The main impetus for the creation of water markets in Australia was increasing water scarcity. By the 1980s it was becoming increasingly evident that many surface water and groundwater systems were fully or over allocated (National Water Commission (NWC), 2011). This led to a number of reforms in the 1990s and 2000s, including the adoption of a cap and trade system across the major trading regions of the Murray-Darling Basin, where water users own a right to a share of the available water supply from a defined water resource (i.e. a river or dam), and have the right to trade these shares with other users.

There are two main water products in Australia: allocations and entitlements. Entitlements are ongoing rights to a share of water from a water resource each year while allocations are the volume of water allocated to an entitlement in a given year, usually expressed as a percentage of entitlement volume. Trade in entitlements represents a permanent transfer of water access rights while trade in allocations involves the temporary transfer of water within an irrigation season.

Trade allows water to be reallocated from lower value to higher value uses. Allocation trade helps irrigators adjust to short term shocks while entitlement trade facilitates longer term structural adjustment. For example, allocation trade significantly reduced the cost of the Millennium drought by allowing irrigators with permanent plantings to purchase water from irrigators in other regions in the southern connected Murray-Darling Basin (sMDB).