A watershed moment is coming to water: the ability to bet against it.
Austin, Texas-based startup Waterfund LLC is working with International Business Machines Corp. IBM -0.58% to establish an index tied to the cost of major cities’ water supplies. The startup also has approached Wall Street securities firms to create derivatives, called swaps, based on the index.
Swaps are individual contracts negotiated between two entities. They are used by institutions, from insurance companies and banks to energy producers and hedge funds, to protect or bet against future swings in prices, including moves in the cost of raw materials and interest rates, among other things.
“There is significant appetite for uncorrelated risk, and that is what an index based on the cost of water can deliver,” said Scott Rickards, chief executive of Waterfund.
The idea behind creating the swaps is that water projects would be better able to attract capital from investors, such as infrastructure funds and investment banks, if they have a reliable benchmark tracking the cost of water production.
Investors have said they also want the ability to hedge against water projects in case they spend more than budgeted.
“It will attract capital inflows into a sector that once upon a time had been too risky from a financial point of view for many investors,” said Dr. Peter Williams, chief technology officer at IBM’s Big Green Innovations unit.
Dealers including Goldman Sachs Group Inc. GS -1.26% and reinsurers such asSwiss Reinsurance Co. SREN.VX +0.21% are weighing the derivatives and insurance products, according to a person familiar with the matter. Representatives for Goldman Sachs and Swiss Re declined to comment.
Waterfund will publish the index, which measures the cost of producing one cubic meter of drinkable water in U.S. dollars across major cities around the world, and IBM Research will calculate the index’s value.
Waterfund’s goal is to provide an index that covers water costs across the world’s 100 largest cities.
Investors could hedge in case project costs run too high and there is a delivery contract in which the price is set. The entity selling protection, such as an insurance company or bank, would collect premiums from the investor buying the derivatives, agreeing to payouts if the index and water costs exceed a predetermined level.
Water projects predominantly are funded with debt. In the U.S., borrowing is typically via municipalities issuing bonds; outside the U.S., it is often financed through loans from development banks.
“There has been very little private investment in water, and what there has been has often not met its investment returns,” said Julia Bucknall, manager of the water unit at the World Bank, which lends to water infrastructure projects. The average financing for such a project in the bank’s portfolio is $167 million.
Analysts said it is hard for investors to rely on tariff increases when trying to recover their investment if a water project exceeds its budget. Also, it is often politically challenging for a government or water entity to cut off the supply.
So far, Uganda, which is financing a project to expand water supplies into rural areas, and Panama, which is building a desalination plant, have licensed the index.
“The nice thing about the water index in particular is that there is a large and readily identified demand,” said Robert Arvanitis, founder of consultant Risk Finance Advisors. He is helping to structure the swaps for Waterfund and other potential users.
There have been swaps that allow investors to protect themselves against unexpected amounts of rainfall and the water table, or the level of water underneath the soil, but this is “the first time we can put a real price on water,” Mr. Arvanitis said.big picture, blue gold, commodities, cost of producing one cubic meter of drinkable water, create a water index, food for thought, hedging water risks, ibm tracking water index, little private investments in water projects, measuring water demand, put a real price on water, water, water index, water infrastructure projects, water projects, water projects funded by municipal bonds, water resources, water supply, waterfund