Although it may seem anathema to put a price on something as essential to human life as water, the arguments for doing so could be compelling, especially in areas of water stress. Looking ahead into the next quarter century, clean drinkable water is expected to become scarcer as the human population grows and climate change shifts the shorelines and weather patterns.
As with other commodities, price can theoretically help manage demand while providing an incentive to increase supply. As weather patterns shift, water could be transported to areas of high demand from areas where there is excess supply. At present, water use tends to be tightly regulated at a local level, while the cost of transporting water over long distance is prohibitively high.
Later this year exchange operators CME Group (NASDAQ:CME) and Nasdaq are planning on launching a cash settled futures contract based on the price of water in California. The operators say the market will allow farmers, speculators and others to hedge and bet on the price of water.
The contract will be settled against the Nasdaq Veles California Water Index, a weekly spot rate price of water rights in California. The unit of measure represents the amount of water required to submerge one acre of land in one foot of water, equivalent to about 1.5 million litres of water. Each futures contract based on the index will represent 10 acre-feet of water.
Since launching in October 2019 the price of water rights averaged around $250 per one-acre foot until March this year. With February 2020 the driest February in California for over 100 years the state suffered from acute water scarcity. Over the next three months the price more than tripled to $700 per one-acre foot in June 2020, before gradually dropping back to $500 per one-acre foot (or $333 per million litres) in October.
The trading of water rights already exists in Australia, an area of acute water stress but also high demand from agriculture has seen significantly higher prices. The price of water rights in the Murray-Darling Basin (an area of very high water stress) has increased from A$1700 per million litres in 2007/08 to A$4000 per million litres in 2019/20 (equivalent to US$2,870).
A number of factors typically complicate ascribing value to water as a commodity. For instance, although bottled water is traded across international borders and offers a transparent and (theoretically) easily observable price for a unit of water, the implicit value of water itself is delinked from its price in that the value of water in sustaining life may be so much greater than a market price can truly capture.
And so the supply of water has always been incredibly political. In an ideal world, water companies would be funded to invest in sufficient infrastructure to ensure there is no scarcity. By keeping things the way they are local and national governments allow that scarcity to continue, enabling local monopolies to extract rents. Any one taking a position on the water futures market should remember that politics trump economics.
In addition, water assets generally do not have clear and transferable ownership title – rarely can one individual claim rights to a specific reservoir or lake – thus making it difficult to trade water assets, as opposed to more conventional commodities. To be traded on the global commodities exchanges, a resource has to be transferable (even if you are selling future rights to it) and transparently priced.
Putting a price on water should mean that efficient users conserve water, and sell it onto those less efficient yet highly demanding users. This physical settlement isn’t possible with water because of complex rights issues – the political factor again.
Another issue with water futures is that there is likely to be little or no information flow prior to the front month of the contract. This is a problem according to Craig Pirrong, one that’s likely to stymie the contracts development, “There is little information that arrives today that would motivate people to trade today contracts with payoffs contingent on future weather, even for a future only months away.” The result is that the contract is unlikely to attract much volume, if any making it very unlikely to turn into a means for speculation or hedging.
Water futures contracts are a nice idea in a perfect world. Unfortunately that’s not where we’re at.