NQH2O: Nasdaq Veles Water Index May 2021 Market Update

The 2021 drought increasingly threatens to be the worst in recent memory

From Bad to Worse

When California Governor Gavin Newsom took to the newly exposed lakebed of Lake Mendocino last month to announce a limited state of emergency proclamation covering only Mendocino and Sonoma counties, one could be forgiven for having felt that the Governor’s action didn’t quite match the severity of the scene that served as his backdrop. While local hydrologic conditions had certainly begun to show signs of an intensifying drought, so too had much of the rest of the state, leaving many wondering why the decision had been made within such a limited scope.

Perhaps a justification of his reasoning at the time – a snapshot of local conditions - for many observers, the image portended a far more dire situation than the Governor’s office was willing to accept in that moment. So, it came as little surprise that on May 10, Governor Newsom, likely succumbing to pressure from county officials throughout the state, extended the emergency proclamation to an additional 39 of California’s 58 counties, now reaching approximately 30% of the state’s total population. While an important acknowledgment, the order is nonetheless unlikely to have a profound effect on the anticipated challenges facing Agricultural water users, in particular.

For one, the Federal Government has itself waded into California’s water woes in a meaningful way. In an effort to preserve dwindling resources through the year, the U.S. Bureau of Reclamation announced that the Central Valley Project will be further limiting in its allocations to municipal water agencies, both North-of-Delta and South-of-Delta with only 25% of the possible allocation being committed, as compared to the 55% allocation cited only a month earlier. Incredibly, farm-irrigation districts, also both North-of-Delta and South-of-Delta will be limited to 0%, down from the already de minimis 5% previously announced. Additionally, at the state level, the California Department of Water Resources is now permitted to request that the State Water Board enact changes to water rights permissioning, while the State Water Board, for its part, will have expanded flexibilities in evoking emergency regulations to curtail water diversions as it sees fit. Going further, the Department of Fish and Wildlife has been ordered to assess instream flows to watershed resources supporting specific fish populations, with abilities in place to maintain minimum flow levels, where it sees the need.

While all such measures are meant to balance resource use among crucial user groups and ecological necessity, the ability to establish that balance only faces greater challenges as the 2021 drought increasingly threatens to be the worst in recent memory. In a tacit recognition of this point, Governor Newsom also unveiled a sweeping $5.1B plan to improve preparedness among water agencies and to build out critical water infrastructure, releasing a list of intended allocations following his May 10 press conference. In the short term, Californians are bracing for sustained shortages over the coming summer.

  • Unchanged MoM: Despite the steady trickle of consistently supportive news, the index pulled back slightly, closing the month at $867 per Acre foot, down from a mid-month high of $877.36. Conceivably, with mounting evidence of drought on the heels of a particularly dry Winter, participants may have already been pricing in greater severity than consensus during the initial run up of prices that began in mid March. While it appears that the index has found its footing over the past two weeks, we suspect that the market continues to digest both hydrologic and policy developments providing significant unknowns heading into June.
  • 76% increase YTD: As NQH2O index history suggests, the California water market has typically exhibited a clear seasonal pattern. As the new yearly water allocations are announced and finalized throughout the spring, water users enter the spot market to address imbalances between their initial supply of water and the quantity they require. This year has been no different in that respect, albeit with a much sharper price increase than we’ve seen in recent years. An unusually dry winter sent an early signal as to the severity of this year’s hydorologic conditions, with the April snowpack survey, which bookends the state’s wet season, indicating only 59% of average levels: a grim warning for a state that relies on melting snowpack for up to 30% of its annual water supply.
  • 28% increase YoY: Readers may notice a substantial decrease in the year-over-year change when compared against our April report. The figure reported last month, (121%), reflected a starting point in late April 2020, when prices had only just breached a crucial resistance of $300 per Acre foot, while amazingly, the index had remained below that level for 67 consecutive pricing periods. From there, the increase would only accelerate, with the index failing to recede to levels approaching anything close to that point over the 61 periods since. The initial run-up that we witnessed from the end of March through the end of June 2020, when prices more than doubled ($299.47 on 3/25 vs. $676.13 on 6/24), illustrates just how reactive participants are to drought expectations and allocations announcements. Recalculating the YoY figure for May reveals, in its own right, a significant increase owing to elevated drought expectations as compared to this time last year. However, it is of value to note, as the index continues to inch toward $900, that the increase over the past year has been more gradual, more range bound and more committed to its general trend than we saw in the year prior. 

A comparison of NQH2O to major commodity benchmarks:

Water index comparison

A comparison of NQH2O performance to ARK Innovation ETF:

Water index vs ARK

A comparison of NQH2O to major equities and water ETFs:

Water index comparison

A comparison of NQH2O to US Drought Monitor and State Water Project Allocation:

Drought vs Veles Water index

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