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Water is the latest commodity to be traded on the futures market

Water can now be traded as a commodity on Wall Street like gold, oil, etc. Investors can bet on or hedge against the future price of the natural resource. The water in question is that of California’s, a region that experiences severe drought and dryness to the extent that it routinely deals with wildfires. It has only just begun to emerge from an 8-year drought.

The contract is being offered by the Chicago Mercantile Exchange (CME) Group Inc., the world’s largest financial derivatives exchange. While it gives consumers an opportunity to hedge against the future availability of water, the contract also acts as a metric that measures water scarcity.

CME Group’s futures contracts are tied to the NASDAQ Veles California Water Index. NASDAQ and Veles Water (a financial products company that specialises in water pricing) have partnered with West Water Research LLC (a financial consulting firm that specialises in water trading) in order to create the NQH2O Index. The index tracks the price of water rights across California’s five most actively traded regions which includes its surface water resources and the four largest groundwater basins in the state.

How does the index work?

The index is priced in US Dollars per acre foot, which refers to the amount of water needed to cover one acre for a depth of one foot, which amounts to about 325,851 gallons of water (the US uses 322 billion gallons of water per day). The index reflects the volume weighted average price of water at the source which excludes conveyance costs and losses incurred at the underlying markets.

It reflects all major water leases and sales (verified by government agencies) that occurred the week before and the results are announced every Wednesday morning at 9:30 a.m California time. The NQH2O Index was officially launched on October 31st 2018, displaying a price of $371.11 per acre foot, and is currently at $489.11 (as of December 9th 2020).

What are the implications?

The fact that water is now being traded on the commodities exchange raises eyebrows for a number of reasons. The first and perhaps the most obvious is the fact that it represents something that we already know – water is increasingly becoming a scarce resource. Climate change is very much a reality regardless of whether people agree and it is impacting the availability of water. Cape Town was the first major city to face the possibility of running out of water entirely. Residents were limited to 50 litres of water a day and a number of drastic measures were taken to deal with the crisis. Eleven other major cities, including the likes of Bangalore, Beijing, and London, are expected to run out of drinking water in the next few years as well.

Another point that deserves to be highlighted is the fact that Wall Street now has an active interest in the price of water. The implications here are that the price may be driven up well beyond the reach of the average consumer. Investors will now begin speculating on the value of the ‘asset’ and a water crisis in California will make for the ideal situation for bankers to profit from.

As of right now, the water that is being speculated upon is limited to only that of California’s, but in the coming years we could very well see the emergence of a global water futures market. Flood insurance companies will naturally get involved in order to mitigate their financial risks, along with pretty much any corporation that conducts its business in a floodplain

If the global grain market is anything to go by, this will lead to an increase in the volatility of the price of water (volatility is where the money is made). When the price of water is high, the price of food will increase.

This will not happen until people can come up with a universally applicable way of measuring water stress. Until then, we will see only localised futures markets coming up in different parts of the world. For example, the increasingly difficult to predict monsoons of South India has led to conceptualisation of a water futures market for that region only, to be potentially traded on the Delhi Stock Exchange.

CME Group Inc. has a different take on this development, naturally. They look at the California water futures market as an avenue through which the risks associated with the supply and demand of water can be managed. If a farmer wants to know what the price of water will be in 6 months time, it’s merely down to his best guess. The market will be an amalgamation of what everyone’s best guess is, giving the farmer more information to work with, and as a result, help him manage his operations more efficiently. 

A professor of natural resources law from Stanford University is of the opinion that the water futures market will not contribute to the scarcity of water, but is merely a reaction to it already being the case.

For feedback, thoughts and views, write to pavan@bclindia.in

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