Climate change in mind, Wall Street to start trading a new commodity: Water

If the record heat and wildfires ravaging California weren’t a clear enough sign that the climate is changing, then consider this: Wall Street is about to start trading futures contracts on the state’s water supply.

The contracts are the first of their kind in the U.S. and are being created by CME Group Inc., the world’s largest futures exchange. They are intended, CME says, to both allow California’s big water consumers -- like almond farms and municipalities -- to hedge against surging prices and can act as a benchmark that signals how acute water scarcity is becoming in the state and, more broadly, across the globe.

Water supplies have been tight for years in California, and large parts of Asia and Africa also face the potential of scarcity as temperatures rise. Almost two-thirds of the world’s population is expected to face water shortages by 2025, according to the CME.

“Water scarcity is certainly one of the biggest challenges facing communities and individuals today across the globe, where currently about 2 billion people are already living in countries experiencing high water stress,” Tim McCourt, the global head of equity index and alternative investment products at CME, said in an interview.

Wall Street first took significant note of the potential for water after investor Michael Burry drew attention to the commodity 10 years ago when he spoke about investing in farmland with “water on site.” Burry, whose bet against the subprime bubble was spotlighted in “The Big Short: Inside the Doomsday Machine” by Michael Lewis and the 2015 movie, has since exited his water and farm holdings, though he noted last year that there’s “a lot of demand for those assets these days.”

The futures could be useful as a hedge instrument for firms including food or agricultural producers, land lease owners, municipalities and public water agencies.

“It’s really a unique mechanism for investors themselves and California to be able to at the very least understand and price the risk and potentially hedge the risk of water price volatility,” said Carter Malloy, founder and chief executive officer of AcreTrader, a farmland investing platform.

“The crucial thing is right now we have very little visibility” on what water prices will look like in the future, he said.

Water preservation and distribution could become increasingly attractive as investors like Jeff Ubben, who recently launched Inclusive Capital Partners, look to tackle problems ranging from environmental damage to food scarcity through their funds.

Climate advocates have warned in recent years for the potential of water wars as competition increases between needs from agriculture, energy and growing cities. Food production in particular could be vulnerable as drought makes it increasingly difficult to grow crops in many parts of the world and farmers balance water and land needs with protecting forest in places like Brazil’s Amazon.

“Food is going to be a flash point” in the world going forward as climate change makes production more challenging, Carter Roberts, chief executive officer of World Wildlife Fund, said in an interview at the Bloomberg Green Festival this week.

CME’s contract, tied to the $1.1 billion California water market, will launch late this year, pending regulatory review, and will be based on the Nasdaq Veles California Water Index, the bourse said Thursday.

In California, about 40% of water currently consumed in the state goes to crop production. The CME contract will help to create a forward curve so users can hedge future price risk, the bourse said.

“What we really wanted to be able to do was firstly to provide clear and transparent rules-based information to the marketplace,” said Patrick Wolf, a senior manager for Nasdaq Global Indexes.