Water is listed on Wall Street

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The economic headlines announce that water is starting to trade on Wall Street, but what does this mean?

For the first time in Wall Street history, the Nasdaq Veles California Water Index has been trading as an indicator of water prices in futures trading since last December 7.It is, without a doubt, a historical milestone in a sector that has usually been heavily intervened by the State and where concessions, monopolies and regulated prices have abounded, and, in which, social considerations in many cases have impeded that water can be marketed as one more raw material.

It should be noted that this index was created in 2018, and the novelty is that it is now possible to sign water futures contracts using it as a reference. On the other hand, it is also necessary to point out that its price does not reflect that of all the water resources of the country but only the average price of water available for sale in the five main river basins of California.

"The press abounds with alarmist headlines about a supposed threat to the water that the population consumes in their daily lives, when in reality this use represents only 10% of the total."

It is important to make these clarifications, since alarmist headlines abound in the press about an alleged threat to the water that the population consumes in their daily lives, when in reality this use represents only 10% of the total. According to data from the Public Policy Institute of California (PPIC), the largest uses of water in the Golden state they are actually ecosystem and watershed preservation (50%) and agriculture (40%).

In addition, both agricultural and urban use have been experiencing a very significant increase in efficiency since the 1990s. In the first case, this phenomenon is explained by the extension of more profitable crops such as grapes and walnuts, which has allowed to increase the agricultural production, while reducing water consumption. With regard to urban use, the installation of more efficient technologies in homes and less use of water for ornamental purposes (watering lawns, public fountains, etc.) have also made it possible to reduce its consumption despite the increase in the population. .

So where is the problem then?

What makes the issue of water in California such a complex issue is that its main difficulty is not economic but climatic: water is increasingly scarce.

Despite all the efforts of the population to reduce their consumption, these advances are still insufficient to offset the effects of the drought that since 2011 afflicts the first state by gross domestic product (GDP) of the United States. For this reason, initiatives such as the listing of this resource in the futures markets have been launched, which for many analysts could contribute to making it more responsible and protecting consumers from scarcity.

A guarantee in the face of uncertainty

"Just as crop futures help farmers reduce uncertainty about their income, trading water futures would give them the ability to do the same about expenses."

Naturally, since they are futures contracts, the operations do not imply an immediate delivery of the underlying asset until the operation is executed, but they do allow the transaction to be carried out at a price agreed in advance. In other words, this means that two people can reach an agreement that within a year, the seller will give the buyer the right to use a certain amount of water, at a price in dollars per acre-foot that they agree on in the moment of signing the contract.

In reality, this is nothing new for farmers, as they are already used to trading in commodity markets, where futures contracts are frequently traded. We can see it, today, in products as basic for consumption as wheat or corn. Although there is a certain controversy in this regard, the truth is that many farmers turn to futures, because they allow them to ensure the sale of their products at a certain price, without running the risk that at the time of harvest it may have overproduction and are forced to sell below their costs.

To understand the problem, it is necessary to remember the role of price formation in a market economy. Prices are, above all, a system for the transmission of information: the moment a transaction takes place at a certain price, the entrepreneur can estimate how much his clients are willing to pay, and that in turn serves as a reference for his clients. competitors. In addition, this variable determines how much the entrepreneur himself is willing to pay for his production factors (raw materials, employees, etc.), since in no case can these exceed the price of the final product.

The efficiency of prices to transmit information is often considered one of the great strengths of the market economy, although in practice this system can run into serious difficulties in some sectors. Thus, while many goods can adjust their prices almost immediately (usually those subject to a shorter production cycle), there are certain agricultural products where it is impossible to do so. The reason is that concentrating all production on a few harvests a year implies that all entrepreneurs must put it on the market at the same time, which reduces their margin to adjust quantities and prices.

This forces farmers to plan their next harvest based on the previous one, which can cause large swings in prices. In this way, if one year the price of wheat has risen, the market is indicating to farmers that the supply is insufficient with respect to the demand, which will incentivize many of them to bet on that crop for the next harvest. The problem is that if this behavior becomes general, the following year there could be an overproduction of wheat that plunges prices and ruins farmers.

In this context, we can understand the importance of futures in the agricultural sector, because they function as a mechanism to reduce the uncertainty of farmers about the price at which they will be able to sell their crops. In addition, the possibility of trading futures throughout the year allows them to adjust to the most up-to-date forecasts on market behavior and thus avoid suffering the price adjustment of a whole year at harvest time. All this results in a more secure calculation of the profitability of each crop, more job stability, as well as more confidence for long-term investment.

With these advantages in mind, why not also consider the possibility of trading futures contracts on water, one of the main production factors used by the agricultural sector?

The reasoning of the supporters of this initiative is that just as crop futures help farmers reduce uncertainty about their income, trading water futures would give them the ability to do the same about expenses. In other words, it would allow businessmen in the sector to safeguard their activity from fluctuations in the price of water, something that is becoming more and more frequent due to recent droughts.

On the other hand, a system of continuous price formation, without the seasonal effect of agriculture, could give market agents a more up-to-date image of the supply and demand of water at all times. Naturally, this could also encourage crops that require less water resources and the installation of more efficient irrigation technology.

Access or ownership?

"It's not really about who owns the water resources, it's about making them accessible to all consumers."

However, there are also people who object to the possibility of contracts of this type being traded in the financial markets. From this point of view, water is an essential good for human life and therefore cannot be subject to any type of speculation, because if it were, it could end up being concentrated in a few hands and many people would be deprived of it.

This debate is broader, since it includes the dilemma around the privatization of water, which we have already analyzed in previous articles. In this sense, the main objection tends to be that the concentration of ownership of water in the form of private monopolies tends to lead to a deterioration in the quality of the service and to a limitation of universal access to it. The logical consequence of this reasoning is usually that water resources must be under state monopoly or in private hands, but under conditions highly regulated by the authorities.

The problem in this case is confusing property with accessibility. When this debate is raised, the two concepts are sometimes confused and it is important to distinguish between them, because in reality it is not a question of who owns the water resources, but that they are accessible to all consumers. In fact, public and private agents can operate on the futures market on equal terms, and ownership of use rights can be concentrated as easily as it can be extended.

In Eastern Europe, in the 1980s, a similar dilemma arose around another good as basic as bread, whose production and distribution was monopolized by the State, precisely to ensure accessibility for all. And yet in those countries bread was scarce while it was plentiful on the other side of the Berlin Wall, where speculation on wheat prices was allowed. The lesson of this experience is that a good can be public and, despite this, not very accessible. And, at times, it can also be affordable for everyone, despite being in private hands.

It is still too early to venture whether the water will continue on the same path, but there are already many investors who point to it as a bet for the future. Some try to develop technologies that allow more efficient use, and others, such as future buyers, seek more security for their businesses, but all of them, attending to a common denominator, try to position themselves around an increasingly precious asset in the world. 21st century economy.

Tags:  administration economic-dictionary present 

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