Seeking Alpha

Water: The 21st Century's Oil

Includes: CGW, PHO, PIO
by: Hard Assets Investor

Is water a commodity?

It's a question that more and more investors are asking these days. The media has been full of stories about rising water scarcity: water lawsuits in the American Southwest; growing demand for water for ethanol plants; drought conditions in key grain-producing countries like Australia. Water's role in the global economy is becoming both more real, and more visible.

It’s not entirely a new idea. An article in Fortune Magazine back in May of 2000 stated, "Water promises to be to the 21st century what oil was to the 20th century: the precious commodity that determines the wealth of nations."

Really? Is water a commodity? Is it a new “hard asset,” and something that investors should include in their portfolios?

We consider the case…

Fungibility And Liquidity

To the academic community, two key hallmarks of what makes a commodity a commodity are fungibility and liquidity. Water passes both tests.

For starters, it is thoroughly fungible. Water from one source is often the same as water from another source. The price and marketing claims of Fiji Water notwithstanding, drinking water in Manhattan is about the same as drinking water in Canada, and irrigation water in California is the same as irrigation water in Ohio.

Is it liquid? We don’t mean in the obvious sense. Rather, can you exchange it for money? Increasingly, the answer to that question is yes as well. While you're not going to fill up a tanker truck and try and hawk it on Fifth Avenue, farmers are selling it (or at least the pumping rights to it) in large cities, and there is an active market for water in many communities.

s It Scarce And Necessary?
While water may meet the academic requirements of a commodity, no one would care if there wasn’t an overhang of scarcity … and a value … associated with it.

In the U.S., water still comes out of your tap clean and ready to use, for pennies a gallon; that contrasts with, say, oil, which costs a lot and is only available through targeted supplies. But like oil, demand for water is rising. Cities, companies, factories and agriculture all use a lot of it, and depend on it for function. Water is essential for life and for business, and there’s only so much of it. And increasingly, the price of water is rising.

At home, more and more cities are installing meters that measure the amount of water you use, and charge accordingly. In the past, water utilities simply applied a fixed fee tied to either your neighborhood, the size of your house or the number of bathrooms you had. But as the value of water increased, we’re increasingly being charged for that cost. (In its refined and packaged state [think plastic bottles], water can already be as expensive as heck … more expensive per gallon than gasoline.)

Abroad, the competition for water is more high-stakes. Kingdoms in the Middle East are spending huge sums of money to build desalinization plants, and farmers around the world are buying and settling water rights for large sums.

Jeff Saut said that investing in land with good access to water … like Brazil … may be a very smart move over the next few decades. As water scarcity grows, the value we attach to water will grow as well, and that will raise costs.

According to the World Resources Institute, global water consumption grew at twice the rate of the population during the 20th century. That rate continues today, as populations grow and countries like China and India put pressure on their water resources to fuel industrial growth. In sum, the long-standing rumors about water scarcity look like they may finally come true.

But Isn’t There Water Everywhere?
This pending scarcity flies in the face of our natural assumptions. We live on a planet covered in water—roughly 70% of our world is water. The problem is that 97% of that is salt water. Great for fish, not so good for humans. Of the world's fresh water, only 1% is available for drinking, with the remaining 2% trapped in glaciers and ice. "Water, water, every where, nor any drop to drink" is a well-known saying for a reason.

But isn't water itself a renewable resource? Through evaporation and precipitation, water is recycled. But just because it was potable water in the first go-round doesn't mean it will be potable water after the cycle is completed. Pollution and other factors are shrinking the supply of clean, potable water, while demand continues to grow. Increasingly, for water to be useful, it needs to be mined, processed, packaged, moved and delivered. Just like oil, coal, gas or gold.

Here's an example.

We have farmers planting corn all over the place because of the ethanol boom. Corn is a thirsty crop, requiring 118 gallons to grow 1 pound of corn. Once you have the corn, estimates vary from 3 to 15 gallons of water needed to produce 1 gallon of ethanol. (Those are just the rational estimates; you can add or subtract decimal places if you troll for statistics hard enough.)

All of that water has to come from somewhere and most often, it has to come from someone else. Cities and states have to make decisions on what is most important for their growth and development, and how that impacts their neighbors. For example, Nebraska has an agreement with Kansas over water rights because they share the same source water (the Ogallala aquifer that stretches under eight states from South Dakota to Texas).

Farmers in Nebraska are under water restrictions as to how much they can irrigate because the water level has to remain constant so that Kansas can get what was agreed to. They say good fences make good neighbors. In this day and age it may well be that good water management is the virtual fence.

Outside the developed world, the need for potable water is even greater, and making the existing water potable or transporting in potable water can be extremely challenging.

But all of these challenges can bring market opportunities.

Market Plays
Water is scarce, demand is going up (due to population increases, agricultural increases, etc.) and you want to get into the water market. What’s the play?

Since backing that tanker up to your tap is out, you'll need to look elsewhere; holding physical water is prohibitively expensive, and while there has been talk of starting a water futures market, one cryptic line on a website does not a market make; it’s not clear how such a futures market would work. One could imagine that water rights would be negotiated and sold on an exchange in the future, but we’re not there yet.

Right now, the best way to play the market is through equities, and fortunately, there are a number of indexes and ETFs that provide exposure to companies involved in the space: water utility companies, pipe and pump manufacturers, filtration and treatment companies, and water management companies. These are the companies who are directly involved in taking water to where it is needed, and as the value of water grows, the demand for these products will likely grow as well.

Currently, there are three water-focused ETFs in the United States:
• Powershares Water Resources Portfolio (NASDAQ:PHO)
• Powershares Global Water Portfolio (NASDAQ:PIO)
• Claymore S&P Global Water ETF (NYSEARCA:CGW)

Each provides a different spin on the water industry, and a full comparison of the three funds is available here. All three have turned in solid performance, as this index comparing one popular water index against the S&P 500 and Dow Jones Utility Index suggests.

Should You Buy Water?
Will that performance continue? That is open for debate. As attractive as the above chart is, the real-time performance record of the water indexes is too short to answer that question definitively. But water does share some interesting characteristics with commodities like oil and copper that make it worth considering, including rising demand and falling supply, and a link to the industrial boom in China, where water scarcity is becoming more and more of an issue.

The most intriguing aspect of the water-as-a-commodity angle is the idea that, like other commodities, water investments may be non-correlated with overall economic health and the broader equity market returns. For starters, demand for water is remarkably steady.

While much is used in industrial applications, farming and domestic uses account for the majority of water consumption in this country and abroad. And while industrial demand may ebb and flow, it’s not like people are going to stop using water … recession, depression or economic boom. The demand slope for water is rising on the backs of a demographic boom, set against a shrinking supply.

Will that story of non-correlation turn into non-correlated returns? That remains to be seen. But it is a story worth watching in the commodity space.