Making a splash

Demand for water is increasing rapidly, and legislation is being passed all over the world requiring substantial investment in improved water standards," said Denis Schmidli, head of product management for Pictet's water funds, listing two of the key drivers that make investing in water so attractive. In addition, investing in water has the unique attraction that "a water contract is usually a monopoly which lasts over at least 20 years," which is very unusual in any other kind of business and gives a great opportunity to get a long payback on investment.

Underlying these economic drivers is the fact that water is vital for the survival of any life form and is something that every human has to have. Governments all over the world have recognised that the supply of clean water is an essential basic to raising a country's quality of life by improving public health and lifting economic productivity. As a result, governments and companies are working hard to improve their water supplies despite increasing pressure on existing water resources, which is where the real challenges exist in the water business.

The world's population is steadily rising to all time highs, and at the same time increasing wealth has led people to change their lifestyles and eat more protein. This all means that demand for water in any one region is soaring and since water has usually been treated very wastefully for hundreds of years, there is a huge opportunity in investing in improving standards of both the treatment and delivery of water.

The real challenge is that there is plenty of water, but it is either salty or polluted, and so unfit for human consumption. Some 97 per cent of the world's water is seawater, and of the remaining three per cent, two per cent is frozen at the two poles. Of the remaining one per cent, three quarters of that is polluted (see freshwater chart below).

Infrastructure

"There is a real need for substantial infrastructure spending, just to keep up with the quality requirements of companies and consumers," said Schmidli. He illustrated his point with several examples of how many old urban water systems are falling apart.

"If you take the example of Glasgow, for every 100 litres pumped into the water system, only 60 get to the consumers. The rest leaks away so 40 per cent of the area's water is lost," he said. "Compared with these figures, Saudia Arabia looks very good, with an average loss of ‘only' around 30 per cent.

"Globally, water losses are estimated at 45 million cubic metres per day. So a 50 per cent fall in urban water losses for low and middle income countries would produce an extra 11 billion cubic metres of water each year, allowing the public supply of water to a further 130 million people and at the same time improving utility cash flow by $4 billion (Dh14 billion) per annum. The latter is the equivalent to funding 10 million new household water and sanitation connections per annum," he said.

Turning to Greater London, Schmidli pointed out a similar opportunity exists in supplying the requirement for refurbishment.

"About 35 per cent of the city's water currently leaks out of a system which has about 20,000 miles of pipes. Every five years, they replace about 1,100 miles of pipes, so that means that they will need 90 years to replace all the pipes. Of course, in actual fact they replace those parts of the networks that are highly used, so there is a tendency to leave large parts untouched. Therefore parts of the London water network are extremely old: 60 per cent of London's mains is 150 years old."

The business case for investing in water systems is that this wasteful situation cannot be tolerated very much longer and governments are requiring water companies to improve their systems. For example, the European Union has passed legislation to improve and maintain water quality across the Union, which will require a spend of 350 billion euros (Dh1,891 billion) within the time frame of 2006 to 2025.

Outsourcing

The United States is also planning a similar high level of renewal, with an expected capital spend of $500 billion to $900 billion. The US Environmental Protection Agency has passed legislation that requires monitoring to be increased, and the treatment of drinking water delivery to be improved.

"Different sorts of investment in infrastructure have been triggered by new legislation, which all adds up to requirements for increased investments," summed up Schmidli.

Traditional water supplies have been run by local governments, which usually have no particular interest in running a water system. The public sector offers little opportunity for business investment, but the obvious improvements available through outsourcing have allowed scores of private companies to take a serious interest in the water business, so allowing investors to follow them.

Cutting costs and enforcing performance targets have helped this trend. For example, in China the concept of private public partnerships, PPPs, in outsourcing water businesses has become popular.

"One factor driving this is that on average PPPs operate with less than 30 per cent the costs of a pure public supplier. In addition, since the government or regulator is in a client-customer relationship with the PPP, they can broaden the performance targets both in quality and quantity," said Schmidli.

The low cost of water to the final consumers remains a key aspect of the market, and is reinforced by the historic trend that water is sourced and distributed very locally.

"It is very expensive to move water far which is the big difference with crude oil. We do not have a global market for water. It is always a very local market," said Schmidli.

Outsourcing water supply requires very large figures and long term deals, combined with substantial growth prospects. "Worldwide, about 11 per cent of the world's population is being serviced by private water suppliers, and this market is expected to grow by 2015 to a level of 16 per cent," said Schmidli.

"Within that overall figure there are big differences around the world. In South East Asia, where 2 billion people live, about 12 per cent of the population (roughly 240 million people) get their water through private operators, and the number of 2015 is expected to grow to 19 per cent, which is 400 million people.

"In the Middle East and Africa, five per cent is being served by private operators at the moment, and that is expected to grow to nine per cent by 2015, almost double the present size of the market." (see map above)

Schmidli described how in such an operation, the investors often need to set up the infrastructure, which often includes laying a new pipe network up the best standards, but also includes finding technology suppliers in areas like cleaning of the water or power production which become an important part of the business picture. But having found the capital and done the set-up "the nice thing about this kind of outsourcing is that you usually end up with a contract for about 20 to 30 years, which is often servicing millions of people," said Schmidli.

Two recent examples of such outsourcing are the world's biggest water supply company, Veolia Environment, going into a substantial PPP in China in September 2007, where it partnered with Tianjin Shibei Water Company, a Chinese water group, to provide water for 3 million people with a cumulative value of 2.65 billion euros over 30 years. Another case was in April 2008 when Suez Environment, a very large French water company, bought a 15 per cent stake in Chongqing Water Group, which serves 8.4 million people, for 140 million euros.

Demographics

The growing population of the world, and the changing eating habits of a more wealthy and stable world population are driving demand for water to volumes never handled in the past.

"The 6.4 billion people in the world in 2005 is expected to grow to 9 billion people by 2050, and as they change their dietary expectations, demand for clean water is exploding because as people become more wealthy they tend to eat more meat, which needs up to six times more water than grain to produce," said Schmidli.

He pointed out that direct per capita consumption has doubled in the last 100 years, the total use of water has gone up nine times since 1900, and demand for water is increasing twice as fast as the world's population.

While a lifestyle of living off the land requires a certain amount of water, the more sophisticated life becomes, the more water is required, said Schmidli. For example, it takes about 50 litres of water to grow one orange. A kilo of flour needs 1,000 litres of water, but a kilo of meat needs 3,000 to 7,000 litres of water.

"Changing from grain based to meat based foods is forcing an exponential growth in need for water," he said.

"This makes agriculture a very important driver for the water business, particularly when you remember that agriculture consumes about 75 per cent of the world's fresh water, individual consumption is only five per cent and industrial use of 20 per cent," he said (see water consumption chart left).

Water is big business, and Swiss private bank Pictet has the world's largest fund focused on investing in the water business. Denis Schmidli, senior product manager for thematic funds at Pictet, explains why Pictet is so confident of the future of its 2.2 billion euro fund.

Profile

Pictet Water Fund

Total funds

The Pictet Water Fund has 2.2 billion euros under management, invested in quoted companies in the water business. This makes it the largest fund in water investment in publicly quoted equities.

Investment drivers

The fund's investment strategy is based on the four drivers of renewing infrastructure, the growth of outsourcing, demographics driving demand, and the high proportion of monopoly business.

"These four investment drivers give us in the long-run an above average growth expectation for the water space, compared to regular investment into world equities," said Denis Schmidli, head of product management for Pictet's water funds.

Investment universe

The Fund first looks at all companies that are working in water: water technology, supply, where we found a potential investment universe of 750 plus companies.

The Fund then applies a criteria of looking for companies that have over 20 per cent of their deals related to water, which knocks out companies like General Electric or Siemens or others that work in water, but it is not over 20 per cent of their business.

"We were then left with an investment universe of about 240 companies," said Schmidli.

Investment sectors

The potential investment universe splits into a biggest sector of 130 companies in water technology, (which is where you find all the desalination companies), 60 companies in water supply, a few in environmental services, and the rest in a range of businesses like water park managers, and a few in packaged and mineral waters.

By a large margin, the Fund invests in companies that develop water technology which they then supply to the operators. These technology companies are the largest numbers of stocks: desalination, membrane technology, development of water pipes, pumps, etc

Suppliers take 40 per cent of the fund, water technology takes 40 per cent, environmental services is around 15 per cent, mineral water companies around 4 per cent.

Geographical spread

The fund invested 60 per cent in North America, 33 per cent in Europe and a small element in Japan, and then the rest of the world. The fund is always fully invested which means the cast element is always less than three per cent.

Survey: Desalination

"Investment opportunities in desalination activities are still hard to find. Also it is still a very expensive process. Desalination will only become more interesting commercially when the price of water to the consumer increases," said Denis Schmidli, head of product management for Pictet's water funds.

An illustration of the way the cost of production is not passed onto the consumers by governments or others subsidising the process, was made clear by a worldwide survey of 260 cities with populations of over 500,000 people.

The survey showed a worldwide median water price of roughly $1 per cubic metre, but there were huge price variations. Copenhagen was the most expensive city for water, where a cubic metre of water costs more than $8.50, compared with Dubai at over $2, and Los Angeles and Ramallah at about $1. However, many cities charge very little or almost nothing for their water, such as Amman at less than $0.50 for a cubic metre, and Cork in Ireland where water is almost free (see water tariff chart below).

"As in the oil business, if the price of water goes up, and stays up, than the desalination may become commercially more interesting. The more the price the consumer pays which reflects the cost of production the more it makes sense to investment in private water desalination. Such investment is only possible if a private company gets a contract from the government," said Schmidli.