Starting this week, farmers can insure themselves against water scarcity while others can earn money with rising prices.
Water connects gold, oil and other commodities traded on Wall Street and underscores concerns that life-sustaining natural resources could become scarce in more parts of the world.
Starting this week, farmers, hedge funds, and communities can hedge or bet on potential water scarcity when CME Group Inc. wins $ 1.1 billion in contracts related to the California spot water market. According to Chicago-based CME, the futures will help water users manage risk and better match supply and demand.
The contracts, a first of its kind in the US, were announced in September when heat and wildfires ravaged the US west coast. They should serve both as a hedge for California’s largest water consumers against skyrocketing prices and as a measure of scarcity for investors worldwide.
“Climate change, droughts, population growth and pollution are likely to make water scarcity and pricing a hot topic in the coming years,” said Deane Dray, managing director and analyst, RBC Capital Markets. “We will definitely watch how this new water futures contract plays out.”
Two billion people now live in countries plagued by water problems, and nearly two-thirds of the world could suffer from water scarcity in just four years, said Tim McCourt, global head of equity index and alternative investment products at CME, in an interview. “The idea of managing water-related risks is certainly growing in importance.”
The futures are financially settled rather than requiring the actual physical delivery of water and are based on the Nasdaq Veles California Water Index, launched two years ago. The Index sets a weekly reference price for California water rights, backed by the volume-weighted average of transaction prices in the state’s five largest and most actively traded water markets.
The contracts include quarterly contracts through 2022 of 10 acres of water each, which equates to approximately 3.26 million gallons.
If a farmer wants to know what water will cost in California six months from now, that’s kind of a “best guess,” said Patrick Wolf, senior manager and head of product development at Nasdaq, in an interview.
The futures will allow market participants to see “what everyone can guess best,” he said.
CME declined to identify potential market participants, except that the exchange was owned by California farm producers, public water companies, utility companies, as well as institutional investors such as asset managers and hedge funds.
Clay Landry, managing director of the consulting firm WestWater Research, which provides the data used to calculate the water index, expects the likelihood of “great interest” in Wall Street, the number of early water futures users to be large and small farms.
“Without this tool, people have no way of managing water supply risk,” Landry of Boise, Idaho, said in an interview. “This may not completely solve the problem, but it will help alleviate the financial blow people will suffer if their water supplies are cut.”
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