M6 BARRON’S September 28, 2020
Just Add Water to These
New Futures Contracts
I
nvestors will be able to make wagers
on the price of water later this year
with the launch of futures contracts,
which are expected to better balance
supply and demand for the commodity
and hedge price risks.
“The water sector had long wished for
some market structure for price discovery
and the ability to hedge risk,” says Deane
Dray, managing director and multi-indus-
try analyst at RBC Capital Markets. “If this
new futures contract shows promise, it
could spawn more innovation in the fu-
tures market related to water.”
CME Group and Nasdaq on Sept. 17
announced a plan for the Nasdaq Veles
California Water Index futures contract,
which will have a settlement price based
on its namesake index (ticker: NQH20).
The launch is expected late in the fourth
quarter of this year, pending a regulatory
review.
The contract will allow investors to
hedge price risks in the spot water market
and better manage price swings, says Tim
McCourt, CME Group’s global head of
equity products and alternative invest-
ments.
The index itself sets a weekly spot rate
price of water rights in California, the ma-
jority of which are owned and managed by
water districts that deliver water to indi-
vidual farms, says Clay Landry, managing
director at consulting firm WestWater Re-
search, which provides the data used to
calculate the index. Some farms own water
rights directly, he says; other water-rights
owners include municipalities, industrial
companies, water utilities, and tribes.
On Sept. 23, the Nasdaq Veles California
Water Index set the weekly spot price of
water rights at $510.99 per one acre-foot.
The unit of measure represents the
amount of water required to submerge one
acre of land in one foot of water—equiva-
lent to about 325,851 gallons of water. Each
futures contract based on the index will
represent 10 acre-feet of water.
The index is “reflective of arms-length
economic efforts to determine fair value”
for water, says Patrick Wolf, lead product
developer with Nasdaq Global Information
Services. The focus on the California mar-
ket offers both relevance and robustness in
the depth and breadth of participants and
the value of transactions, he says.
Wolf points out that the index is up
markedly this year following an extremely
dry winter in California, with February
2020 marking the driest February for the
state in at least 100 years.
For commodities, “supply conditions
are extremely variable year to year, and the
relative scarcity of water is what deter-
mines price,” Wolf says. Future price risk
is a key feature of the California water
market, and this index “captures and dis-
tills that risk in real time.” Whether the
index is “substantially up or down, it is
adding tremendous value to the market-
place.”
Year to date, the index value has dou-
bled, boasting a return of more than 100%.
The water futures contract will be spe-
cific to prices in California, a state that the
CME’s McCourt refers to as having among
the “most active and dynamic water mar-
kets” in the U.S. California saw more than
$1.1 billion in water-market activity last
year, he says, and having a “robust, trans-
parent futures market can help more effi-
ciently align supply and demand of this
vital resource,” which may, in turn, help
consumers.
RBC’s Dray, meanwhile, points out that
“what California is paying for water has
little relevance for other parts of the coun-
try.” He also expresses skepticism about
the new contract, saying water futures
would be a niche “unlikely to generate
enough open interest,” or volume of con-
tracts, “to support a reliable forward-pric-
ing model.”
Still, Dray says he and his team will
examine this new security more closely, “to
see what the potential might be.”B
By Myra P. Saefong
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