Let me help you understand that answer by explaining how water rights work, how farmers can buy and sell water through “water markets,” and how a futures market in water operates.
While the people of California own the water within the state, beneficial users of the public’s water can secure rights to use water called “water rights.” In California and all other western states, water users can transfer their right to use water to others who need water, subject to certain restrictions. For example, a farmer can conserve water by planting a less thirsty crop and then allow a downstream farmer to have more water. In recent years, several western states have sought to facilitate temporary water transfers through the water markets that reduce the costs of putting together a water transfer deal. These exchanges allow water users to readily exchange water rights -- and now even use online platforms for the buying and selling of water. These exchanges are what we call “water markets.” Water markets permit easy redistribution of scarce agricultural water, allowing farmers to adapt more readily to the increasingly severe and frequent climate-induced droughts that the western United States is experiencing.
California has several “spot” water markets where agricultural users can purchase the right to have water delivered for immediate use on their thirsty crops. The trades made in these markets allow the state to deliver water to the water purchaser. The water, of course, goes to the highest bidder – which usually means the bidder who makes the most money from their crops, or the bidder who has the most money. For example, farmers who have replaced vegetable crops with extremely thirsty nut trees because of high nut prices might be able to outbid a farmer with a less lucrative crop. As a result, spot markets theoretically allow the state to re-direct water cheaply and immediately to more beneficial economic uses.
Spot water markets do pose some issues. First, it does not necessarily make sense for the public to give away water rights without charge, and then allow the “water user” to profit from selling that water. Second, given the high level of income inequality and even higher level of wealth inequality in the United States, the water does not necessarily go to the most beneficial economic use. Wealthy agricultural water users may bid up the price of water during droughts and prevent farmers of more modest means from securing water. Those less wealthy farmers end up fallowing their fields. Water markets respond to high bids. They have a tendency to exacerbate income and wealth inequality and concentrate agricultural production, which could threaten the future of small family farms. Small family farms are not a nostalgic relic of the past; they are important because they provide a decent living to many families and they are frequently more productive than huge corporate farms. Third, exchanges design their water markets to facilitate consumptive agricultural uses, even though the best use of water may be leaving it instream so that the rivers do not run dry and fish can survive. Nonetheless, spot water markets can serve a limited purpose in encouraging agricultural water conservation and moving water among agricultural water users.
Future markets are different. The purported value of a futures market is that agricultural users can hedge, essentially insure, against steep price increases before or at the time that they plant their crops by securing a contract for water to be delivered later, say in July 2022. The current price of that contract is the collective best guess of the market about what water will cost at that time. One might think that futures contracts purchased by water users are no more objectionable than spot water contracts.
However, trading in water futures contracts is not limited to water users. Indeed most of the interest in futures contracts comes from Wall Street speculators who invest in water without any actual need for the water. A seller of a July 2022 future water contract settles by paying, on 1 July 2022, the amount of money required to buy that quantity of water on the spot market, rather than actually delivering water. If the price of the water on the spot market is higher than the seller received for the futures contract, the seller loses money. If the price of the water on the spot market is lower than the seller received for the futures contract, the seller loses money. This permits Wall Street gamblers to enter the market, bet on the future price of water and attempt to make money on those bets.
This speculation in water is dangerous, inequitable, and contrary to both public ownership of water and the law against granting water rights to speculators. It is dangerous because a wealthy speculator might buy much of the available water supply and then drive prices up far beyond the normal competitive price. Just imagine the level of excessive profits and chaos that would occur if some billionaire decided to secure a monopoly on water available through the California markets --costing a billion dollars or so -- and then California experienced a severe drought. Future water markets are inequitable to all water users because the presence of non-water users in the market automatically raises the price of water beyond the normal price – and those higher prices hobble the ability of less wealthy water users to secure the water they need. Finally, futures water markets are contrary to public ownership of water as well as the anti-speculation rule in granting water rights. The public gives water rights to water users without charge with the expectation that water rights holders will use the water beneficially for agriculture, commercial use, or industry – uses that somehow benefit the public. When water speculators own water rights, they do not benefit the public in any manner; they are just making private profits. For that reason, the dominant system of water law in the western United States, prior appropriation, has long had a uniform rule against allowing water speculators to secure water rights:
The company responsible for the California futures market has suggested that the market will provide a good signal about water availability. That is patently false and hazardous to real water users. Market speculators are notorious for investing based on many factors, including optimism, following trends fueled by mob madness, and similarly subjective factors, as opposed to objective factors such as agricultural demand for water and projected water availability. Inserting these irrelevant subjective factors into the market equation threatens to cause false signals about water availability and inefficient allocation of water during droughts, the point in time when water availability is most crucial. Suggesting that casual retail “Robinhood” investors or even sophisticated pension fund managers somehow know more about water availability than professional hydrologists and farmers is pure folly.
With the global awareness of water scarcity increasing, many places are facing an influx of water speculators seeking to profit from water. It is critically important that all national and state legal systems, in the United States and elsewhere, resist this infiltration of water speculators and prevent involvement in spot or futures markets by those who do not intend to use that water for beneficial purposes.