Justin Lucas and Maryam Minai report on increased trading in water assets and the entry into the market of funds directed at investment in water assets.

Background and market activity – when it rains it pours

In September 2009, the Australian Water Commission released the Australian Water Markets Report (AWM Report) which charts the remarkable growth of Australia’s water markets.

The AWM Report found that the trade of water rights almost doubled in 2008-2009 and that trade in allocated water continued to grow significantly. The maturing water trading market is currently worth $2.8 billion p.a.

The rapid expansion of the water trading market is due largely to the reforms which are being implemented as part of the National Water Initiative (NWI).

The NWI commenced in June 2004 and is a joint commitment by Australia’s governments to make the nation’s water use more efficient and sustainable, leading to greater certainty for investors, producers, communities and the environment.

Reforms – opening the floodgates

Unbundling and Trade

One aspect of the reforms has involved ‘unbundling’, being the separation of water rights from land ownership and the creation of separately tradeable interests in water (formerly water rights were tied to land).

Most, but not all, water rights in Australia have been unbundled and this has facilitated the expansion of water trading, separate from land.

In Victoria, water rights started to be unbundled in July 2007. Three years on, we have seen increased market activity in Victoria in this new class of tradeable asset. Trading activity measured by the number of trades (rather than by volume) indicates that Victoria was the most active trading state for 2008-09, with more than double the number of trades than in New South Wales.

Unbundling created a tradable water asset in the form of a water access entitlement (each jurisdiction gives the entitlement a different name and it is described in Victoria as a “water share”). Essentially, a water share is a proprietary interest in a share of the water available for use in a defined water system. A water share is specified as a maximum volume of the seasonal allocation that may be made against that share. Water allocations for each water system are made throughout the year based on the volume of water available in the system.

Water that is allocated under a water share is recorded in an “allocation bank account” kept by the water authority responsible for the water system. The annual allocation under the water share gives rise to another tradeable asset: the water that is allocated. This water can be drawn from the system and used or sold to others to use. Any water volume used or sold is deducted from the allocation bank account.

Trading often arises in the context of land transactions but we are also seeing a number of stand alone dealings in disassociated water (that is, water not tied to use on specified land or on land in a limited zone). We are also seeing deals where the value of water traded with land far exceeds the land value (by a significant multiple) and the entry of funds directed to investment in water.

4% limit

Another aspect of the reforms under the NWI is that jurisdictions agreed to remove barriers to entitlement trade out of irrigation districts, up to an annual threshold limit of 4% of the total entitlement of each area (4% limit).

The AWM Report found that in 2009, the 4% limit was still in force in most jurisdictions. During 2008-09, the 4% limit was triggered in six irrigation districts in Victoria, constraining entitlement trade out of those districts. After negotiation with the Commonwealth Government, the Victorian Government has agreed to start phasing out the 4% limit from irrigation districts from July 2011, with the aim of removing the cap entirely by 2014.

To implement the outcome of negotiations with the Commonwealth Government, the Victorian Government announced some exemptions to the 4% limit in September 2009. The purpose of the exemptions is to better align the Commonwealth’s environmental water buybacks with the $2 billion investment in Northern Victorian Irrigation Renewal Project to modernise Victoria’s irrigation system.

Abolition of 10% limit

In November 2009, a rule in Victoria was abolished that limited the separation of water rights from land in a district to 10% per annum of the water for the district. This rule restricted the separation of water ownership from land. The removal of the rule has further enhanced the ability to trade water rights.

Diving into the water market

The system of ownership of water shares and the registration of interests in water shares is modelled closely on the land titles system. In many respects, statutory provisions relating to real estate are replicated with only minor changes to the water context.

This places Norton Rose’s experienced real estate lawyers in a unique position to advise on the structuring of water transactions. Transactions on which we have advised have involved the consolidation and subdivision of water shares, mortgagee sales and leasing of water shares (including sale and leaseback deals).

In addition to a knowledge of the extensive regulatory system, knowledge of the requirements and processes adopted by the water authorities is essential to the successful structuring and completion of transactions in water assets.