Exit fees and termination fees revisited: funding irrigation infrastructure in a manner compatible with water trade *

It has long been recognised that the mechanism for funding irrigation infrastructure in Australia may be incompatible with efficient trade in the rural water market. If the revenue received by an irrigation operator is dependent on the volume of water entitlements held in the operator’s region, out‐of‐region permanent water sales threaten the operator’s revenue stream, potentially leading to higher charges on remaining irrigators, encouraging an inefficient ‘rush for the exit’. In response, irrigation operators have imposed restrictions on permanent water trade, such as exit fees and termination fees, to protect their revenue stream. Previous economic analysis has suggested that exit fees, in particular, are a barrier to efficient trade in the water market and should be abolished. In contrast, this paper argues that allowing irrigators to cancel their water delivery rights without fees or charges leads to inefficient trade in the water market, hinders efficient on‐farm investment in sunk complementary assets and leads to inefficient network rationalisation decisions. Instead, the revenue stream of irrigation operators should be insulated from water trade decisions, through high termination fees, tying irrigation charges to the land, or tagging the obligation to pay delivery charges to the new owner of the traded water.