Investing in the Most Basic of Needs

 | Jul 03, 2014 | 1:37 PM EDT
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In keeping with my theme of the past two weeks of reviewing defensive investing strategies and investing in basic needs, I'm concluding this week with a review of the most basic of all investments: water.

I last wrote about water this past February in the column As Basic as Water, in which I discussed only one equity opportunity. 

In this column I'll expand that into five more equity issues that are dedicated to the space: Israel Chemicals (ISCHY), Consolidated Water (CWCO), California Water Service Group (CWT), American States Water Company (AWR), and American Water Works Company (AWK).

The first issue to note is that Veolia (VE) has done very well this year, up about 18%. The performance of the others is mixed, with American States and American Water up about the same as Veolia, while Israel Chemicals is sideways and Consolidated is down about 12%.

More importantly, however, the immediate and also longer-term fundamentals suggest the sector should perform well in the future regardless of general economic activity because there is a growing crisis concerning access to agricultural water in the US and potable (drinking) water in many parts of the world.

Specifically to the US, one of the issues that traditionally precludes speculators and even investors from participating in the water stocks is that the crises that have arisen in the past due to drought conditions that have prompted speculators and investors to move into the space have abruptly ended with rainfall, which replenishes the watershed and crushes these stocks in the process.

One of the issues this time though is that the drought in the west, (most notably in California), where 75% of all US agricultural water is consumed, is also where the primary building of residential properties has been over the past two decades. The urbanization of land areas that have traditionally been used for agriculture is an ongoing political and social issue, but once established, residential, commercial, and industrial water customers gain priority access to the watershed.

Between 80% and 90% of all water consumption in the US is for agricultural purposes and these traditional users are being hemmed in on one side by the perpetual encroachment of residential and commercial users and on the other by periodic droughts.

The two largest reservoirs, and feeders to others, in the west are, Lake Powell and Lake Mead.

These two reservoirs are the main suppliers of water from the Colorado River to the entire southwest, with Powell being the primary provider of water to the lower basin states of California, Nevada and Arizona, and Mead doing the same for the upper basin states of Colorado, New Mexico, Utah, and Wyoming, an area with about 40 million residents. Without the water supplied and directed by just these two reservoirs modern life would not be possible in this entire area.

Both reservoirs are at or near all-time record low levels and continuing to fall. Powell is at about 50% of capacity and Mead at about 40%. More importantly, inflows to them both are 50% below normal and also continuing to fall.

Low water levels are also causing problems for the production of electricity by way of Powell's Glen Canyon Dam and Mead's Hoover Dam. 

As these issues continue to mount, the people closest to them are becoming increasingly concerned that this time may indeed be different and that new rainfall or snowpack water that has traditionally replenished the reservoirs will no longer be enough to meet the growing need for the water produced by them.

This is leading to discussions about forming a futures market for water, which is the capital markets' way of recognizing that this is likely now a one-way bet, with water prices rising as the demand for it will now permanently outstrip the supply. 

Unlike with oil though, as the price rises there is no water shale to be invested in to either meet the new demand or counteract the reduction in traditional supplies.

The only way for investors to capture this is by way of investing in companies dedicated to creating technologies for conservation and making water use more efficient.

Besides the companies listed above, investors interested in participating in this area but not sure whether or not this time it really is different, two large diversified companies also have substantial water industry operations: Lockheed Martin (LMT), and General Electric (GE).

In either case, this is a sector that should perform well over the next several years and is excellent for long term investors, in my opinion. 

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