Price and volume relationships across water trading zones

Abstract

In the Australian context greater policy reliance has been placed on the role that market based solutions can play in solving problems in the allocation of irrigation water. In Northern Victoria one of the most active areas of water trading is in the Goulburn-Murray Irrigation District. To facilitate water trading in this area an electronic market clearing mechanism exists through the Watermove arrangements. Under the Watermove arrangements the state is divided into regions and trading zones, however most of the trading zones have very little trading activity. This paper explores relationships in price and volumes across the two most active trading zones in the Goulburn-Murray Irrigation District in Northern Victoria. While previous papers have explored spatial dimensions of pricing across trading zones our focus is on relationships driven by price and volume characteristics. An analysis of price and volume relationships across trading zones enables an understanding of whether trading volume in a zone produces more informed prices and enables that zone to take on a price leadership role. Our analysis considers the stationarity properties of the price and volume data across the two trading zones and then estimates VAR models of the price and volume relationships across these trading zones. From the VAR models we are able to conduct both Granger causality tests and variance decomposition analysis. This analysis shows that the most actively traded of the two trading zones (the Greater Goulburn trading zone) plays the key role in price leadership. This finding is broadly consistent with previous research on highly liquid financial markets and suggests that irrigation water markets are developing characteristics similar to more liquid financial markets, giving confidence in their successful operations.