Reversing Dangerous Water Trends

Peter is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

According to some estimates, global fresh water requirements are expected to rise by as much as 50% from 4,500 billion cubic meters in 2010 to 6,999 billion cubic meters in 2030. The current global water supplies will be able to satisfy just 60% of that projected demand. Furthermore, the UN believes that fresh water sources will deplete by 20% per capita. This high demand for drinking water will necessitate a large investment and, most likely a rise in price, depending on what technologies are developed.  The best estimates out there point to water becoming a $400 billion industry worldwide.  

Price Fixing Creates Supply Problems

Part of the problem in many places is the complete lack of adequate pricing models for water, which has caused a structural mismanagement of the recourse.  People, through their governments, are generally distrustful of leaving the fresh water supply open to the vicissitudes of the market and have placed controls on its production, use, and price.  By not having accurate pricing signals, both consumers and producers have no idea of what the true cost of water from the tap actually is.  That’s why they balk at any increase in price, feeling entitled to nearly unlimited water usage.  So many businesses have been built on water costs that are unsustainable that this shift will cause a number of industries to have to re-assess their cost structure, namely shale-gas production.

Those Who Will Lead

The leading firms of the water management industry are GE (NYSE: GE) and Dow Chemicals (NYSE: DOW)In Dow’s latest uninspiring earnings report, where top-line revenue contracted nearly 10%, only its water-solutions division saw both increased sales and margins.  Dow is a leader in reverse-osmosis (RO) membranes and is investing heavily in Chinese production and R&D in South Korea to supply the growing markets there.  Dow completed its investment in Clean Filtration Technologies in April, buying up the rest of the company and shoring up its pre-filtration technology portfolio.

GE Water has signed a partnership agreement with Singapore-based Memsys Clearwater to develop membrane distillation (MD) that will reduce water demands from hydraulic fracturing. MD uses a low cost and low energy technology which mimics thermal evaporation to produce water usable by gas drillers.  Singapore, in general, is a leader in water technologies, as the island nation seeks to be water independent by 2050.

In many ways the industry is controlled by GE and Dow, both of which provide a majority of the filtration systems and underlying technology, while companies like France’s Veolia Environnement (NYSE: VE) implement it.  Veolia is a utility spread across Europe, which is currently operating under difficult conditions.  Competing with Dow and GE is Singapore’s small but growing company Hyflux, who is partnered with Hitachi to build what will be the biggest desalinization plant in the world in the Dehaej SEZ (Special Economic Zone) in India. 

In April, Dow and the Saudi Arabian state-owned utility SWCC, signed a memorandum of understanding to perform research into desalination technologie.  This builds on their announced RO membrane manufacturing facility there as well as another facility in Huzhou, China which will be on-line by mid-2013.

Reverse Competition?

Dow and GE have billions invested in RO, which has finally gotten its costs down to where it is competitive in high-needs locations.   For operationally-challenged companies like Dow, the long-term fundamentals in the water trade are enormous.  The industry currently has made its bed with reverse-osmosis, a technology that has been building in robustness and efficiency for more than 30 years.  At current costs between $0.70 and $1 per cubic meter, or $0.30 to $0.40 per gallon, depending on energy costs and salinity, RO represents the best available option for reducing the drain on natural sources of freshwater which are badly managed and as a resource completely mispriced.

The S&P Global Water Index has risen by 10.6% since the beginning of 2012, while the SPDR S&P 500 ETF (NYSE: SPY) has risen by 12.5%.  For investors wanting broad exposure to the water industry, the PowerShares Global Water ETF (NYSE: PIO) is 47% exposed to water utilities and 37% to water industrials.  Neither Dow nor GE is represented in the fund, as it is focused more on smaller companies involved in the growing water industry, and has an AUM of $211 million. 

The fund has risen 8.3% this year to date, lagging the S&P 500.  It looks to be building a very strong consolidation base between $15 and $18 per share, and in the past 12 months has paid out 2.6% in dividends.  Current prices have it near medium-term fair value, and in the face of a global recession in 2013 the demand for water will not abate.  Foundational commodities (food, energy, water, and gold) will do well in a debt-deflationary environment met by central bank easing, while industrial commodities will struggle. 

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PeterPham8 has no positions in the stocks mentioned above. The Motley Fool owns shares of General Electric Company. Motley Fool newsletter services recommend Veolia Environnement (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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