How much is water worth to us?

World Water Day on March 22 will focus attention this year on the value of water. Asking how much water is worth poses a question that couldn’t be more complex. Available in abundance in some places but in scarce supply in ever more regions of the world, “blue gold” is a vital resource whose importance is continually increasing. Water is also more topical than ever as an investment theme.

 

An essential theme

Consumers in northern and central Europe and North America could easily forget that water is a scarce resource. After all, in our latitudes, crystal-clear water flows from our faucets reliably every morning. But that’s not the case everywhere in the world. According to data from the World Health Organization (WHO), 2.2 billion people around the globe do not have access to safe drinking water, and a startling 4.5 billion lack access to sanitary facilities. The World Bank estimates that poor sanitation, contaminated water supplies and inadequate hygiene practices cause 675,000 deaths each year and annual economic losses of up to 7% of GDP in the countries worst affected.

 

The price question

The numbers above show quite strikingly that (clean) water is precious and has a value. But how high is the value of water? This is precisely the subject being addressed by this year’s World Water Day, which since 1993 is celebrated annually on March 22. The question about how much water is worth is a multidimensional one. Besides the nutritional and health aspect of water, the question is also about water’s value as a factor of production in agriculture and industry and also concerns the (often underestimated) value of water infrastructure (storage, treatment and distribution). World Water Day is also meant to deepen people’s appreciation of the natural hydrological cycle, which is perhaps the most important service provided by our ecosystem, and to encourage corresponding steps to protect our environment. And, finally, World Water Day also seeks to ascribe value to the sociocultural aspect of water as a source of recreation and spirituality and as an intrinsic part of every culture the world over, because water – the wellspring of life – is more than just a resource solely for consumption.

 

Water is growing scarce | Business as usual is becoming problematic

Water stress in 2040 based on estimated ratio of withdrawals to supply

Sources: World Resources Institute, Kaiser Partner Privatbank

 

The question of what the fair (economic) value of water is has no easy reply, in part because there’s no universal answer. Since water is becoming increasingly scarce, it justly ought to be getting more expensive. But the price of water seldom corresponds to its true value due to complex pricing regimes and inefficient markets. Water is a special commodity. At its sources where it originates, water has the nature of a public good that requires strict (environmental protection) regulation to preserve those sources. Canal, pipe and treatment systems turn water into a private good. The water business therefore cannot be left to the free market alone – the right regulatory framework is needed. In some very arid countries that are severely afflicted by a shortage of water, such as Australia for example, a market for trading water rights has taken root in recent decades, but political scandals involving overpriced water licenses and headlines about profit-greedy institutional investors have exposed the risks of putting a price tag on this scarce, vital resource. A water-rights market also came into existence in California some time ago, and futures contracts on California water prices, as measured by the Nasdaq Veles California Index, can now also be traded on the Chicago Mercantile Exchange since December of last year. However, the results after the first few weeks are disillusioning: few transactions have taken place on a daily basis thus far and trading volume has been correspondingly low.

Investing in water security and supply presents a sustainably valuable investment opportunity.

The blue trend: Barriers…

But seeing the big picture of water should be more important than knowing its (local) market prices, and that goes for investors as well. Alongside the aspects described above that give water a value from different perspectives, investing in water security and supply likewise presents a sustainably valuable investment opportunity. One of the most obvious ways to play water, at least in theory, is to invest in water infrastructure.

According to an OECD working paper, water insecurity (inadequate water supply and sanitation, flooding, and drought) causes economic harm amounting to around USD 500 billion per annum. Developing countries unquestionably have the biggest need (and thus the greatest potential) for investments in water. The OECD estimates that each dollar invested in water and sanitation services in those countries generates seven dollars in benefits. But even though a powerful economic incentive would thus exist, worldwide investments related to water are insufficient. For example, in order to reach the sixth UN Sustainable Development Goal, which includes ensuring access to safe, affordable drinking water for all people, around USD 1.7 trillion would have to be invested, three times more than is currently planned. There are a variety of reasons for this huge funding shortfall. Investments in water infrastructure, for instance, are generally very capital-intensive and have a long amortization period. At the same time, it is usually difficult to cover costs because water services are (or are required to be) provided at too low a price. The lack of suitable analytical tools and data for valuing complex water-related investments and the poor track record of such investments can scare off financiers. Last but not least, water projects are often too small and too tied to a specific context, which increases transaction costs and makes it hard to employ new, innovative financing models on a large scale. Financing water infrastructure is and remains an extraordinarily tough challenge. Initiatives like the annual Roundtable on Water Financing and the World Water Forum regularly try to foster the necessary dialogue between governments, financial institutions, businesses and civil society.

In a recent study conducted by Cerulli Associates, 90% said they expect demand for water-themed investments to expand over the next two years.

…and investment opportunities

Although there are some investment vehicles that enable access to water infrastructure projects, they are likely to remain a niche segment for the time being. But whoever would like to invest in the blue trend has other possibilities on hand. One popular (and well diversified) investment option is theme funds specialized in water-related assets. Several dozen such products currently exist on the market in Switzerland alone. They give investors an opportunity to invest in companies that provide technologies, products or services relating to the water value chain, enabling them to invest in a market that promises a great deal of innovation and growth. Even those who prefer to invest passively have an ever-increasing range of investment products to choose from. In a recent study conducted by consulting firm Cerulli Associates, 90% of the ETF issuers surveyed said they expect demand for water-themed investments to expand over the next two years. We are thus likely to see a corresponding increase in water-themed exchange-traded index funds.

 

A market for innovations | Water technologies augur growth

Number of water-related patents

Sources: OECD, Kaiser Partner Privatbank

 

Oliver Hackel, CFA Senior Investment Strategist

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