A new commodity has been approved for futures trading on the United States’ Wall Street- WATER! This is something the world has never seen before. This simple life-sustaining resource will be a part of many other commodities to be traded in the market. The futures of the California Water Index was launched earlier this month on the Chicago Mercantile Exchange. What was the reason behind such a move? Who will be able to trade or bet on water? Let us learn more about the concept of Water Futures.
The Global Water Crisis
As we all know, more than 71% of the Earth’s surface is covered by water. Out of this, only 1% of fresh-water is readily accessible to meet the rising global demand. Most of us are extremely blessed with adequate water supply in our areas to meet all basic needs. Unfortunately, there are billions of people around the world who are affected by the lack of basic water access. According to water.org, more than 800 million people do not have access to safe drinking water. Young children die from diseases such as diarrhoea every single day. People in under-developed countries do not have access to proper sanitation facilities. Women and girls collectively spend more than 200 million hours every day searching for a water source.
The time spent gathering water or seeking safe sanitation accounts for billions of dollars in lost economic opportunities. Water.org estimates that $260 Billion (~Rs 19 lakh crore) is lost globally each year due to the lack of basic water and sanitation. By 2050, one in four people is likely to live in a country affected by fresh-water shortages.
Amidst the fear of water scarcity, the US-based CME Group has launched futures on the California Water Index. This means that water can be traded on Wall Street, just like other commodities such as gold, oil, and metals. This highlights the fact that water, as a life-sustaining natural resource, may become scarce across the world. CME Group Inc is the world’s largest financial derivatives exchange, and trades in asset classes such as agricultural products, currencies, energy, metals, etc.
The futures tied to the Nasdaq Veles California Water Index (NQH2O) have begun trading on the Chicago Mercantile Exchange (CME) since Monday. It should be noted that water has never been traded through this method before.
What is the NQH2O Index?
The Nasdaq Velez California Water Index (NQH2O) was jointly developed by the CME Group, Veles Water, and Western Water Research LLC in 2018. This particular index tracks the volume-weighted average price of water in California. It is based on prices in the state’s five major river basins. The Index value is priced in U.S. Dollars per acre-foot ($/AF) at the source, excluding conveyance costs and losses. The NQH2O is calculated once every week. According to the NQH2O index, the price of water in California has jumped by more than three times this year. You can see this in the chart shown below.
What Led to the Need for Water Futures?
Let us take a look at how water had been traded before. 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. The spot market is the financial market in which financial instruments or commodities are traded for immediate delivery. During dry years, more water would be required to grow crops and supply municipalities. This meant that buyers were facing high prices and a lot of uncertainty.
The new futures are meant to bring an end to this old practice and improve transparency in price discovery. These futures contracts do not require physical delivery of water and are purely financial. They are based on the weekly price averaged across California’s top five watersheds. At the same time, it could also invite speculation from financial players, including hedge funds.
This market allows farmers, hedge funds, and municipalities to bet on the future price of water and water availability in California. You may wonder why it is specifically introduced in this US state. Located towards the western part of the country, California is prone to worsening heat, droughts, and wildfires. We know that all these events are caused due to climate change. The region is also facing high population growth and is the biggest agricultural market in the United States. Moreover, California accounts for 9% of the nation’s daily water consumption. The current estimated value of the California water market is around $1.1 billion (~Rs 8,111 crore).
The farmers can look to the market for guidance on both the current price and the price developments in previous dry years. Thus, they can hedge against higher prices in the month in which additional water is required for their crops.
Water scarcity is one of the biggest challenges of the 21st century. Surely, two-thirds of the world’s population will face water shortages by the next five years. The scarcity of water has forced the need for more innovations. And now, the futures tied to the NQH2O will play a small role in tackling this global issue. However, the scope of water futures is limited to a small region in the United States. It will prove to be helpful for the farmers and municipalities in California, by making water prices more transparent.
There are also various concerns with respect to the launch of water futures. Some experts believe that treating water as a tradable commodity puts a basic human right or a vital resource into the hands of financial institutions and investors. This would be a dangerous arrangement, as prices of water can further increase due to climate change. Precipitation patterns have already been affected and this would essentially lead to increased water scarcity. Thus, water futures could be an arrangement wherein some people make money, while many others are suffering.
To tackle the global water crisis, we need more concrete steps such as desalination projects. However, the technology required to conduct widespread desalination of seawater is still in its initial stages. The price of water would keep increasing until we have better water conservation methods or practices.
Let us look forward to seeing if more countries adopt this method of water futures. At the same time, the trading of water needs to be scrutinized and regulated, to ensure that it serves the purpose for which it was introduced.