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Water futures trading index elicits questions, concerns

Todd Fitchette Shasta Lake
Wider swings of "want" and "plenty" for California water supplies could raise the attraction of future's exchange water contracts to commercial growers as they try to mitigate their water costs.
The water futures contract idea is merely a financial tool; It does not wheel an ounce of water.

Trading water futures in California is nothing new, according to those involved with water and financing. While those in the finance industry say it will bring a sense of transparency to water pricing, a longtime water manager says the realities remain to be seen.

The water futures contract idea is merely a financial tool; It does not wheel an ounce of water. Unlike other commodity futures trades, where the buyer is guaranteed the volume of commodity purchased through the futures exchange, it does not work that way with water, according to Tom Birmingham, general manager of Westlands Water District in central California.

It cannot work that way, Birmingham continues, because of the complexities of how water is conveyed and stored.

"What is different about water as a commodity is the ability to transport it," Birmingham said.

"I think about this in the context of existing futures markets, but water is not like soybeans or pork bellies in large part because the availability of water is determined by factors beyond anyone's control," he continued. "Unlike moving these other commodities, it is very difficult to transport water from one region to the other, so I'm going to be very interested to see how the trading of water futures as a commodity works."

Roland Fumasi, head of Rabobank's RaboResearch Food and Agribusiness division for North America, agrees in part.

"These futures contracts don't do anything to help growers get more water, but they do allow growers to hedge their bets if they think the price is going to go up," he said.

Birmingham admits he's unsure how it will all work in practicality.

"There are lots of unanswered questions with this," he said.

Water exchange

According to Fumasi, the Nasdaq Veles California Water Index sets a price once a week based on an average price for water among four southern California water districts and the spot market trades of surface water. Water is traded in a per-acre-foot price with the index pricing water in 10-acre-foot shares. What this means practically, is if the index price listed is $500, the cost of a contract is $5,000 – or the index price multiplied by 10.

Fumasi said the exchange allows growers to protect themselves against rising water costs. In simple terms, if a grower believes the price of water six months from now, when he or she needs it, will be higher, the grower can purchase the futures contracts today then sell them in six months when the water price rises. Any net gain can then be used to pay for the water at the time of purchase.

For instance, if that $5,000 contract for 10-acre feet of water rises to $10,000 at the time the water is needed, the contract can be sold at the higher price with the capital gains from that purchase then available to buy the actual water, thereby "hedging" the water costs at the time of purchase. The grower is still responsible for covering the full market cost of water at the time of purchase if it is available.

That is one of the risks a buyer takes when purchasing a contract. Not only do they bet on the price going higher for water, but they also bet on its availability and the opportunity to wheel it where they need.

The 2021 growing season in California may be a good time to test this, Fumasi believes. The U.S. Climate Prediction Center points to a growing size and intensity of drought conditions in the West, including California. Barring a "miracle March" event that fills reservoirs and packs the Sierra Nevada with feet of snow, the outlook for water availability in 2021 is bleak.

The Veles Index shows that water contracts traded from January through early March 2020, hovered at just over $200 per contract. The contract price then rose sharply through mid-June to over $700 per contract, before retreating to about $500 by the end of 2020.

The Veles Index can be found online at https://www.nasdaq.com/market-activity/index/nqh2o

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