Is Water Replacing Gold and Oil in Investor’s Asset Portfolio?

Is Water Replacing Gold and Oil in Investor’s Asset Portfolio?

Pardhasaradhi Madasu

Associate Professor (Finance Area)

Siva Sivani Institute of Management

Email: [email protected]

Prelude:

At the outset, the answer for the question of whether water is replacing gold and oil in the asset portfolio of investors is ‘Yes’. Water is needed in all circumstances and the supply is ‘finite’. Future investment portfolios would be certainly having ‘Water’ as a commodity for trading and investing. No water – no survival of life on planet earth. This is the basic logic behind water becoming a valuable commodity for trading. It is a common-sense rule that whatever is ‘scarce’ and has demand will gain more ‘value’. Increase in population, enhanced economic activities,  clubbed with climate change is the cause for water becoming a scarce commodity. Here comes the attention of financial engineers who could come out with tradable financial products where water is the underlying asset. Immediate issues that come up for discussion are related to the ‘Ethics’ and ‘Values’ that have to be followed while creating wealth. The debate and deliberation on the social-consciousness, ethical and value related issues are continuing but the investments in water based financial assets are moving northwards only. The present article is a curtain raiser for a productive deliberation on ‘Water’ as an investment product.

Trading in ‘Water’: An Overview

UNESCO (2020) states that during the past century the global water usage has increased by six times and the rate of usage is increasing by 1% per year. The major factor that could be attributed to the abnormal usage of water is the ‘Climate Change’. To quote further, few nations are not even having a proper water management system in place. The current scarcity of water clubbed with future forecast of water resources shrinkage has made water an ‘Asset’ that could be traded in stock markets for gains. Almendros (2020) mentions that stress on water resources is what made investing community to think of trading in water. Water is a universal asset and now is considered as a commodity which could be of more value than gold and oil. In this backdrop, from December 7, 2020 water futures have started to be traded on Wall Street at USD 486.53 per acre-foot. The water futures contract would be for 10 acre per foot of water and has a maximum contract period of 48 months. The futures contracts are tied up with NASDAQ Veles California Water Index which indicates volume-weighted average price of water. NQH2O is being published since the fall of 2018 and is the reflection of water prices in spot market of California.

In this regard, Tappe (2020) writes that the trading of water in stock markets is entirely new to the mankind. Previously, trading in water rights was known to all of us. Water rights gave right to the holder to pump water from a particular water body when there were dry years and these rights were trade in ‘Spot Market’. In the case of water rights, there was lot of uncertainly involved. However, the advocates of water futures mention that the uncertainty involved in water rights could be eliminated due to these futures. Water futures is expected to bring more transparency and equilibrium in water trading. The agriculture sector participants are the buyers and the municipalities are the sellers in the water futures market.  

In this backdrop, water is now similar to cocoa or wheat whose prices fluctuate based on scarcity or abundance. Along the stock market option, investors now have wide variety of options to invest in water. Investors could think of including virtual water investments or shares of water companies of water ETFs in their portfolios. As a member of financial planning community, it is my responsibility to educate the investors on this option. These investment avenues are not yet available in India, but it won’t be too late to have these options in our own country.

Water Futures: Advantages and Challenges

CME Group (2021) acknowledges that the first and foremost advantage of water futures is that of eliminating ‘Price Risk’. To quote a fact, cash water prices was USD 489 per acre foot on 16th December 2020 and have increased to USD 877 per acre foot by 12th May 2021. If the farmers or anyone would have hedged this risk they could have gained. On the other hand, if this price risk was not hedged, they would have incurred a loss of USD 388 per acre foot. In business eliminating price risk and creating certainty is essential and for them water futures are good hedging tools. But the problem comes when even ‘Speculators’ trade in water futures. Kammeyer (2021) opines that farmer in California could be considered as hedgers in the water futures contracts. On the other hand, other than farmer and other entities who need water for their smooth functioning of business could be considered as speculators. Like in another derivatives market, if the role of speculators is not under control, the prices may be rigged up in the water futures market. One of the features of water futures contract is ‘Cash Settled’ contracts. The long position holder is eligible to the difference between spot price on the day of settlement and NQH2O Index value. The feature of cash settlement could attract speculators to the water futures market also. However, in case of water futures market, physical settlement is not feasible. It is only the regulators who can keep the market stable. Yadav (2020) put forward his thought by stating that countries where proper water management system is not yet in place introducing water futures in their respective markets would be a cause of disaster. Developing countries which high population density could get trapped in this game of making water a commodity for wealth creation. This could happen in India also. Water futures being realty in India may not be ruled out. However, many of us pretty well-acknowledge that the Indian financial markets and the market regulator SEBI are very efficient in their work and could handle the negatives of the water futures markets.

One more advantage of the water futures market for country like India is efficient and effective use of water bodies. Once water get traded on stock markets, no one may want to waste water rather wants to preserve it and trade the same on stock market.

All of us have to adopt ourselves to the changing financial world but we should also be cautious about the society as well. In Indian context, by the time water futures or similar product see light in our market, maybe we could learn from the happening in other water markets. Let hope the best.

Works Cited

Almendros, P. S. (2020). The Future of Water is Traded in the Stock Exchange. Smart Water Magazine.

CME Group. (2021, May 26). Hedging With Water Futures. CME Group.

Kammeyer, C. (2021). California's Water Futures Market: Explained. Pacific Institute.

Tappe, A. (2020, December 7). Investors Can Now Trade WAter Futures. CNN Business.

UNESCO. (2020). Water and Climate Change. Paris, France: UNESDOC.

Yadav, S. (2020). Water is Now Traded Commodity: Can It Still Be a Human Right, Too? The Swaddle.