By Kim Chipman
December 6, 2020
Water joined gold, oil and other commodities traded on Wall Street, highlighting worries that the life-sustaining natural resource may become scarce across more of the world.
Farmers, hedge funds and municipalities alike are now able to hedge against — or bet on — future water availability in California, the biggest U.S. agriculture market and world’s fifth-largest economy. CME Group Inc.’s January 2021 contract, linked to California’s $1.1 billion spot water market, last traded Monday at 496 index points, equal to $496 per acre-foot.
The contracts, a first of their kind in the U.S., were announced in September as heat and wildfires ravaged the U.S. West Coast and as California was emerging from an eight-year drought. They are meant to serve both as a hedge for big water consumers, such as almond farmers and electric utilities, against water prices fluctuations as well a scarcity gauge for investors worldwide.
“Climate change, droughts, population growth, and pollution are likely to make water scarcity issues and pricing a hot topic for years to come,” said RBC Capital Markets managing director and analyst Deane Dray. “We are definitely going to watch how this new water futures contract develops.”
The United Nations has long warned that human-driven climate change is leading to severe droughts and more flooding, making water availability increasingly less predictable. In California, the most recent acute dry spell stretched from December 2011 until March of last year, according to the U.S. Drought Monitor. The most dire effects took hold in July 2014, with 58% of the state’s land suffering “exceptional drought,” leading to crop and pasture losses and other water emergencies.
The futures are tied to the Nasdaq Veles California Water Index, which was started two years ago and measures the volume-weighted average price of water. The January 2021 water contract that went live Monday had two trades.
“I’m delighted we’ve had trades,” said Clay Landry, managing director at consulting firm WestWater Research, which provides the data used to calculate the water index. “In the physical market, it’s so hard to get a deal done. This feels like lightning fast to me.”
The index sets a weekly benchmark spot price of water rights in California, underpinned by the volume-weighted average of the transaction prices in the state’s five largest and most actively traded markets.
The futures are financially settled, as opposed to requiring the actual physical delivery. Contracts include quarterly ones through 2022, with each representing 10 acre-feet of water, equal to roughly 3.26 million gallons.
According to Chicago-based CME, the futures will help water users manage risk and better align supply and demand.
Two billion people now live in nations plagued by water problems, and almost two-thirds of the world could face water shortages in just four years, Tim McCourt, global head of equity index and alternative investment products at CME, said in an interview. “The idea of managing risks associated to water is certainly increased in importance.”
Currently, if a farmer wants to know what water will cost in California six months from now, it’s kind of a “best guess,” Patrick Wolf, senior manager and head of product development at Nasdaq, said in an interview.
The futures will allow market participants to see “what is everybody’s best guess,” he said.
Barton “Buzz” Thompson, a professor of natural-resources law at Stanford University, said while he has “no idea” if the futures will be successful, he doesn’t see it as a transformation of the water market.
“I don’t think the futures contract itself is really changing the water markets,” Thompson said. “Nor is it changing the risk that exists out there that water in the future at some point will be in shorter supply, it’s simply responding to those things.”
CME declined to identify potential market participants, except to note that the exchange has heard from California agriculture producers, public water agencies, utilities as well as institutional investors like asset managers and hedge funds.
Landry of WestWater Research said in addition to the likelihood of a “great deal of interest” from Wall Street, he expects the early water futures adopters to be large and small agriculture businesses.
“Without this tool people have no way of managing water supply risk,” Boise, Idaho-based Landry said in an interview. “This may not solve that problem entirely, but it will help soften the financial blow that people will take if their water supply is cut off.”
— With assistance by Elizabeth Elkin