Water, Water – Sadly Not Everywhere

With an acute need for capital, investors looking to do good with their portfolios need look no further. Ensuring the preservation of, and access to, clean drinking water is one of the major challenges of our times.

What is the most precious commodity on earth? Financial markets give pretty clear answers. Gold currently trades at around USD1,800 per troy ounce. A round, brilliant cut 1-carat diamond will set you back anywhere between USD2,500-18,000, depending on its quality.

By contrast, a bottle of own-brand mineral water costs 1.9p per 100ml in a UK supermarket1 – which equates to 0.5909p per troy ounce. You can live a perfectly happy life without ever being given a diamond or owning gold bullion. But, as everyone knows, you can’t even have a perfectly happy day without a drink of water.

The discrepancy between water’s price and value is in part a function of scarcity: gems are less common than raindrops. But as droughts, wildfires and climate change are driving home, without access to clean water, human life becomes precarious. If investors wish to do good with their portfolio, we can think of few better places to start than ensuring the conservation of the Earth’s most precious resource.

2.3 billion people live in high waterstressed countries, meaning that they are using more than 80% of the surface and groundwater available to them.

The Need for Better Water Management: UN Sustainable Development Goals

Water’s importance to a dignified life is underlined by the place it holds in the UN’s Sustainable Development Goals. Goal 6 is to ensure the availability and sustainability of water and sanitation for all.

Sadly, improving access to water is still a critical need in many parts of the world. The UN estimates that around 2 billion people lack access to clean water and 3.6 billion lack safely managed sanitation.2 Additionally, 2.3 billion people live in high waterstressed countries, meaning that they are using more than 80% of the surface and groundwater available to them (Figure 1).

Figure 1. Water Stress – Freshwater Withdrawal as a Proportion of Available Freshwater Resources

Source: UN; as of 2018.

And this water stress is likely to increase, driven by increasing demand and decreasing supply. On the demand front, a combination of population growth, socio-economic development and changing consumption patterns has resulted in global water usage more than tripling since the 1950s, growing by more than twice the rate of population growth (Figure 2). If this demand continues to grow at a similar rate, global water consumption is expected to increase to almost six trillion cubic metres in 2050.3 In contrast, supply has not kept pace: driven mostly by climate change, 21 of the world’s 37 major aquifers (gravel and sand-filled underground reservoirs) are receding, from India and China to the US and France.4

Figure 2. Global Freshwater Use

Source: Global International Geosphere-Biosphere Programme, Our World in Data; as of 2014. Note: Global freshwater withdrawals for agriculture, industry and domestic uses since 1900, measured in cubic metres (m3) per year.

It might be assumed that this is a problem largely confined to the developing world, or those areas with a particularly arid climate. To some extent this is true: water stress is strongly related to rainfall, which does mean that the Middle East, North Africa and the Indian subcontinent suffer more water stress than more temperate or tropical regions. However, major economies such as the US, the UK, China and Australia suffer medium to high stress. Likewise, proper access to water and sanitation are not universal. Some 2 million Americans lack properly connected water systems, and a fifth of all US households use septic tanks rather public water supplies.5

A good deal of water stress in the developed world can be attributed to leaking infrastructure.

The Need for Investment

A good deal of water stress in the developed world can be attributed to leaking infrastructure. According to the American Society of Civil Engineers, around 6 billion gallons of treated drinking water are lost in the US every day due to leaking water mains.

The Environmental Protection Agency estimates that between 6.5 and 10 million water pipes are still made of lead, a major health hazard which needs urgent replacement. As a consequence, events like the Flint Water Crisis are not an example of grotesque 19th century inequality. Instead, the city of Flint, Michigan, had drinking water contaminated with lead and possibly legionella for around five years6 – in the richest country in the world in the 21st century.

Safe drinking water and reliable water infrastructure is therefore not a given, even in the developed world. But nor is it a nice to have. Estimates indicate that around USD2 trillion spent over 20 years would be needed to upgrade US water infrastructure alone.7 While the Infrastructure Investment and Jobs Act – passed by US President Joe Biden in November 2021 – guaranteed USD48.4 billion between 2022-26 for various water related projects, it is a drop in the ocean of capital needed to address the problem fully.8 These figures, while significant for sector growth, do not account for the need for infrastructure upgrades around the world, which are equally urgent.

Figure 3. US Water Investment – Need Versus Allocated Spending

Source: Man Group; as of 20 December 2021.

It is important to invest in a country in which there is a stable political framework with regards to water.

The Opportunity Set

While there is a pressing need for water investment, investors should be wary of diving in indiscriminately. Even though the scale of the problem is vast, it is not a given that all water-related investments will provide consistently positive returns. Indeed, if this was the case, we would not be looking at a capital shortage in the first place.

This is often due to regulatory and political risk. Because water is a basic need, raising prices to cover the cost of investment is often highly unpopular and controversial. Many countries have nationalised water infrastructure, and even in countries where investors can invest in private water provision, there is often a high degree of risk. Examples would include the UK, where the Labour Party stood on a platform of renationalising water companies9 in the 2019 General Election, and have maintained this stance ever since10, and Catalonia, where there were 27 instances of water being returned to public management between 2010 and 2020.11 It is therefore important to invest in a country in which there is a stable political framework with regards to water.

Once political risk has been accounted for, investors need to consider how the world’s water needs will impact returns. Given the number of stimulus and infrastructure plans which are extant in the wake of the coronavirus pandemic, it is likely that we will see strong demand for piping, pumps and a variety of other hardware, as governments attempt to improve water management and reduce waste. However, it is important to make distinctions when investing in water hardware. Much low-grade hardware is relatively commoditised, with corresponding margin constraints. While there may still be significant structural growth and volume upside, investors should not necessarily assume that basic hardware is the totality of investment opportunity.

Instead, managers should look to less commoditised water products and services, especially those firms which combine hardware and software to create smart water infrastructure. As we’ve already mentioned, leaks waste enormous amounts of treated drinking water every year. However, identifying a leak is easier said than done. Many water pipes are underground, and leaks may not be obvious. Smart sensors, which can constantly monitor water pressure within pipes, allow for leaks to be identified and monitored remotely, and for quicker repairs to be implemented. Sensors can also monitor water quality and identify increases in pollution levels. Importantly, this kind of technology is specialised and not easily replicable and margins are much higher than for basic hardware.

Likewise, firms supplying water filtration and treatment services have the ability to outperform. Pollution remains a major problem worldwide: just as water demand is tied to population growth, as the number of people increases, so does the production of waste and sewage. Governments are responding: the US has passed the bi-partisan Infrastructure Investment and Jobs Act, which guarantees some USD10 billion to tackle water pollution.12 Firms which can supply innovative, cost-effective water treatment, or consistently safe waste disposal are well-positioned to take advantage of this trend. In particular, we note the advances made in using ultraviolet light to remove pathogens such as E.coli, a breakthrough which removes the need to treat water using chemicals. Similarly, the development of aeration bioreactors and membrane filtration has provided a biological rather than a chemical method of purifying polluted water.

By identifying market segments which are growing the fastest and are more independent of the macro cycle, investors can look to provide a degree of diversification within a water-focused portfolio.

Investors looking to do good with their portfolios need look no further: ensuring the preservation of, and access to, clean drinking water is one of the major challenges of our times.

Conclusion

Water is, and will continue to be, the Earth’s most precious commodity. Investors looking to do good with their portfolios need look no further: ensuring the preservation of, and access to, clean drinking water is one of the major challenges of our times. The size and scale of the infrastructure needed to improve water management means that there is an acute need for capital in the sector.

The various stimulus plans in the US, Europe or Asia provide a significant support for several years, but will not be enough to solve the global water issues. Besides, investors should be wary of blindly investing in water-related companies. Political and country risks can be significant for water utilities, hence the need to carefully screen for regions where water is ‘investable’. It is also important to select companies with the strongest growth and pricing power. In our view, this tends to be firms with strong reputation and distribution networks, and most importantly, which benefit from a technological edge. This includes, for example, certain providers of smart monitoring, waste-water treatment or consultancy services which display these characteristics, while giving investors a chance to make a positive contribution to society.

 

1. groceries.morrisons.com/search?entry=bottled%20water
2. sdgs.un.org/goals/goal6
3. Source: OECD
4. Source: Water Resources Research; Quantifying renewable groundwater stress with GRACE; 16 June 2015.
5. Allianz; “Financial flows, the Fountain of youth for an ailing water infrastructure”;
6. en.wikipedia.org/wiki/Flint_water_crisis
7. Allianz; “Financial flows, the Fountain of youth for an ailing water infrastructure”;
8. waterfm.com/house-passes-infrastructure-bill-including-funding-boosts-for-the-water-sector/
9. www.independent.co.uk/news/uk/politics/labour-general-election-jeremy-corbyn-nationalise-energy-water-john-mcdonnell-a9238526.html
10. www.express.co.uk/news/politics/1490786/Labour-latest-Ed-Miliband-pledge-nationalise-energy-water-transport-BBC-Newsnight-vn
11. www.theguardian.com/cities/2020/jan/16/the-case-for-truly-taking-back-control-by-reversing-the-privatisation-of-our-cities
12. news.bloomberglaw.com/environment-and-energy/infrastructure-law-gears-10-billion-to-fight-pfas-in-water

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