Investing in Water: The World's Most Precious Resource

| About: PowerShares Water (PHO)

For most of us, water is much like oxygen: life sustaining, plentiful and virtually free. Aside from selling overpriced bottles of Evian, it's hard to imagine how you can make money from water. Yet some savvy investors have predicted that water will become the "oil of the 21st century."

Water is the most plentiful commodity on earth. But with the earth's rapidly growing population of six billion, supplies of water on a per capita basis are diminishing rapidly. And unlike coal or oil, water is irreplaceable. That makes water the most valuable of all commodities. Yet we complain most loudly when our water bill goes up -- even when the price we pay comes nowhere near the actual cost of providing it.

Investing in Water: A Commodity in Crisis

As plentiful as water seems, only 20% of the world's population has access to running water. And, only one-third of the world's population has access to clean water at all. By 2050, more than four billion people -- nearly half the world's population -- are expected to live in areas that are chronically short of water. Economic development has placed greater pressure than ever on the supply of fresh water. In 1900, the global annual water use per capita was 350 cubic meters. In 2000, that number had grown to 642 cubic meters. In the United States alone, water demand tripled in the past 30 years, while the population has grown just 50%.

Shortages of water are already biting in countries such as Egypt, which imports more than half of its food because it lacks enough water to grow more. Droughts in recent years have caused water shortages in Australia, the United States, China, India and Europe. Pollution is the other culprit, reducing the amount of fresh water available in places like China, where the drinking water of nearly a quarter of the population is contaminated.

The water shortage is starting to hurt. The lack of clean water and basic sanitation knocks at least $556 billion a year off the world's potential economic growth. That's about 1% of global GDP -- or Brazil's annual economic output. The U.S.'s losses from drought are estimated at $6 billion to $8 billion. Europe's water shortages in 2003 cost the region's economies about twice that amount.

Investing in Water: The World's Best Business Model

Investing in water (which can be done via the PowerShares Water Resources ETF (NYSEARCA:PHO)) sounds prosaic. Yet no other industry has a more compelling -- or sustainable -- business model. Water by far is the most stable of all commodities and it remains virtually immune to business cycles. Demand for water is unaffected by inflation, recession, interest rates, changing preferences, or inventory loss. There is no obvious substitute. The infrastructure demands for transporting water create huge barriers to entry. For investors, this has meant a long history of strong and consistent growth under all market or economic conditions.

Water utilities are the most obvious target of investment. Yet that overlooks the vast array of companies involved in the collection, conveyance, treatment and monitoring/analysis of water. Indeed, as in any gold rush, the biggest fortunes are made by selling the equivalent of picks and shovels to the miners. Companies providing the pumps, pipes, valves, filters, testing, instrumentation, engineering, and construction of water systems have the strongest investment prospects. Here's why. Companies selling to water utilities have a much more predictable and stable business profile than companies selling into more cyclical industries. A valve maker selling to water utilities is likely to have a much better business than a valve maker selling to the oil industry or to the aircraft industry.

The EPA estimates that up to $1 trillion will have to be spent upgrading U.S. water infrastructure over the next few years. This aging infrastructure, much of which is more than 100 years old and has long exceeded its useful life, is in a state of utter disrepair. In the United States alone, the network of drinking water pipes extends more than 700,000 miles -- more than four times the length of the National Highway System. Much of the water infrastructure in the rest of the world must be replaced in the next 20 years as well. This means construction ! of reservoirs, better water canals, and more efficient irrigation systems.

How to pay for all this? Municipal and private utility operators often do not have the resources to finance this massive reconstruction of dilapidated water infrastructure. As a result, water utilities around the world are being privatized. Lehman Brothers estimates that the number of people served globally by investor-owned water companies is expected to rise 500% over the next 10 years. And investors are acquiring solid assets at a fraction of replacement value, providing excellent returns on their investment.

Investing in Water: The Safest China Play?

While investors throw money at any stocks remotely associated with China, they have overlooked the most basic requirement for sustainable growth of the Chinese economy: adequate water and sanitation facilities. China has more than 20% of the world's population and only 7% of its water. Per-capita water reserves are only about one-fourth of the global average. Of China's 669 cities, 440 regularly suffer moderate to critical water shortages and most have no centralized sewage treatment facilities. Half of the rivers and lakes and one-third of the aquifers are classified as polluted. The mighty Yangtze River is now a shadow of its former self -- absorbing nearly half of the country's (untreated) waste water.

China has become dependent on grain imports from the West directly as a result of its water shortages. The Chinese government is pumping over $128 billion into water related investments between now and 2010. Companies that can help solve the massive water problems in China are set to make a mint.

Disclosure: none