Water is Too Cheap!

The city of Milwaukee is starting to figure out it has a great resource in its backyard – access to the fresh water of Lake Michigan.

The history of Milwaukee is a history of that plentiful water supply. Water-intensive businesses such as breweries and tanneries flourished here. They helped build this city on the shores of Lake Michigan. By the early 20th century, Milwaukee was the nation’s chief brewer. Pabst, Miller, Schlitz and Blatz – they all called Milwaukee home.

Things topped out in 1960, and since then, Milwaukee’s population has been in decline. The tanneries left. The big breweries are gone. What remains, though, is the water system. Pipes, tanks, pumping stations, treatment plants… Today, it runs at only a third of its capacity.

So the city plans to use this as a lure for so-called “wet businesses,” or businesses that use a lot of water. Come to Milwaukee and it’ll give you a break on water rates for up to five years. The city is not alone. Erie, Pa., has been offering Lake Erie water at 40% off for businesses that relocate there.

The fact that Milwaukee and Erie can do this at all tells you something about America’s water supply. It is – or is in the process of becoming – unreliable. I’ve written about this unfolding water crisis for years, and it always interests me. I think water will be one of the most important investment themes over the next decade, at least.

So when offered a spot at the Gabelli Water Investment Summit in New York, I duly took it. The folks at Gabelli do a good job of bringing together a dozen or so executives of water companies from around the country. It’s a worthwhile day, and I always learn something. I also can’t help but come away thinking bad thoughts about the way the US runs it water supply.

The most eye-opening presentation was by Nick DeBenedictis, the CEO of Aqua America, which is the second largest investor-owned water utility in the country. (It trades on the NYSE under the ticker WTR.)

He gave a good overview of the water utility industry. In a word, I’d have to say “messy” is an apt way to think of it. As DeBenedictis said, “You would never design it this way.” First, there are way too many systems. We have 55,000 water systems in this country. Second, most are too small, serving fewer than 3,000 people. The whole thing is inefficient, like trying to sled uphill.

But for whatever reasons, most people in this country think access to water is some kind of right and that we shouldn’t charge a market price for water. So market forces have not shaped the water industry as much as they might have. In the US, the government runs most of these systems. Only about 10% of the population gets its water from a private entity such as Aqua America.

In other parts of the world, the story is different. In England, 100% of the people get their water from private sources, and they have just 10 water systems. Even in France, 90% of the people get their water from private companies. In the US, we let government officials run amok. It was not always so. In 1850, about 80% of the country got its water from private companies. By 1900, it was 50%. So we’ve taken decades to get where we are today. Where we are today is an expensive place to be.

Summit Asset Management recently put out a white paper, The Case for Water Equity Investing 2010. (It’s available free on the Web and is well worth the read for the broad overview it gives.) In the paper, the authors sum up the damage. “In the US alone, the network of drinking water pipes extends almost a million miles – more than four times the length of the National Highway System. This aging infrastructure, much of which is more than 100 years old, has long exceeded its useful life and in many areas is in a state of utter disrepair.”

To fix it will cost at least $500 billion over the next 20 years. That’s a lot of new pipes, treatment plants, security upgrades and more. I bet it costs twice that. These projects always cost more when you start digging and pulling stuff out of the ground.

You would be appalled at the pictures of government-run water systems, which look like something out of the old Soviet Union. Dirty, old, rusted plants…water pipes filled with crud and buildup…little outhouse-like structures with no security that tap right into the drinking water supply…

“Cities around the country are playing the game of pay me later,” DeBenedictis says. “Leave it for the next mayor.” That’s always the problem. Who wants to be the politician to raise water rates to pay for needed repairs and maintenance?

And so the systems plunge deeper into decrepitude. The city does nothing until it has to. But the day of reckoning has arrived!

To be continued tomorrow…

Chris Mayer
for The Daily Reckoning