Blog #1 from our series "War, scarcity and trading: What is the future of water?"
The American Revolution, The Battle of Plassey, The Finnish-Soviet war… all wars fought over valuable commodities… but what about a war involving one of the most precious of all natural resources – water. With evidence of this becoming a reality, the clock is ticking to find a way to optimally manage water systems. The question remains – are Water Future’s instruments the solution?
So much available, so little consumable
According to the World Wide Fund for Nature (WWF), only 3% of the worlds water mass is fresh water. Even more concerning, only 1/3 of that is readily available for consumption. With climate change disrupting rainfall patterns, consumable water has become a scare resource in many regions. This has, inevitably, led to conflicts; commonly known as ‘Water Wars’.
One such area of concern, is Chihuahua, Mexico. With an on-going drought, Mexican farmers are struggling to send water to the U.S., as per the 1944 landmark treaty. This treaty has governed the rights of the water from the Colorado and Tijuana Rivers, between the United States of America and Mexico for over 75 years. On October 11, 1948, Arizona signed the Upper Colorado River Basin Compact along with Colorado, New Mexico, Utah, and Wyoming. The Compact granted Arizona 50,000-acre feet of Colorado River water from the Upper Basin. In addition, the Compact created the Upper Colorado River Commission. The image below, abstracted from Helfgott (2021), depicts the bilateral water management agreement between the U.S. and Mexico.
Despite efforts to avert conflict and manage water supplies, as water stress increases, there have been more occurrences of clashing between Mexico’s National Guard, who are looking to uphold the treaty, and the Mexican farmers. Mexican farmers, struggling to maintain their livelihoods due to the lack of water availability, have voiced their anger of having to send the water resources across the border, to the U.S.
To prevent such risks of conflict, and to secure access to fresh water supply, a Water Future’s instrument has become available to trade. As of December 2020, the California Mercantile Exchange (CME) has introduced such an instrument to lock-in future volume-weighted average water prices. Simply put, investors are now able to place bets on future water prices.
Raised brows: To trade or not to trade?
Future trading is common among commodities like oil and gold, which protect commodity users against future price fluctuations. Future trading being extended to water resources has received mixed responses – whilst some note this as an opportunity to manage risks associated with climate change, others believe it undermines human rights to access to water. One such critic of the future instrument is Pedro Arrojo-Agudo, United Nations’ Special Rapporteur, who stated:
“Water belongs to everyone and is a public good. It is closely tied to all of our lives and livelihoods, and is an essential component to public health,”
The worry seems to be that, although anyone can participate and speculate on water futures, it may impact the price and supply of water. Other concerns involve the ability to trade water, especially since it is locally managed.
Other sceptics believe that the water instrument is merely a responsive instrument rather than a preventative one. Barton “Buzz” Thompson, a professor of natural-resources law at Stanford University, said while he has “no idea” if the futures will be successful, he does not see it as a transformation of the water market.
“I don’t think the futures contract itself is really changing the water markets,” Thompson said. “Nor is it changing the risk that exists out there that water in the future at some point will be in shorter supply, it’s simply responding to those things.”
Related, pricing of water has also been noted as a potential issue. All countries value water differently, all depending on the scarcity of the resource. Whilst those countries with an abundance of water offer it as a public good, countries such as Germany pay hefty prices for water; at an estimated average $3.88 per cubic meter, and $8.45 when wastewater charges are included, according to Global Water Intelligence.
On the contrary, people like Richard Sandor, CEO of Environmental Financial Products, believe that these obstacles will be overcome, and he fully expects to see trading of water via financial instruments in the next five to 10 years. People like Mark Fulton, founder of Energy Transition Advisors, with a background in climate economics, notes that, with the current Global Warming trends, there is no other option but to effectively manage these natural systems.
Whilst many believe that the water futures may not completely eradicate the water scarcity problem, there is the belief that it is a tool to manage the risks. Biose, Idaho-based Landry of West Water Research said that:
“This may not solve that problem entirely, but it will help soften the financial blow that people will take if their water supply is cut off.”
What to look out for
Despite the debates for and against Water Futures, there have been advances in the trading of water resources, especially in water-scare areas such as California. The Nasdaq Veles California Water Index future contract, announced on 17 September 2020 by the CME Group and Nasdaq, sets a weekly spot rate price of water rights in California. According to Nasdaq, this index is useful in.
- Tracking the spot rate price of water in the state of California
- Representing current valuation of water as determined by water entitlement transactions from California’s surface water market and four adjudicated groundwater basins
- Provides response to the supply and demand conditions within the underlying physical water markets
- Delivering enhanced transparency and innovative risk management solutions to the individuals and entities that rely on water markets to align supply and demand
This index tracks the price of water rights across the five largest, and most actively traded regions in the state of California, including California’s surface water market and the following four adjudicated groundwater basins:
- Central Basin
- Chino Basin
- Main San Gabriel Basin
- The Mojave Basin
According to the CME Group, from 2012 to 2019, these markets accounted for nearly $2.6 billion US dollars in transactional activity. Sales and lease transactions are included in the NQH2O Index. The index is priced in US dollars per acre foot. An acre foot is the volume of water required to cover one acre of land to a depth of one foot, which is equivalent to 325,851 gallons.
Intuitively, the price of water tends to rise when there is a shortage, such as during a drought, and falls in times of plenty, such as when there's an especially large winter snowpack in the mountains. It's spiked in recent weeks due to drier weather. The current Nasdaq Veles California Index is represented as follows;
The NQH2O Index was launched on October 31, 2018 at a value of $371.11 per acre foot. The values are calculated and released once per week and published every Wednesday morning at approximately 9:30 a.m. (Eastern Time), representing water leases and sales that occurred Monday through Friday of the prior week.
As of mid-February, the water futures market had seen 180 trades—equivalent to more than 550 million gallons of actual water. Sellers of these trades are water districts with surplus supply, for example, farmers and municipalities in water-rich parts of the U.S. Although anyone can trade, the agriculture sector seems to be the dominant sector buying and selling these futures.
Whether this is seen as a way to distribute water more equitably, or a dangerous path toward benefitting from natural disasters that threaten livelihoods of communities, what is known, is that steps need to be taken to properly manage this depleting resource, or as some call it “liquid gold”.
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