December 7, 2020

Investors can now trade water futures

By Anneken Tappe, CNN Business

There's a new commodity in town for investors to trade: water.

Futures tied to the Nasdaq Veles California Water Index, which measures the volume-weighted average price of water, began trading under the ticker NQH2O on the Chicago Mercantile Exchange on Monday.
Water has never been traded this way before.

Before the futures came along, the buying and selling of water rights, which allow the holder to pump water from the ground or reservoirs, only happened in the spot market. In dry years, when more water is required to grow crops and supply municipalities, it meant that buyers were facing high prices and a lot of uncertainty.

The new futures are meant to bring an end to that and add price transparency to a previously opaque market.

Those who need to buy extra water in a dry year, when prices are naturally higher, can now bet on futures contracts to offset the higher prices they might have to pay in the water market down the line.
At the same time, the new futures market could also invite speculation from financial players, including hedge funds.

Hedging for droughts

The United States is the second biggest consumer of water in the world, with California accounting for 9% of the nation's daily consumption.

The size of California's water market is four times larger than in any other state. Water transactions in the state totaled $2.6 billion between 2012 and 2019.

But the state is often hit by droughts.

"California has long periods of dry conditions followed by short periods of very wet conditions. And that affects the price a lot," said Patrick Wolf, lead product developer with Nasdaq Global Indexes.

Having a publicly traded contract will bring more transparency to the market and that will be good for all the parties that have to buy water, Wolf told CNN Business.

The agriculture sectors is the biggest buyer in California's spot market, meaning they buy the most water during dry years. This trend has been intensified in recent years by the move to popular high-value permanent crops like almonds and pistachios, which require a lot of water for upkeep.

Sellers are water districts with surplus supply, for example farmers and municipalities in other parts of the state.

For farmers, having some knowledge about the price of water could be a game changer. Some allocation of water comes with land ownership, but in drought-struck California, farmers often need additional water to get their crops ready for the harvest. That's when these farmers have to go into the public market to buy more.

Now that there's a futures market, farmers can look to the market for guidance on both the current price and the price developments in previous dry years, and hedge against higher prices in the month they will need the additional water for their crops.

Unlike other futures contracts, the water contract is only about locking in a price to hedge against higher prices in the spot market at a certain time in the future.

"Price certainty is what you're buying," said Clay Landry, managing director and principal at WestWater Research, a consulting firm in the space that provides the data behind the water index.

Most other commodities futures are about the delivery of the asset, such as oil or corn. Investors agree to buy an asset at a certain price in the future.

But it's not just farmers who need waters. Municipalities, which get water into everyone's homes, as well as manufacturers and energy producers also need it.
Sounds a bit dystopian? Perhaps.

At the end of the day, water is just another scarce resource, just like oil, except you need it to brush your teeth every day.

"Water scarcity is one of the biggest challenges of the 21st century," said Tim McCourt, global head of equity products and alternative investments at CME Group, adding that two-thirds of the world's population will face water shortages by 2025.

Experts think the California index, as well as the new futures, could only be the first of its kind, with more local indexes to come as water scarcity is forcing innovation in the field.

Efforts like desalination projects, which remove salt and minerals from sea water, could help with this down the line. But its an industry that is still in its infancy.

The new futures don't solve the issue of scarcity either, but they might help making prices for water more transparent, at least in California.


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