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The regulation of river systems to meet water demands for irrigation in the southern Murray Darling Basin has changed the timing and the volume of the natural pattern of flows. Australian governments have committed to restoring, in part, winter and spring flow regimes to preserve and enhance the riverine environment. These changes will involve trade-offs against the foregone returns to agriculture and between different environmental objectives. To better understand these trade-offs, environmental flow objectives are specified as a change in the inter-arrival time distributions of winter and spring flow events, ranging from brief flooding events to the inundation of flood plains and wetlands over several weeks. Expected costs, and hence the trade-offs, depend on the required volume, the threshold inter-arrival time between environmental watering events, and the acceptable probability of exceeding that threshold time. The economic costs of meeting environmental flow objectives will depend on prevailing climatic conditions. The key to minimising costs to other water users is to time the environmental release to avoid periods of low water availability and take advantage of periods of high availability while still meeting the flow objectives. In doing so, an environmental manager must weigh current environmental condition against the likelihood of more or less favourable conditions in the future. A stochastic optimisation model is used to develop release strategies based on a known set of stream inflows and evaluated against a randomised sequence of unknown flows. The model is used to elicit the economic trade-offs associated with environmental flow objectives and the threshold inter-arrival time between events. The model was also used to examine how different institutional arrangements affect the economic efficiency of delivering these objectives.

Environmental intervention is often seen as being high risk and high return. Traditional scientific hypothesis testing provides limited guidance to policy makers unless there is a high level of certainty in the supporting scientific evidence. Traditional cost-benefit analysis under uncertainty has shortcomings when considering high-risk investment, largely due to the choice of how to discount uncertainty outcomes. A corollary is that traditional cost-benefit analysis does not place a value on increased certainty, an important outcome of successful scientific research. A fiducial costbenefit methodology is presented in this paper, which integrates hypothesis testing and traditional cost-benefit analysis. The fiducial approach is one way of objectively placing a value on changes in the level of uncertainty that does not depend on an assumption about a decision maker's attitudes towards variability in returns. This has two important implications. First, there is a level of uncertainty at which we would reject an investment with a positive expected net rate of return on the basis that the uncertainty associated with the outcome is too great. Second, it is possible to value a program of research that reduces the uncertainty about a critical decision parameter. An example based on data from a weather modification experiment conducted in South Australia is presented. The approach is the generalised using more traditional statistical methodology.

Most urban centres across Australia are facing water shortages. In part, these water shortages are due to the variability of supply and demand caused by variable climatic conditions. Permanent supply augmentation to meet periodic water shortages can be costly. Water trade between rural and urban areas, through urban water options contracts, may be a less costly way to meet variability. Urban water options could be used to improve system reliability and may reduce costs by delaying investment and reducing the frequency and severity of water shortages. This paper investigates the potential to use urban water options contracts, and develops a methodology for evaluation.

Many irrigation areas are facing the problems of aging infrastructure and a declining revenue base from which to fund maintenance and repair activities. The push toward full cost recovery for storage and delivery services arising from water reform policies means that some supply utilities will need to consider the strategic rationalisation of infrastructure to remain viable in the long term. Consideration must also be given to the implementation of appropriate charging regimes for infrastructure access to ensure that irrigators are not sub-optimally excluded from the delivery system. Below the point of congestion, non-volumetric charges for access to irrigation infrastructure are analogous to a pricing regime for a non-rival but exclusive good. Two charging models for infrastructure access are analysed in this paper – socialised cost sharing and serial cost sharing – in the context of the efficient provision of a non-rival good. Findings indicate that over-rationalisation may occur under a socialised cost sharing model but that this potential is eliminated under a serial cost sharing model.

Australian governments have agreed to develop and implement policies to promote more efficient use of water resources and improved water quality. Policy objectives may include incentives for investment in efficient irrigation technologies. However, the presence of large, sunk investment and the uncertainty of future returns will have an impact on the efficiency of such policies and the timing of the water savings and environmental benefits that they generate. A case study of Murrumbidgee Irrigation Area is used to quantify the effect of sunk investment cost and uncertainty of future returns on the effectiveness and efficiency of policy initiatives to increase water use efficiency. The results indicate that these factors slow adoption rates substantially. Policies that promote greater certainty with respect to water resource can potentially increase adoption rates and resultant environmental outcomes.

The joint conference paper, 'Third-party effects of water trading and potential policy responses' by Anna Heaney (ABARE), Gavan Dwyer (PC), Stephen Beare (ABARE), Deborah Peterson (PC) and Lili Pechey (ABARE), was presented to the American Agricultural Economics Association conference, Providence, Rhode Island, 25 - 27 July 2005. A key feature of water policy reform in Australia has been the separation of water access entitlements from land titles and the establishment of markets for water. However, the separation of water entitlements from land entitlement is not a sufficient condition to ensure that water markets are complete. In the absence of fully defined property rights, water markets will be incomplete and trade has the potential to create third-party effects. However, property rights over natural resources are seldom completely specified, because of the existence of transactions costs. The benefits from eliminating third-party effects need to be sufficient to warrant intervention. The objectives in this paper are to identify key potential third-party effects of water trade under existing property rights structures in Australia, and to examine policy responses to address these effects. The discussion draws on the concepts of exclusiveness and rivalry as key characteristics that determine the applicability of property rights solutions to third-party effects of trade. It is likely that many of the third-party effects of trade discussed in this paper do not warrant policy intervention at the national or state level. In some instances, effects are likely to be relatively minor, although some may be significant at the local level. The costs of addressing some third-party effects may outweigh the benefits. Where there are significant gains from trade, the existence of these third-party effects should not been seen as a reason to impede trade. There are first-best policy instruments to address these effects at an appropriate scale. *ABARE (Australian Bureau of Agricultural and Resource Economics); PC (Productivity Commission) **The views expressed in this paper do not necessarily reflect those of the Productivity Commission.

Problems in natural resource management arise when markets do not work effectively to resolve the inefficiencies associated with the way resource access rights are currently specified. In most cases, this can be linked to incomplete markets. In order to assess potential management options it is important to consider the characteristics of the good or goods that are in essence, missing from the market. This paper explores a taxonomy of goods and services, based around exclusivity and rivalry, to assist in determining when intervention in the form of regulation, property right solutions or market interventions are suited to deliver an optimal or improved social outcome.

A modelling framework incorporating relationships between agricultural production and groundwater hydrology was developed to estimate the benefits of improved irrigation efficiency in the Riverland of South Australia. Increased irrigation efficiency can generate external benefits to downstream users through reduced discharge of saline groundwater. In the Riverland these benefits are large in comparison to the direct value of the irrigation water. However, the non‐exclusive and site‐specific nature of these benefits makes it difficult to fully internalise them through market instruments such as salinity credits. Achieving optimal irrigation efficiency is likely to require institutional arrangements that promote collective investment and public expenditure.

Efficient investment in salinity mitigation requires an understanding of how different landscapes respond to alternative land and water use options at both a regional and a broader scale. A simulation modeling framework that integrates the relationships between land use, vegetation cover, surface and groundwater hydrology and agricultural returns was developed. The model presented here has been used to estimate the direct and external benefits of improved water use efficiency in the Mallee irrigation areas of South Australia. Upstream investments in water use efficiency can generate substantial external benefits to downstream users through improved water quality. Given the non-exclusive and diffuse nature of these benefits, achieving the socially optimal level of improvement in water quality is likely to require institutional arrangements that promote collective investment and public expidenture.

There is pressure in Australia for water management reform to ensure an efficient allocation of resources between productive uses and to provide adequate conservation of the environment. The establishment of water markets and trade has been seen as the primary mechanism for improving the efficiency of water use in the Southern Murray Darling Basin. However, with the existing trading arrangements, irrigators can only reallocate water within a season. Individuals do not hold property rights that allow them to manage the variability in water demand and supply between seasons. The objective of the study presented in this paper is to establish an order of magnitude for the benefits of property rights that allow for inter-seasonal arbitrage in water markets. A stochastic optimal control model was developed for the Murrumbidgee catchment, which integrates agronomic, economic and hydrologic aspects of farm irrigation. The modelling framework allows consideration of the impact of alternative strategies for the pricing of water released from storages, when there exists uncertainty in both water availability and demand. The current allocation system adopted in the Murrumbidgee valley has the traded price of water largely determined at the start of the irrigation season according to allocation levels. The impact of this strategy on water use and farm incomes is compared with that which would arise from a system of property rights that allow trade of water held in storage within and between seasons. The results indicate that under a system of storage access rights which allows trade between seasons, irrigators could increase returns compared to the current allocation rule by reducing the average amount of water held in storage between seasons. The increase in returns was estimated to be in the order of $700 million, discounted over 30 years. However, the associated increase in water use would result in lower but more volatile water prices and greater variability in water use between seasons. Realising these benefits might require investments in delivery and farm infrastructure. There would also be implications for the overall management of water flows for the environment.

Uncertainty has long been recognised as an important aspect of renewable resource assessment and management. Stochastic optimal control provides a framework in which to incorporate uncertainty, whether arising from fluctuations in the biological or economic environment or from lack of a precise understanding of inter-relationships within a system. However, overlaying complex and interdependent biological, physical and economic relationships with uncertainty often results in an optimal control problem which is analytically complex. In this paper, a parametric approximation to the control equation is combined with genetic search algorithms to solve the stochastic control problem. The parametric approximation to the solution of optimal control problems is compared with a collocation approach. The use of these two numerical solution techniques is explored in the context of a harvest model for a multi-species fishery. While the two techniques yielded similar solutions, they offered different advantages and disadvantages. The use of collocation methods facilitates the understanding of the problem and the nature of the solution. However, for multi-dimensional state space problems, collocation techniques require exponentially increasing computational time. Parametric approximation techniques require prior specification of an explicit relationship between the state and control variables. As a result, the approximation may impose or miss features of the solution. However, when combined with a genetic search algorithm, the technique is very robust and computation time is significantly less than for the collocation technique. The use of collocation techniques to characterise the solution to the problem followed by the application of an appropriate approximation technique may to prove to be an expedient method for dealing with larger scale problems.