Comparing water options for irrigation farmers using Modern Portfolio Theory

D.S. Gaydon, H. Meinke, D. Rodriguez and D.J. McGrath

Agricultural Water Management, 2012, vol. 115, issue C, 1-9

Abstract: For irrigation farmers, the deregulation of water markets and consequent emergence of water as a tradeable commodity calls for a method of comparing traditional on-farm water options (growing crops) with off-farm market options (selling water seasonally, or selling water licences permanently). The option to diversify farm income in this way is a desirable future adaptation strategy in response to decreased and more variable water supplies. We demonstrate a method for comparing such options based on their risk-return characteristics. A framework commonly used in the finance sector is adapted to agricultural water decisions, and illustrated using a case-study farm from Australia's Riverina region. In our example, a range of potential farm management practices are examined for several future water availability scenarios, and then compared with a fixed-return option (selling water entitlements to the Australian Government's current water buy-back scheme). We demonstrate how the attractiveness of the scheme for farmers depends on future water availability levels. For any future allocation level, the best way to use water on-farm varies with the value of the fixed-return option. The farmer's decision on what portion of their water entitlement to sell provides them with the opportunity to tailor their operation's risk-return performance. This method is universally applicable wherever there is a mix of variable and fixed-return options, and offers a framework to assist farmers in conceptualizing comparisons between traditional on-farm uses for water and newer, market-based options.

Keywords: Irrigation; Farming systems modeling; Modern Portfolio Theory; Efficiency frontier (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:agiwat:v:115:y:2012:i:c:p:1-9

DOI: 10.1016/j.agwat.2012.08.007

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