Blue Gold

By Chris Mayer

A gallon of crude oil costs $1.50. A gallon of Evian costs $12.00. This simple observation led one successful investor to assert that oil is undervalued.

We see things a little differently…Oil may be undervalued, but NOT relative to drinking water. In fact, the truth is exactly the opposite.

For most of the world, clean drinking water is a far more precious commodity than oil.

There are few industrial countries in the world feeling that scarcity more acutely than China. Its water needs are more critical than its much-ballyhooed power needs. I did not fully appreciate this until I visited China myself and talked to Chinese business people. Even Chinese officials – prone to covering up or understating the extent of problems – sound alarmist when it comes to water.

Water Scarcity:  China’s Problem “Serious and Urgent” One official recently said China’s problem is “more serious and urgent than [in] any other country in the world.” China’s rapid industrialization has outpaced its water infrastructure, which is on the verge of collapse. As Minister of Water Resources Wang Shucheng noted, “The price of China’s economic boom is being paid in water.” Two-thirds of China’s 600 largest cities don’t have enough water; half of these cities have polluted groundwater. Less than 15% of China’s population has safe drinking water from tap.

For further perspective, consider this: China has about as much water as Canada, but a population 40 times as large. On a per capita basis, China’s water reserves are only about one-quarter of the global average. Worse, the distribution of people and water creates its own logistical obstacles. Nearly half of China’s population resides in the northeastern provinces, where only 14% of the water resources are located.

These facts provide endless challenges for the Chinese. Water shortages and widespread pollution are serious threats to China’s booming economy. It costs billions each year in lost output. The World Bank says environmental damage and health problems cost the Chinese economy more than $54 billion a year – or almost 20% of its GDP. That’s why China is drastically stepping up its commitment to water management, particularly wastewater treatment and recycling. In 2005, the Chinese government pledged a US$30 billion 5-year package to overhaul its wastewater sector. Municipalities there are now required to treat between 40% and 60% of their wastewater.

The Christian Science Monitor in December 2004 contained a provocative article suggesting that we could see a cartel of water-exporting countries emerge over the next decade, in a style not unlike the Organization of Petroleum Exporting Countries. “Water is blue gold; it’s terribly precious,” Maude Barlow, chairwoman of the Council of Canadians, told the Monitor, “Not too far in the future, we’re going to see a move to surround and commodify the world’s fresh water. Just as they’ve divvied up the world’s oil, in the coming century, there’s going to be a grab.”

Whether or not you choose to believe Barlow, it is clear that the demand for clean water is real. In an attempt to avert crisis, China plans to build hundreds of new water-treatment plants. But for now, bottled water is the preferred choice – even among the Chinese, at least among those who can afford it. When I was in China, bottled water was nearly everywhere. As the Monitor points out, consumption of bottled water nearly quadrupled between 1997 and 2002.

Water Scarcity: Veolia Environnement

So how to play it? There are several interesting companies working on the water crisis in China. I’ll run through two of them below. These are not the only companies engaged in solving China’s water resource problems, but they were two of the more interesting stories I found. The largest water company in the world is Veolia Environnement, of France, and, oddly enough, a spinoff of entertainment giant Vivendi. Veolia has a 20-year deal to provide water to Tianjin as well as a bundle of other water and waste management contracts throughout China. Veolia currently serves over 14 million residents in China.

Another company is Watts Water Technologies, which has been doing business in China since 1995. The company produced valves used in China’s Three Gorges Dam project on the Yangtze River. In November, the company increased its commitment to China by acquiring Changsha Valve Works. According to Watts, Changsha is “a leading manufacturer of large-diameter hydraulic-actuated butterfly valves for thermopower and hydropower plants, water distribution projects and water works projects in China. This acquisition strengthens Watts’ position in the fast-growing water market.”

There are two problems here. First, neither company does all that much business in China. Veolia’s contracts bring in only a small fraction of its more than $30 billion in sales. Watt’s China revenues represent only 3% of sales at this point. This is a common drawback in looking at publicly traded water companies. If you want more concentrated exposure to China’s water crisis, you’ve got to explore the foreign equity markets. The other problem is that none of these companies strike me as being particularly cheap. Still, they remain interesting companies to watch.

One thing seems certain: Clean drinking water will remain more precious than oil – especially in China.

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