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How Drought and Climate Change Impact Your Water Allocation Prices
In Australia's water market, no single factor wields more influence over the price of water allocations than drought. The cycle of wet and dry periods is a fundamental characteristic of the Australian climate, and its impact on water availability and market prices is direct, dramatic, and increasingly pronounced. As the climate continues to change, bringing with it the prospect of more frequent and severe droughts, understanding this relationship is paramount for any irrigator, farmer, or water investor seeking to manage risk and maintain viability.
The Direct Link: Scarcity Drives Price
The mechanism by which drought affects water allocation prices is a straightforward case of supply and demand. Drought conditions are characterised by prolonged periods of low rainfall and reduced inflows into the river systems of the Murray-Darling Basin.62 This has a cascading effect on the water supply available for irrigators:
- Storage Levels Fall: Major water storages, which act as the system's reservoirs, are not replenished. As water is released to meet existing needs, their levels decline significantly.62
- Allocations are Reduced: State water authorities, responsible for managing water resources, respond to falling storage levels by drastically cutting the volume of water allocated to entitlement holders. In severe droughts, allocations for general-security entitlements can fall to zero.2
- Market Supply Shrinks: With little or no new water being allocated, the supply of water available for trade on the temporary market contracts dramatically.
- Demand Intensifies: At the same time, the lack of rainfall means that demand for irrigation water increases. Farmers with permanent plantings, such as orchards and vineyards, have a critical need for water to ensure the survival of their long-term assets.53
- Prices Soar: This collision of shrinking supply and desperate demand inevitably leads to a sharp increase in the price of water allocations. Historical data clearly shows that the highest allocation prices on record have occurred during the peak of major droughts, such as the Millennium Drought, when prices in some regions exceeded $900 per megalitre.51
Conversely, the breaking of a drought with widespread rainfall leads to a rapid reversal of this process. Storages fill, allocations increase, and the price of water on the temporary market can fall dramatically as supply outstrips immediate demand.2
The Long-Term Impact of Climate Change
While drought has always been a feature of the Australian landscape, climate change is altering the pattern, frequency, and intensity of these events. Scientific analysis indicates a long-term trend towards a hotter and drier climate in southeastern Australia, which has profound implications for the water market.5
- Reduced River Inflows: Higher average temperatures and lower average rainfall have led to a significant reduction in the average volume of water flowing into the rivers of the MDB. The MDBA estimates that average River Murray inflows over the last 20 years have been almost 50% lower than the long-term historical average.53 This structural reduction in supply means that the starting point for water availability is lower than in the past, making the system more vulnerable to drought.
- Increased Frequency of Dry Years: The increased frequency of dry years is a primary cause of the higher average water prices observed in recent times.53 As dry years become more common, the periods of high prices are likely to become longer and more frequent, while the periods of low prices during wet spells may become shorter.
- Exacerbated Water Scarcity: Climate change is a "threat multiplier" for water scarcity. It not only reduces the amount of water entering the system but also increases demand through higher evaporation rates and greater plant water needs.62
This long-term climatic shift suggests that while the water market will continue to experience cyclical price swings, the baseline price of water is likely to trend upwards over time. The extreme price peaks seen during past droughts may become a more regular feature of the market landscape.
For water users, this reality underscores the importance of strategic planning. Managing water assets effectively in this changing climate requires a proactive approach, including investing in on-farm water efficiency, maintaining a diverse portfolio of water entitlements with varying reliability, and strategically using market tools like carryover and forward contracts to hedge against the risk of future price shocks.