With populations expanding and dietary requirements becoming more water-intensive, water is an ever-more valuable resource, and a rich source of profits, says John Stepek.
“Thirsty foreigners soak up scarce water rights,” screamed a headline in the Australian broadsheet, the Sydney Morning Herald, earlier this month. “International investors are circling Australia’s water market, looking to snap up hundreds of millions of dollars worth of our most precious national resource.”
Australia has the world’s most developed water market. It was designed to encourage the irrigation industry (the biggest user of freshwater in Australia) to allocate water more efficiently.
Water rights (in the form of either annual allocations or permanent rights) are traded separately to the underlying land. So farmers and other users who can make better use of the water can buy it from those who have a surplus. The whole market is worth around A$30bn ($27bn). In 2007/2008, the total value of trades came in at A$1.6bn ($1.4bn). In 2008/2009, trade rose to A$2.8bn ($2.5bn).
The ability to sell water rights has helped marginal farmers to survive Australia’s recent long years of drought, while the government also inflated the market by wading in to buy back water rights for conservation purposes. According to the Herald’s Deborah Snow and Debra Jopson, ten years ago, “rural water was worth as little as $2 a megalitre [a million litres]”. Yet last year peak prices ranged from $1,300 to $2,400 per megalitre. For many farmers, their “water was worth more than their land”.
But what’s now worrying some is the news that Melbourne-based Causeway Asset Management is trying to raise $100m from foreign investors to buy permanent water rights in the all-important Murray-Darling Basin in New South Wales. It’s the latest in a line of investors, rather than farmers, to buy into the water market. The spectre of foreign agribusinesses dictating what farmers are allowed to grow and where has been raised by some pressure groups.
A priceless commodity
It’s easy to see why people don’t like the idea of commoditising water. No one frets about foreigners drilling for North Sea oil. But water isn’t like any other natural resource. It’s vital to life, and there’s no substitute for it, at any price. However, whether or not the Australian model is the best way to do it, it makes sense to try to put a price on water that better reflects its scarcity.
You probably already know the statistics. The global supply of fresh water is essentially fixed. Of all the water on the planet, 97% is salty. Of the 3% of fresh water, more than two-thirds is locked up in the form of glaciers and permafrost. And of the remainder, most is underground in aquifers and the like. Only a tiny portion of the overall water on Earth is easily accessible in rivers and lakes for us to use (see the diagram below).
So on the one hand you have a static supply. And on the other, demand is growing. In the past 60 years, the global population has more than doubled, along with the area of the world under irrigation. This in turn has seen the amount of water drawn for farming triple. Already around 1.1 billion people don’t have access to fresh drinking water. And more than two billion have no access to adequate sanitation.
Even if the world’s population was to remain static from here on, demand for water would still grow. Why? Because as people get wealthier, their diets become more water-intensive.
Very roughly speaking, a meat-eater’s diet requires about 5,000 litres of water a day to produce, while a vegetarian can live on the equivalent of around 2,000 litres of water a day. That’s because it takes a lot more water to raise and feed a cow that ends up as a steak, than it takes to grow a bowl of rice, for example. Incidentally, this is one reason why a global water market could be useful – it would encourage the production and export of water-intensive goods in the countries with the most surplus water, leaving water-poor countries to focus on more efficient uses of their water.
As it stands, populations in more arid parts of the world are already draining underground aquifers more rapidly than they can replenish. And it’s not just in developing countries such as India. In the US, the Ogallala Aquifer, which stretches across eight states and provides nearly a third of the groundwater used for irrigation in the US, is being depleted.
This is before you even start talking about pollution or climate change (which is expected to cause longer droughts and more regular flooding as a result of more extreme weather conditions). Most people have heard of industrial pollution damaging waterways in China. But fewer perhaps realise that more than 40% of rivers and lakes in the US are considered dangerously polluted.
As Hugo Rogers of the Thames River Water and Agriculture Absolute Return Fund puts it: “Trading water rights is difficult. But to get the appropriate amount of investment to deliver the required volumes of water to people, the price of water has to rise and mechanisms that reveal the price of water are all good. I’m not suggesting you turn people’s water off, but if people understand the true value of water it will be used more efficiently and people will take it for granted less.” But given that a global market in water is unlikely to materialise in the near future, how can we make better use of our water in the meantime?
Desalination – no silver bullet
The coastal city of Chennai in southern India – a car manufacturing hub dubbed the “Detroit of India” – is a microcosm of the water issues facing the entire globe. In the 1950s, reports the FT, Chennai’s water demand clocked in at about 237 million litres a day. Since then, the population has soared from 1.5 million to more than six million in 2005. Water demand is now around one billion litres a day. “While water supplies have improved, there is not enough water to satisfy even half the demand,” says the FT.
The solution? Desalination. In July, the city’s first desalination plant came on line. It adds 100 million litres a day to the city’s drinking water supply. A second plant is set to start up next December. There’s lots of room for expansion across India. No Indian city has a 24-hour water supply as yet, and Mumbai is already planning its own 100-million-litre-a-day plant.
There’s just one problem: desalination is expensive. The process uses a lot of energy, while cleaning up the briny waste left behind is also a major challenge. While corporations are willing and able to pay for desalinated water to provide their needs (Reliance Industries’ Jamnagar oil refinery has the world’s biggest desalination plant, churning out 160 millon litres a day), generating water for consumers is a different matter. There’s a huge gap between what customers pay the water utilities, and what the utilities have to pay for the desalinated water. Putting up the prices that consumers have to pay for water is one solution of course, but it’s not a vote winner.
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It’s this cost issue that explains why desalination is not yet a “silver bullet” solution to our water woes. Even in a water-poor, energy-rich country such as Saudi Arabia, which is expected to be the biggest global market for desalination over the next three years (according to Global Water Intelligence), only 5.5% of the water supply comes from desalination – the vast majority comes from non-renewable groundwater. A breakthrough in renewable energy would help to reduce the costs. As Clare Brook of socially responsible investment group WHEB says, “combine desalination with solar power and for places like Northern Australia and the Middle East it suddenly becomes a far more interesting opportunity”. But for now, as The Economist puts it, “people go for desalination when they have few other options and are able to bear the costs”.
That’s partly why investment in desalination has fallen in recent years, following a spike in 2007. But spending in the sector is recovering and is expected to return to 2007 levels by next year. And evolving technology means there are ways to make the process more cost-effective by reducing the amount of energy used and working on ways to deal with waste. We take a look at some promising stocks in the sector below.
Fixing our leaky pipes
If we can’t easily create more water, then the other solution left to us is to make better use of what we do have. About 40% of the water used in Singapore never goes back into the ‘wild’ – it’s recycled straight back into the domestic water supply. Singapore has good reason to be careful with its water – it imports around 40% of its water from Malaysia, which makes for an uncomfortable dependence on its neighbour. But it shows what can be done in terms of water efficiency.
Metering water supplies and charging per unit is one way to encourage conservation among consumers. Big corporations are increasingly trying to save water too, partly for cost reasons and partly for fear of PR disasters. Néstle has cut its water withdrawals by a third since 2000, even as the volume of food and drink it makes has risen by 60%. Coca-Cola aims to cut its usage by 20% by 2012.
Improving the quality of water infrastructure is also an important area. There’s a demand for infrastructure, such as pumps and valves and pipes, in countries where basic sanitary and water supply systems are still being built. But even in developed countries, around 20% of the water produced never actually reaches the end-user because of leaks in the pipes. Sure, some of it returns to the system eventually as groundwater. But it’s hardly an efficient means of recycling. So investing in the companies that will be fitting and fixing these leaky pipes, and installing pumps and water control systems, is another good way to get exposure to the water market.
And on a global basis, agriculture is where the biggest gains stand to be made. Farming accounts for 70% of global water usage (with industry on 22% and domestic use on 8%). Improving efficiency in the field starts with better irrigation systems. ‘Drip’ irrigation, for example, basically involves watering the soil right next to the plants, rather than simply spraying a wide area. This means you lose far less water to evaporation. And more high-tech applications involve measuring evaporation in individual fields, which can help farmers work out the most efficient places and times to grow their crops. We look at how to invest in these areas below.
The best ways into the sector
Water utilities are one obvious way to play the water market. And yields on UK-listed utilities are still reasonable, certainly compared to bonds. However, we’ve tipped several of them in the past year, and if you’ve bought in, you’re probably sitting on some decent gains. As my colleague David Stevenson noted in our free daily email Money Morning, waste manager Pennon and utilities Severn Trent and Northumbrian Water have all risen sharply.
Of them all, Northumbrian Water (LSE: NWG) remains the best value, on a p/e of 13.4 and a 4.2% yield, but if you bought it when we tipped it back in June, we’d lock in the 20%-odd profit you’ll have made by now. And avoid French water utilities, warns Thames River fund manager Hugo Rogers. “They’ve got too much debt and they are empire builders. They are some of the cheapest stocks on an earnings basis, but if you look at their balance sheet you know why.”
A better bet on the infrastructure side of water supply, is Pentair (NYSE: PNR), says Rogers. This industrial group provides everything from water filtration to pumps and valves. It’s on a p/e of 15.9 for 2011, and pays a dividend yield of 2.5%.
And sticking with infrastructure, another good bet, says Clare Brook of WHEB, is InSituForm (Nasdaq: INSU). The company is in the business of rehabilitating mining, sewer, water, and energy piping systems. In effect, InSituForm is able to reline pipes without having to dig the whole thing up – instead they can “shoot a sleeve down within the pipe”. The 2011 p/e is around 12 and the PEG ratio is just 0.55.
As for the developing world, “a huge amount of rural China is as yet unserved by clean water supplies”, says Brook. Singapore-listed Sound Global (SP: SGL) provides water and waste-treatment solutions in China, and trades on a forward p/e of 14.3.
In the water-metering business, both Rogers and Brook like Badger Meter (NYSE: BMI). The US-listed stock trades on a p/e of 22 times this year, falling to 19 in 2011. It specialises in smart meters – these transmit usage data electronically, which saves on sending out staff to read a customer’s meter manually.
It’s not cheap by any means, but as the purest play in the sector, there’s the possibility that a bigger rival might decide to snap it up. Another candidate – although less of a pure play – is Itron (Nasdaq: ITRI). The company is also involved in smart metering for energy providers and trades on a 2011 p/e of 14.5.
On desalination, Rogers likes Energy Recovery (Nasdaq: ERII). An increasingly dominant method of desalination is reverse osmosis (RO). In simple terms, this involves squirting water at high pressure through a filter. When the waste water comes out, it is still under a lot of pressure. Energy recovery involves using this highly pressurised water to turn a piston, then using the energy generated to feedback into the desalination process, reducing the amount of energy used and wasted in the process.
Given that there are so many sectors that touch on the water theme, you may prefer to invest in a fund. On the unit trust side, there’s the Thames River Water and Agriculture Absolute Return Fund run by Rogers and Kristof Bulkai. As the name suggests, the fund invests in both water and food-related themes (as water scarcity, of course, has a big impact on the food chain too). You can get hold of the fund via Hargreaves Landsdown, which will save you the initial 5% fee. However, there’s still a hefty annual fee of 1.75% to pay, with a potential 10% performance fee on top.
If you don’t like the idea of paying those fees (and we don’t blame you), then there are a number of exchange-traded funds (ETFs) to consider. The largest in the sector is the PowerShares Water Resources ETF (NYSE: PHO), which tracks the Palisades Water Index. This American-focused index aims to track companies that focus on water provision, treatment, and technology and services directly related to water consumption. The annual expense ratio is 0.6%. Its top ten holdings include irrigation giant Lindsay Corp, the aforementioned Badger Meter, and infrastructure group URS.
Another option is the Claymore S&P Global Water Index Fund (NYSE: CGW). This has a more global focus, tracking the S&P Global Water index, which is made up of around 50 water-related stocks chosen from around the world’s developed markets. The annual expense ratio is around 0.7%. As well as a number of British water utilities, its top ten holdings include Japanese waste treatment group Kurita and Swiss pipe manufacturer Geberit.
• This article was originally published in MoneyWeek magazine issue number 503 on 10 September 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don’t miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now
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