Water is in short supply in the West as it has always been. Last week, we learned the Chicago Mercantile Exchange (CME) is going to try and capitalize on Western water, specifically California water. Water has been an issue in California ever since I was a little kid.
The CME is going to start offering a California water contract, starting Dec. 7. The contract specs are 10 acre-feet and will be a cash settled contract, so no delivery takes place, and it’s settled against the Nasdaq Veles California Water Index, which tracks California spot market transactions.
In a press release, the CME says that nearly two-thirds of the world’s population are expected to face water shortages by 2025. Water scarcity presents a growing risk for businesses and communities around the world, and particularly the $1.1 billion California water market. Developing risk management tools that address growing environmental concerns is increasingly important to CME Group. This innovative, new water contract builds on our strong partnership with Nasdaq, as well as our proven 175-year track record of helping end users and other market participants manage risk in essential commodity markets including agriculture, energy, and metals.
It really sounds like the CME is desperate to come up with new contracts to trade. I can’t believe that there would be enough trade volume to establish any price discovery. Water is a local thing and will always be. But it’s California. They will undoubtably try to send large volumes of water up hill, say, by bullet train.
This contract is for only the California water market. Water from other states is not allowed to be delivered to California or visa versa. Of course, there is already a limited supply of water in California, which has made little progress in adding storage to its water infrastructure, and then the environmental allocation for fish. California has done a miserable job managing its water resources.
Ten acre-feet is about the amount of water required to grow 2.5 acres of cotton. So, if you want to hedge your farm operations you will need to secure thousands of contracts to cover your water risk. Frankly, this contract is just the thing speculators will flock to and more than likely distort the real market for water.
The farming community in California seems reluctant to support the contract. Mike Wade, director of California Farm Water Coalition, said, “This type of water futures market is an investment tool more than a water management tool. There likely will be non-farm people who try it out to see if there is any money to be made.”
John Ritter, who founded the ag water consultancy, Caralrei, commented, “Something to help farmers hedge their risk was needed. Farmers would still need to buy water at the spot price during a drought since the contracts do not enable forward pricing.”
It will be interesting to see how this is going to work. With water as a local commodity, you can’t forward price your water and no one must deliver it. I can’t see how the farming community in California will benefit, but I can to a degree understand that municipal water systems could.
This year water apparently traded between $200 to $700 per acre-foot on the spot market, according to the water index, and the value can change dramatically in just a month or two. We’re in a drought so there is less supply. Water rights are much more valuable and sometimes they are sold on a short-term basis, but long-term rights can cost hundreds of thousands of dollars.
Water law is different in every state, but one thing is constant and that is if municipalities in the West want to grow, they need to secure long-term water rights.
Many cities like Las Vegas and the front range of Colorado have been buying up ag properties just to secure the water. The tactic is called “buy and dry.”
It’s easy to understand the need for fresh water on a global basis; the year 2025 seems a little close. But you all know where this story is headed, and it’s the root of all evil—and that is climate change.
When you look at the government’s environmental water demands for fish in the West, we might have plenty of water. And it’s a fact that there hasn’t been a major water infrastructure project in the West since the 1970s when all the environmental laws were written.
Good luck to the CME and their water contract. It doesn’t seem realistic for end users. It is terribly realistic as another area of financial speculation. Meanwhile, let’s pray for rain. — PETE CROW
