Markets: Turn on the Tap
New York: May 14, 2007
By John R. Stephenson

Your next great investment idea could come to you when you are washing dishes. Yes, water is in a massive bull market with US-based water companies outperforming the S&P 500 by a three to one margin over the last three years. Internationally, the story is much the same as global water indices have outperformed their North American peers and the broader markets respectively. Best yet, the water business is much less volatile than most other industries, meaning that it is hardly impacted by economic cycles.

The supply of fresh water is no larger today than it was at the dawn of mankind. While the world is covered in water, much of it is seawater leaving only 0.1% of the world's water supply readily accessible to people. The growth in water demand is truly staggering with demand surging each year by roughly 65 billion cubic meters (the annual flow rate of the Rhine River) and global demand is doubling every twenty years (twice the rate of population growth).

Figure 1: The Global Supply of Water

Water utilization rates have doubled in the last 45 years creating a situation where the global excess supply of water has tumbled dramatically during the same period of time. While the world is not running out of water, its supply is not evenly distributed around the world with nine countries possessing 60% of the world's available freshwater. Many people around the world live under conditions of high water stress (a water supply of less than 1,700 cubic meters/yr versus the US at 9,600 cubic meters/yr). Even in developed countries such as the United States, many regions of the country (e.g. southwestern US) are forced to import water from other parts of the country.

Figure 2: Falling Excess Water Supplies

For the developing world, the situation will only worsen over the coming years as climate change, urbanization and rapid population growth conspire to further tax strained water systems. In China, some 440 cities out of 669 have already experienced water shortages. The fact that globalization is highly water intensive is only partly to blame for China's water shortages, with part of the blame arising because of huge inefficiencies in the use of water in China. The amount of water that China uses to produce a ton of steel is seven times the amount used to make steel in the United States.

In the developed world, the story is one of crumbling water infrastructure. Many of America's water systems were built during the Lincoln administration and in some major cities, more than half of the water intended for delivery to consumers is lost en route. As well, it is estimated that one-fifth of America's municipal wastewater facilities do not comply with federal regulations. The price tag for North America and Europe to update their crumbling water infrastructure is estimated in the hundreds of billions of dollars. Yet, federal governments are already cash strapped at a time when, increasingly, the demands of an aging population are getting ready to more fully tax an already over-burdened health care sector.

Governments may have little if any choice but to turn to the private sector for help in creating the necessary water infrastructure assets. But water is not priced like an ordinary commodity, which makes it somewhat difficult to attract private industry into the water business absent the proper price signals. Today, water's pricing is still controlled by politicians rather than a normally functioning marketplace. All of this is beginning to change with water markets starting to spring up in the western US (Colorado, California, Utah and Nevada) where hundreds of thousands of acre-feet of water rights are traded each year through a private over-the-counter market.

In order to attract the private sector, municipalities are allowing private industry to get a full recovery of costs for investments that they make in water infrastructure. In many places around the globe, water prices are rising faster than the overall rate of inflation. The World Bank estimates that outsourcing and privatization in the water sector is set to double in the coming five years to a nearly 40% share of the overall market.

Figure 3: US Water Index Outperformed the S&P 500

While the performance of the American water companies have been impressive, they pale in comparison with the returns of both Asian and European water companies. While water is a local problem, the solution is very often global in nature. American companies account for only 36% of the total market capitalization of the global water industry while European companies by contrast account for half. Companies specializing in solutions such as pumps, valves and pipes, wastewater treatment and quality testing have been the standout performers of the water industry of late.

Figure 4: Water, A Global Business

Next time you are taking a shower, consider making an investment in the water business. Unrelenting global demand, coupled with waning excess supplies and uneven distribution of available fresh water, has created strong positive fundamentals for the water business. Water investing is truly global in nature, with a breadth of scope and considerably less volatile than many other investment sectors. For our money, water makes sense.