Description
Documentation describes explores the use of water of commodity.
Water as a next commodity
1
Table of Contents
1. Commodity .................................................................................................. 3 2. Water as a next commodity ......................................................................... 3 2.1 Long term drivers of water use ................................................................. 4 2.2 Current Scenario .................................................................................... 4
2.3 Indices where water is being traded ......................................................... 5 2.4 Urban Indian Water Scenario ................................................................ 5
2.5 Investment Opportunities ......................................................................... 6 3. Problems for water supply ........................................................................... 6 4. Water: The economic good.......................................................................... 7 4.1 Uses of Water ........................................................................................... 8 4.2 4.3 Demand & Supply of Water ................................................................... 8 Water as a Private Good ........................................................................ 9
5. Water traded in exchange ......................................................................... 10 5.1 Limitations .............................................................................................. 11 5.2 Government Intervention ....................................................................... 11 6. Conclusion ................................................................................................. 12
2
1. Commodity
A commodity is a good whose price is determined as a function of its demand and supply in a market. Well-established physical commodities have actively traded spot and derivative markets. Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, salt, sugar, coffee beans, soya beans, aluminium, gold, copper, rice, wheat, gold, silver, palladium and platinum. Soft commodities are goods that are grown, while hard commodities are the ones that are extracted through mining. A commodity is a physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts. The price of the commodity is subject to supply and demand. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be.
2. Water as a next commodity
The importance of water as the most fundamental constituent of life needs no explanation. It will always remain a vital element for the survival of the human race. It is within as well as around us in seemingly abundant amounts. Nevertheless severe problems with its provision are as old as mankind. Like gold and oil, water is a commodity - and it happens to be rather scarce. There has recently been a historic increase in the public awareness of global water issues. Virtually every country in the world is faced with some combination of water quality and quantity issues that will require significant expenditures for their resolution. It is clear that not only human health but, also, environmental protection and economic development are critically dependent upon the efficient management of this increasingly scarce resource. The water industry is poised for considerable growth as convergent technologies and institutional changes combine to address the global demand for clean water. The provision of healthful drinking water has implications that span the entire spectrum of human existence. At the same time, the consumptive use of water cannot be disassociated from the planet’s ecological balance. Because the hydrologic cycle is, practically speaking, a closed system, the Earth’s biosphere contains all of the water that it will ever have. Its allocation, treatment, consumption and discharge, however, are subject to the institutions, practices and technologies that are put in place by mankind. Consequently, the economic value of water will play a major role in defining the future of water usage.
3
2.1 Long term drivers of water use
? ? ? ? ? ? ?
Population growth & urbanization Degradation of water supplies Resource sustainability Climate changes Geopolitical instability Aging water infrastructure Convergent Techniologies
2.2 Current Scenario
About 70% of the earth's surface is covered in water, but 97% of it is saltwater, which is unfit for human use. Saltwater cannot be used for drinking, crop irrigation or most industrial uses. Of the remaining 3% of the world's water resources, only about 1% is readily available for human consumption. Rapid industrialization and increasing agricultural use have contributed to worldwide water shortages. Pollution also highlights the need for clean water.
4
Global Water Supply
Unavailable Freshwater 2% Readily available Freshwater 1%
Saltwater 97%
2.3 Indices where water is being traded
Like any other scarcity, the water shortage creates investment opportunities. Some of the popular indexes designed to track various water-related investment opportunities are as follows:
?
Palisades Water Index - The Palisades Water Index is an unmanaged benchmark that many water indexes and ETFs track. This index was designed to track the performance of companies involved in the global water industry, including pump and filter manufacturers, water utilities and irrigation equipment manufacturers. Dow Jones U.S. Water Index ISE-B&S Water Index S&P 1500 Water Utilities Index
? ? ?
2.4 Urban Indian Water Scenario
The rate of urbanization in India is amongst the lowest, but the nation has more than 250 million city dwellers. By 2020 it is predicted that the 50% of India’s population will be living in the city which will put pressure on the already strained centralised water supply systems of urban areas. he urban water supply and sanitation sector in the country is suffering from inadequate levels of service, an increasing demand-supply gap, poor sanitary conditions and deteriorating financial and technical performance.
5
According to Central Public Health Engineering Organisation (CPHEEO) estimates 88 per cent of urban population has access to a potable water supply. But this supply is highly erratic and unreliable. Transmission and distribution networks are old and poorly maintained, and generally of a poor quality. Consequently physical losses are typically high, ranging from 25 to over 50 per cent. Low pressures and intermittent supplies allow back siphoning, which results in contamination of water in the distribution network. Water is typically available for only 2-8 hours a day in most Indian cities. The situation is even worse in summer when water is available only for a few minutes, sometimes not at all. In most cities, centralised water supply systems depend on surface water sources like rivers and lakes. Chennai, for instance, has to bring in water from a distance of 200 km whereas Bangalore gets its water from the Cauvery river, which is 95 km away. Where surface water sources fail to meet the rising demand, groundwater reserves are being tapped, often to unsustainable levels.
2.5 Investment Opportunities
Many companies are seeking a piece of the water market. In addition to direct stock purchases, some of the larger firms offer dividend reinvestment plans. Firms seeking to profit from water-related businesses include beverage providers, utilities, water treatment/purification firms and equipment makers, such as those that provide pumps, valves and desalination units. When it comes to bottled water, the market is growing internationally. On the desalination front, some 100 countries currently rely on desalination for at least part of their freshwater consumption needs.
3. Problems for water supply
Firstly, increased population led to an increased pressure on the limited amount of fresh water which constitutes only about 3% of the total water available in the world. Most water stems from seas and oceans and is saline. Technologies to desalinate this water are required to transfer this water into potable water. Up to now these technologies have been considered too costly. However the increased pressure on fresh water supplies may change desalination into an economically attractive option in the near future. Secondly, concentration of people in locations which over time were further and further removed from water sources resulted in a need for networks transporting water from source to user. Thirdly, industrialization and increased population have tremendously increased the pollution of water urging for cleaning and costly water treatment facilities.
6
Finally, the technological developments have in the 20th century resulted in a situation where in the industrialized world almost all houses are connected to the public water network resulting in a drastic increase in per capita water demand. Almost everywhere in the world, serious problems exist with supplying a sufficient amount of clean water whereas at several places there are also problems with the absolute amount of water available for consumptive use in at least particular cities.
4. Water: The economic good
The above developments have called for a good management of water resulting in a sustainable use of water, making water an economic good. The crucial characteristic of water from an economic point of view is that assignment of property rights is difficult which makes it non-excludable to a large extent. It is however, rival and is thus defined as a common-pool resource, meaning that there is a finite amount that must be shared in common over a variety of uses and all over geographic areas. The classical tragedy of commons arises since users are likely to ignore the effects of their actions on the pool when pursuing their self interests Renewal of water is both stochastic and seasonal implying uncertainty in its supply. This calls for investments in infrastructure that enable us to store and regulate the supply of water. Besides, water cannot be considered as a homogeneous good. There are all sorts of qualities, ranging from surface water to drinking water. This scarcity in water might lead in water being traded in the market as a normal good.
P P1 Po Do Q
D1
7
4.1 Uses of Water
The uses of water are many, from drinking and cleaning to irrigating crops and landscapes. Water is also used for recreational purpose, cooling and dust control. We can broadly categorize the use of water in three main categories as follows: ? For drinking – The human body depends on water anywhere in the range from 55% to 78% depending on body size. The body requires atleast 7 litres of water per day depending on the temperature, dehydration, humidity as well as other factors. Most of this is ingested through foods or beverages other than drinking straight water. It is not clear how much water intake is needed by the healthy people, though most advocates agrees that eight to ten glasses of water daily in the minimum to maintain proper hydration. Humans require water that does not contain too many impurities. Some solutes are acceptable and even describe for taste enhancement and to provide needed electrolytes. As a heat transfer fluid – Water and steam are used as heat transfer fluids in diverse heat exchange systems, due to its availability and high heat capacity, both as a coolant and for heating. In almost all electric power plants, water is the coolant, which vaporizes and drives steam turbines to drive generators. Water can also be used as a neutron moderator in the nuclear industry. Recreation – Humans use water for many recreational purposes, as well as for exercising and for sports. Some of these include living, boating, waterskiing, and swimming. In addition, some sports, such as ice skating and ice hockey are played on ice. Water parks, beaches and lakesides are popular places for people to g to relax and enjoy recreation. Many find the sound of flowing water to be calming, too. Some keep fish and other life in aquariums or ponds for show, companionship and fun. Humans also use water for snow sports like snowboarding or skiing, which requires the water to be frozen. People may also use water for play fighting such as with water balloons, water guns, and snow balls. They may also make fountains as well as use water in their public or private decorations.
?
?
4.2 Demand & Supply of Water
The key determinants of the demand for water are as follows: Water can be used for productive as well as consumptive purposes. Within these categories, subdivisions can be made between water intensive and water extensive producers, low and high income households and households with and without gardens etc One can look at its variability over regions, family types, housing characteristics, industrial composition and income. A substantial part of total water consumption is made up of residential use. Within the category of residential use there are important differences between single-family establishments and multi-family establishments (flats and apartments). Demand also varies with various qualities of water – a natural distinction is between water used for drinking washing and showering purposes (has to be of high quality), and water used for other activities such as gardening and flushing toilets (maybe of lesser quality).
8
4.3 Water as a Private Good
The activity of the water industry would consist of gathering, treating, transporting, storing and distributing water as well as collecting, transporting and treating waste water. A distinctive characteristic of this industry is that it is extremely capital intensive. Huge investments will have to be made in terms of building dams, developing and maintaining networks and factories built to collect and treat water. Thus the industry of water should likely be considered a natural monopoly. The required investments in especially the distribution networks are so large that it is unlikely that two firms each with their own network can profitably operate. The monopolists are only guided by the profit motive. Knowing that he is the only supplier in the market a monopolist will hoard water and hence create a further artificial scarcity which will lead to a further rise in the water price. Water being an essential commodity will not have its demand affected and thus will be sold at exorbitant prices. Profit is maximised at the point where Marginal Revenue is equal to the Marginal Cost. At this point we observe that the monopolist is producing quantity Q0 and charging a high price of P1. But the actual demand here is Q1, hence we see that a certain section of buyers are neglected. Water being a necessary good people will be willing to pay any price. Hence water hoarding might happen in the informal market. Existence of informal market will give rise to a black market for water which will lead to nothing but water inflation.
MC
MONOPOLY
P1
DD Qo Q1 MR’
9
5. Water traded in exchange
It is required that water be traded in a market characterized by large number of buyers and sellers. Since water is a homogeneous good, it can be traded at exchanges where there will be efficient price discovery of water. In the efficient markets price discovery occurs at the point of equilibrium i.e. where demand equals supply. A particular characteristic of the exchange is that transaction will occur only when the order and price of both sides i.e. buyers and sellers match. Unless that happens there will be no transactions. Thus exchange will provide buyers with the opportunity of buying water at the lowest rate and sellers the opportunity to sell it at a higher rate. The exchange will also be able to avoid counter party risk. Once orders are matched the exchange is liable to ensure that the good and cash exchange hands with no default from either side. Another advantage of trading water in an exchange would be the information available. Lack of asymmetric information will yield to efficient markets where buyers and sellers have full knowledge of the product and price. As we can observe from the diagram below equilibrium occurs at A where water supplied is W1 and price is P. Any deviation from the equilibrium price and quantity will bring the market back to point A, thus making it a stable equilibrium. Incase price is above P, there will be excess supply and in order to sell their good, sellers will start lowering the price until it reaches the equilibrium point again. For price below P, excess demand will push up the price till the market stabilizes again.
Excess Supply pushing the price down
Supply P1
Excess Demand pushing the price up Demand W1
10
5.1 Limitations
The vast majority of commercial trade exchanges are small local operations that average between a few hundred to a little over one thousand members. In most cases, the bulk of the member businesses offer services or “soft goods” rather than “hard goods” like manufactures and commodities. Further, trade exchanges have been limited by their almost exclusive focus on the retail level of business-to-business trading. While retailers and service providers are the most readily available client prospects, the greatest potential lies in connecting suppliers and customers throughout all levels of the supply chain. Although futures are an important tool in maintaining stable prices in the economy, the risks in these trades are also quite high, especially because of leverage. Investors must be very cautious when investing in futures because of the unpredictability and potential of huge losses. These risks are addressed to some extent by the various limitations and regulations that are imposed on futures trading. Only certain types of commodities can be the basis for futures trading. The shelf life, the price volatility and the state of the commodity (processed or unprocessed) determines whether it can be used in a futures contract. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they are traded on an exchange, commodities must also meet specified minimum standards, also known as a basis grade.
5.2 Government Intervention
To prevent a market failure, government intervention is required. Given the huge investments required for technological improvements and the installation of networks, a role of the government seems justified. Theoretically government intervention can be terms of taxes, subsidies and regulations. ? Subsidies: The government can provide subsidies to households and firms investing in water conservation techniques, e.g. a use of storage tank of 30l or above for households, a rain water reservoir for communities etc. ? Taxes: The government can tax industries and households on water usage, if the usage exceeds pre-specified volumes. The practical use of tax is often problematic. First of all, the damage that is caused by the excess demand of water is often not known or highly uncertain. For practical policy making, goals are often expressed in terms of volumetric reductions in demand which again poses problems in terms of
11
measurement of actual consumption. Another reason why the uses of taxes is often not advocated is because it is considered unfair especially amongst w income households who may start experiencing budgetary problems. ? Regulation/Technical Intervention: Government regulation is unavoidable given that the industry being a natural monopoly requires regulation to avoid the abuse of monopoly power. Secondly, health considerations require the imposition of high quality standards and effort aimed at controlling whether the standards are met. Thirdly regulation of the dumping of waste water by industries is needed. ? Water Credits: As seen in case of carbon credits, the government can also allocate credit points for low water consumption. These credits can be redeemed at the end of a period by the consumers for discounts or subsidies, or be used as a reserve against high consumption in future. However, the problem of measurement crops up yet again. ? Restricted Supply: The supply of water can be restricted to a specific number of hours in a day unless consumers are willing to pay for more. This is by far the most implementable measure. ? Distribution: Places which are located far away from sources of water are often supplied by transporting water by vehicles. The distribution is often carried out by informal players. The government can have a role in organizing this service and carrying it out more systematically,
6. Conclusion
Recent years have seen an upswing in the demand for investments that seek to profit from the need for fresh, clean water. If the trend continues, and by all indications it will, investors can expect to see a host of new investments that provide exposure to this precious commodity and to the firms that deliver it to the marketplace. There are currently numerous ways to add water exposure to your portfolio - most simply require a bit of research. Just as with any other investment in commodities or sector funds, wise investors should limit their exposure to water. Generally speaking, highly concentrated investments such as these should not represent more than 10% of the assets in a well-diversified portfolio. Limiting exposure to concentrated positions provides some opportunity to capture positive returns while limiting overall portfolio volatility.
12
doc_754638560.docx
Documentation describes explores the use of water of commodity.
Water as a next commodity
1
Table of Contents
1. Commodity .................................................................................................. 3 2. Water as a next commodity ......................................................................... 3 2.1 Long term drivers of water use ................................................................. 4 2.2 Current Scenario .................................................................................... 4
2.3 Indices where water is being traded ......................................................... 5 2.4 Urban Indian Water Scenario ................................................................ 5
2.5 Investment Opportunities ......................................................................... 6 3. Problems for water supply ........................................................................... 6 4. Water: The economic good.......................................................................... 7 4.1 Uses of Water ........................................................................................... 8 4.2 4.3 Demand & Supply of Water ................................................................... 8 Water as a Private Good ........................................................................ 9
5. Water traded in exchange ......................................................................... 10 5.1 Limitations .............................................................................................. 11 5.2 Government Intervention ....................................................................... 11 6. Conclusion ................................................................................................. 12
2
1. Commodity
A commodity is a good whose price is determined as a function of its demand and supply in a market. Well-established physical commodities have actively traded spot and derivative markets. Generally, these are basic resources and agricultural products such as iron ore, crude oil, coal, salt, sugar, coffee beans, soya beans, aluminium, gold, copper, rice, wheat, gold, silver, palladium and platinum. Soft commodities are goods that are grown, while hard commodities are the ones that are extracted through mining. A commodity is a physical substance, such as food, grains, and metals, which is interchangeable with another product of the same type, and which investors buy or sell, usually through futures contracts. The price of the commodity is subject to supply and demand. Risk is actually the reason exchange trading of the basic agricultural products began. For example, a farmer risks the cost of producing a product ready for market at sometime in the future because he doesn't know what the selling price will be.
2. Water as a next commodity
The importance of water as the most fundamental constituent of life needs no explanation. It will always remain a vital element for the survival of the human race. It is within as well as around us in seemingly abundant amounts. Nevertheless severe problems with its provision are as old as mankind. Like gold and oil, water is a commodity - and it happens to be rather scarce. There has recently been a historic increase in the public awareness of global water issues. Virtually every country in the world is faced with some combination of water quality and quantity issues that will require significant expenditures for their resolution. It is clear that not only human health but, also, environmental protection and economic development are critically dependent upon the efficient management of this increasingly scarce resource. The water industry is poised for considerable growth as convergent technologies and institutional changes combine to address the global demand for clean water. The provision of healthful drinking water has implications that span the entire spectrum of human existence. At the same time, the consumptive use of water cannot be disassociated from the planet’s ecological balance. Because the hydrologic cycle is, practically speaking, a closed system, the Earth’s biosphere contains all of the water that it will ever have. Its allocation, treatment, consumption and discharge, however, are subject to the institutions, practices and technologies that are put in place by mankind. Consequently, the economic value of water will play a major role in defining the future of water usage.
3
2.1 Long term drivers of water use
? ? ? ? ? ? ?
Population growth & urbanization Degradation of water supplies Resource sustainability Climate changes Geopolitical instability Aging water infrastructure Convergent Techniologies
2.2 Current Scenario
About 70% of the earth's surface is covered in water, but 97% of it is saltwater, which is unfit for human use. Saltwater cannot be used for drinking, crop irrigation or most industrial uses. Of the remaining 3% of the world's water resources, only about 1% is readily available for human consumption. Rapid industrialization and increasing agricultural use have contributed to worldwide water shortages. Pollution also highlights the need for clean water.
4
Global Water Supply
Unavailable Freshwater 2% Readily available Freshwater 1%
Saltwater 97%
2.3 Indices where water is being traded
Like any other scarcity, the water shortage creates investment opportunities. Some of the popular indexes designed to track various water-related investment opportunities are as follows:
?
Palisades Water Index - The Palisades Water Index is an unmanaged benchmark that many water indexes and ETFs track. This index was designed to track the performance of companies involved in the global water industry, including pump and filter manufacturers, water utilities and irrigation equipment manufacturers. Dow Jones U.S. Water Index ISE-B&S Water Index S&P 1500 Water Utilities Index
? ? ?
2.4 Urban Indian Water Scenario
The rate of urbanization in India is amongst the lowest, but the nation has more than 250 million city dwellers. By 2020 it is predicted that the 50% of India’s population will be living in the city which will put pressure on the already strained centralised water supply systems of urban areas. he urban water supply and sanitation sector in the country is suffering from inadequate levels of service, an increasing demand-supply gap, poor sanitary conditions and deteriorating financial and technical performance.
5
According to Central Public Health Engineering Organisation (CPHEEO) estimates 88 per cent of urban population has access to a potable water supply. But this supply is highly erratic and unreliable. Transmission and distribution networks are old and poorly maintained, and generally of a poor quality. Consequently physical losses are typically high, ranging from 25 to over 50 per cent. Low pressures and intermittent supplies allow back siphoning, which results in contamination of water in the distribution network. Water is typically available for only 2-8 hours a day in most Indian cities. The situation is even worse in summer when water is available only for a few minutes, sometimes not at all. In most cities, centralised water supply systems depend on surface water sources like rivers and lakes. Chennai, for instance, has to bring in water from a distance of 200 km whereas Bangalore gets its water from the Cauvery river, which is 95 km away. Where surface water sources fail to meet the rising demand, groundwater reserves are being tapped, often to unsustainable levels.
2.5 Investment Opportunities
Many companies are seeking a piece of the water market. In addition to direct stock purchases, some of the larger firms offer dividend reinvestment plans. Firms seeking to profit from water-related businesses include beverage providers, utilities, water treatment/purification firms and equipment makers, such as those that provide pumps, valves and desalination units. When it comes to bottled water, the market is growing internationally. On the desalination front, some 100 countries currently rely on desalination for at least part of their freshwater consumption needs.
3. Problems for water supply
Firstly, increased population led to an increased pressure on the limited amount of fresh water which constitutes only about 3% of the total water available in the world. Most water stems from seas and oceans and is saline. Technologies to desalinate this water are required to transfer this water into potable water. Up to now these technologies have been considered too costly. However the increased pressure on fresh water supplies may change desalination into an economically attractive option in the near future. Secondly, concentration of people in locations which over time were further and further removed from water sources resulted in a need for networks transporting water from source to user. Thirdly, industrialization and increased population have tremendously increased the pollution of water urging for cleaning and costly water treatment facilities.
6
Finally, the technological developments have in the 20th century resulted in a situation where in the industrialized world almost all houses are connected to the public water network resulting in a drastic increase in per capita water demand. Almost everywhere in the world, serious problems exist with supplying a sufficient amount of clean water whereas at several places there are also problems with the absolute amount of water available for consumptive use in at least particular cities.
4. Water: The economic good
The above developments have called for a good management of water resulting in a sustainable use of water, making water an economic good. The crucial characteristic of water from an economic point of view is that assignment of property rights is difficult which makes it non-excludable to a large extent. It is however, rival and is thus defined as a common-pool resource, meaning that there is a finite amount that must be shared in common over a variety of uses and all over geographic areas. The classical tragedy of commons arises since users are likely to ignore the effects of their actions on the pool when pursuing their self interests Renewal of water is both stochastic and seasonal implying uncertainty in its supply. This calls for investments in infrastructure that enable us to store and regulate the supply of water. Besides, water cannot be considered as a homogeneous good. There are all sorts of qualities, ranging from surface water to drinking water. This scarcity in water might lead in water being traded in the market as a normal good.
P P1 Po Do Q
D1
7
4.1 Uses of Water
The uses of water are many, from drinking and cleaning to irrigating crops and landscapes. Water is also used for recreational purpose, cooling and dust control. We can broadly categorize the use of water in three main categories as follows: ? For drinking – The human body depends on water anywhere in the range from 55% to 78% depending on body size. The body requires atleast 7 litres of water per day depending on the temperature, dehydration, humidity as well as other factors. Most of this is ingested through foods or beverages other than drinking straight water. It is not clear how much water intake is needed by the healthy people, though most advocates agrees that eight to ten glasses of water daily in the minimum to maintain proper hydration. Humans require water that does not contain too many impurities. Some solutes are acceptable and even describe for taste enhancement and to provide needed electrolytes. As a heat transfer fluid – Water and steam are used as heat transfer fluids in diverse heat exchange systems, due to its availability and high heat capacity, both as a coolant and for heating. In almost all electric power plants, water is the coolant, which vaporizes and drives steam turbines to drive generators. Water can also be used as a neutron moderator in the nuclear industry. Recreation – Humans use water for many recreational purposes, as well as for exercising and for sports. Some of these include living, boating, waterskiing, and swimming. In addition, some sports, such as ice skating and ice hockey are played on ice. Water parks, beaches and lakesides are popular places for people to g to relax and enjoy recreation. Many find the sound of flowing water to be calming, too. Some keep fish and other life in aquariums or ponds for show, companionship and fun. Humans also use water for snow sports like snowboarding or skiing, which requires the water to be frozen. People may also use water for play fighting such as with water balloons, water guns, and snow balls. They may also make fountains as well as use water in their public or private decorations.
?
?
4.2 Demand & Supply of Water
The key determinants of the demand for water are as follows: Water can be used for productive as well as consumptive purposes. Within these categories, subdivisions can be made between water intensive and water extensive producers, low and high income households and households with and without gardens etc One can look at its variability over regions, family types, housing characteristics, industrial composition and income. A substantial part of total water consumption is made up of residential use. Within the category of residential use there are important differences between single-family establishments and multi-family establishments (flats and apartments). Demand also varies with various qualities of water – a natural distinction is between water used for drinking washing and showering purposes (has to be of high quality), and water used for other activities such as gardening and flushing toilets (maybe of lesser quality).
8
4.3 Water as a Private Good
The activity of the water industry would consist of gathering, treating, transporting, storing and distributing water as well as collecting, transporting and treating waste water. A distinctive characteristic of this industry is that it is extremely capital intensive. Huge investments will have to be made in terms of building dams, developing and maintaining networks and factories built to collect and treat water. Thus the industry of water should likely be considered a natural monopoly. The required investments in especially the distribution networks are so large that it is unlikely that two firms each with their own network can profitably operate. The monopolists are only guided by the profit motive. Knowing that he is the only supplier in the market a monopolist will hoard water and hence create a further artificial scarcity which will lead to a further rise in the water price. Water being an essential commodity will not have its demand affected and thus will be sold at exorbitant prices. Profit is maximised at the point where Marginal Revenue is equal to the Marginal Cost. At this point we observe that the monopolist is producing quantity Q0 and charging a high price of P1. But the actual demand here is Q1, hence we see that a certain section of buyers are neglected. Water being a necessary good people will be willing to pay any price. Hence water hoarding might happen in the informal market. Existence of informal market will give rise to a black market for water which will lead to nothing but water inflation.
MC
MONOPOLY
P1
DD Qo Q1 MR’
9
5. Water traded in exchange
It is required that water be traded in a market characterized by large number of buyers and sellers. Since water is a homogeneous good, it can be traded at exchanges where there will be efficient price discovery of water. In the efficient markets price discovery occurs at the point of equilibrium i.e. where demand equals supply. A particular characteristic of the exchange is that transaction will occur only when the order and price of both sides i.e. buyers and sellers match. Unless that happens there will be no transactions. Thus exchange will provide buyers with the opportunity of buying water at the lowest rate and sellers the opportunity to sell it at a higher rate. The exchange will also be able to avoid counter party risk. Once orders are matched the exchange is liable to ensure that the good and cash exchange hands with no default from either side. Another advantage of trading water in an exchange would be the information available. Lack of asymmetric information will yield to efficient markets where buyers and sellers have full knowledge of the product and price. As we can observe from the diagram below equilibrium occurs at A where water supplied is W1 and price is P. Any deviation from the equilibrium price and quantity will bring the market back to point A, thus making it a stable equilibrium. Incase price is above P, there will be excess supply and in order to sell their good, sellers will start lowering the price until it reaches the equilibrium point again. For price below P, excess demand will push up the price till the market stabilizes again.
Excess Supply pushing the price down
Supply P1
Excess Demand pushing the price up Demand W1
10
5.1 Limitations
The vast majority of commercial trade exchanges are small local operations that average between a few hundred to a little over one thousand members. In most cases, the bulk of the member businesses offer services or “soft goods” rather than “hard goods” like manufactures and commodities. Further, trade exchanges have been limited by their almost exclusive focus on the retail level of business-to-business trading. While retailers and service providers are the most readily available client prospects, the greatest potential lies in connecting suppliers and customers throughout all levels of the supply chain. Although futures are an important tool in maintaining stable prices in the economy, the risks in these trades are also quite high, especially because of leverage. Investors must be very cautious when investing in futures because of the unpredictability and potential of huge losses. These risks are addressed to some extent by the various limitations and regulations that are imposed on futures trading. Only certain types of commodities can be the basis for futures trading. The shelf life, the price volatility and the state of the commodity (processed or unprocessed) determines whether it can be used in a futures contract. The quality of a given commodity may differ slightly, but it is essentially uniform across producers. When they are traded on an exchange, commodities must also meet specified minimum standards, also known as a basis grade.
5.2 Government Intervention
To prevent a market failure, government intervention is required. Given the huge investments required for technological improvements and the installation of networks, a role of the government seems justified. Theoretically government intervention can be terms of taxes, subsidies and regulations. ? Subsidies: The government can provide subsidies to households and firms investing in water conservation techniques, e.g. a use of storage tank of 30l or above for households, a rain water reservoir for communities etc. ? Taxes: The government can tax industries and households on water usage, if the usage exceeds pre-specified volumes. The practical use of tax is often problematic. First of all, the damage that is caused by the excess demand of water is often not known or highly uncertain. For practical policy making, goals are often expressed in terms of volumetric reductions in demand which again poses problems in terms of
11
measurement of actual consumption. Another reason why the uses of taxes is often not advocated is because it is considered unfair especially amongst w income households who may start experiencing budgetary problems. ? Regulation/Technical Intervention: Government regulation is unavoidable given that the industry being a natural monopoly requires regulation to avoid the abuse of monopoly power. Secondly, health considerations require the imposition of high quality standards and effort aimed at controlling whether the standards are met. Thirdly regulation of the dumping of waste water by industries is needed. ? Water Credits: As seen in case of carbon credits, the government can also allocate credit points for low water consumption. These credits can be redeemed at the end of a period by the consumers for discounts or subsidies, or be used as a reserve against high consumption in future. However, the problem of measurement crops up yet again. ? Restricted Supply: The supply of water can be restricted to a specific number of hours in a day unless consumers are willing to pay for more. This is by far the most implementable measure. ? Distribution: Places which are located far away from sources of water are often supplied by transporting water by vehicles. The distribution is often carried out by informal players. The government can have a role in organizing this service and carrying it out more systematically,
6. Conclusion
Recent years have seen an upswing in the demand for investments that seek to profit from the need for fresh, clean water. If the trend continues, and by all indications it will, investors can expect to see a host of new investments that provide exposure to this precious commodity and to the firms that deliver it to the marketplace. There are currently numerous ways to add water exposure to your portfolio - most simply require a bit of research. Just as with any other investment in commodities or sector funds, wise investors should limit their exposure to water. Generally speaking, highly concentrated investments such as these should not represent more than 10% of the assets in a well-diversified portfolio. Limiting exposure to concentrated positions provides some opportunity to capture positive returns while limiting overall portfolio volatility.
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