Stalling trade pushes Australian water market to ominous peak

Investors risk being wrong-footed as lower yields eventually bring down prices, Aither's Chris Olszak tells Agri Investor. How should they respond?

The unbundling of Australian water assets from land to create a transparent, tradable market has been a success story in the past 20 or so years.

But even prolonged success must experience change, and recent market conditions in the Murray-Darling Basin, where water entitlement prices have begun to top A$5,000 per ML on certain deals, signals a shift in how investors need to think about their water portfolios.

Frothy market

Consultant Aither has shared data with Agri Investor that show recorded prices for Murrumbidgee High Security (HS) at more than A$5,000 per ML, with a 52 ML parcel recently selling at auction for $5,160 per ML. In July 2016, that parcel would have been valued at around A$3,600 per ML.

“We have been continually surprised by the growth,” says Chris Olszak, co-founder and director of Aither. “Twelve months ago, we probably thought that further capital growth was limited, but we’ve seen a 23 percent increase in 2017-18, which is pretty substantial.”

This rise can be seen in the consultant’s own Aither Southern Murray-Darling Basin Entitlement Index (AEI), which tracks the relative performance of a group of major water entitlement types across the southern Murray-Darling Basin. This is the index that has increased by 23 percent since the start of the 2017-18 water year, experiencing a year of consecutive month-on-month growth.

What’s behind this growth? Several factors have combined to drive prices upwards, beyond what many experts predicted they could reach, but the primary driver is a slowdown in turnover in the entitlement market.

Aither says that monthly entitlement trade volumes in the southern Murray-Darling Basin have more than halved from an average of approximately 25 GL in the 2016-17 water year to 12 GL in the 2017-18 water year.

Behind these numbers, there has been a great deal of investment in the region in almonds, citrus fruits, table grapes, and cotton, and the owners of those assets are competing with each other to secure future water supply.

“They’re all working pretty profitably at the moment, with good outlooks for the future, so they’re looking to secure their supply of water in the market, which in turn drives up prices,” Olszak says.

“A lot of adjustments have occurred over the last two years, because a lot of people willing to sell have got out of the market. There’s just not as many willing sellers now, because water is so important to their business model into the future.”

Sink again

Yields have consequently declined as prices have risen, which is likely to suppress prices eventually.

“It’s very hard to get 5 percent gross yield in this market, and that has to kick in at some point – so the question is, what is going to be sustainable in the long term?”

This is where the question of future investment strategies comes into play, with Olszak arguing that investors need to have greater sophistication in their water portfolios to hedge against the increased risk that comes with higher prices.

“There is risk, but also opportunity. There are markets now for leases, forwards, and options contracts, which are more attractive and more available. The challenge for investors is to work out their optimal portfolio strategy,” Olszak says.

American appeal

The Australian rural water market is envied in other countries around the world , as a tradeable market with transparency and price discovery ticks a lot of boxes for foreign investors.

“We’ve got a really good story here, and it’s actually been a big attraction for international investment into Australia, including out of the western US, where they’re looking for opportunities to diversify into countries with stable economic and political situations, and good regulatory frameworks.”

The success looks set to continue for some time yet, but investors should be aware of the new risks (and opportunities) that come with a maturing market.

“There’s been a huge amount of change – now there’s a need for something more sophisticated,” Olszak concludes.