A drought in California has led to a spike in the state’s water prices, nearly doubling the value of futures contracts for the essential commodity this year and creating opportunities in water-related investments.
As of Aug. 24, the Nasdaq Veles California Water Index , which represents the weighted average price of water-rights transactions across five major markets in California and is published weekly, has climbed by roughly 87% year to date to $923.54 per one-acre foot.
The unit of measure represents the amount of water needed to submerge one acre of land in one foot of water, or about 325,851 gallons of water. On the CME
water futures based on that index have climbed 90% this year to $942 per one-acre foot.
It’s a “perfect storm of conditions” for California’s water, with “worsening supply/demand imbalances, telltale signs of climate change, and a hesitancy by state officials to step up permanent solutions like conservation, water reuse, and desalination,” says Deane Dray, a managing director and multi-industry analyst at RBC Capital Markets.
The Department of Water Resources reported that storage in major California reservoirs stood at just 53% of their historical average as of July 31.
Droughts like the one in California can “no longer be considered rare, unexpected, or even abnormal,” said Kirsten James, program director, water at Ceres, a sustainability nonprofit organization. “The climate crisis is acting as a threat multiplier, accelerating the already daunting pressures” on the state’s freshwater resources.
At least 50% of the stocks listed in each of the four major U.S. stock indexes are in industries with medium-to-high water risk, according to an analysis by Ceres, says James. Even so, companies often “do not realize they will be significantly impacted if they fail to be an active player in smart water management.” Opportunities for water-related investment exist in areas such as water treatment and conservation that can help California manage drought, she says.
Water futures contracts were launched less than a year ago and are still in the early stages of development. But market interest and participation has expanded as people “start to look at next year and position themselves to ride out a competitive market” and rising water prices, says Clay Landry, managing director at consulting firm WestWater Research, which provides data used to calculate the Nasdaq water index.
Since the Dec. 7 launch, 1,019 water futures contracts representing 10,190 acre feet of water have traded at CME Group, with the second-highest monthly volume in April.
California Gov. Gavin Newsom declared a drought emergency in April, and in July called on Californians to cut water use by 15%. “The path of least resistance for water prices is higher, as water scarcity is already a concern in certain areas around the world, and we believe that water as a commodity is gaining more traction,” says RBC Capital’s Dray.
He believes that water futures are a “proverbial ‘toe-dip into the water’ in providing some market-driven insight into California’s water pricing,” but volume of trading needs to ramp up significantly before they can “advance past this novelty state.”
RBC’s investment framework for water focuses on the names at the “higher end” of what it calls the “water valuation continuum.” Those include firms that have “more embedded water technology” such as Xylem Inc.
Evoqua Water Technologies Corp.
and Mueller Water Products Inc.
In order to raise water supplies, California, and the rest of world, need to focus on conservation efforts, water reuse, and more desalination, he says.