Paul Callow: Quenching our thirst for water

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Opinion

Developing greater access to irrigation is critical to our economic prosperity and the private sector will likely play a big part.

New Zealand's economy is heavily dependent on the agriculture sector for generating much of our wealth and wellbeing. The sector itself depends on a range of inputs, but by far the most important is water - you only have to look at the devastating effect recent droughts have had on dairy, lamb and beef production to realise just how important.

Interestingly, the problem is not that there isn't enough water in an absolute sense; it is just that it often isn't available in the right place at the right time. Even a wet spring resulting in abundant water can be followed by a very dry summer with its attendant problems for farmers and producers.

Providing water at the right place and time is not exactly rocket science, however. It can be stored and pumped to the places it is needed and if the storage is big enough for a given irrigated area, there will always be a sufficient supply. So why hasn't this happened?

In some respects it has. Many farms have boreholes which essentially tap into underground storage in the aquifer and provide localised irrigation more or less on demand.

Boreholes are, however, expensive to operate with high pumping costs and can, if not properly managed, deplete the aquifer more quickly than it can be replenished with potentially adverse effects on natural water courses.

A more efficient response to water availability has been the establishment of community-based irrigation schemes where groups of producers secure a water consent and build a distribution network to provide water to a number of properties in an area.

This tends to be more efficient than using boreholes and provides a significant economic payoff to the producers by providing a substantial step up in the productivity of their land. It also enables them to change the use of their land to much higher value use by moving from, for example, dry stock farming to dairy or cropping.

The amount of land suitable for irrigation is sizeable with approximately 475,000 hectares identified by various planed schemes. The economic pay-off from irrigation on this scale would be substantial. So why have larger schemes taken so long to progress when smaller schemes have shown such benefits?

The co-operative schemes have largely been designed to take water from existing water courses and have been developed as community co-operative bodies. Two problems arise when you try to scale up schemes using this model: firstly, there usually isn't enough water in one river to feed a large scheme, and secondly a co-operative of the size needed would be so unwieldy as to be unworkable.

Essentially this means you need storage, a lot more capital, and a different ownership structure and balance sheet which can provide it.

A large irrigation project is a major undertaking on almost every front and faces a number of challenges, not least securing consents to take and store water. This can become a highly emotive issue, particularly if handled poorly. The other major challenge of course is finding the money to pay for building and operating the project.

The key issue here is demand risk: in other words, how many farmers in the area to be irrigated will be willing to pay for water and how much will they be prepared to pay? This is often quoted as a reason why Government support of a project is necessary but the private sector is quite adept at managing this type of risk. In a commercial property development, for example, the risk is managed by securing pre-sales before a project is committed to construction. Similar principles could be applied to irrigation schemes where commitments from farmers to take water could be used to underwrite the capital cost.

Clearly the on-farm economics would need to stack up, including any on-farm investment needed to use the water. It is incumbent on the scheme promoter to understand these in determining the pricing of the water it would supply and its affordability to its prospective customers. All this analysis can, and should, be carried out before significant capital is committed.

The crunch comes when the revenues a scheme is expected to generate are insufficient to support the capital needed for its development. There may still, however, be a worthwhile economic, as opposed to financial, payoff and it is here that Government has a role to play.

Government can support marginal projects or those which provide an insufficient rate of return to attract a private investor in a range of ways. It can either provide part of the capital without requiring an economic return or it can subsidise the cost of water to end users. Either will provide adequate support but can lock in the Government to financial commitments which may prove undesirable at a later stage. Understandably, the Government's appetite for this type of arrangement is unlikely to be high, particularly when faced with pressing financial needs elsewhere. It needs a smarter way to invest.

Studies have shown that irrigation schemes often have a slow initial take-up but as the benefits are realised by those who invest, others join the scheme. A lot of landowners will "wait and see" and commit only when they have seen the benefits reaped by others, particularly where land use change is needed. The price differential between irrigated and dry land also usually gets their attention - but that change takes time to emerge and develop.

What this means is that revenue the scheme generates will grow over time but there is considerable risk around when and if this will happen at the outset. Ultimately a scheme which needs Government capital to get off the ground may be self-sustaining in due course, but what the Government needs is a flexible model where it maximises risk transfer to the private sector.

In the development stage this could be achieved by requiring the private partner to secure advance commitments for off-take and passing across the risk of capital cost over-runs. Partners would be selected through a tender process and as the scheme revenue grows, the private partner would be obliged to buy out the Government's interest. This would allow the public capital to be recycled into other schemes. Such an arrangement would allow the development skills of the private partner to be harnessed while partially underwriting the demand risk.

Getting irrigation right is important to New Zealand's economic future and the Government is likely to have a part to play. But this should be restricted to facilitating projects, with capital if necessary, and a clear exit route. It is vital that the skills of the private sector are fully utilised and prices are set by the market.

Irrigation projects are not easy to deliver. They are expensive to build and often attract intense public and political debate. But if we are to grow our economy in the area where we are strongest, we need to deliver more large-scale projects and find smarter ways to develop them.

*Paul Callow is a corporate finance partner at Deloitte and leads its energy and infrastructure team.