Commodities & Metals

Will Water Futures Become a Hot Commodity?

Many types of futures contracts trade around commodities. While water is the source of life, no futures contract really allows for trading in and hedging of water prices. That will change in the coming months. A key question that needs to be addressed is whether having water futures will allow for true hedging by the end users, or whether it will become manipulated by financial speculators.

CME Group and Nasdaq announced in mid-September that they plan to launch a new futures contract that tracks the Nasdaq Veles California Water Index. While this is pending regulatory review, CME expects that trading will begin late in the fourth quarter of 2020.

The CME announcement noted that this first-of-its-kind contract will provide agricultural, commercial and municipal water users with greater transparency, price discovery and risk transfer. It also was noted that it can help to align more efficiently the supply and demand of this vital resource.

A liquid and transparent futures contract for water is expected to help create a forward curve that will allow large users of water to hedge their future price risk. According to the CME/Nasdaq release, some 40% of the water currently consumed in California is for irrigation for crops covering 9 million acres. The release also specified that it will allow commercial end users, such as a manufacturer, to navigate business and financial risks better when water prices fluctuate.

According to the CME, this California water futures contract settles based on the Nasdaq Veles California Water Index, which was launched in 2018. Each contract will represent 10 acre-feet of water, and the index sets a weekly benchmark spot price of water rights in California. That benchmark is based on the volume-weighted average of the transaction prices in California’s five largest and most actively traded water markets.

Water remains a highly regulated utility in America. Human beings can go quite some time without electricity and other goods that have futures contracts, but people cannot go very long without water. The same is true for countless numbers of businesses and entities.

The CME statement also projected that nearly two-thirds of the world’s population is expected to face some form of water shortages by 2025. The size of the California water market was referred to as $1.1 billion, but measuring this market in simple dollars and cents is much harder to determine when the value is theoretically more than anything else in the world.

It remains to be seen how this futures contract actually will trade, as well as what sort of entities will get access to trade it. Some of the inherent risks of setting a formal market around water price expectations for the future should be obvious.