The Murray-Darling Basin Authority should be split, while taxpayers face being hit by half a billion dollars in extra costs if projects fail, the Productivity Commission has found.
The commission's draft report into the first five years of the $13 billion basin plan, released on Thursday, called for "immediate action", saying that while a "significant step change" had been made to correct excessive extraction, its success was "not guaranteed".
A key recommendation is to spin off the authority's compliance powers into a new Basin Plan Regulator, leaving the implementation role to a rebadged basin corporation.
"These roles are conflicted and the conflicts will intensify in the next five years," the report found.
Current arrangements had "major shortcomings" - including a lack of transparency and accountability - and if not addressed, "projects are likely to fail or be implemented poorly".
Even with $4.9 billion of the plan's funding remaining, future costs could blowout by another $480 million if governments had to make up for any water recovery shortfall.
Ineffective collaboration between the governments - Queensland, NSW, Victoria, South Australia, the ACT and the Commonwealth - had resulted in "key risks not being strategically managed" and implementation often based on last-minute negotiations, the report said.
The report acknowledged work by academics - Matthew Colloff, John Williams and Quentin Grafton - that investments to improve water use efficiency may underestimate the water lost to the environment.
So-called return flows, or water lost from irrigation systems that end up in river systems, have been credited in the US, for instance, but "are not systematically accounted for"in the basin plan, it said.
Dr Williams welcomed the commission's findings but said it was "a fairly light treatment of the issues at hand".
The splitting of the authority's roles would be "an important step", but true oversight would need independent peer review. The commission had also underestimated the magnitude of the return flow losses, he said.
The authority said changes to its structure were "a matter for government, the MDBA remains able to fulfil its different roles independently and properly under the current structure".
“The MDBA and Basin governments are already addressing many of the issues the Productivity Commission has identified as areas for improvement, including a review of governance arrangements, the establishment of an Office of Compliance, and improved monitoring and evaluation," an Authority spokesman said.
David Littleproud, federal water minister, noted the report found the plan had already recovered the necessary water savings in 22 of 28 catchments.
He did not comment on the recommendation of splitting the authority.
Niall Blair, NSW water minister, said he did not yet have a view on the separation of power.
"I'd hate to go through all the pain as we have in parts of NSW, and not have the outcomes that people want," Mr Blair said.
He also welcomed the call for greater transparency, including the release of modelling: "When you leave a void, people will assume the worst."
Lisa Neville, Victoria's water minister, said her government would consider the recommendation to split the authority: "Any decisions like this need to be done collaboratively with all Basin states."
Rex Patrick, a Centre Alliance senator, said the Commission had confirmed his party's reservations about the cuts recently approved to water savings earmarked for the northern basin and sustainable diversion limit allowances.
"Due diligence was not properly carried out by the Senate and in that respect it has failed the Australian public, and particularly South Australians," Senator Patrick said.