Water, Recession and the Growing Need to Invest

Could a world-wide recession actually help improve technologies in the water market? Dr Gareth Evans finds out.


Given the run of recent events in the global financial markets – from the fall-out of the subprime mortgage debacle to the threatened collapse of various banking institutions – it is small wonder that talk of the economic 'slowdown' has gradually morphed into the 'R' word.

Although the water industry is seldom a widely acknowledged investment vehicle, conventional wisdom has always seen it as 'recession proof' and those conservative investors who recognised its potential have reaped good rewards.

"Although around five-sevenths of the earth is covered in water, only around 3% of it is fresh water."

While the Media General water utilities index rose by 133% during the past ten years, the Dow Jones Utilities Index ($UTIL) struggled to achieve half of that over the same period.

In 2007, as the S&P 500 Index and the Morgan Stanley MSCI World Index reported rises of 4% and 10% respectively, the Janney Water Index – a global stock index of 60 water-utility, technology and infrastructure services – rose by 15%.

Historically, water has proven a safe place for investors to put their money, but the inevitable question remains, given the particular modalities of today's impending recession, will it continue?

THE RESOURCE CHALLENGE

Part of the reason for water's unique position both practically and financially lies in the particular nature of the resource itself. Although around five-sevenths of the planet's surface is covered in water, only around 3% of it is fresh water – and two-thirds of this is locked up as permanent ice.

Aside from minor fluctuations due to natural shifts in the global climate, for most of our current epoch the amount of available water has remained substantially the same as at any time since the end of the last ice age. The number of people sharing it – and the scale of their demands – has however risen dramatically.

This ongoing trend clearly has significant ramifications. A doubling of the world's population since 1950 has tripled water usage, leading to burgeoning demands from people, agriculture and industry and, as a corollary, the continuing pollution of the resource base.

With more and more regions of the globe increasingly suffering shortages of supplies and many drier areas undergoing significant residential and commercial development, irrespective of recessionary pressures, the need for water grows, year on year.

"A doubling of the world's population since 1950 has tripled water usage."

Although technological innovation will play an important role in meeting the overall demand, as John Dickerson, manager of the Summit Water Equity Fund, San Diego recently observed, unlike finding alternatives to oil, technology can never offer a viable substitute. When it comes to water, nothing else will do.

GROWTH AND OPPORTUNITIES

On the global stage, the hugely expansive emerging markets offered by the buoyant new economies of China and India – both countries with large populations, growing industry and vast potential consumer demand – make for seemingly attractive investment opportunities.

China's per-capita water reserves represent only around a quarter of the world average, with around two-thirds of the country's cities suffering from moderate to critical supply shortfalls on a regular basis.

In addition, as the population has become more urbanised, the near-wholesale exodus from rural areas has further exacerbated the problem leading to the need to extract 30km³ more water from underground supplies each year than can be naturally replaced. It is a story which is repeated throughout southern Asia.

According to studies presented at the most recent Stockholm Water Symposium, some 200km³ of water is being drawn from Indian aquifers to support the nation's agriculture – only a small fraction of which is replenished by the annual monsoon rains. If this rate of withdrawal continues, within five to ten years, groundwater supplies will be exhausted in some areas of the country.

The growing demand across the developing world for more, and better quality, water yields a fiscal environment where the need for greater investment in the industry has begun to assume increased priority.

Aside from conventional infrastructure, sewerage and supply projects, for an increasingly thirsty planet, a number of commentators anticipate that the contribution of purification technologies will become ever-more significant over the coming years.

"Two-thirds of the world's water is locked up as permanent ice."

Compelled by drivers independent of the imminent recessionary forces impacting the financial markets, the development and deployment of enhanced filtration, sanitisation and desalination technology represents a sector widely tipped for future growth. Moreover, such opportunities are not restricted to the developing world.

Some of the driest states in the US – Arizona, Nevada and Texas – are amongst the fastest growing, while the booming population of Saudi Arabia, set to increase by 45% by 2020, will require $100bn investment in water and sanitation over the next 20 years. Marafiq, the country's first private integrated utilities company, has estimated that future desalination projects alone will call for around $55bn.

INVESTING IN WATER USAGE

Although the compelling, mounting pressure on water resources around the globe remains undiminished by recession, paradoxically, studies suggest that water usage often drops.

As a recent report in the Wall Street Journal highlighted, in the US industrial activity accounts for around 40% of freshwater consumption and industries affected by a prolonged economic downturn inevitably look to make cost reductions to survive. Recent events have already begun to flavour an increasingly jittery and pessimistic market and in the wake of the recent Bear Stearns crisis, the value of many US water utility companies' stock has fallen.

However, this may not always be the best indicator of the industry's health. As Josh Levine, co-editor of ChangeWave Investing, observes, "investors in water should keep a close eye on water project spending during a recession."

"China's per-capita water reserves represent only around a quarter of the world average."

Their recent survey revealed that two-thirds of their industry respondents felt that spending would increase over 2008, although not at the record levels seen in previous years.

Although this will leave investors with a good range of opportunities, there are still some threatening clouds looming over the wider US economy, though infrastructure projects may ultimately offer at least one ray of sunshine.

According to Debra Coy, senior water analyst at Janney Montgomery Scott, "the global financial markets have rediscovered infrastructure in the past couple of years and this is fast becoming a popular asset class that is attracting many billions of dollars in new private investment capital."

Ms Coy points to research from Stanford University which revealed that over $160bn in infrastructure funds had been launched in 2006 and 2007 – raised by a number of the world's major institutions, including Goldman Sachs, Barclays Bank, Deutsche Bank and Morgan Stanley. Yet, despite fund managers efforts to locate suitable opportunities, to date few water assets have featured.

WATER TECHNOLOGY OUTLOOK

Unsurprisingly, speculation regarding the possible outcomes and implications of recession is currently rife throughout the entire clean-technology sector, with component technologies in the water arena represented in the discussions as strongly as any.

The most favourable prediction holds that technologies such as water purification stand well placed to ride out the worst effects of a recession driven by the combination of escalating energy costs and a credit squeeze. This largely trades on the inherently counter-cyclical nature of clean technology and the likelihood of short-term incentives for start-ups from central governments.

Moreover, if other technology clusters are impacted more heavily, venture capital and project finance will be looking for a new home. A close, but slightly less optimistic, vision sees these factors balanced out by a general reduction in corporate spending and a more innately cautious financial environment, leading to a retained 'status quo'.

Rob Day, however, principal with the venture capital group @Ventures, believes a third and yet more down-beat scenario is the most likely. This would see clean-technologies obtaining some measure of counter-cyclical protection from the rising tide of macro-economic ruin, but set amid an overall slow-down within the sector as a whole.

"More and more regions of the globe are increasingly suffering shortages of supplies."

Interestingly he predicts a "company by company" outcome, chiefly dependent on individual circumstance rather than sphere of activity – though some trends are expected to emerge here too. Start-ups scrambling towards an early IPO to finance future development – and investors looking for a timely exit – may find their returns lower than anticipated and certainly more difficult to realise. Conversely, Day expects capital efficient start-ups which have prioritised a cash flow break-even to be able to wait out what he describes as the 'temporarily unfriendly market conditions'.

For obvious reasons, few in the industry wish to dwell for too long on the fourth option – the so-called 'doom-and-gloom' scenario – though it inevitably forms the stuff of many private fears, despite the apparent recession-proof nature of the industry, at least in relative terms. In the end, only time will tell which way the economic winds will ultimately blow – and how strongly.