California Drought Derivatives: The Water Betting Door is Open

Water is the most important resource in the world. But in many places it is running out and prices are rising. In California, however, farms can now hedge on the stock market. Your counterpart in financial bets are professional speculators. A disaster with an announcement?

In James Bond – Quantum of Solace, the villain has only one goal: He wants to control the world's most valuable resource. Much to the surprise of 007, it's not about oil or gold, but about water. The villain caused a devastating drought in Bolivia through dams. Now he wants to sell his secret underground water supplies at high prices to the government in La Paz. The film was in theaters at the end of 2008. Now, a good twelve years later, reality seems to overtake fiction: Financial bets on water can be made on the Chicago futures exchange since the beginning of December.

Forward contracts, called futures, are not uncommon on Wall Street. They are also available for raw materials such as oil and gold or for agricultural products such as soy and wheat. In itself, that's a sensible thing, says ntv stock market expert Raimund Brichta in the podcast "Wieder was learned". With water futures, water consumers could protect themselves against rising water prices.

"Let's take a large farm that regularly uses a lot of water in the summer," he explains. "If there is a drought or if he fears one, the water prices can rise sharply. On the other hand, he can hedge on the futures market by betting on rising prices and buying such futures. If the prices actually rise, he suffers as a water consumer, but can his Set off profits on the futures market and limit your losses. "

California, agricultural powerhouse

Rising water prices are feared above all by farmers in California, where droughts don't need James Bond villains. The sunny state on the US Pacific coast is the fifth largest economy in the world and is not only a technical but also an agricultural powerhouse. A third of all American vegetables are grown in the "Golden State", plus two thirds of all American fruits and nuts. But the vital harvest is in danger: California has suffered from extreme drought for years. A historic five-year drought only ended in 2017. The water has been becoming scarcer and more expensive for years. Most recently, the price doubled within a year.

The futures contracts that are now traded are therefore linked to the price development on the California water market. Above all, they are intended to serve as a kind of insurance for local farms and communities, for which one pays a fee that, in the worst case, is lost in a wet summer. In contrast to James Bond, nobody buys water sources, they just bet on the price development.

But the greatest knowledge about the development of water prices is useless without a counterpart. Nobody can bet against themselves. For futures contracts, you need someone to take the opposite position. In the case of water prices, they could be owners of water sources who want to hedge against falling prices. In case there is surprisingly more rain than expected and the drinking water reservoirs in California overflow differently than usual because they are so full. But that's unrealistic, keyword: climate change. A bet between two farms is therefore unlikely. Smallholder farmers are likely to lack the necessary know-how for these complicated financial transactions anyway.

Klaus Gabriel received his doctorate from the University of Vienna on the subject of sustainability in the financial market.

(Photo: Cric)

As a counter-position for the futures contracts, professional speculators are most likely to come into question, says Klaus Gabriel. He is a social and business ethicist and co-managing director of the Corporate Responsibility Interface Center (Cric), an association for ethical and sustainable investments. He suspects that hedge funds or other large institutional investors are interested in the contracts in order to diversify their portfolio and to tap new profits despite low interest rates.

Bitter lessons from the financial crisis

The request is understandable. Farmers can secure themselves, financial speculators can tap a new source of income. But when it comes to money, people tend to be cocky. What if farms are repeatedly correct with their bets and suddenly no longer want to use the futures contracts for hedging, but instead discover the pleasure of gambling? Or bet with money that they may not even have?

"My experience is that wherever abuse is possible, abuse is also practiced," says Gabriel. "Unfortunately, in the financial market in particular, that cannot be avoided. This is called residual risk. Life is also designed in such a way that one thing always exists. We cannot prevent damage from occurring."

But especially when there is a lot of money involved, very great damage can occur. That was seen in the case of derivatives during the 2008 financial crisis, when the speculative market drove real estate prices higher and higher in the US, one mortgage loan after another was taken out and no one wondered which properties were actually being bought by which people. Speculation has left the basic business behind.

Distorted picture of supply and demand

This can unintentionally happen to water prices too. When a lot of people bet a lot of money that it will go up, the impression is that consumption has gone up too. But it is not, just the desire to bet. The result is a distorted picture of supply and demand.

If a water bubble forms in the overheated futures market, outsiders will be affected. The United Nations warned against this, and Cric boss Gabriel also warns against this: "In developing and emerging countries, the existence of many people would be threatened if food were 20 or 30 percent more expensive. These are risks that are not borne by speculators, but those on them Society are outsourced. "

The futures contracts still only cover the Californian water market, the interest is limited. But in five years, two thirds of the world could suffer from water scarcity. It is likely that more companies and communities will then want to protect themselves against threatening price fluctuations than fewer. It is also likely that people speculate who do not care about the water supply. The door to water betting is open.

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. (tagsToTranslate) economy (t) derivatives trading (t) water supply (t) California (t) extreme weather (t) agriculture (t) financial markets (t) Wall Street (t) financial crisis