California’s historically severe drought, which ended in March 2019, had dominated Capitol discussions during its eight-year run, yet had not led to any dramatic changes in the way the state manages its water resources. This seems hard to fathom, given that state officials continue to warn about the impact of climate change on water availability.

Unfortunately, the state’s leaders seem far more interested in mandatory water cutbacks than in expanding California’s impressive system of reservoirs and canals or in letting private firms desalinate ocean water or tap massive aquifers underneath the Mojave Desert. With the coronavirus situation and the state’s usual array of unfolding crises, thoughts about water shortages have drained away.

Nevertheless, there are signs that the state could soon face a new drought. Fortunately, the private marketplace is doing something to get at least a handle on the matter. The Chicago Mercantile Exchange (CME) has started a new price index that allows investors to trade in water futures — the latest example of how a better pricing system is crucial to improving the state’s water system.

“Farmers, hedge funds and municipalities alike are now able to hedge against — or bet on — future water availability in California, the biggest U.S. agriculture market and world’s fifth-largest economy,” according to a recent report in Bloomberg Green. “CME Group Inc.’s January 2021 contract, linked to California’s $1.1 billion spot water market, last traded Monday at 496 index points, equal to $496 per acre-foot.”

As I explain in my new book, Winning the Water Wars: California Can Meet its Water Needs by Promoting Abundance Rather than Scarcity, California has made it inordinately difficult to buy and sell water because of a Byzantine bureaucratic approval system for water trades. Until now, the state has lacked a precise way to gauge water pricing. Environmentalists often fear the idea of putting a price on water because of their ideological hostility to markets, but better pricing is one of the key ways to assure a future of plenty.

The new index emerges amid concerns about coming problems. As Bloomberg added, “The contracts, a first of their kind in the U.S., were announced in September as heat and wildfires ravaged the U.S. West Coast.… They are meant to serve both as a hedge for big water consumers, such as almond farmers and electric utilities, against water prices fluctuations as well a scarcity gauge for investors worldwide.”

As I explained in my chapter on water pricing:

Without accurate pricing, we can’t have vibrant markets where people buy, sell and trade water — so the people who need it the most can obtain it at a negotiated price. Water is vital to our lives, yet so is food. Imagine how our system would work if various government agencies, through planning edicts and complex regulations and public investments, decided how to stock supermarkets and what to charge for items rather than allowing businesses to do that for us based on consumer preferences and price signals.

And we’d all hate to envision government food-rationing edicts. Yet, that’s how it works with water. We should price water more accurately because it will assure it is used for the highest and best purposes, as the market decides. Markets aren’t nefarious entities, but simply the sum total of decisions that willing buyers and sellers make every day.

In California’s government-dominated water systems, the price consumers pay is disconnected from reality. I quoted Matthew Fienup and Bill Watkins in New Geography:

When you pay your personal water bill, the price that you pay does not signal that we are facing a critical water shortage. Water prices have increased incrementally, but not nearly enough to convey our dire situation. The gas lines of the 70s remind us of what a world without scarcity pricing looks like. Remember how quickly shortages disappeared when price controls were abandoned?

Of course, in rainy years the cost of water should plummet — but we’re wise to fear that government will never reduce prices. Californians are also right to distrust their leaders, who haven’t built significant water infrastructure since the 1970s, when the state’s population was roughly half its current size. Without such investments — along with a quicker embrace of recycling and desalination — we’re likely to see louder calls for limits on the personal use of water.

California’s rainfall ranges from 150 million-acre-feet to 300 million-acre-feet a year. Around half of that water is diverted to environmental uses (flowing to the Pacific) and 40 percent is used for agriculture. Only 10 percent is for residential and commercial uses. Our policy makers are fixated on fighting over the smallest portion — without focusing sufficient attention on capturing more water during wet years or in adjusting those environmental percentages.

The new water futures market won’t add new water into the system, but it will help individual companies guard against future price hikes. As Quartz reported, “In theory, this will ease the financial crunch for farmers and other businesses that need insurance against wild price swings. (Unlike some commodities, water futures don’t require the buyer to take physical delivery since water distribution is highly regional, as are the regulations.)”

The new index will also serve as a warning sign about coming scarcity and perhaps incentivize local governments to push for more storage. Given the current policies of California officials, however, it’s not hard to guess which way prices might go.