WATER RESOURCES RESEARCH, VOL. 40, W09S07, doi:10.

1029/2003WR002852, 2004

Formal and informal water markets:

Drivers of sustainable rural communities?
Henning Bjornlund
Centre for Land Economics and Real Estate Research, School of International Business, University of South Australia,
Adelaide, South Australia, Australia

Received 5 November 2003; revised 20 February 2004; accepted 29 March 2004; published 29 July 2004.
[1] This paper analyzes irrigator behavior in formal and informal water markets within an
irrigation region of southeastern Australia to identify the extent to which these markets
have facilitated the development of sustainable rural communities. The analyses show
clear evidence that both the formal and informal markets have assisted irrigators in
managing the significant adjustment pressure within the irrigation industry and the
increased risk management burden placed on them by changing allocation policies. There
is also evidence that many irrigators are active as both buyers and sellers and within both
the formal and informal market, shifting their risk position within and between seasons
and adjusting the allocation of their capital assets. All of these functions are essential to
develop sustainable rural communities and retain community cohesion. INDEX TERMS:
1842 Hydrology: Irrigation; 1812 Hydrology: Drought; 6309 Policy Sciences: Decision making under
uncertainty; 9330 Information Related to Geographic Region: Australia; 6399 Policy Sciences: General or
miscellaneous; KEYWORDS: water markets, water transfers, Australia, sustainable rural communities
Citation: Bjornlund, H. (2004), Formal and informal water markets: Drivers of sustainable rural communities?, Water Resour. Res.,
40, W09S07, doi:10.1029/2003WR002852.

1. Introduction paradigm, treating water as an economic, rather than a

[2] Many rural communities are under stress. Their
natural resource base is threatened by agricultural practices
driven by short-term economic objectives rather than long-
term sustainability. This is the case not least in areas
dependent on irrigation. The construction of large dams
and water delivery systems, extensive tree clearing, and
modern intensive farming methods have all had a detrimen-
tal impact on the natural environment and its ability to
produce and, consequently, a detrimental socioeconomic
impact within affected rural communities [Postel, 1999;
Sharma, 2000]. The pressure to expand production in order
to pay for the cost of these developments has exacerbated
this impact because new crop varieties have been introduced
to increase yields, but they require a high level of input of
water, fertilizer, and chemicals.
[3] Rural communities and policy makers are therefore at
a crossroads, where a new path forward has to be defined
that can reverse this degradation process and restore the
health and vitality of the natural resource base to allow for
future prosperity [Wolff and Gleick, 2002]. More water
needs to be dedicated to the environment to restore ecosys-
tems and improve water quality. Water needs to be applied
more efficiently, so that less water augments the underlying
water table and less water drains back into natural water-
ways, bringing with it residual fertilizers and chemicals as
well as salt. As less water is available for consumptive uses,
irrigators need to use what is left more efficiently, on higher-
valued crops and more productive soils. To facilitate this
process, the 1990s saw the emergence of a new water policy
Copyright 2004 by the American Geophysical Union.
0043-1397/04/2003WR002852
W09S07
social, good. This new paradigm was promoted by the
United Nations at the Rio Convention on Environment
and Development in 1992 [Sitarz, 1993] and by the World
Bank in its Water Policy Document [World Bank, 1993].
Within this paradigm, great importance is placed on water
markets and pricing policies as tools to facilitate the
necessary reallocation of water in an era where no new
supply is forthcoming.
[4] Two different water markets have emerged. In the
international literature they are often referred to as formal
and informal markets [Easter et al., 1999]. In the formal
market the long-term entitlement to the water is traded,
while in the informal market, only the right to use a given
volume of water, for a given period of time, is traded.
Informal markets have been widely implemented in many
countries such as India, Pakistan, and Mexico [Saleth, 1998;
Meinzen-Dick, 1998; Rosegrant and Binswanger, 1994].
They often take place as simple agreements between irri-
gators and require little administrative input. Formal mar-
kets, however, have been far less implemented because the
underlying entitlement to the water is transferred, which
requires that rights are registered and defined and their use
monitored and measured [Bjornlund and McKay, 2002].
This requires far more complex institutional and adminis-
trative arrangements, which are not available in many
developing countries [Appelgren and Klohn, 1999].
[5] Unregulated markets based on neoclassical econom-
ics, in which private interests, represented by willing buyers
and sellers, are deciding the allocation of water, are not
going to ensure water for vital social, cultural, and ecolog-
ical purposes [Gleick et al., 2002]. In order to ensure this
outcome, transparent markets guided by strong regulatory
instruments are needed [Bjornlund, 2000; Bjornlund and
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W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS
Figure 1. The Murray-Darling Basin.
McKay, 2003]. It has also been argued that pure economic
and market-based approaches fall short of social and non-
economic aspirations of many developing countries
[Appelgren and Klohn, 1999]. Likewise, research in the
United States and Australia has shown that irrigation
communities are not comfortable with water markets as
the sole instrument for allocating and reallocating water
[Syme et al., 1999; Keenan et al., 1999; Tisdell and Ward,
2003; Bjornlund, 2002a].
[6] Australia has in many ways been at the forefront of
implementing the new policy paradigm and probably has
the most active water markets in the world, almost entirely
facilitating transfers between competing agricultural users.
Markets are being relied on as a major instrument in
reversing the trend of environmental degradation within
the Murray-Darling Basin (MDB) [Murray-Darling Basin
Ministerial Council (MDBMC), 2002]. This paper analyzes
the early outcomes of an Australian water market and
discusses the potential benefits and pitfalls of formal and
informal water markets as drivers of sustainable rural
communities. Given the significant and increasing interna-
tional interests in water markets as instruments for allocat-
ing scarce water resources among competing users, the
Australian experiences should be of interest to water man-
agers and academics as well as irrigators throughout the
world who are considering introducing water markets.
Section 2 describes the study area and the data sources
and methodologies used. Section 3 briefly defines sustain-
ability in the context of rural communities, while sections 4
and 5 discuss the results for the formal and informal
markets, respectively. Section 6 describes how the two
markets interact, and section 7 outlines the pitfalls associ-
ated with the introduction of water markets.
2. Study Area, Data Sources, and Methodologies
2.1. Murray-Darling Basin
[7] The MDB is Australias largest and most important
river system (Figure 1). It covers most of the inland part of
southeastern Australia, makes up 14% of the countrys total
area, supports 75% of irrigation, and provides just over 41%
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W09S07
of total gross value of agricultural production, with a
significant flow-on effect, supporting more than 1.5 million
jobs, most of them in the major cities outside the basin. It
also supports significant tourism, with 15 million visitors a
year in its national parks and forests, and it also has
important cultural, social, and environmental values. The
basin thus has significant importance for all facets of
Australian life [MDBMC, 2001].
[8] Jurisdictions within the basin have followed very
different policy paths with respect to water allocation and
management, which reflects the differences in agricultural
productions. For the three southern states along the Murray
River this is illustrated by the following facts.
[9] 1. In South Australia (SA), irrigation almost entirely
consists of horticulture and viticulture, which are dependent
on a reliable water supply. The emphasis of water policies
has therefore always been on security of supply rather than
on maximizing the volume of water use every year. Entitle-
ments in SA are therefore considered 100% secure.
[10] 2. In New South Wales (NSW) most water is applied
to annual crops with the ability to expand and contract
production depending on water availability. Allocation
policies have therefore aimed at maximizing annual access
to water. This policy leaves little water in the storages at the
end of each season; as a result, the security of seasonal
supply is low with highly variable seasonal allocations
that have a long-term average of 70%. To accommodate
the horticultural industry, particularly in the downstream
reaches, high-security licenses are available.
[11] 3. In Victoria the largest water user is the dairy
industry, which is heavily dependent on the security of
supply because of investments in permanent pastures, herds,
and dairy equipment. At the same time, they have the ability
to benefit from a variable supply of extra water to produce
additional feed. The allocation policy is therefore twofold.
Irrigators have a water right, which is 96% secure, plus
sales water that is announced each season as a percentage
of water right (see section 2.2).
[12] The MDB came under stress during the 1970s,
1980s, and 1990s, with large blue-green algae blooms in
the early 1990s bringing the issue to the fore. An audit of
W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS
Figure 2. The Goulburn-Murray irrigation district.
water use was therefore initiated in 1995 [MDBMC, 1995],
and it concluded that the level of extraction for consumptive
use was far in excess of what was ecologically sustainable
and that use continued to increase. The basin spans four
states, and all these jurisdictions have in the past issued
large volumes of water entitlements, which have not been
used or only partly used. As water markets take hold, this
water is likely to be activated, further escalating the increase
in use. The audit predicted significant environmental and
economic impacts, if the estimated development continued.
It was therefore decided to cap water extraction for con-
sumptive use to the volume that would have been used at
the 1993/1994 level of development [MDBMC, 1996]. It
was recommended to accept existing entitlements, whether
they had been developed or not, but it was left to the states
to decide how they were going to implement the cap.
[13] It is generally accepted that the present cap will have
to be revised and that the volume of water for consumptive
uses will have to be further reduced [Department or Natural
Resources and Environment (DNRE), 2001a], the question is
by how much. The Murray Darling Basin Commission
(MDBC) has just started a community process The Living
Murray [MDBMC, 2002] to determine how much more
water should be set aside for environmental purposes, to
secure continued prosperity within the basin, and to deter-
mine how such reduction should be paid for and imple-
mented. These processes have generated policy uncertainty
within the irrigation industry and have been a major imped-
iment to the adoption of formal markets [Bjornlund, 2002a].
[14] Water markets have been an important instrument
enabling irrigators to manage the impact of the cap and are
anticipated to play an even more important role in facilitat-
ing the process of further reductions [MDBMC, 2002]. The
MDBC has therefore established an Inter-state Permanent
Water Trading Pilot Project within a part of the basin (see
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Figure 1) [Young et al., 2000] and is working on finding
ways of expanding the program.
2.2. Goulburn Murray Irrigation District (GMID) in
Victoria
[15] The GMID is Australias largest irrigation district
with a total permanent entitlement of 1940 GL. More than
80% of the water is used within a number of gravity-fed
irrigation areas, while private diverters, pumping their own
water directly from the river, use the remaining water. The
GMID consists of two main systems: the Goulburn System
and the Murray System (Figure 2). The study area is
located within the western part of the GMID and includes
two sections: (1) the Torrumbarry irrigation district in the
north, supplied from the Murray system and (2) the
Pyramid Hill-Boort area (PHB) in the south, supplied by
the Goulburn system (Figure 2). Trade is possible through-
out the GMID, but a number of spatial restrictions exist so
that trade can only take place if the water can be moved
from the seller to the buyer. The major limitation is the
restriction on trade between the Goulburn and the Murray
Systems. Trade can take place from the Goulburn to the
Murray System but not in the opposite direction. Initially,
little trade took place in that direction because most of the
high-value dairy producers are located in the Goulburn
system, and allocations in the Murray system generally
are higher (Table 1), which has eased demand and
reduced prices [Bjornlund, 2002b]. In December 1994,
the trading regulations were amended to allow trade from
upstream to downstream of Nyah (Figure 1). From 1997
to 2000, 25,000 ML were traded from the Goulburn
system to downstream of Nyah mainly to develop new
vineyards [Bjornlund, 2003a]. Following this develop-
ment, Goulburn-Murray Water (GMW) was given the
authority to allow upstream trade into the Goulburn
W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS W09S07

Table 1. Relationship Between Seasonal Allocations and Extent year to year, depending on availability, and is announced as a
of Tradea percentage of water right; irrigators only pay for this water if
Goulburn System Murray System
they use it. The high level of reliability of water rights is
maintained by only announcing sales once the next seasons
b
Allocation, Percent Allocation,b Percent water rights are secure in the reservoirs. Historically, sales
Season % Tradedc % Tradedc have been very high, exceeding 100% of water right in most
1995/1996 150 7 200 3 years. Dairy farmers have therefore developed their proper-
1996/1997 200 4 200 3 ties with infrastructure depending on sales of 60%, giving
1997/1998 120 9 130 13 them access to a volume of water equivalent to 160% of water
1998/1999 100 13 200 5 right. However, in recent years, sales have been declining
1999/2000 100 14 190 8
2000/2001 100 16 200 2 (Table 1) because of (1) general resource constraints, caused
2001/2002 100 18 200 5 by a long period of drought; (2) water trading, which has
2002/2003 57 24 129 16 activated previously unused water and thereby increased use;
a
This table is based on the work of DNRE [2001a] and updated on the
and (3) the impact of the MDB cap. To stay within the cap
basis of Goulburn-Murray Waters records. while maintaining a high level of supply certainty of water
b
Allocations are announced as a percent of water right at the beginning of rights, sales have been reduced [MDBMC, 1996], and access
the season and then adjusted monthly during the season. These are the to sales has been limited to 30% if the irrigator sells any water
maximum allocation level reached for each season. during a season [DNRE, 2001a].
c
This is the total temporary trade as percentage of total water use for each
season. [18] The water allocation is announced at the beginning of
the season and is then revised on the 1st and 15th of each
system in substitution for downstream trade. This rule has month as additional water enters the reservoirs. This repre-
been invoked twice in 2001/2002 and 2002/2003. sents a significant change in policy. Traditionally, the author-
[16] Both sections have large areas with very high soil ities made one allocation at the beginning of the season on the
salinity levels caused by the impact of inefficient irrigation basis of what was available in the reservoirs and expected
and high saline water tables. This has had a significant inflows. This has significantly shifted the risk management
impact on the productivity of the area and the ability of burden from the authorities to the individual irrigators.
farmers to stay in business and prosper. Land uses in the
area have traditionally been low-value mixed farming, with 2.3. Trade Within the GMID
broad acre cropping and annual pastures for cattle and [19] Informal markets were first introduced by a legisla-
sheep production, with pockets of high-value dairy produc- tive amendment in 1987. Formal markets were introduced
tion, especially around Cohuna in the Torrumbarry section with the Water Act 1989 and made effective by regulations
[Bjornlund, 1999]. Irrigators within the study region have late in 1991. Trade on the informal market started at about
therefore been under constant adjustment pressure. 25,000 ML per year during the first 7 years and then
[17] To understand the outcome of trade, it is important to increased markedly in 1994/1995 and has, since 1997/
discuss the structure of water entitlements. All irrigators have 1998, stayed above 200,000 ML or around 10% of total
a water right with a high level of reliability of supply with full entitlement (Figure 3). Trade on the formal market was also
delivery in 96 out of 100 years; irrigators pay for this water subdued during the first years, then surged in 1997/1998, and
every year, whether they use it or not. In addition, irrigators has since been at a level between 17,000 and 24,000 ML or
have access to sales water. The level of sales varies from just around 1% of total entitlements. The low volume of

Figure 3. Temporary and permanent trade within the Goulburn Murray irrigation district.
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trade in the formal market should be taken into account when
reading the discussions in section 4. The high volume of trade
in the informal market indicates that this market has a far
more profound impact within the irrigation industry, which
places increased importance on the discussions in section 5.
A water exchange was introduced in 1998/1999 to facilitate
fast, easy, secure, and cheap trading in the informal market.
This exchange has been very successful, and it has extended
its market share from 15% during the first year to a level
around one third of all informal trade [Bjornlund, 2003b].
[20] The surge in trade has been caused by a number of
factors: (1) a 5 year drought with no sales within the
Goulburn system, (2) the impact of the cap, (3) the
relaxation of trading rules in 1994/1995 [Bjornlund,
2002b], (4) the fact that irrigators have increasingly become
familiar with water trading and aware of the potential
benefits [Bjornlund, 2003a, 2003b], and (5) the initial
success of water markets activating large volumes of unused
water, augmenting resource constraints.
2.4. Data Sources and Methodologies
[21] The discussions in sections 4, 5, and 6 will be
supported by empirical and anecdotal evidence based on
both quantitative and qualitative data and gathered over a
10 year period. As is apparent from the text a number of
papers have been published based on the quantitative part of
this material to illustrate various aspects of water markets
and their operations. The strength of this paper is that it, for
the first time, tries to consolidate all of these findings to
explore the extent to which the operations of existing
markets have facilitated the development of more sustain-
able rural communities. It does this by supporting the
previous quantitative data with new qualitative data gathered
during 2002 and 2003. As a consequence of this history a
number of methodologies have been used to support the
discussion in each section of the paper. The use of these
methods has been justified and explained in the paper in
which they were first published as referenced in the text.
[22] The material on which this paper is based is as
follows: first is full day workshop with 14 key stakeholders
in the irrigation industry including irrigators, water brokers,
senior staff from the relevant government department,
Goulburn-Murray Water (GMW, the authority managing
the GMID), Victorian Farmers Federation, and one of the
largest milk-processing factories in the region as well as a
representative from the environmental movement held in
Tatura, Victoria in March 2002. Second is 12 focus groups
held during April 2003 with irrigators within the study
region with different experiences in the water market. The
objectives of the focus groups were to get a more detailed
understanding of how irrigators used the formal and infor-
mal markets, what they expected to achieve, what triggered
their decisions to buy and sell water in both markets, and
how they perceived the two most contemporary and con-
tentious issues: the separation of land and water rights and
environmental flows. The focus groups followed a set
structure to ensure that all the issues were covered in each
group. The discussions in the focus groups were conducted
by a professional facilitator with extensive experience in
facilitating community meetings and focus groups with
respect to natural resource issues. A summarized transcript
of the discussions was entered directly into a computer and
displayed by a data projector so that the participants could
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follow the discussions and the record that was being kept.
Focus group transcripts were analyzed using Nudist N6
software. The third source is telephone interviews with
(1) 100 buyers (49%) and 100 sellers (63%) using the
informal market during 1998/1999, (2) 100 irrigators who
have never participated in water trading as of July 1999
(26%), and (3) 100 sellers (41%) and 100 buyers (35%)
using the formal market during 1994 1996. The samples
interviewed represent a significant proportion of the respec-
tive populations (as indicated above 26 63%); the findings
of the analyses should therefore reflect the outcome of trade
within the study region. These quantitative data were
entered into SPSS and analyzed using descriptive statistics
and significance tests. These analyses are used to support
the discussions in sections 4.2, 4.3, 4.4, 5.1, 5.2, and
6. Factor and cluster analyses were used to support
the discussions in section 5.3; these methodologies were
described by Bjornlund [2002c]. Next is the trading and
water rights registers of GMW (used to produce Table 1
and the statistics in section 6). Last is the records of the
Northern Victorian Water Exchange during the first 5 years
of operation 1998/1999 to 2002/2003 (used to create
Figures 4 and 5).
[23] Among many other questions the irrigators were
asked to rate how important a number of reasons for buying
and selling were in their decision making process to use the
informal or formal market. A 1 to 5 scale was used, with
1 being not important and 5 being very important. In the
discussions in sections 5 and 6, when reference is made to
irrigators finding a certain reason important, they gave that
reason a rating of 4 or 5.
3. Sustainable Rural Communities
[24] The issue of sustainable rural communities has been
widely debated in recent times [e.g., Lockie and Bourke,
2001; Gray and Lawrence, 2001; Beer et al., 2003;
Cheers, 1998; Martinez-Brawley, 2000]. Rural sociologists
do not normally define sustainable development as some
well-defined end-point; rather, they consider it as a
multidimensional process toward socially, economically,
and environmentally strong communities, with a flexible
economy not totally dependent on the seasonal price for
specific commodities [Gray and Lawrence, 2001]. Lockie
[2001, p.229] provided a good definition of sustainability
when he stated that . . .in very general terms, sustainabil-
ity is defined as the ability of current generations to meet
their needs and aspirations without compromising the
ability of future generations to do the same thing.
Following these definitions, policies that promote devel-
opment of farming practices that reduce the negative
environmental impact of farming and the abandonment
of old damaging practices must be said to drive the
process toward more environmentally sustainable commu-
nities; those that promote more efficient use of water as
well as production of higher-valued commodities must be
said to drive the process toward environmentally, socially,
and economically stronger communities. These outcomes
will increase the value of output per unit of water used and
will reduce saline return flows to the river and reduce
leaching of water into the aquifers. High-value commod-
ities are often more labor intensive both on farm and off
farm since they are often associated with processing,
W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS W09S07

Figure 4. Prices on the northern Victorian water exchange 1998 2002.

packaging, and transport industries. Such commodities also
depend on more sophisticated service industries such as
consultants, technicians, accountants, lawyers, etc. These
professions offer alternative opportunities for the young
generation and thereby make it more attractive for them to
stay in the community. Policies that promote more flexible
use of the farmers resources must also be said to drive the
process toward socially and economically stronger commu-
nities. More flexible resource management will enable the
farmers to better manage their farm businesses on an ongoing
basis and therefore make them less dependent on fluctuating
annual commodity prices and climatic conditions. Such
policies might also allow unviable farmers better avenues
to fully or partly exit farming, while remaining within the
local community. This will facilitate the process of maintain-
ing community cohesion and thereby drive the process
toward socially stronger communities. The discussions in
section 4, 5, and 6 will analyze how water markets in
Australia has assisted farmers and thereby their communities
in the above processes and thereby have driven the process
toward more sustainable rural communities.
4. Formal Markets
[25] It has been argued that irrigators are unlikely to make
the significant financial commitments associated with a

Figure 5. Prices and volumes traded on the exchange 2001/2002 and 2002/2003.
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change to more efficient and higher-value use unless they
have the long-term control of adequate water resources to
protect the investment [Crase et al., 2000; Bjornlund and
McKay, 2001]. It has therefore been of some concern that
formal markets have not been more widely adopted, and it
has been argued that economic benefits have been foregone
or postponed as a result [Marsden Jacob and Associates,
1999]. The major benefits of the formal market are associ-
ated with a reallocation of water to (1) more productive soils
in more suitable locations, (2) more efficient water users,
(3) higher-valued uses, and (4) new developments and the
consolidation of water into larger more viable units. The net
effect of such reallocations is structural change and an
increase in the volume of output as well as the gross margin
per unit of water used. Such developments will increase
employment and economic activity and improve the social
and economic prospects of the affected communities. The
reallocation to more suitable soils and more efficient irri-
gators will also produce environmental benefits [Cullen et
al., 2000]. In other words, it will reduce the negative
environmental impacts of irrigation. These developments,
if achieved, will drive the process toward more sustainable
rural communities.
4.1. A Reallocation of Water Into More Productive
Soils in More Suitable Locations
[26] This outcome of trade is partly secured by regulation.
Trade will only be allowed to move additional water onto a
property if it has soils with a low salinity level. Further,
some areas along the Murray River have been zoned into
low- and high-impact zones. Trade will not be allowed into
a high-impact zone, while trading out of these zones is
encouraged by a government subsidy of A$50/ML. Trade
into low-impact zones is allowed, but developers are
required to pay a levy of A$130/ML to cover the capital
cost of salt interception schemes to offset the impacts that
might be caused by the increase in water use in that location
[Government of Victoria, 1993]. Early markets showed a
shift of water away from highly saline to low saline soils
within the PHB and Torrumbarry areas and from saline
areas in PHB into better soils in the eastern part of the
Goulburn System [Bjornlund, 1999; DNRE, 2001a].
[27] To encourage the reallocation of water into more
suitable soils, the Victorian government has promoted the
development of salinity plans for some of the worst affected
areas. One of the purposes of these plans is to identify the
saline areas and the areas most suitable for development.
Detailed farm analysis by Barr [1999] showed that half the
saline soils irrigated in 1989 were no longer irrigated 5 years
later. Water had been reallocated to better areas on the same
farm or had been sold to other farms with better soils. These
results indicate that the combination of appropriate regula-
tion and trade has driven the process toward environmen-
tally sustainable rural communities.
4.2. Reallocation to More Efficient Water Users
[28] Within the study area most water is supplied by
gravity and applied by flood irrigation. Water use efficiency
is therefore determined by the extent and quality of laser
grading, reuse systems, surface drains, and access to off-
farm drainage. Again, the water-trading regulations, to some
extent, ensure that the buyers are efficient users. The
regulations set maximum water use limits for properties
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depending on water use efficiency. To be allowed to apply
the maximum volume of water of 10,000 ML/ha, the
irrigator must have access to off-farm drainage and have a
reuse system [DNRE, 2001b]. For new developments the
developer must produce a whole farm plan demonstrating
best practice irrigation and drainage methods.
[29] The interviews of buyers and sellers in the formal
market showed that (1) 82.6% of the water bought moved
onto farms with a reuse system, while 63.5% of the water
sold moved out of farms without it; (2) 90.7% of the water
bought moved onto properties with laser grading, while
45.6% of the water sold moved out of farms without it; and
(3) 89.4% of the water bought moved onto farms with
surface drainage, while 29.8% of the water sold moved out
of farms without it [Bjornlund and McKay, 2000]. Since
1996, there has been a trend toward water going to new
greenfield developments such as vineyards, olives, and
vegetable production [DNRE, 2001a]. These operators all
have relatively high tech efficient irrigation. These results
indicate that the combination of appropriate regulation and
trade has driven the process toward environmentally,
socially, and economically sustainable rural communities.
4.3. Reallocation to Higher-Value Uses
[30] The potential social gains from this reallocation are
linked to the heterogeneity of water values across commod-
ities. In Australia, if water moves out of grazing for sheep or
cattle, which has a gross margin at about A$50/ML, or grain
growing at about A$100/ML and into wine grapes at about
A$2800/ML, various vegetable productions at A$400
1800/ML, or dairying at around A$500/ML, the economic
benefit to the farm economy is evident. In addition, it has
been estimated that for each 1000 ML traded into horticul-
ture, 30 new jobs will be created on farm and within
processing and support industries, while for dairying the
job creation is about 15 per 1000 ML [DNRE, 2001a].
[31] Interviews with buyers and sellers in the formal
market showed that most of the water traded had no impact
on the production of the buyers and sellers: 58.3% of the
water sold did not cause a reduction in the sellers irrigated
area, while 56.8% of the water bought did not cause any
expansion of the buyers irrigated area. Sellers disposed of
unused water or expected to increase their reliance on the
informal market to maintain production, while buyers
purchased water to maintain existing production because
sales had declined. However, 75.4% of the water was sold
out of cattle, sheep, and grain-producing properties, and
8.6% was sold out of properties with no irrigated production
at all. Of the 41.7% of the water sold causing a reduction in
the irrigated area, 63.3% of the reduction took place in cattle
and cropping production. Likewise, 69.0% of the water was
purchased by dairy farmers, which is the group that has
traditionally developed their properties to depend on 60%
sales and, as a consequence, is suffering most from reduced
sales. Of the 43.2% of water purchased for expansion most
of it, 67.4%, was used to expand dairy production. As
mentioned above, since 1996, large volumes of water have
gone into horticulture and vegetable production, which are
higher-value uses than dairying.
[32] It also has to be acknowledged that not only water
used for expanding production has this effect. If the dairy
industry had not been able to purchase this water, it
could not have maintained production, which would have
W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS
resulted in loss of farm income and associated loss of
employment and economic flow-on effects within the com-
munity. These results indicate that water markets have
driven the process toward socially and economically sus-
tainable rural communities.
4.4. New Developments and a Consolidation of
Properties Into Larger More Viable Businesses
[33] Analyzing the property and entitlement sizes of the
buying and selling properties as well as the farm expan-
sion or reduction caused by trade, it is apparent that the
buying properties have become larger and the selling
properties have become smaller [Bjornlund and McKay,
1999]. There is, however, no evidence to suggest that as
of 1996, trade has resulted in a movement of water from
small family farms to large corporate farms. There is,
however, evidence to suggest that trade has generated a
polarization of the farming community into a group of
larger more viable family farms, dependent on a nonfam-
ily workforce, and a group of smaller unviable family
farms, dependent on off-farm work. There is also evidence
to suggest that the polarization is between larger water-
rich farms, which can better sustain periods of resource
scarcity, and smaller water-poor farms, which are depen-
dent on annual purchases of water and therefore more at
risk during periods of resource constraints and associated
high water prices (during most of the season 2002/2003
prices on the exchange were between A$350/ML and
A$500/ML, Figure 5).
[34] Among water buyers there is, however, also evidence
of growth in the number of properties with an unviable size
of <20 ha [Bjornlund and McKay, 1999]. This growth
expresses an increase in the demand for life style farms
coming from people working within the growing support
industries for the irrigation sector. This in its own right has
an important function in the process toward more sustain-
able rural communities. This demand for smaller properties
has allowed exiting farmers to sell properties for which
there would have been no demand from expanding com-
mercial farmers, for whom additional improvements have
little or no value. It has also allowed such farmers more
flexibility in their exit strategy by selling their dwelling to
life style farmers and the best agricultural land and the water
to neighboring farmers, thereby maximizing the return on
their asset and putting them in a better position when
relocating. These results indicate that water markets have
driven the process toward socially and economically sus-
tainable rural communities but also indicate that there might
be some less favorable outcomes with long-term socioeco-
nomic impacts on some farmers selling water.
5. Informal Markets
[35] Seasonal transfers should be able to assist farmers in
managing fluctuations in commodity prices and water
supply from year to year and managing periods of personal
hardship such as illness. It should also assist many farm
families to remain on the land and within the community by
generating an income from water sales, off-farm work, and
possibly some farming, while assisting other expanding or
new irrigators in the development phase by giving them
access to water without having to invest their available
capital in expensive long-term entitlements. Such outcomes
8 of 12
W09S07
would drive the process toward socially and economically
sustainable communities.
5.1. Allow Irrigators to Respond to Annual
Fluctuations in Commodity Prices
[36] When buyers and sellers were asked why they
bought and sold water during 1998/1999, the impact of
fluctuating commodity prices was apparent: 26% of the
buyers quoted good commodity prices and 16% cited a one-
off opportunity to sell more of a certain crop as important
reasons for buying, while among the sellers, 36% referred to
low commodity prices as an important reason for selling.
During the workshop in March 2002 and the focus groups
in 2003, the ability to respond to fluctuating commodity
prices was also mentioned as an important function of
informal markets. Commodity prices have two potential
impacts: (1) irrigators react to the prices of the commodities
they are growing and decide to sell when the price of water
on the informal market exceeds their gross margin per
megaliter, while they decide to buy when the price drops
below that amount; and (2) dairy farmers react to the prices
of substitute feed, such as feeding grain, silage, or hay.
Extension officers had advised that at A$90/ML, dairy
farmers would be better off buying feed; hence prices
during 1998/1999 and 1999/2000 flattened out at A$90/
ML (see Figure 4).
[37] Traditionally, grain, cattle and lamb producers are the
major sellers of water. However, during 2000/2001, prices
for cattle, lamb, and grain were high, causing these pro-
ducers to be reluctant to sell. As a consequence, supply was
low, forcing prices up. Not until prices reached A$130/ML
in early January did sellers in significant numbers appear in
the market. For several reasons, prices reached A$200/ML
later that season, one of which was that prices of substitute
feed were very high since supply was low because of the
drought. This increased the comparable price of water to
produce grass; at the same time, prices for dairy products
were high, which increased dairy farmers willingness to
pay. In conclusion, informal markets have significantly
improved irrigators ability to respond to changing com-
modity prices, which has driven the process toward socially
and economically sustainable rural communities.
5.2. Allow Irrigators to Respond to Fluctuations in
Supply and Demand
[38] The workshop and focus groups emphasized that one
of the most important functions of informal markets during
the last 5 years has been to assist farmers managing the
drought. When allocations are relatively high, trade
accounts for around 5% of total water use, but during the
last 6 years, when there have been no sales, trading has
slowly increased its contribution to total water use to 24%
(Table 1). Reflecting this, 82% of the buyers in the informal
market during 1998/1999 said that an important reason for
doing so was that sales were very low that year. At the
beginning of 1998/1999 the allocation was at record low
levels. As a result, horticultural growers bought in panic to
secure their permanent plantings, which forced up prices.
Once allocation levels increased, prices dropped back to
A$90/ML (Figure 4). Horticultural growers again reacted to
low allocations during 2002/2003 when opening allocations
were very low and GMW gave a very low probability of
allocations getting much higher. Most horticultural growers
W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS
Figure 6. Socioeconomic structure of irrigation communities (source: Bjornlund [2002c]).
anticipated an allocation of 60 70% and entered the market
to buy water based on that assumption. This demand caused
prices to increase to record levels of A$500/ML, forcing
most other irrigators out of the market (Figure 5). As
the horticultural growers satisfied their demand, prices
decreased. However, it soon became apparent that alloca-
tions would not reach 60%, and horticultural growers again
entered the market to protect their permanent plantings,
forcing prices back up to A$500/ML. When that demand
was satisfied, prices again dropped but not down to the
levels of the first 4 years.
[39] Resource constraint is not only caused by the allo-
cation level but also by natural precipitation during the
season. If rainfall is low or evaporation is high, demand for
water will increase. Trade on the exchange over the first
5 years shows evidence of this (Figure 4). At the opening of
2000/2001, spring rain was good, reducing the need to
irrigate, and prices therefore remained low, whereas at the
opening of 2001/2002, the spring season was very dry.
Water use was up by around 15%, compared with normal 15% of all sellers on the informal market are selling all their
years, and this resulted in increased demand for water on the
exchange. This was one of several coinciding factors
causing prices to be exceptionally high during that year
[Bjornlund, 2003b]. Also in that year, opening winter rains
were late, contributing to prices remaining high toward the
end of the season. When good rains finally arrived in May,
prices dropped. In conclusion, informal markets have sig-
nificantly improved irrigators ability to respond to chang-
ing resource availability and have driven the process toward
socially and economically sustainable rural communities.
5.3. Maintain Community Cohesion
[40] The use of multivariate techniques to analyze the
responses from buyers and sellers using the informal
market during 1998/1999 and from irrigators who have
never participated in any kind of water trading provided
some interesting insight into how different sectors of the
irrigation community use water markets to cope with
9 of 12
W09S07
adjustment pressures [Bjornlund, 2002c]. Three main
groups emerged representing the socioeconomic structure
of the community: the nonadjusters or strugglers (57%), the
adjusters or defenders (35%), and the comfortable farmers
(8%) (Figure 6).
[41] The nonadjusters or strugglers make up 57% of all
farm businesses. They have given up developing their
properties to be viable in the long term; they are simply
trying to maintain the farming life style and postpone exit
adjustment to the time of intergenerational change and stay
within the community. The existence of this group is clearly
illustrated by the fact that only 39% of the sellers, 48% of
the buyers, and 26% of the nontraders expected family
continuity of the property, while 15% expressed uncer-
tainty. The buyers in this category use the informal market
to replace what they used to get as sales, that is, to maintain
their production. They have low farm incomes and a high
dependence on off-farm work. The sellers are in two
subgroups: (1) The first is professional water sellers;
water every year. They are selling to generate an income,
which combined with off-farm work and possibly some dry-
land farming, secures their annual income and makes it
possible for them to stay in the community. (2) The second
group is struggling farmers, who are selling a large propor-
tion of their water every year. They have given up devel-
oping their properties to be viable in the long term but have
not given up irrigated farming all together. They are able to
stay on the property by some low-value production, annual
water sales, and a large dependence on off-farm work.
[42] The adjusting irrigators are using the informal mar-
ket to assist them in the adjustment process and are
generally higher-value users. The buyers do not have
enough water for this process, and they cannot afford to
buy water in the formal market because all their available
finance is tied up in other parts of the adjustment process.
This group was clearly reflected when the buyers during
1998/1999 were interviewed: 62% said that they actually
W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS
need the water every year but could not afford to buy it. The
sellers have water enough for the development of their
property and are able to use the informal market to generate
some income to assist them in the adjustment process.
[43] The comfortable irrigators generally have larger
properties with higher farm incomes and low off-farm work
dependence. They are opportunistic traders, buying water in
the informal market if commodity prices relative to the price
of water are good and selling if prices are low. This
discussion indicates that the informal market has several
important ways in which it drives the process toward
economically and socially sustainable rural communities
and maintain community cohesion.
6. Working Together
[44] Analyses of water rights and water trading registers
indicate that farm businesses cannot simply be classified as
buyers or sellers of water. In total, 23% of all farm
businesses have both bought and sold water in the informal
market. This reflects the findings that farmers respond to
annual fluctuations in prices and supply as discussed above.
Looking at the informal market during 1998/1999, it was
found that 16% both bought and sold water during that
season, with half of them net trading nothing, that is, ending
the season with the same volume as they started. They
shifted their risk position during the season, buying early
when allocations were low, and selling again as allocations
increased or they speculated in price developments during
the season.
[45] The analysis also indicated that a large section of
farm businesses trade both in the formal and informal
market: 26.2% within the PHB and 17.4% within the
Torrumbarry area. These farmers are changing their risk
position and adjusting the capital assets that they have tied
up in water rights. Cross tabulating the activities in the
formal and informal markets revealed the following:
(1) Some 39.3% within Torrumbarry and 65.6% within
PHB selling water in the formal market also buy water in
the informal market. This indicates that there is a group of
irrigators shifting their risk position to rely more heavily on
annual purchases in exchange for a cash injection. This
clearly was more predominant within PHB. This reflects
that 61% of the sellers in the formal market said that an
important reason for selling was that they needed the
money. (2) Some 74.7% within Torrumbarry and 88.5%
within PHB of those selling water in the formal market also
sold water in the informal market. This indicates that there
is a group of irrigators who have sold some of the water that
they traditionally have not used and who sell the remaining
excess in the informal market; in effect, they have not
shifted their risk position but cashed in on an unused asset.
This reflects that 69% of the sellers in the formal market
said that an important reason for selling was that they did
not need the water. (3) Some 84.8% within Torrumbarry and
79.7% within PHB of those buying water in the formal
market also bought water in the informal market. These
irrigators have shifted their risk position to rely less on the
informal market. They have, in effect, bought some drought
insurance but could not afford full coverage. This reflects
that 60% of the buyers in the informal market said that an
important reason for using the informal market was that
they could not afford the prices in the formal market, despite
10 of 12
W09S07
the fact that they needed the water every year. (4) Some
53.2% within Torrumbarry and 60.9% within PHB of those
buying in the formal market also sold water in the informal
market. These irrigators have, in effect, bought full drought
insurance and now sell water annually when they do not
need it. The above clearly shows that irrigators use both
formal and informal markets to shift their risk position
during individual seasons, between seasons, and on a
long-term basis, which has driven the process toward
socially and economically sustainable rural communities.
7. What are the Pitfalls?
[46] Sections 4, 5, and 6 have illustrated how water
markets have helped irrigators in managing changes in
policy, economic, and climatic conditions and, consequently,
have assisted communities in the process toward economic,
social, and environmental sustainability. However, the intro-
duction of water markets is not without risk to the sustain-
able future of irrigation communities. The focus groups and
workshops showed a very high level of concern with the
potential negative impacts of the formal market. The prob-
lem is not that irrigators fail to see the benefits from this trade
but, rather, that they can see some potentially serious
negative community impacts as well. The following are
some of the identified concerns, which provide important
lessons for policy makers, researchers, irrigators, and water
managers to consider before introducing water markets in
other regions.
[47] 1. If large volumes of unused entitlements exist at the
time trade is introduced and use is not capped, then trade
will activate unused water, resulting in environmental
degradation.
[48] 2. If large volumes of unused entitlements exist at the
time trade is introduced and use is capped, then trade is
likely to activate such unused entitlements, which will
reduce water availability for existing users. This has been
the case within the MDB and has caused hardship and
resentment within irrigation communities [Bjornlund,
2002a]. Many farmers see it as wealth transfer when they
have to pay their neighbors for water they have traditionally
received via the allocation process.
[49] 3. If trading moves large volumes of water out of an
irrigation area, it will have significant community implica-
tions: (1) Economic activity in the area will be reduced as
farm output declines, which in turn results in fewer jobs both
on and off farm and a loss of local businesses services as
well as a decline in the population base. (2) Farms will be
left dry, which can have a negative impact on neighboring
farms as weeds and pests infest the abandoned land and
spread to other farms. (3) Property values decline when
water is sold off; this will reduce the revenue from rates and
taxes for local councils, resulting either in a reduction in
services or an increase in the rate burden for other farmers.
Such developments will result in unsustainable communities
and could eventually result in community disintegration.
[50] 4. If trading moves large volumes of water out of an
irrigation area, the volume of water used within the system
will be reduced and thereby increase the burden of main-
taining the infrastructure for the remaining irrigators. Even-
tually, the supply channels may become unviable, and the
authority will be forced to stop supply; this will leave
remaining properties dry. This is a major impediment to
W09S07 BJORNLUND: FORMAL AND INFORMAL WATER MARKETS
formal markets in Australia and has been dealt with differ-
ently in each state [Bjornlund, 2002d]. It is also one of the
main problems with the wider implementation of interstate
trading [DNRE, 2001a].
[51] 5. If trading moves water into certain channels, the
supply pressure will increase, with the result that supply
reliability is reduced for existing irrigators. Within the study
region, channel capacity is one of the assessment criteria
that the authority uses when approving trade. Trade will not
be allowed into a channel if the supply reliability of existing
irrigators will be affected. However, many irrigators now
relying on purchases on the informal market are concerned
that other irrigators on their channel will buy water on the
formal market and thereby commit the full supply capacity
of the channel. This would effectively prevent them from
buying water on the informal market in the future.
[52] 6. If the point of extraction is moved, it can have
third-party effects. If water has to be transported longer in
the river, more evaporation losses or seepage may occur
before it reaches the new user. The question is, who is going
to carry that loss? If water is traded upriver, sources of
supply can be cut off, which reduces supply options and
thereby the supply reliability of existing irrigators.
[53] 7. If water is traded upstream, dilution flow from the
new point to the old point of extraction will be reduced,
with potential impact on river salinity. Further, some loca-
tions produce more saline drainage back into the river
because of higher natural salinity levels of the groundwater.
If trade moves water from areas with low salinity return
flow to areas with high salinity return flow, it will have an
impact on river salinity levels. Both of these impacts have
been identified in South Australia [Bjornlund and McKay,
2000].
[54] 8. If trade moves water to more efficient users, return
flow will be reduced; this has some environmental benefits
but also decreases supply for downstream users and reduces
total river flow with negative environmental impacts.
8. Conclusions
[55] This paper identifies several ways in which Austra-
lian water markets have facilitated the process toward more
sustainable rural communities guided by strong regulatory
frameworks. It also identifies that formal and informal water
markets play separate but equally important roles in this
process and that the practice of using both markets has been
widely adopted to shift irrigators risk position and to
manage increased supply uncertainty. Irrigators clearly
acknowledge that without water markets they could not
have maintained production during the last 5 years of
drought and communities would have suffered much more
than they have.
[56] Water markets have achieved these outcomes by
assisting irrigators in managing resource constraints,
increased supply risk, and the general adjustment pressures
within agriculture. Markets have allowed many farm
families to remain in the community while partly or fully
exiting irrigation. This has significantly helped individuals
and their communities to adjust over a long time period,
rather than forcing a large number of irrigators out of
business and out of the communities.
[57] These findings clearly illustrate the potential positive
outcomes that can be expected if trade is introduced into
11 of 12
W09S07
other regions of the world. However, it should be noted that
several of these positive outcomes are contingent on proper
regulatory instruments.
[58] The introduction of markets therefore holds signifi-
cant promises for regions of the world with a semiarid
climate like that of Australias. However, the Australian
experiences also show that water markets can have a
negative impact on the sustainable future of rural commu-
nities if regulatory instruments and policies do not properly
guide trade and that several pitfalls exist during the process
of introducing water trading. These experiences and pitfalls
should be taken into account by water managers and policy
makers planning to introduce water markets: the water
market can be a very good servant to move water around
between competing uses and drive the process toward
sustainable rural communities, but if left to its own forces,
it could prove a very unforgiving master.
[59] Acknowledgments. This research project is funded by the Aus-
tralian Research Council and 10 industry partners: Department of Water
Land and Biodiversity Conservation, Department of Primary Industries,
SA Water, Central Irrigation Trust and River Murray Catchment Water
Management Board in SA, Goulburn Murray Water, and Department of
Natural Resources and Environment in Victoria, Murray Irrigation Limited,
and Department of Land and Water Conservation in NSW, and the
Australian National Committee on Irrigation and Drainage. The interviews
were conducted as part of a project funded by Land and Water Australia
held jointly with Jennifer McKay. I would also like to acknowledge the
advice provided by Brian Cheers, associate professor or Rural Sociology.
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