1 Introduction Returning river systems to sustainable levels of extraction requires identification of necessary environmental flow levels, the issuing of water entitlements to provide for such flows, and the prioritisation of some entitlements at or above the level of existing economic entitlements. To achieve these outcomes, governments around the world must enhance their capacity to understand dynamic relationships between hydrological, social, and ecological systems in an effort to discover new ways to balance human and environmental needs for water resources (UNESCO, 2006). By way of example, the maturity of Australia’s water economy and an increasing need for mechanisms to restrain water demand and reallocate existing supplies to address externalities has been recognised since the 1980s (Randall, 1981). This requirement has been reemphas- ised by the significant environmental degradation that Australia’s Murray-Darling Basin (MDB) has suffered over the last two decades (Connell, 2007; Jones et al, 2002; Norris et al, 2001). Achieving targeted environmental flows: alternative allocation and trading models under scarce supply ö lessons from the Australian reform process Adam Loch Centre for Regulation and Market Analysis, School of Commerce, University of South Australia, GPO Box 2471, Adelaide SA 5001, Australia; e-mail: Adam.Loch@unisa.edu.au Henning Bjornlund Centre for Regulation and Market Analysis, School of Commerce, University of South Australia, Adelaide SA 5001, Australia and Department of Economics, University of Lethbridge, Lethbridge, Alberta, Canada; e-mail: Henning.Bjornlund@unisa.edu.au Ronald McIver Centre for Accounting, Governance and Sustainability, School of Commerce, University of South Australia, Adelaide SA5001, Australia; e-mail: Ron.McIver@unisa.edu.au Received 15 August 2010; in revised form 15 February 2011 Environment and Planning C: Government and Policy 2011, volume 29, pages 745 ^ 760 Abstract. The problem of water overallocation in many regions of the world involves how to include environmental flow provisions for long-term sustainability of river systems, especially under scarce supply conditions. Market mechanisms have provided pathways for returning water to rivers for environmental use. We argue that it is important to consider how both market mechanisms and initial water allocation models contribute to achieving satisfactory environmental flow outcomes. The Murray-Darling Basin (MDB) in Australia has had policy processes applied to it for almost twenty years to address these issues, and provides an excellent basis for case-study analysis. Two MDB case studies are used to consider differences in the interpretation and implementation of environmental flow requirements, and the potential for institutional inertia of the systems within which water markets operate. We identify two simplified models from these case studies öone prioritising environ- mental rights above consumptive extraction and the other prioritising consumptive and environmental rights equally. However, neither of these case-study models provides the full environmental flow spectrum of base in-stream flows to over-bank flush events. Our findings suggest that combining allocation and market-based rights (a third model) offers an effective means to deliver full-spectrum environmental flows. If governments provide prioritised environmental rights for base in-stream ecosystem benefits, together with targeted temporary and permanent water market acquisitions to meet environmental needs associated with over-bank floods and flushes, there will be lower potential for shortfalls relative to targeted environmental flow outcomes. doi:10.1068/c10142