4 Reasons Investing in Water is Smart

Although it doesn’t produce the constant headlines like other commodities these days, water (NYSE:PHO) is irrefutably the most essential natural resource to human survival. A basic comparison of an individual’s nominal monthly water bill and the relatively low per unit rates versus their electric bill suggests on the surface that the fresh water supply is well beyond that of the aggregate world demand. However, available fresh water is less than ½ of 1% of all of the water on Earth and various trends are constantly driving the supply of fresh water lower and the demand for fresh water higher at increasing rates. There will be significant worldwide implications as water scarcity issues become both more frequent and widespread.

Demand Forces

At its core, water demand growth stems from general population growth. Water is so essential that demand is largely unaffected by recession, changing preferences, interest rates, or inflation. There are now 6.5 billion people in the world with that total expected to reach 8 billion over the next 15 years. All things being equal, this would drive annual water consumption growth of roughly 1-2%/year. However, over the past century, water use has quintupled although the population only doubled. Per-capita water use increases have been driven in part by growth in emerging markets that has increased the availability of drinking water via infrastructure. More modernized nations use drastically more water with the U.S. and Europe leading the way at 200-600 liters per day/citizen vs. 50 liters per day for the average world citizen and 20 liters per day in emerging markets. China, in particular, has 20% of the world’s population and as they continue to grow rapidly and modernize their infrastructure, per capita water usage will grow exponentially, having a significant impact on world water demand. An indirect source of demand for water comes from an increasing rate of protein consumption growth in emerging economies in general. This has had the effect of increasing demand for agricultural products including wheat, corn, soy etc. Agriculture accounts for 70% of all freshwater use globally, and the amount of water required for the irrigation of crops to keep pace with global food demand is expected to triple by 2025. Major food producing areas of the world including the Southwest U.S., the Punjab region in India, the Murray Darling Basin in Australia, and much of China have already seen drought conditions from unsustainable water mining above replacement rates in their rivers, lakes and aquifers.

Supply Issues

As demand for fresh water grows, the overall supply is moving in an inverse manner. Desalination is one process by which we can increase the relative supply of fresh water, but the current inefficient technology allows only 1% of fresh water to come from this source annually. At the same time, various forces have converged to reduce the overall supply of fresh water in the aggregate. The main culprits are disease and pollution. At the current pace of pollution, the world would lose 18,000 cubic kilometers of water by 2050, nine years’ worth of the world’s current irrigation water demand. 2.6 billion people do not have adequate water sanitation facilities, a number that will increase without heavy investment in water infrastructure. One of the largest contributors to infant deaths in developing nations is exposure to water-borne illnesses and this is likely to grow along with populations. Groundwater is the primary source of freshwater for most of the world and 80% of the population is exposed to supplies that have been dangerously depleted. Developing countries lag in their water efficiency which has a drag on overall supplies. China, for instance, recycles only 25% of its urban and industrial water while more developed nations such as the U.S. have infrastructure in place to recycle about 85%.

Implications in Developed Economies

Given the supply and demand forces discussed, water rate appreciation seems likely over the next decade creating potential investment opportunities. Simply put, as water becomes a more valuable commodity, providers will increase investments aimed at protecting their supply and driving efficiencies to maintain their margins. Major beneficiaries should be providers of more advanced water infrastructure products including pumps, pipes, and valves, filtration systems, testing equipment and instrumentation providers. Also, engineering and construction firms and service and maintenance companies should see incremental demand from the water industry. Developed regions such as the U.S. and European Union have aged, crumbling infrastructure, some of which is over 100 years old. The U.S. alone has over 700,000 miles of water pipes that are seeing increasing instances of failure that results in loss of water and significant replacement and cleanup costs. The quickest way for developed countries to stem fresh water decline rates is to insulate themselves from losses of current supply due to pipe breakage and pollution worries. In response, key legislation in the U.S., including the Clean Water Act and Safe Drinking Water Act, and other countries are driving much tougher industry regulation that should propel investments in the infrastructure.

Emerging Market Investment

Furthermore, emerging markets still require substantial investment in water infrastructure to increase freshwater availability and to prevent pollution/sanitation issues from ruining precious supplies. Many countries in Africa and the Middle East are just beginning to develop modern water networks which should drive demand for infrastructure products. Furthermore, increasing demand for food and the need for more arable acres worldwide should drive adoption of higher-efficiency irrigation systems in developing countries including Russia, India, and China. China will be an intriguing story to watch unfold from a water perspective given massive population and huge increase in per capita demand expected over the next decade. More than 65% of Chinese cities currently suffer from domestic water shortage, and overall Chinese water demand is expected to outstrip domestic demand by nearly 25% by 2030. A major issue there is the fact that 21% of China’s fresh water is currently unusable due to pollution, stemming primarily from increasing industrial use without subsequent acceptable water treatment. As noted above, industrial water recycling in China and other emerging markets severely lags that of the developed nations and represents a large supply-based improvement opportunity.

Conclusion

Water scarcity is slowly becoming an important geopolitical issue, highlighted by the increased exposure in the press as well as increased regulations by both developed and developing nations to improve their domestic water efficiency, capacity, and delivery networks. Demand will continue to increase at significant rates while desalination and near-term efficiencies are unlikely to make up for the drags on the world’s freshwater supplies. Therefore, low per-unit rates for water are likely to go higher and incidences of water shortages and droughts in both developed and emerging nations are likely to become more frequent. Given the essential nature of water to human life, significant measures must be taken to ensure water availability over the next few decades and it will likely be the catalyst for not only significant investment but possibly international and intra-national conflicts as well.

Kent Croft is the President of Croft-Leominster and CIO of the Croft Funds. Russell Croft is the Vice President of Croft-Leominster and Portfolio Manager of the Croft Funds.

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To contact the editor responsible for this story: Damien Hoffman at editors@wallstcheatsheet.com