One of the most senior bureaucrats in the Commonwealth public service has proposed a new system of water trading for Australian cities.

In a speech in Melbourne last night, Treasury Secretary Ken Henry expressed frustration at the way that water is currently managed and suggested a market-based system for trading water in urban centres whereby it would be sold in the same way as electricity and gas.

He jokes that he has been accused of knowing a lot about Treasury but not much about water.

But that is not what key players in the water sector seem to think of comments he made last night when delivering the Ian Little Memorial Lecture in Melbourne.

Dr Henry has proposed a water trading system for cities, whereby usage is controlled by price instead of rationing through water restrictions.

Peter Cullen, the National Water Commissioner and a member of the Wentworth Group of Concerned Scientists, told AM it makes sense.

"We don't ration petrol," he said.

"As petrol gets scarcer, the price goes up and we make our individual choices.

"The opportunity to really use the water market to confront the water scarcity that we now have is very important."

In saying that Australia does not currently have a well-functioning water market, Dr Henry is criticising the previous federal government and the current state governments which are responsible for allocating urban water.

Pricing signals

Professor Cullen says that for too long governments have avoided putting water prices up out of a misguided sense of social welfare.

"The argument has been [that] these poor families who can't afford it," he said.

"I think we've made a mess when we mix up water pricing with social welfare.

"Yes, there are poor people who need help and we should help them through the social welfare system, not by trying to reduce water prices."

"There are people who feel very strongly that watering their roses is important and they would be prepared to pay whatever it takes to do that. Well, why shouldn't they have that right?

"During a drought, why shouldn't water prices go up? Those who don't really need it just wouldn't use it, perhaps, at that time, so we would get a lot of better signals if we had clearer pricing."

Professor Cullen says a system like the one Dr Henry's proposing could see water restrictions in Australian cities become more of a last resort.

"I'm not sure it would mean an end because I think there will be times when the system just can't cope and you do have to have restrictions.

"But we shouldn't be having restrictions all of the time. We should be reducing the frequency and the severity perhaps of restrictions. This would take some of the heat off restrictions."

Credit for saving

Another supporter of Dr Henry's ideas is John Marsden, a water economist who has advised prime ministers and cabinets.

"What this means for the average household is that if they saved water then they could possibly get a credit," he said.

"There is obviously transaction costs, that is, it costs a lot of money to be able to trade your savings so you mightn't do it for the average household.

"But for industry or large households or people with large gardens, they can buy and sell water so that people who really want water - and that could include our local governments - they could go out and buy water in a water market and they can buy water savings.

"You could link this with a savings system. So they're the sort of things that Ken is implying."

Dr Marsden says it is the first time ideas like this have been raised so publicly from within the Federal Government and there is a strong logic behind them.

"There is a lot of thinking to be done but there is a lot of good sense in what he is saying," he said.

"If we can do it for carbon, why can't you do it for water?"

But it is unclear so far what Water Minister Penny Wong is making of Ken Henry's comments. When approached by AM, a spokeswoman declined to comment.