By Stephen J. Hoffmann
Water Investment Newsletter
The New Year is likely to be remembered as a watershed year for water. Never before has such an awareness of global water issues translated into investment opportunity.
For the year 2005, the Dow Jones Industrial Average Index (DJI) was virtually flat, posting a 0.61% decline for the year. The S&P 500 Index (GSPC) gained 3%, the Nasdaq Composite Index (IXIC) gained 1.37%, and the Palisades Water Index (ZWI) gained 8.48%.
Water stocks as a composite clearly outperformed the general market. The headlines were replete with warnings. Water was characterized as 'blue gold', 'the next oil crisis', and the subject of 'water wars.' As they say, past performance is no guarantee of future performance. But all indications are that water will be an attractive investment theme in the coming year as well.
Already in 2006, the Palisades Water Index is outperforming all but the technology- laden Nasadaq, with a meteoric 4.76% rise in only the first few weeks of the New Year.
Despite the sensationalism of headlines, it is instructive to understand the factors behind the burgeoning demand for clean water and the reasons for scarcity of supply. The drivers of the water market can be summarized as follows:
(1) Population growth; globalization/urbanization
(2) Degradation of water supplies
(3) Resource sustainability and climate change
(4) Geopolitical instability
(5) Regulation and institutional change
(6) Aging water infrastructure
(7) Convergent and enabling technologies.
Population growth is a fundamental driver of the global demand for potable water. But the simplicity of this direct relationship does not do justice to the underlying factors that are fundamental to the prospects for the industry. In particular, the divergence between population growth in the developed countries versus the developing countries has a major impact on the water industry.
The World Health Organization reports that 1.1 billion people worldwide lack safe drinking water and 2.6 billion people lack basic sanitation needs. Most over-populated and crowded cities throughout the developing world simply cannot afford to use the highly centralized water and wastewater technology systems that are available.
Besides the initial capital investment, these large centralized systems are beyond the reach of much of the world's population because of high-energy consumption and high maintenance regimes. The water situation in developing countries has an enormous impact on their economic development - more than 2.2 million people in developing countries, most of them children, die each year from diseases associated with lack of access to safe drinking water, inadequate sanitation and poor hygiene.
It is estimated that over 10 million person-years are spent by women and female children carrying water from distant sources every year - and half of all hospital beds in the world are filled with people suffering from water-related diseases such as malaria, diarrhea and trachoma.
In short, national economies are weakened by the need to spend significant funds on health care and medicines, while many working days are lost to ill health resulting from poor water and inadequate sanitation.
The degradation of water supplies is also a major driver for the water industry, particularly in the treatment sector. In the U.S. there are widespread concerns about arsenic, perchlorates and MTBE to name a few contaminants.
And recent events in China point out the enormous needs for treatment in developing countries. The pollution in Xiangjiang River by cadmium from a smeltering plant and a diesel oil spill on the Yellow River threatened the drinking water supply of millions of people. There is little question that water and wastewater treatment is a global concern and that this sector is likely to experience above-average growth prospects.
Resource sustainability and climate change are also drivers for the water industry. Resource sustainability refers to the notion that integrated and comprehensive solutions are required to ensure that water usage coincides with measures to effectively manage water resources today for the benefit of future generations. Water resource management is perhaps the greatest single challenge faced by the industry in addressing global water challenges and spans the entire spectrum of activities; from conservation to watershed management to operational efficiency.
And the notion of sustainability is linked to the realities of global climate change. Whether man-made or not, it is evident that climatological changes have an impact on the global distribution of water and the occurrence of waterborne disease.
Much is said about 'water wars' and the prospect that water will increasingly become the subject of conflict. While water is obviously critical to human health and economic development, it knows no political boundaries. Geopolitical considerations are therefore likely to be a major driver within the water industry.
Whether it centers on supply, pricing, or institutional factors, water is an increasingly scarce and valuable resource. Much like oil, it is a critical commodity, affecting everything from food production, to population growth to human welfare. Particularly in the developed countries, the regulation of water and the institutional changes that correspond to the more efficient stewardship of water resources will continue as a major driver for the water industry. The ability to detect contaminants at ever smaller quantities is destined to lead to more stringent regulatory mandates for specific contaminant removal with a growing list of best available technologies for their removal.
And the recognition of a holistic or systems approach to solving water problems opens the door for a completely new and expansive set of regulations. In addition, market solutions to water issues are likely to drive institutional changes in the areas of water rights, water transfers, permit trading, and pricing. The aging of the water infrastructure by itself is an enormous driver of activity in the water industry. This category includes the companies that stand to benefit from the massive construction, replacement, repair and rehabilitation of water distribution systems, wastewater systems, and stormwater collection systems throughout the world.
In the U.S. alone, the EPA estimates that water and wastewater infrastructure repair costs may be as much as $745 billion to $1 trillion over the next 20 years.
The deterioration of the U.S. drinking water infrastructure, a network that spans over 700,000 miles, poses significant risks to public health, security and economic development. International markets for new infrastructure construction in emerging economies add significantly to the magnitude of the potential expenditures. Convergent and enabling technologies are likely to be primary drivers of growth in emerging water applications. Convergent technology refers to advances in other industries that find an application in the water industry while enabling technology represents the improvement or addition of value to existing water applications. Examples include advances in information technology, materials, or processes such as analytical applications in instrumentation or sensors, new infrastructure materials, and advanced or innovative treatment applications.
In addition to the visibility afforded to the water industry as a result of the growing awareness of water as a scare resource and critical commodity, there are a number of fundamental drivers that are favorable for water stocks in the coming year and beyond.
Editor's Note: Stephen Hoffman is a contributing editor to Water Investment Newsletter, 230 Main St., Halstead, KS 67056, 1 year, 12 issues, $140. www.uswaternews.com.
