Written by HardAssetsInvestor.com
Sunday, 04 November 2007 19:07
We all need water to live. As useful as oil, copper and corn may be, we could get by without them for a while. But water? Water is a necessity. And for some, this makes it the ultimate commodity.
People invest in commodities for a lot of reasons: for diversification; as a way to play growth in the developing world; because they think demand growth will outstrip supply.
By those metrics, water may be the ultimate commodity investment. Demand for water is steady and never-ending, meaning water investments should not be correlated with broader economic developments. Meanwhile, history shows that as economies develop, citizens will demand more and more water to support richer lifestyles, making water an interesting play on countries like China and India. And finally, the world is in a silent water crisis, with rising demand set against limited supply; a classic commodities squeeze.
Water Crisis
The world currently faces a water crisis of both supply and demand.
We're taught to think that there's plenty of water: 75% of the earth's surface is covered with it. The problem is, most of that water is useless: 97% is seawater, 2.5% is frozen in the ice caps, and just 0.5% is fresh and available for use. Worse, much of what remains is contaminated, polluted or otherwise degraded, and not fit for consumption.
On the demand side, water needs are growing ... fast. The world's population growth provides an underlying pressure on demand, while growth in the developing world accelerates that demand curve dramatically.
Meeting this global crisis from a fixed supply will involve massive expenditure, and it will be the companies that clean, support, supply, reuse and save water that will benefit from this flow of capital.
Supply
As if the problem of a fixed supply were not enough, there are three further major supply problems affecting the world's water situation.
First, the distribution of existing water resources around the world is horribly uneven: 60% of the world's fresh water is located in just nine countries. And unlike many commodities, water isn't portable; it simply doesn't make economic sense to transport water from (say) Canada to (say) China; water, even if its value rises tenfold, is simply too voluminous.
Second, where water is actually available, it is often not available in a suitable form. It may, for instance, be either too hot or too old, or, perhaps, too dirty or too salty. Increasingly, it's also too polluted; in the U.S., the gasoline additive MTBE has rendered a significant percentage of wells unfit for human consumption.
Third, in developed countries, where water is generally available as needed, the infrastructure supplying it is old and decaying. Estimates of how much a country like the U.S. must spend upgrading its water infrastructure over the next 20 years measure in the billion.
Demand
Population growth and economic growth are the two biggest drivers of demand. On the one hand, as population numbers increase, so does the demand for potable water. On the other, as economies grow, so does the demand for water for use in both agriculture and industry: the richer people get, the higher they live on the water food chain. The U.S., for instance, is the world leader in water consumption per capita, largely because we live such a rich, luxurious lifestyle.
Water: The Business Activities
While the case for investing in water, as a theme, is compelling, the question remains of how actually to go about making such an investment.
Unfortunately, unlike many other strategic commodities, water is not yet traded on any exchange. Indirect investment, therefore, remains the only option available to investors; that is, investment in those companies in a position to provide solutions to the water crisis. Estimated by some already to be worth $450 billion a year[1], the water and water treatment industry is predicted to grow to some $650 billion in the next 20 years.[2]
The current major investment options are:
Utilities
The job of water utilities is to deliver the actual water to the consumer. Most water in the world is delivered through utilities.
In the U.S., there are a number of large such companies, for example California Water Services Group (NYSE: CWT) and Aqua America (NYSE: WTR), and myriad small ones. Continued consolidation and rising water values are the key to profits in these markets.
Historically speaking, water utilities have provided consistently strong returns, and these companies remain respected as steady, low P/E and high-yield stocks.
In addition to the current crisis, the further privatization of public water utilities globally will also offer established utilities the opportunity for water utilities to grow their businesses.
Water Treatment
The greatest innovations in the water industry are to be found in the field of water treatment. The three most important technologies are:
Wastewater treatment (whether industrial or domestic) - a market worth more than $200 billion a year - with such players as the French companies Veolia and Suez and the U.S.-based NALCO.
Filtration and chemical treatment, with pure-plays like Calgon Carbon and the involvement of such large entities as ITT and General Electric.
Desalination, an arena in which, again, General Electric plays, together with others such as Dow Chemical and Singapore's Hyflux.
Each of these sectors has a key role to play in solving the water crisis, and each will benefit from efforts to solve the crisis.
Infrastructure
Currently a $50 billion sector, infrastructure companies make their business from making and supplying equipment - for example, valves, pumps and pipes - and servicing the water utilities - for example, digging wells and irrigation canals. In addition, there are companies that both make and supply the systems to actually monitor, measure and meter water use ... increasingly important as the value of water grows.
Once again ITT and General Electric are to be found in this space, but so, too, are a number of smaller specialized companies based both in the U.S. and Europe, such as Badger Meter - a leading provider of residential water meters.
Investing In Water
Companies active in the business of water can be categorized not only by activity, but also by their structure.
The behavior of the small, specialized, often technology-based, companies can be akin to that of any other technology stocks. In contrast, companies like Suez and Veolia are essentially just huge utilities, and behave according. Finally, large conglomerates like General Electric are also major players in the market.
Although there has been considerable consolidation, across its breadth the industry remains highly fragmented, with some very large players and a slew of mid-size and smaller players. As a result, and with the large role that conglomerates play, developing a coherent water-themed investment strategy is challenging.
There are now, however, several water-sector tracking indexes available to help address just this issue: the ISE Water Index (HHO), the Palisades Water Indices (PIIWI and ZWI) and the S&P Global Water Index (SPGTAQUA). Backtested data on each of these stocks shows water has been a strong-performing theme already; moreover, water stocks have had only a weak correlation to the S&P 500, and have been negatively correlated with other commodities, making them a strong diversification option for new portfolios.
These indexes are currently ‘investable' through four different exchange-traded funds, or ETFs: First Trust ISE Water (FIW), Powershares Global Water (PIO), Powershares Water Resources (PHO) and Claymore S&P Global Water (CGW).
Conclusion
Water is the most important commodity in the world, and it is a commodity ‘in crisis.' As the world's population grows, and as the emerging markets develop, ever more water is needed and commensurately less is readily available. For companies that find, extract, clean, supply, reuse and save water, business opportunities are, therefore, set only to multiply. Consequently, for investors, water as a theme, commodity and a sector provides a unique and exciting investment opportunity.
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[1] "The Global Water Market: A Slow Business With Pockets of Action." Global Water Intelligence. Issue 10, Oct 2007. 30 Sept 2007
[2] Water and Waste Water Markets Worldwide Increase to Over 650 Billion US $ by 2025. More High Tech. Helmut Kaiser Consultancy. 12 Jul 2007. 30 Sept 2007 http://www.prlog.org/10023705-water-and-waste-water-markets-worldwide-increase-to-over-650-billion-us-by-2025-more-high-tech.html
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