Why trading water futures could be in our future

Water is the one natural resource required to sustain all life on the planet, making it already the most important commodity on Earth.

Although it has been fought over, sold, diverted, dammed, claimed by governments and overseen by authorities, Wall Street has never really gotten its hands in it the way it has with, say, oil.

Looking ahead into the next quarter century, clean drinkable water is expected to become more scarce as the human population grows and climate change shifts the shorelines and weather patterns.

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So the question is, Will this most precious commodity become a traded resource that will be bartered for, and traded on a futures exchange, much like oil, corn or gold?

"It's intuitively appealing to talk about water as a traded asset. If you look at projections over the next 25 years, you'll see that global water supply and demand imbalances are on track to get worse," said Deane Dray, a Citigroup analyst who heads up global water-sector research. "The majority of the world population is living in water-scarce and water-stressed regions of the world. "

But Dray and other experts say trading water will be difficult, as water supply is ultimately a local issue all over the world.

"I don't see how you would do it. Water's regulated locally. It's regulated in every state. You can't put a pipe in a waterway and start selling it somewhere else," said Robert Kennedy Jr., president of Waterkeeper Alliance, which promotes watershed protection globally. "The waterways are owned by the people of the state."

History is full of examples where water diversion led to wars or environmental tragedies. The former Soviet Union diverted rivers for crops in the 1960s, ultimately drying out the Aral Sea in Central Asia, where fishing boats are now stranded on dry land.

"Anything that ships water as a commodity out of a watershed would be extremely disruptive environmentally, and it would be disruptive to democracy and the public trust. We've already seen water wars all around the world because of companies trying to do that and governments trying to do that," Kennedy said.

The Middle East has seen many conflicts over water, including in Syria. The Euphrates River has long been a source of conflict between Turkey and Syria, and in the last month Turkey turned off the tap, affecting water flow to Syria and Iraq.

Kennedy said Western law, dating back to Roman times and even the Magna Carta, stated that water belongs to the people.

"Water is a multitrillion-dollar industry now, according to the World Bank, and because it is a commodity that is vital for human life and we're experiencing global shortages because of global warming and population growth ... it's something [that] people will try to figure out a way to commoditize and sell," Kennedy said. "The best measure of how a democracy functions is how the government distributes the goods of the land."

That would include waterways, fisheries, wildlife and public land.

 

"Economists like the idea of trading [commodities] freely. The process increases economic efficiency," said Professor John Reilly, co-director of the Joint Program on the Science and Policy of Global Change at the Center for Environmental Policy Research at MIT Sloan School of Management.

"In terms of large-scale international trading of water, we already have bottled water moving around. I think its more likely we will see desalinization and other sorts of things—such as water reclaimed, cleaning up and recycling of water—before we see large-scale trading of massive amounts of water, because it would be expensive to move," said Reilly. He said a solution to lack of water may be to move activities that require water, like crop production and manufacturing, from dry areas to wetter regions.

Necessity the mother of invention

Richard Sandor, CEO of Environmental Financial Products, said he believes obstacles will be overcome, and he fully expects to see trading of water via financial instruments in the next five to 10 years—something he's been thinking about for quite some time.

Sandor was behind the creation of interest-rate futures while working as an economist at the CME, and he also was behind the Chicago Climate Exchange, a North American trading system for greenhouse gases, now owned by ICE.

"I think this one is going to require invention. The physical limitations of piping water is a problem that will require creativity," he said.

The more important issue is how to price such financial instruments. As Sandor explained, "The delivery from futures is very small. They're really meant to keep the pricing honest, not to change ownership. The delivery and the threat of delivery is what keeps a price honest and fair, at least on the derivatives side."

Sandor said water trading would have to based on the dynamics of regional markets, and he's been working up a plan. "I think we're going to have to invent something that takes into account the varying geographical differences. We'll have to figure that out," he said.

http://www.cnbc.com/id/101789481