Speculations of California Water Scarcity Cause Trading of Futures

Dec 09, 2020 02:25 PM EST

California water scarcity has caused it to now start futures trading along with oil, gold, and various other commodities on Wall Street. This arose from speculations that water may turn scarce in most places in the world.

It is now possible for municipalities, hedge funds, and farmers to bet on or hedge against the availability of water in the future in the state of California.

The state has the largest agriculture market in the US and is the fifth biggest economy in the world.

The contract of CME Group in January 2021, which is linked to the 1.1 billion-dollar California spot water market, traded this Monday at a level of 496 index points, which is equivalent to 496 dollars for each acre-foot.

These contracts are a first of a kind in the country, which was announced last September when California and the West Coast were experiencing extensive wildfires and heatwaves. This also occurred as the state was recovering from a drought that lasted for eight years.

The contracts are intended to be a hedge for major consumers of water, including power utilities and almond farmers, against the fluctuations of the prices of water and global investors’ scarcity gauge.

READ: How to Stay Protected from Toxic Drinking Water Caused by Wildfires

The effects of climate change on water availability

According to Deane Dray, analyst and managing director of RBC Capital Markets, many factors will likely cause scarcity of water. These include climate change, overpopulation, pollution, and droughts, affecting its price for the coming years. Dray says that they will watch how the new futures contract for water will develop.

According to the UN, anthropogenic climate change causes severe flooding and droughts, which make the availability of water more and more unpredictable.

The USDM or US Drought Monitor says that California experienced its most acute drought in recent memory from December of 2011 up to March 2019. The worst effects were in July of 2014 when 58 percent of the land in California suffered severe drought which caused massive losses in pasture and crops.

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Trading water

The water futures are connected to the NQH2O or Nasdaq Veles California H2O (Water) Index, which began two years prior and which measures water’s average volume-weighted price. There were two trades which occurred last Monday when the January 2021’s water contract went live.

Westwater Research managing director Clay Landry says that they are happy with the trades. They consider it fast, especially since it is often difficult to close deals in physical markets.

The water index determines the weekly benchmark water rights spot price for California, which is underpinned by the water’s volume-weighted average of transaction prices in the five most active and largest markets in the state.

Water futures are settled financially versus requiring actual physical delivery. These include quarterly contracts up to 2022, each of which represents water measuring 10 acre-feet, which is equal to approximately 3.26 million water gallons.

CME, which is based in Chicago, says that water futures trading will help users of water manage the risks involved in California water scarcity and align with water’s supply & demand better.

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