. That is a very material amount of the water that is left over.”

And there is a huge question over whether it is even practical to secure the 450GL through buybacks, with consultancy Aither’s most recent Water Markets Report revealing the four-year average of annual water entitlement commercial turnover is less than 100GL LTDLE (Long Term Diversion Limit Equivalent) per annum  – in nominal terms it is higher.

Aither water markets advisory lead Ben Williams says: “Anything over 200GL is going to be challenging [for the government to purchase] in a three-year timeframe, depending on what types of entitlements they try to acquire.”

Impact on water prices

All this points to one logical outcome, according to everyone you speak with that is involved in MDB water markets or irrigation farming: water prices are going to go up.

“These are big, big volumes to recover,” says Cullen Gunn, CEO of Kilter Rural, which has experience in irrigated cropping and runs two water funds: the Murray-Darling Basin Balanced Water Fund and the Kilter Water Fund.

When asked if prices will rise, Gunn says: “Well, if you’ve got less water in the system, it has to. It’s not like demand isn’t increasing – they’re still planting permanent crops in the Lower Murray, and those all need permanent water. If you then reduce the amount of water that is available, you’d have to reckon that, at least at the extreme ends of things when we get shortage years, it will absolutely drive prices up. When there is less resource around it becomes more precious – that is just supply and demand fundamentals.

“We don’t know how the market will respond. But if history is any guide, farmers generally wait for the best price, don’t they?

Brook’s view is that the Commonwealth has “completely underwritten the value” of water with its announcement.

“Commercially, a farmer could just sit still. You know the deadline is 2027, so farmers know [the government] is going to get more desperate [as that approaches]. Two years from now, you could be a rational seller selling to an irrational buyer.”

Agri Investor‘s unnamed source points out that the MDB Plan up to this point has already seen the value of water rights appreciate significantly thanks to the amount of consumptive water that farmers have given up the environment.

“There is less water available for irrigation, and that then incentivized everybody to use whatever water they did have for its highest and best-value use,” the source said. “That meant people were forced to be very competitive, ensuring that what they were using water for is profitable, allowing them to sustain their operations and continue accessing water for irrigation.

“In a sense, this doesn’t change anything with that but it’s an accelerant to it over the next couple of years. The government will be trying to buy water but I don’t think they will find many sellers at current water values.”

Nick Waters, managing partner of Riparian Capital Partners, which manages the Riparian Water Fund, points to historical trends as a guide for what may happen.

“In the past, buybacks have generally been quite supportive of water entitlement values – and over a longer period of time than people often realize because they permanently reduce supply.

“Buybacks reduce the amount of water available to irrigators at the same time as irrigation consumptive demand is generally increasing, with irrigated areas expanding and more water being used [for irrigation] than less. There is also a more permanent demand base than when the last round of buybacks occurred, with far more permanent crops like almonds that need water every year and don’t have the flexibility when it comes to water use that annual crops like rice and cotton do.”

Waters adds that the volume of water traded each year means he feels it is unlikely the Commonwealth will be able to secure all 450GL through buybacks, meaning that efficiency projects will be needed.

Socioeconomic effects

Beyond the likelihood that water prices will rise, the amount of water being removed from the consumptive pool will affect the communities of the Murray-Darling Basin. Water buybacks were always balanced with socioeconomic outcomes in the past – but the 450GL being pursued now is just for the environment, meaning that the balance of priorities is not the same.

“With the timeframe they have set, it is hard to imagine they can do it without impacting the market and communities in a pretty serious way,” Gunn says. “It’s a big volume of water whichever way you look at it.”

Brooks says moving water to the environment and reducing the consumptive pool will “by design” increase the price of water, particularly allocations, and reduce lower-value production of certain annual crops like rice.

“But that’s not necessarily the best outcome, because there is an immense amount of land that will move to lower-value production because it can’t be irrigated at all anymore. The limit for agriculture in Australia, particularly in the southern MDB, is not land – it’s water. If you remove water, it will change some of that land back to grazing and other lower-value production items.”

Brooks says that the “worst possible scenario” could be on the horizon, where Australia experiences an extremely dry period brought on by an El Niño event at the same time as the Commonwealth is pursuing large-scale water purchases.

“You can see the headlines now,” Brooks says, remembering the last drought, when many of Australia’s newspapers and other media outlets attacked water investors over the perception they had driven prices up.

This eventually led to an inquiry by the Australian Competition and Consumer Commission, which cleared investors of market manipulation and said they had not artificially inflated prices – although the report did call for more transparency and regulation.

Agri Investor‘s anonymous asset manager says: “We’ve always felt our role in the industry is to provide new sources of capital and innovative ways for farmers to access water, through leasing the entitlements we’ve invested in. We bought those entitlements from farmers, unlocking their balance sheet capital – how they use that is up to them.

“We are actually disappointed the Commonwealth doesn’t seem to understand the impact this agreement will have on regional communities that rely on these industries, and the impact that could have on our food security. We’re effectively going to shut down some pretty significant and profitable irrigation enterprises – and you need irrigators to keep food on the shelves during drought in Australia.

“It was agreed in 2012 that if they could get this extra 450GL, they would only try to do it if there was no social or economic impact. But of course there is an impact, and that’s why no government before now has been too worried about trying to pursue it.

“For a water fund, this is likely to be beneficial for investors as that fund continues to own entitlements and lease out the allocation; irrigators are likely to have to pay more, which will increase returns. But with an irrigators’ hat on, it’s really disappointing. We’d rather see more industries have access to water under a highly-regulated cap-and-trade system.”

Gunn declined to comment on whether pursuing the 450GL is the right thing to do or not, saying that that is a “political question”. “They had to do something to get South Australia to sign it and that’s what they agreed,” he says.

But he goes on: “If you ask some scientists, most will tell you that the 450GL is well short of what’s required. And if you ask an irrigator, they will say we’re already well over what’s required. There is no easy answer.

“But 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.

“Most of our returns are generated by leasing – we don’t do a heap of spot trade. During dry times, our returns will be locked in through stable leases of three to five years and our returns won’t go up so much during changes in the market. They also don’t go down when it gets really wet.”

But long term, it does appear clear that removing more water from the Murray-Darling Basin will be a tailwind behind rising water entitlement values.

Or as Waters puts it: “You’re introducing a large, well-funded buyer into a market that’s already generally tightly held. It’s not hard to see how that is supportive to values longer term.”

9/4/23: This article was amended to reflect that Rob Brooks is speaking in a personal capacity.