The Value of Climate Hedge Assets: Evidence from Australian Water Markets
In Australia’s Murray Darling Basin (MDB), short term (allocation) and long term (entitlement) water rights are separately traded, centrally reported, and disseminated to the public. I utilize this setting to demonstrate three primary findings concerning water rights and climate change risk. First, water rights appear to be a climate change hedge: in periods of diminishing supply, allocation cash flows spike as price increases offset quantity declines. Second, since 2014, entitlement prices in climate exposed areas have increased approximately $1500 per MegaLitre (about 39%) more than prices in non-climate exposed areas while allocation prices are similar in both areas. These price differences provide a clear market signal about future scarcity and help to define investment opportunities available today to preserve water resources. Finally, estimating the allocation cash- flow–rainfall elasticity and extrapolating using the 2050 IPCC rainfall scenarios, I attribute about 21% of the price effect to differences in expected cash flow, and the remainder to a lower discount rate. The premium I estimate equates to a 1.2% lower rate of return for climate hedge or mitigation assets, a critical parameter in climate economics.