Water Markets for Climate Change Adaptation: Trade, Storage, and Investment Under Stochastic Water Supply

Abstract It is widely accepted that water markets can support adaptation to climate change. However, quantifying this adaptive capacity is difficult as it requires models that represent both stochastic water supplies and forward-looking behaviour by market participants. We develop a stochastic dynamic model of the Murray-Darling Basin water market in which irrigators form rational expectations over future water prices, and make monthly water use, annual crop planting, and long-run investment decisions. The model is solved using reinforcement learning methods to approximate expectations, combined with mathematical programming to estimate market equilibrium. We validate the model against observed prices and irrigation activity from 2008 to 09 to 2021–22 and apply it to an ensemble of 37 CMIP6 climate projections for the southern Basin. Under drier future climates, water markets support adaptation through increased inter-regional trade flows into the downstream Murray, and larger storage reserves through more conservative crop planting. However, under the driest projections, inter-regional trade constraints bind, price differences widen across zones, and long-run irrigation development contracts by up to 16 per cent. The results highlight both the value and the limits of market-based adaptation, with implications for the design of water market institutions under a non-stationary climate.