Water - Still Blue Gold

I was in Bangkok while the floods were raging. I also visited Cambodia. The floods were in the news there as well. Though it did not affect Phnom Penh, where I was, the remote villages were dealing with a lot of water.

That’s the curious thing about water. There always seems to be either too much of it or not enough. What follows is another look at my favorite commodity and the opportunities of investing in it.

At breakfast at the Raffles in Phnom Penh, I read a story about how Levi Strauss is trying to minimize its water use. A pair of blue jeans will consume over 900 gallons of water in its lifetime. That includes everything from the water to irrigate the cotton crop to multiple washings of the jeans.

The pressure is mounting on Levi, and other companies, to reduce their water footprint. Miners, food companies, tobacco companies and beverage makers all face pressure to use less water. In many places where they operate — such as India or China or Africa — fresh water is in short supply. This forces a re-examination of everything — from favoring drought-resistant crops to creating new ways to sanitize things.

Companies are also looking to use all of this to their advantage in marketing. Imagine idyllic farms in India with a smiling farmer using new efficient irrigation methods financed by Levi Strauss. However it may reflect reality, such an ad would appeal to the feel-good consumers of today.

The one part of the story that caught my eye was on a 15-acre cotton farm some 90 miles west of Mumbai. The farmer uses drip irrigation, a method of delivering water and fertilizer piped through veins spread over his fields. It’s vastly more efficient than flood plain irrigation, as the water gets right where it needs to go. There are also fewer weeds and less need for power, a not small consideration in a country in which periodic blackouts, however brief, are as common as flies. The farmer reports his water use is down 70% since using drip irrigation.

A group called the Better Cotton Initiative installed the irrigation equipment. The founders are a group of organizations and retailers, including Gap, Ikea and Adidas. Ikea hopes to use only “better cotton” by 2015. Adidas promises to do so by 2018. You can see how this is appealing to the companies.

There was a time when US companies didn’t really want to know what went on in their factories overseas. That time has passed, probably for the better. In an age when any competitive edge can be a difference-maker, why not try to gain an edge in customers’ minds this way and do some good for the world in the process?

The market is saying it approves. Early research indicates customers like to think they are changing the world for the better. Products that meet that need will enjoy an edge over those that don’t.

Given all of this, I think it is a profitable exercise to think about what kinds of companies benefit in such a world. What kinds of companies enable such a world? As it turns out, there are plenty of them.

Water is a $500 billion industry. You could break that into two giant buckets.

The first is water infrastructure. These include the water utilities — some 250,000 of them globally. These are necessary assets of vital importance wherever they are. They absorb a steady amount of spending that tends to be pretty resilient, regardless of what’s going on in the economy. Population growth drives the creation of new utilities every year. See the chart below on US water and sewer construction spending.

US Water and Sewer Construction Spending

If anything, we’ve underinvested in these facilities over time, leading to leaky pipes and contaminated water. There will be a lot of pressure here to gain efficiencies.

The second big bucket is applied water. You can think of this as irrigation and industrial water uses (such as those used in the manufacturing process). Irrigation is a big one, representing some 70% of applied water use.

Emerging markets play a big role in all of this. Just over the next five years, China alone will spend nearly $50 billion on water, mostly on water treatment systems and flood control projects. In India, there are plans for 30-plus power plants by 2017 — all of which will use heavy amounts of water for cooling. India also has large irrigation projects on the docket, which will divert rivers and soak parched farmland. In Africa, where mining companies are busy cracking open the earth to get at much-sought goodies, there will be a great need to manage the water use of these projects.

As you can see, water touches almost everything — from energy and mining to basic food production and manufacturing. You want to talk about shale gas and the great revolution in American energy? Well, water management is going to play a big role there — testing it, filtering it, recycling it. You want to talk about feeding 9 billion people by 2050? We’re going to need to manage our water assets more intelligently. You want to talk about technology? New smart phones, computers and lifesaving drugs? All of the companies that make these things use tremendous amounts of water. And they need the water to be pure and meet strict standards.

The beauty of water as an investment theme is that “inevitables” power these trends. There is really no way to get around it. If you think about the pressures applied by population growth and urbanization, you can readily see how important efficiency and sustainability will be.

You don’t have to get a lot of things right, either. You don’t need to know what the world’s favored energy source will be in the future — coal, natural gas, nuclear or alternative energy — it doesn’t matter. They all use water, and lots of it.

Water was the key theme that kicked off my Mayer’s Special Situations newsletter in the summer of 2006. The original Blue Gold Portfolio unveiled five stocks with exposure to powerful trends emerging in water — the need to purify it, preserve it and move it. That portfolio delivered an 87% return in its first year and has been a solid winner ever since. We’ve added names since then and over time have sold off some or watched them get bought out. Now only two stocks remain, both part of the original set.

Water remains one of my most favorite investment sectors.


Chris Mayer,
for The Daily Reckoning

The Daily Reckoning