Written by Edward Smith
While it still may be early to see the effect public trading of water might have on farmers, the debut of water futures contracts Monday may establish a level of certainty for growers as uncertainty abounds.
Trading began this week for California water on the Chicago Mercantile Exchange based on prices established by the Nasdaq Veles California Water Index. The futures trading would not result in the actual delivery of water to a buyer, but rather act as a hedge for investors who may want to take a chance on the value of water in the future.
“The price of water moves,” said Tim McCourt, global head of equity index with the CME Group, which runs the Chicago Mercantile Exchange. “There is real price movement as a function of supply and demand and that creates price risk for those people that need to use it for their day-to-day operations.”
Nasdaq partnered with VelesWater, a London-based company, and West Water Research based in Boise, Idaho, to create the index. They based prices off of spot market sales from surface water, as well as four regional water basins in California, said Clay Landry, managing director with WestWater Research. The transactions they include range from short-term to multi-year contracts. The price is then averaged and quarterly contracts are sold on the exchange.
Unlike commodities such as pork bellies or corn, there is no delivery of the product. In the case of a regular commodity, if a holder of a contract can’t close it out by the maturity date, they end up with the products they purchased. In the case of water futures, it is only a financially settled commodity, meaning no actual water is delivered. Livestock futures are similarly settled.
While anybody can buy or sell contracts, the market would be most effective for water users such as manufacturers, energy producers or growers, said McCourt.
For example, if a grower knew they were going to need water delivered in June 2021, they could buy a contract and establish a price. If the price of an acre-foot of water goes up by the time the contract ends, they could take the profit off of the futures contract and use it to make water purchases.
Water-price variability exists. In February of this year, water was priced at $225 an acre-foot. By June, it was over $700 for the same amount. Now, it sits closer to $500.
As a financial hedge, Jon Reiter, principal at Fresno-based Cavalrei, an investor-advisor company specializing in ag, sees the potential for growers.
“You can buy crop insurance, but you can’t buy water insurance,” Reiter said.
He sees its potential for farmers especially in Western Fresno County and in Kern County who have permanent plantings. But he is hesitant about the effectiveness of it as a hedge considering how localized water issues are.
“Water is trading right now at $500 an acre foot, no one in [Fresno Irrigation District] would buy water at $500 an acre foot,” Reiter said.
In other districts however, that price may be more attractive.
The value of water is contingent on where you are in the state and even where you are within districts, Reiter said. “You can have neighboring districts that have wildly different water costs and availability. Trying to regionalize it is very challenging,” he said.
Having an established price may create some transparency in the water trading market, says Roland Fumasi, North American regional head for RaboResearch Food & Agribusiness in Fresno.
The price set by the index uses a weighted average of transactions across five water sources and gives the public an idea of what is being traded.
“It’s tough to judge how accurate it is, but it is the most transparent thing we have,” Fumasi said.
The public can get an idea about the information being used to make decisions. Landry said they try to include all pertinent water trades into establishing the price.
“We feel like we get a vast majority of [transactions],” Landry said.
The only transactions they exclude are long-term contracts whose price includes adjustments for inflation over the years.
“I think information for decisions being made helps,” Fumasi said. “It allows that level of transparency whether the value of water is going up or going down.”
Fumasi and Reiter both foresee a lot of growers looking into the water futures market as a good way for growers to cope with uncertainty.
“I think it’s a good start and a good thing,” said Reiter. “It creates more transparency in the market, but it’s a very fragmented market and to distill it into one index is a major challenge.”
Correction: This story was corrected to show that transactions are calculated using spot water sales.