A new financial tool that allows water users and investors to hedge on the future price of California water rights settled its first contracts Jan. 20.
“And it was really exciting,” Tim McCourt, global head of equity index and alternative investment products at the CME Group, said the next day. The CME Group’s NASDAQ Veles California Water Index (NQH2O) futures market was launched in December. It became possible following the establishment of the California water index in 2018.
WestWater Research developed an algorithm for price discovery, which is based on transactions for water access from surface water and four groundwater basins (Central, Chino, Main and Mojave). Veles, a financial firm focused on water, and NASDAQ established the index using WestWater’s pricing tool. Once the index was created, financial instruments such as the futures contract could follow.
The index calculates the spot market price, in dollars per acre foot, each week. McCourt said the January expiration settled 32 contracts. As of this week, there had been 180 trades on the contract.
“All great milestones for a futures contract that’s just about a month old,” he said. The first contracts settled at $506.66 per acre foot.
The water futures contract is financially settled, meaning there is no physical delivery of water. McCourt says it’s a good risk management tool for water users who want to protect themselves from sudden increases in the spot price, and he says it could also lead to more efficient water management.
Tim McCourt, CME Group
“With the price transparency and efficiency provided by the futures market, you can now make a very informed decision about consumption or provision of water at that certain time,” McCourt said.
Alan Boyce is executive chairman of Materra Farming, which grows dates, pistachios, tomatoes and other crops in California’s Imperial and Central valleys. He has been watching the launch of the futures market because of its potential to help protect him from high prices on the spot market.
“We have so many variables we can’t control, if I could just lock in the price of water, that’d be good,” he said. Or, if the market suggests the water he needs will become more expensive, he could choose to not plant his cannery tomatoes and sell whatever water rights he has to a neighbor. But Boyce hasn’t gotten involved in the market yet because he says the futures contract needs more players.
“If I’m going to use it as a hedge, then I need to be able to get in and out,” he said. And that means there needs to be enough activity “so that when I want to transact, I’m not moving the market.”
CME Group has a “market maker” program to entice investors, McCourt says. They will provide balance as players who are not vested in the actual use of the water.
“We have liquidity providers that help marry, for lack of a better word, the natural suppliers and the natural demanders,” McCourt said. Though he declined to name specific participants, he says the water futures might be of interest to managers of sustainable investment portfolios.
“You also have investment firms who are looking at investing in water as a diversified investment allocation,” he said.
Boyce says the ability to protect against higher prices could also lead to more farms investing in water efficiency so they ultimately use less water. Right now, he says there are big water market users who buy and sell frequently and are more well-versed in the systems. That gives them an advantage over smaller operators.
“The futures market’s gonna benefit the smaller guy a lot,” Boyce said.
But some California water managers, users and market observers are less confident the futures contract will do much. Tom Birmingham is general manager of Westlands Water District, which manages water for western Fresno and Kings counties. The creation of the futures contract, he says, seems to reflect growing interest in California’s water scarcity and how the state is trying to manage that, including the existence of the spot market.
“Somebody saw it as an opportunity to make some money,” Birmingham said. That’s not a criticism, he adds, because the growing interest in California water reflects real challenges that agricultural users, especially, face. But hedging in the futures market does not strike him as particularly advantageous over other market tools.
“When you think about it in the context of a tool to hedge on the price of water, you’re just making a bet,” he said. “And there are potentially safer bets that you might be able to make.”
Interested in more coverage and insights? Receive a free month of Agri-Pulse West.
The California State Board of Food and Agriculture focused its Feb. 2 meeting on the water market and the futures contact.
Roland Fumasi, head of RaboResearch Food & Agribusiness, offered his perspective as an ag lender. He says most California crops are not part of existing commodity futures contracts, which means the concept of using this risk management tool will be brand new to most producers.
Roland Fumasi, RaboResearch
“I think overall right now, it's all about us being in the learning and experimentation phase,” he said. “I think we're a ways out from producers in California using this to actively hedge on a regular basis.”
“At the end of the day, there is no new water, there is no new conveyance, as a result of this futures trading. And even more importantly, it doesn't mitigate a single acre from being fallowed due to SGMA (Sustainable Groundwater Management Act) or any other regulation that is coming at us down the pipe,” said Jared Plumlee, vice president of farming at Booth Ranches, which grows citrus.
He added that it doesn’t seem likely water districts would want to put public funds into the financial markets, even as a risk management strategy. “It's just too early to tell what the impact is going to be if, if there is one at all.”
“Financial risk is a fact,” said Ellen Hanak, vice president and director of the Water Policy Center at the Public Policy Institute of California. “If you look at how businesses try to manage, they often will try to use various kinds of financial instruments to manage financial risk.”
Hanak presented at the board meeting and also spoke with Agri-Pulse in an interview earlier. She said even though the futures market will not directly help with any of the water scarcity and transport challenges in California, the new futures contract is attracting more out-of-state attention to the spot market.
“The more people understand how the actual market works and what kind of protections are in place, and the more there’s a conversation about how to grow this market in a way that is environmentally and socially responsible, the better,” she said.
For more news, go to www.Agri-Pulse.com.
