What A Water Market Can Do – Water Markets & Water Futures

New developments in water markets and water futures trading have stirred up plenty of controversy in recent months as ag lenders, growers, investors, and conservationists worry about the impact these practices will have on water stress and water costs in agriculture.

However, it’s important to keep in mind that physical water trading markets and water futures markets aren’t the same thing. Water markets are useful when they’re designed properly, implemented effectively, and are fortified by appropriate regulations to ensure that water resources are protected from misuse.

This article will take a close look at the current state of water markets, and what ag professionals need to know about their purpose, capabilities, and risks.

The Current State of Water Markets

On January 13, 2021, Madera County, CA launched a water market pilot program that’s designed to “simulate multiple years of trading,” and to “test market structure, potential rules, and administrative processes.” The program will experiment with rules such as restricting trades across subbasins and limiting the resale of water.

Ultimately, the county hopes to “decrease negative impacts associated with SGMA,” and “empower and provide flexibility to landowners to make appropriate business decisions.” By making physical water available for sale or purchase, farmers are incentivized to use less water and sell water they don’t need.

Other regions have already rolled out similar programs, including smart water markets that use algorithms to match buyers and sellers. In some areas, farmers can be paid to “bank” their water in order to replenish aquifers and discourage overuse.

Wall Street and Water Markets

What worries farmers is that private speculators could enter water markets and sit on water resources without putting them to good use. The Salt Lake Tribune points out that “investors could theoretically dry up farmlands, which use the vast majority of water in the basin, and store the savings in the reservoir to sell to cities during shortages.”

Critics argue that water resources would become “the new oil.” However, the Tribune notes that, with the right protections and regulations in place, these kinds of worst-case scenarios can be avoided: “Detaching water rights from legally defined beneficial uses and selling them to the highest bidder aren’t easy under current laws in Utah or Colorado.”

Advocates of water trading argue that the current price of water doesn’t reflect its true value, and that water markets can provide a beneficial tool for conservation, demand management, and more efficient water distribution.

How Water Futures Differ From Water Markets

One thing that makes this a complicated subject is that water futures and water markets aren’t the same thing. 

There are water markets such as the kind being trialed in Madera County: local markets that allow for the physical transfer of water between buyers and sellers.

In the Wall Street scenario, much of the subject has to do with water futures. As the LA Times explains, investors can now purchase water futures in California:

“Those who take the gamble are effectively betting that the spot price for water will rise during the life of the contract; they’ll pocket the difference. Sellers are betting that the price will fall.”

Unlike other types of futures, such as wheat, coal, and oil, water futures can’t be settled with a physical transfer of the item in question. Growers can, however, “lock in” a price by buying a futures contract in order to offset a rise in water costs.

Betting vs. Trading

In order words, water futures are about financial betting rather than actual water trading. The Nasdaq Water Index can be used to track the current “spot rate price” of water in the five most active California markets. This information can be useful for identifying changes in supply and demand and pricing water rights in agricultural investing.

Physical water markets exist in regions such as California, Australia, Nebraska, Colorado, and more. Australia’s markets have been active for 14 years and are valued at $2 billion. However, a lack of regulation has led to “a market in complex financial products, such as derivatives, based on water,” which separates water use from water ownership.

This is exactly the scenario that many farmers want to avoid when they talk about Wall Street investors speculating in water. 

Increased interest in water as a commodity shows its importance, but water markets must be bound by appropriate regulations in order to ensure that all parties – growers, municipalities, investors, and more – all benefit.

Why Water Markets Are Important

The Public Policy Institute of California points out that the new water futures market in California “won’t change the amount of water that’s available in the state,” but it could “enable farmers who locked in a lower price to use their profits to cover some of the costs of fallowing farmland—like a type of weather insurance.”

Likewise, physical water markets can’t eliminate water scarcity, but they can help to conserve, allocate, and transfer water more efficiently. The PPIC determined that with better regulations and infrastructure, water trading could “reduce the costs of ending excess groundwater use by about 60% in the San Joaquin Valley.”

To ensure that water markets are run fairly and equitably, it’s important that businesses, communities, municipalities, and individuals all come together at the watershed level to determine the best use for their water. Without the right regulations in place, growers, cities, and disadvantaged communities may not be able to afford the rising price of water on an open market.

The worry that entities will purchase water rights and misuse them is rational, but it isn’t an inevitable result. Water resources must be put to beneficial use for communities, food production and the environment, which all play an essential role in our economies as natural capital – something that businesses must steward and work with. 

With collaborative decision-making and regional oversight, water markets can be a powerful tool for maximizing water’s value and mandating its fair and responsible use.

Understand new developments in water risk with the AQUAOSO Water Trends Guide.

The Bottom Line

Water markets can provide ways for ag professionals to sell physical water resources. Water futures can provide a way to put a value on water in an attempt to leverage it as a commodity. While water markets can’t change the underlying conditions that cause water stress, they can help to allocate resources more efficiently and help investors monitor the market price of water.

Recent developments have raised fears that water will become a tradeable commodity like gold and oil, but with the right regulations in place, communities can work together to develop regulated water markets that prioritize local users and benefit us all.

AQUAOSO is committed to providing accurate water data that helps ag professionals and other stakeholders identify and monitor water risk. The Water Security Platform is specifically designed for researching water rights and land data with an easy-to-use, map-based tool. Lenders and investors can use this information to make the right financial decisions and mitigate water risk across their portfolios.

Contact the team directly or schedule a demo to learn more about the platform, or browse the resources page to read about other water security issues.

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