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This article is an economic analysis of reallocating River Murray Basin water from agriculture to the environment with and without the possibility of interregional water trade. Acquiring environmental flows as an equal percentage of water allocations from all irrigation regions in the Basin is estimated to reduce returns to irrigation. When the same volume of water is taken from selected low-value regions only, the net revenue reduction is less. In all scenarios considered, net revenue gains from freeing trade are estimated to outweigh the negative revenue effects of reallocating water for environmental flows. The model accounts for how stochastic weather affects market water demand, supply and requirements for environmental flows. Net irrigation revenue is estimated to be # 75 million less than the baseline level for a scenario involving reallocating a constant volume of water for the environment in both wet and dry years. For a more realistic scenario involving more water for the environment in wet and less in dry years, estimated net revenue loss is reduced by 48 per cent to # 39 million. Finally, the external salinity-related costs of water trading are estimated at around # 1 million per annum, a quite modest amount compared to the direct irrigation benefits of trade.

[1] With increasing urban, industrial, and agricultural water demand and projected reduced supply under climate change, allocations to the environment are critically low in many arid and semiarid basins. Consequently, many governments are striving to augment environmental flows, often through market-oriented mechanisms that involve compensating irrigated agriculture, the largest water user in most basins, for reducing diversions. A widely documented challenge with policies to recover water for the environment arises because part of the water diversion reduction can form the basis for downstream consumptive water rights or environmental flows. This article gives an empirical comparison of two incentive policies to acquire water for environmental flows for a part of the Murray-Darling Basin (MDB), Australia. One policy consists of paying irrigators and water delivery firms to make capital and management investments that improve on-farm irrigation and water-conveyance; the other policy consists of having the government buy water from irrigators on the active MDB water market. The results show that the first option results in relatively larger return flow reduction, while the second option tends to induce significant irrigated land retirement with relatively large reductions in consumptive use and small reductions in return flow. In cases where irrigation losses result in little useful return flow (e.g., evaporative loss reduction or during drought in some instances), efficiency-improving investments may provide some cost-effective opportunities. Where a large portion of loss forms valuable return flow, it is difficult to make a case for the cost-effectiveness of policies involving payments for investments in irrigation and conveyance system upgrades.