Water futures now trading on the markets for the first time

Futures contracts tied to the spot price of water were traded for the first time this week in the United States.

It is a significant move in the way water is viewed and managed as a commodity with opportunities and threats in the forecasting markets.

A futures contract is an agreement to buy or sell an asset at a specific time at an agreed price, and these legal instruments have generally been used to trade resources such as oil, precious metals and food. Unlike those goods though, the contracts will be financially settled, meaning that those who purchase them and who hold on to expiration will not have to take delivery of millions of gallons of water.

The market has been created by the Chicago Mercantile Exchange (CME), the world’s largest futures exchange and each contract would represent 10 acre feet of water (40,468 square metres), or the amount of water it takes to cover an acre of land in one foot (30.48 cm) of water.

Bet on future water prices

In essence, the new move will give investors, and farmers, the facility to bet on the future price of water with the contracts being tied to the $1.1 billion California spot water market, looking forward through to 2022.

The index reflects prices in California’s major river basins, where water scarcity has increased. The Nasdaq Veles California Water Index was launched two years ago and is driven by the volume-weighted average of transaction prices in the state’s five largest and most actively traded water markets.

Financial experts suggest that this value can be used as a reference for the rest of the world in the water markets. Contracts will each represent 10 acre-feet of water, equal to about 3.26 million gallons.

In announcing the market move, Tim McCourt, CME Group Global Head of Equity Index and Alternative Investment Products said:

“With nearly two-thirds of the world’s population expected to face water shortages by 2025, water scarcity presents a growing risk for businesses and communities around the world, and particularly for the $1.1 billion California water market.”

On the first day of trade on Monday (With the NQH2O ticker), the price of water futures in California was trading at about $486.53 per acre-foot, which is equivalent to 1,233 cubic metres. The new trading scheme was first announced in September, prompted by the worsening heat, drought, and wildfires in the American West, fuelled by climate change. There were two trades when the market went live on the day.

Serious water shortages

According to the United Nations, 2 billion people around the globe have serious problems in getting access to water. The UN forecasts that in the next decade two-thirds of the world could suffer from water shortages with millions of people being displaced. The United States China and are the main consumers of water.

The prime drivers of the growing water shortages around the world are seen as excessive use by the primary sector and industry, as well as human consumption and climate change.

RBC Capital Markets managing director and analyst Deane Dray advises:

“Climate change, droughts, population growth, and pollution are likely to make water scarcity issues and pricing a hot topic for years to come. We are definitely going to watch how this new water futures contract develops.”

Michael Burry – who was the subject of the film The Big Short –  is seen as a prime contender for an early move into the new water futures market. Burry has publicly promoted water as one of his top investment ideas following the great financial crisis of 2008 because he views the growing pressures of population growth and climate change will mean ever-increasing demand for this finite natural resource at the same time as there is a shrinking supply.

However, it is more likely that farmers rather than aggressive investors will buy the futures contracts as a potential way to manage their future input costs, hedging against increasingly likely changes in the environment sparked by global heating.

Guaranteed water prices

In this context, the main evangelists for the water futures markets contend that this form of trade will help to align supply and demand for water. With 40 per cent of Californian water consumed in the irrigation of more than 3.5m hectares (8.6m acres) of crops, CME believes that water futures contracts will give farmers and other agricultural businesses in the state an opportunity to buy at a guaranteed price for the resource even if there are shortages.

Beyond agriculture, the market developers say that buying futures contracts would help all water-dependent businesses to manage climate risks, and so manage costs more efficiently for the benefit of consumers.

Some experts argue that by transforming water from a basic human right into a tradable commodity places the precious resource in the hands of financial institutions and investors at a time when climate change is shifting precipitation patterns with consequent scarcity.

Basav Sen, climate justice project director at the Institute for Policy Studies said:

“What this represents is a cynical attempt at setting up what’s almost like a betting casino so some people can make money from others suffering. My first reaction when I saw this was horror, but we’ve also seen this coming for quite some time.”

Climatologists have been warning that the growing water shortages are already increasing tensions around the world with the water economy having to balance competing demands, from homes and factories to energy production and farming. Get the balance wrong and this could provoke violence – the nightmare of water wars could become a reality.