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There is no product more central to human activity than the one that represents 60 percent of our bodies. So why isn’t water a fixture of financial markets like gold, crude oil, copper, and soybeans? Some investors think it should be that way.
CME Group Inc. is thinking along the same lines, launching futures contracts this week tied to the water market $ 1.1 billion from California. It’s tempting to believe that such a move could make H2O as important a commodity to financial markets as oil, metal, and agricultural products, but don’t stand by.
The world will benefit from putting a price on water rather than treating it as a public good that is provided for free, especially as climate change wreaks havoc on supply systems built for the 20th century.
That does not mean that you will ever see the futures price of the chicago water on the evening news. The reason ultimately comes down to abundance, price, and weight.
(You may be interested: For fear of scarcity, water begins to trade on Wall Street)
The most important commodities for financial markets have several common characteristics: they are used globally, but they are produced in only a few places; they are relatively rare and therefore expensive, and their value is high relative to their mass, so that even over long distances the cost of freight is a small proportion of the final price.
Take a look at the Nasdaq Veles Water Index, the basis for CME’s new water futures contract. A acre-foot of water currently costs $ 486.53, equivalent to 39 cents per metric ton.
A ton of gold, on the other hand, changes hands for a whopping $ 60 million. Copper traded on Comex costs $ 7,706, Brent crude costs $ 355, and at the low end, even coal in the Australian port of Newcastle will cost you $ 77.35.
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Those spreads determine the viability of world commodity trade. Precious metals are so expensive that they are generally transported by air, a fact that wreaked havoc on the gold market earlier this year when the Covid pandemic hit much of the world’s aviation fleet.
Almost everything else moves cheaper in ships, trains and trucks, and the cost of transportation takes an increasing share of final prices as the value per ton decreases.
It typically costs between $ 5 and $ 10 per tonne to ship coal from Australia’s east coast to consumers in Northeast Asia, making long-distance trade barely viable.
However, it doesn’t make much sense to spend dollars on transporting water that changes hands in your end markets for just pennies. That is particularly the case because, for everything we talk about water scarcity, it is enormously abundant compared to any other commodity. In most places, it can be collected for free by simply connecting a tank to the drain pipe.
Even in places with little rain, the desalination it is a much cheaper option than long distance transport. As a result, there will never be a global market for water, and that means it will never fly as a major product.
Taking a derivatives position on the BML copper is a reasonable way for a Chinese electronics company to hedge its commodity price risk.
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Whenever the physical price of copper in China goes out of line with financial futures in London, traders will move to take advantage of the spread by shipping metal from one place to another.
The same cannot be said for water. We see something comparable in the electricity market, which is also highly localized. Electricity revenues in Germany reach approximately 80,000 million euros (US $ 96.9 billion) per year, but the value of all outstanding contracts for the main base-load power derivative is only 698 million euros, because only the generators and the main consumers in Germany have any interest in the market .
In the United States, the energy trade is even more marginal: open interest for electricity at peak hours in the PJM West market, the most celebrated contract, comes to just $ 383,000. The conversion of such quasi-public goods into commodities has a fairly bad reputation in United States, after Enron Corp.’s attempts to manipulate California’s electricity market in 2001 caused blackouts and ultimately contributed to the company’s collapse.
Still, even if water never becomes a global benchmark, the motivation for a futures market is sensible. The recent success of the carbon markets of Europe after years of glut is evidence that once institutional conditions are fixed, a low price of public resources is crucial to encourage less wasteful use.
In all parts of the planet, water is being used badly, it is being used in excess.
Bloomberg
