Water is the most important natural resource in the world, and in an agriculture-rich state like California, much of a farmer or rancher’s bottom line can be tied to the cost of water. That bottom line may be called into question with the addition of a CME water futures contract.
CME Group, along with Nasdaq, recently announced plans for a new futures contract on the Nasdaq Veles California Water Index. The new futures contract is set to be released in late Q4, after regulatory review.
CME Group said in a released statement the Nasdaq Veles California Water Index futures will be an “innovative, first-of-its-kind tool to provide agricultural, commercial, and municipal water users with greater transparency, price discovery, and risk transfer—all of which can help to more efficiently align supply and demand of this vital resource.”
The group said having a liquid transparent futures market will help create a forward curve so water users can hedge future price risk. CME Group cited 40 percent of water currently consumed in California goes toward crop irrigation, so having the water index futures would “allow an agricultural producer to plan ahead for changing costs of the water they need for large-scale irrigation.” In addition, commercial end users such as manufacturers would be better able to navigate risk when water prices fluctuate, according to the group.
The new contract would be financially settled based on the Nasdaq Veles California Water Index (NQH2O) launched in 2018, with each contract representing 10 acre-feet of water.
The index sets a weekly benchmark spot price of water rights in California based on the volume-weighted average of the transaction prices in the state’s five largest and most actively traded water markets. Prices from the index reflect the commodity value of water at the source and do not include additional costs associated with transportation or losses. As of Nov. 11, the NQH2O index set the weekly spot price of water rights at $480.03 per acre-foot. During the peak of summer, the weekly spot price was anywhere from the mid-$500s to $700 per acre-foot.
Impact on ag
Mike Wade, executive director of the California Farm Water Coalition (CFWC), told WLJ he thinks there has always been a desire for there to be an open market for buying and selling water in California.
“I see this as kind of an incremental step toward a full water market similar to what they have in Australia, but certainly not one that we think is good for California water users—particularly our agricultural industry because of the potential downsides of a water futures market,” Wade said.
Following the millennium drought in Australia in the early 2000s, the country changed water rights nationwide to where they were no longer tied to the land. Any person in Australia can buy and own water allotments and choose to retain, sell, or lend them.
“What we’re seeing in Australia is people not involved in agriculture are buying shares in the water market and then selling, or renting rather, the value of their water to water users,” Wade said. He equated this transaction to buying a house and then renting it out.
Australians will buy a share of water in the water market and buy an entitlement, and then water will be made available on a year-to-year basis to somebody who will actually use the water.
Wade noted California is nowhere near adapting Australia’s water market, but the new water futures pricing index is a small step toward that direction.
“I've talked to farmers in Australia and they have said they’re unhappy with the water market there,” Wade said. “It has caused price increases, it’s made water more scarce and harder to come by, and it’s made it more expensive for agriculture. I think the long-term water supply situation and pricing in California is probably headed in the same direction starting with something like this.”
Regarding more short-term effects of the futures, Wade said there are many variables in California that impact water prices—whether they be environmental regulations or actual year-to-year precipitation—which make it difficult to predict what water pricing will be in a year or more based on how the market has performed historically.
“I think the problem is people will start speculating on the future price of water and it could potentially cause actual prices to rise because of that speculation—and that’s where the danger is for agriculture,” Wade said. “When water is such a large component of our production budget, folks use the least amount possible to maintain their operation. When water costs go up, your bottom line tends to go down, so any outside influences could affect the price of the overall water supply for farmers’ water costs.”
Wade said although CFWC does not have an official stance on the water futures, they will be watching the first contracts to see how much of a market there is, and what the trading activity might say about what people are anticipating the water markets to do.
The new contract is projected to be released the first week of December. Pending regulatory approval, the contract will run on eight consecutive quarterly contracts (March, June, September, December) plus the nearest two serial months. The minimum price fluctuation for outright options will be $1 per acre-foot, equal to $10 per contract. Calendar spread options will be set at 25 cents per acre-foot equal to $2.50 per contract.
The block trade minimum threshold will be 25 contracts and the last trading day will be the business day prior to the final settlement day, which will be the third Wednesday of the contract month or the next business day if not a CME business day. — Anna Miller, WLJ editor