Hedge funds are now looking to turn scarcity into profit
Endemic water shortages might seem like a dystopian nightmare, but the reality is fast approaching. The financial services industry, always alert to trends that can be translated into price rises or falls, now believes water scarcity is enough of a future certainty to want to make money from it. CME Group and Nasdaq have announced plans to launch a water futures product based on the Nasdaq Veles California Water Index, which tracks the cost of buying water in the state of California.
A futures contract is an agreement to buy or sell something in the real world at a fixed price. If you believe the price of a given commodity is going to fluctuate, it may make sense to take out a contract ahead of time that fixes the price of that commodity.
Let’s say I’m a Californian farmer thinking about expanding into almonds production. I’m aware that growing a single almond takes 1.1 gallons of water; I’m also conscious that California spent seven years in a drought up to 2019, and this year wildfires ripped through the state. It’s risky to invest in thirsty crops, but on the other hand, supplying the growing plant-based milk industry looks like a promising bet. I might therefore look to fix the price of supplying water to my farm, so I can make my economic projections with greater confidence.
Once a futures market exists, futures contracts are then bought and sold by commodity traders as products in their own right, with traders betting that a price will rise or fall and taking a buy or sell position accordingly. For traders, this means it doesn’t really matter what’s happening in the real world of the commodity itself, as long as you make the right bet on the price change. You can profit from Californian drought just as you can from flood, provided you see the drought or the flood coming. So the launch of a water futures product means uneven availability of water has been identified as a promising source of future profits.
Hedge funds aren’t infallible, of course. But when colossal profits or losses turn on their predictions, they’re highly motivated to make accurate calls about price changes. If the financial services industry thinks there’s enough of a profit to be made now out of competition for water, then for those of us who live in the world of actual things it’s a signal that water shortages are likely to be part of our near future.