Environmental Risk: The Changing Climate: A rising tide
There is plenty of water in the world – but useful water gets scarcer by the day. Mike Scott finds that managing the supply in world with a warming climate could be a compelling and diverse investment opportunity
A battle has broken out in the US between farmers in the Dakotas and shippers operating out of St Louis, Louisiana. The link – and the source of conflict – might not seem immediately obvious, but both groups rely for their livelihoods on the Missouri River.
For the farmers, the Missouri is crucial for irrigating their land or feeding their cattle, while the shippers depend on the waters of the river to feed the Mississippi, so they can move their barges up and down the busiest waterway in the country. The US Army usually reduces the water flow of the Missouri in winter to protect resources for farmers and ranchers, but with today’s water levels in the Mississippi so low in the aftermath of the worst drought since the 1930s, it is considering whether to allow an increased flow to prevent barge traffic being suspended.
The proposal is making farmers and lawmakers in the Dakotas nervous. North Dakota congressmen and officials from South Dakota, Montana and Kansas wrote to President Barack Obama to warn that increasing the outflow of water from the Missouri “will undoubtedly have a negative impact on the people and many businesses in the states we represent, which are also suffering overwhelmingly from the effects of drought”.
With hydro-electric power plants, shale gas producers and recreational users all also placing demands on the river’s water, this conflict over a scarce resource is a microcosm of the problems many parts of the world face now – and that many more are going to face in future.
“Aquifers in large parts of the world are depleted,” says Tom Whitehouse, chairman of the London Environmental Investment Forum, “and large parts of the world are still being irrigated using techniques developed by the Mesopotamians – that is, they are just flooded once a year when the rivers are high.”
The situation will be exacerbated by the changing climate, he adds. “Climate change makes water supply so unpredictable that it has to be really well managed, not just for agriculture but also for industry and consumers,” he adds.
Fresh water is set to be scarcer than oil by 2030, with demand outstripping water supply by 40%, according to Bank of America Merrill Lynch (BAML). While this is a headache for governments and businesses, it should be a situation with exciting prospects for investors. BAML says that the global water services industry is set to double to $1trn (€760bn) a year as companies address growing water scarcity. There are certainly opportunities – global utility infrastructure company Sensus says that using water more efficiently could save utilities $12.5bn a year, for example.
Citigroup chief economist Willem Buiter has suggested that in the next 25-30 years there will be a globally-integrated market for fresh water in the same way as there is for oil now.
“Water as an asset class will, in my view, become eventually the single most important physical-commodity-based asset class, dwarfing oil, copper, agricultural commodities and precious metals,” he says.
BAML says that water scarcity creates three investable themes – water treatment, water management and water infrastructure and supply. “As industries across emerging markets expand, their demand for water rises,” it says. “Opportunities lie in areas such as producing drinking water, irrigation, or returning water to the natural environment. For instance, desalination could emerge as a $25bn industry by 2025.”
Simon Gottelier, an investment manager at Impax, says that between $450bn and $550bn of capital expenditure is required each year to upgrade existing infrastructure in developed markets and build new infrastructure in emerging markets. BAML puts the figure even higher, at $770bn, and says that the biggest growth markets are likely to be Latin America and Asia. It suggests investing in companies involved in engineering, construction and consulting, pipes, pumps and valves, and sewage treatment.
“Climate change is the over-arching driver behind pretty much everything going on in the space,” Gottelier adds. “Changes in the hydrological cycle are combining with massive population growth, rising living standards and historical underinvestment in ageing infrastructure to create imbalances between supply and demand.”
There will also be considerable growth in wastewater treatment, recycling and reuse, with higher water quality standards colliding with supply constraints, says Whitehouse, citing companies such as Ostara, a Canadian firm that extracts phosphates from industrial waste water streams, and Emefcy, which generates energy from wastewater using microbial fuel cells.
Meanwhile, the need to use water more effectively creates markets in water efficiency measures ranging from smart meters to smart irrigation. “The water services sector will be a winner from climate change because climate change will manifest itself first in various water problems,” Whitehouse reasons.
One driver for the sector, particularly on the efficiency side, is the increasing pressure investors are putting on companies to get to grips with their water risks. The Carbon Disclosure Project’s work on water disclosure involves calling on companies to report on their water exposure on behalf of 470 investors with $50trn of assets under management.
Marcus Fox, head of water at the CDP, identifies some of the sectors under most threat.
These range from anything that has agriculture in the supply chain, such as food and beverages, tobacco and apparel to almost any form of power generation, which requires large volumes of water. Other sectors that are heavily reliant on water include semiconductors, chemicals, pharmaceuticals and oil and gas.
Almost every sector of the economy has significant water issues in its supply chain, Fox says. “There is a perception that water stress is something companies will need to think about 10-20 years down the line, but depending on where you are and what business you are in, it is a very current issue.”
Yet despite the promising prospects for the sector, investors can find it difficult to get to grips with water companies outside of investing in water utilities. “Many new technologies are bought up relatively early by the ‘water majors’ such as Danaher, GE, Siemens and 3M,” explains Gottelier. “Compared to something like renewables, there are quite high technical barriers to entry here.”
Marc-Olivier Buffle, senior analyst at SAM Group, identifies utilities in emerging markets that are being privatised as attractive investments but adds that “for us, two thirds of the story is about suppliers to those utilities – water treatment, water movement, pumps and pipes as well as some more high-tech companies in fields such as leak detection, wastewater treatment and irrigation”.
Other technologies to look out for include forward osmosis, a process for treating polluted water from industrial waste streams and desalinating water. Buffle says the process is 30% cheaper than reverse osmosis and it therefore has the potential to transform the economics of desalination, which is set to become increasingly important as a source of water in many parts of the world as groundwater supplies are depleted and contaminated, but which is also very expensive and energy intensive.
Analysis indicates that current ‘business-as-usual’ water management practices and levels of water productivity will put at risk approximately $63trn, or 45% of projected 2050 global GDP (at 2000 prices), equivalent to 1.5 times the size of today’s entire global economy, the CDP reports. However, it adds that the links between water and economic growth shows that every $1 invested in water infrastructure can deliver nearly $5 of wider economic benefits over the long term. This suggests that the industry is a good place for climate-savvy investors to put their money.