Water Futures: A New Way to Invest in The Essence of Life

The Chicago Mercantile Exchange (CME) recently added water futures to the list of contracts available to trade. This is big news because water has never been traded like this before. Prior to this development buying and selling water rights took place on the spot market.

Water futures could impact the cost of watering crops
For a deeper explanation of futures trading and how it works, click here.

This makes water – at least in the eyes of Wall Street – a commodity just like gold, oil and lean hog. The commodity started trading for $496 per acre-foot. Feelings on the commodification of this human necessity hasn’t been met with unanimity.

“As clean, useable water is becoming scarcer, the incentives in capitalism work to commodify it, and work to ensure that the scarcity is an opportunity to make money,” Basav Sen of the Institute for Policy Studies told Earther in an interview.

On the other hand, economist Steve H. Hanke wrote in the National Review:

“Sharp fluctuations in water supply and demand can now be offset by ‘insurance policies’ offered by the new futures contracts. This innovative insurance will lower the cost of producing agricultural products — a win for farmers and a win for consumers.”

Regardless of opinions as to whether they should or should not be, water futures are now tradable. Water scarcity will cost some and make money for others, as Sen said. And that’s always been the case. Farmers pay a premium during dry years when more water is needed because not enough is falling from the sky. This leads to high prices for the consumer and uncertainty for the farmer.

If things go according to plan, this could have a stabilizing impact on the otherwise ambiguous market place of water for crops. But as this is a new development, it’ll be years before we actually know if things shake out that way.

How Water Futures Work

The CME launched the country’s first water market with $1.1 billion in contracts. Contracts are tied to the Nasdaq Veles California Water Index. This index acts as the spot price for an acre-foot of water. The CME ticker is NQH2O.

These futures contracts are an agreement between buyer and seller to swap water in exchange for a set price at predetermined date in the future. But in this case, it will be a completely cash-based transaction. Nobody involved will have ten acre-feet of water delivered to them. And each contract will have a quarterly duration – so they will be settled in three months’ time.

Let’s say there is a contract for NQH2O at $500 that expires in three months. If heavy rainfall takes place, this can drive down the spot price. And if this proves to be the case when the contract expires, the buyer of the contract will be required to pay the difference between the current price and the agreed upon price.

On the other hand, if the spot price of NQH2O has risen above the agreed upon price when the contract expires, the seller pays the buyer the difference. For the average investor, this is pretty much a crap shoot. In the early months of this, the odds of a winning trade will probably be as likely as blackjack, baccarat or, well, craps.

But gambling investors aside, this will also allow farmers and municipalities to hedge their bets on the future price of water… Or even the availability of water in Western states. In this new marketplace, those who need to buy extra water when prices are high, can now bet on futures contracts to offset higher prices in the future.

How It Could Go Sideways

This new futures market has the potential to bring speculators with deep pockets and lots of power. And when lots of money is on the line, it can induce some truly nefarious behavior.

Imagine a well-connected investor betting on drought and a raised NQH2O spot price. If he had the means to temporarily limit access to water and its distribution, it could artificially increase the spot price… and make the immoral investor a good chuck of change. In the process, it could have damaging effects on crops and the price of food.

While unlikely, the idea isn’t without out precedent. Similar schemes have been done in Australia. But for now, this is merely a hyperbolic conspiracy in the U.S.

The Bottom Line on Water Futures

The agriculture sector is the largest buyer of water in California during dry years. And water shortages have only been exacerbated as thirsty almond and pistachio growing has increased.

The sellers are the districts in other areas with a surplus of water. And now that there’s a futures market, farmers will be able to look to the past for price developments. And this can be an extremely useful tool to hedge against rising prices in the months they know they will need the most water.

Farmers know their land better than anybody else. Plus, they’ve already been forced to prepare for shortages and learn the complexities of the public market when they need more. These factors put farmers in a unique position to understand water futures contracts better than anyone else… And protect themselves from outsized increases in water prices. So, when it comes to water futures, follow the farmers. They’re practically insiders.

Not the Market You’re Looking For?

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Source: investmentu.com

Water Futures: A New Way to Invest in The Essence of Life