Calculating exchange rates for water trading in the Murray-Darling Basin, Australia

Water markets have the potential to greatly improve the productive use of water by reallocating entitlements to where they are most highly valued. However, trading can actually reduce the volumetric reliability of other parties' entitlements if relatively more water needs to be supplied to the transferred entitlement after the trade. Exchange rates are a conversion factor applied to the traded entitlement volume to account for third party impacts caused when the water is consumed in a new location. The calculation of exchange rates must consider the inherent uncertainties associated with the volume supplied between years and across valleys. This paper explains the application of exchange rates in overcoming third party effects from trade and demonstrates the calculation of exchange rates for a case study of permanent intervalley trade between four valleys in the Murray-Darling Basin, Australia. Also, it identifies the "seller matched'' method as the most desirable system for determining the volume of water to be transferred each season to supply the traded entitlement.