One way to analyse the scope for urban water markets is to consider the motivations for rural water trade and make some assessment about the extent to which these forces are likely to hold in an urban setting. We focus primarily upon household users in the first instance.

It has been argued earlier that one of the primary features that led to a flourishing temporary rural water market was the heterogeneity that typifies modern irrigated agriculture. Combined with the critical nature of this resource for some (but not all) irrigated production and the volumes of water involved in a transaction, these are probably the major considerations in the current debate about the potential of urban water markets.

Unlike agricultural water users, the major determinants of water demand for households are family size, size of land allotment and, to some extent, income (see, for instance, Hoffman et al. 2007). Nevertheless, even a cursory assessment of most urban groups would indicate that there are relatively modest welfare gains from trade between households per se compared to that on offer between different agriculturalists. This observation can only be substantiated by empirical research but, prima facie, households face relatively similar demands for water. Most vary between a low of about 100 kilolitres per year and a high of about 400 kilolitres per annum (ABS 2004). Moreover, there is only limited potential for overcoming the constraints imposed on one group of households by transferring water from other households. After all, indoor demand is generally regarded as non-discretionary for all households and is estimated to be equivalent to about 60 per cent of domestic water use (WSAA 2005). Notwithstanding that this figure is, in part, a function of water restrictions that ban outdoor use, the extent to which inter-household trade in its own right could alleviate the constraints imposed by water restrictions is limited.^[4]

In line with the arguments presented earlier, it is also worth noting the relative knowledge of potential market participants in an urban water market. This issue has several pertinent components. Unlike their agricultural cousins, urban users might be expected to have only a limited appreciation of hydrological constraints and the implications of these for water delivery and pricing. This is not to imply that there are some supernatural powers bestowed on the irrigation fraternity. Rather, the modest use (and cost) of water by urban residents is unlikely to justify the investments in the knowledge required to be able to discern between water products with different hydrological characteristics.^[5] A similar argument may hold for the limited understanding of the production functions for lawns, gardens and the like. It must be emphasised that this should not serve as a criticism of urban water users or act as a justification for lavish public ‘education’ programs aimed at such users. The reality is that the price and production-related motivation to gain such knowledge is relatively weak for potential participants in a household urban water market.

We contend that unlike household behaviour and demand, the industrial use of water in urban areas is a more complex question, varying with the nature of production, value of outputs and the like. Relatively little research has been undertaken in the area of non-residential urban water use but anecdotally the quality and reliability of supply are more critical to this group than the price of the input per se. Nevertheless, in some cases industrial users will have incentives to gain knowledge and participate in the market that matches or even surpasses that of irrigators. However, the decision by governments to isolate most industrial water users from urban water restrictions has curtailed the incentive to acquire the knowledge and enthusiasm to participate in a market setting. Were a market to be available to this group, it is also difficult to see an industry champion emerging to limit transaction costs, as was the case with the irrigation sector and the activities of Murray Irrigation Limited and Goulburn-Murray Water. In this context, the state would invariably be expected to fulfil this role.

Notwithstanding the limitations facing inter-household trade and the likely necessity for the state to play a major part in fostering participation by industrial users, there remains considerable scope for trade between the household sector as a whole, industrial users who prize ongoing water access and agricultural users. A comparison of the estimated willingness to pay to avoid urban water restrictions with the going rate for temporary rural water allocations in parts of eastern Australia provides some support for this view. For example, Brennan et al. (2006) estimate that the household impacts of water restrictions are between $347 and $870 per season in Perth. In a similar vein, Hensher et al. (2006) report a household willingness to pay $239 per year to avoid water restrictions. To provide a rough basis for comparison, it is worth noting that in 2004/05 Australian households consumed on average 103 kilolitres per capita in total. This equates to about 300 kilolitres for an average three-person household or less than a third of one megalitre of water. By way of contrast, the going rate for temporary access to a megalitre of ‘raw’ water currently stands at about $300 (see, for example, Watermove 2008), although this varies across the irrigation season. Even after accounting for the additional cost of converting raw water to potable water, there should be ample scope for alleviating or lowering water restrictions by trading water away from agriculture into urban areas.

Similar support can be found in the outcomes from a recent inter-sectoral water-trading program in Northern Victoria. In this case, commercial urban users and larger water users responsible for managing community sporting assets (such as bowling clubs, tennis clubs, schools and the like) were afforded the opportunity to enter the temporary rural water market and ‘trade their way out of water restrictions’. The popularity of this program and the willingness of participants to pay standard delivery charges on top of the cost of the bulk water purchased are indicative of the potential benefits of inter-sectoral trading activity. Regrettably, few similar cases of trade at this level are available, at least to the knowledge of the authors.

Of course, all water trades are contingent on some form of interconnection between users. There is some doubt that this will ever be feasible for all jurisdictions. For instance, Victoria already enjoys interconnection between different sectors and the planned north–south pipeline should expand this ‘grid’ of connectivity. By way of contrast, the scope for interconnectivity between agricultural water users and the urban residents of Sydney seems remote in the context of current water prices. The point here is that any program of reform adopted on a national scale should at least consider this most rudimentary principle.^[6] There seems little point in insisting on national standards for inter-sectoral trade where interconnection is never likely to be feasible in some jurisdictions.

In addition to physical connectivity, two additional conditions need to be met to ensure the operation of the urban-rural trade. First, trade between sectors needs to be politically acceptable or run the risk of stalling. Second, the institutions charged with actually delivering water to purchasers must have sufficient incentives to honour such trades. Regrettably, both of these conditions remain as significant obstacles in some states. Water traded to urban users from willing agricultural sellers continues to be described in the press as ‘taking water’ and dubious water-for-infrastructure swaps are put in place to appease those who claim to be disaffected (see, for example, DSE 2008). In some jurisdictions the function of bulk water delivery has yet to be adequately separated from agricultural interests, resulting in inequitable treatment of water users regardless of the status of validly purchased water access rights.