The new oil

WATER:Control of the world's water supply is about to become very big business.

When Geoff Read, founder of the Ballygowan Company, appeared on the Late Late Show in the 1990s and said he was going to sell water, people laughed. Since then, a plethora of companies have made significant amounts of money selling bottled water in the developed world.

In fact, it's such a popular business that this summer, Ballygowan itself was sold by its most recent owners, C and C, along with the rest of its soft drinks business, to UK group Britvic for €249 million.

And while this might have been a high-profile deal in the world of bottled water, it is not the only type of water that is attracting the attention of the investment community.

"Everyone is pretty clear about the shortages of water worldwide, particularly in China and India, and this is having a positive effect on the valuations of water companies," says Richard Power, a Dublin-based fund manager who heads up Dolmen Securities' Green Effects Fund. "They are not overly expensive and pay good dividend yields."

While the Irish public may again laugh - according to Power there is very little appetite for such "boring" stocks amongst Irish retail investors - utilities, and water companies in particular, are attracting the attention of many pension fund managers.

According to one London-based utilities analyst, water companies are viewed as a long-term asset in the same way as an index-linked bond.

As a result of the strict regulatory environment, water companies in the UK are required to outline their capital expenditure in advance for a five-year period and must stick to their plans or face fines. This means that investors get a much clearer picture of what is going on internally than they do at some other companies.

Add to that the fact that they generally pay healthy dividends - yielding anywhere between 3.5 and 5 per cent, according to Dolmen's Power - and you have to wonder why everyone isn't investing in this commodity. You would have to wonder even more when you consider some of the assertions being made about the future of water.

Even the UN is viewing water as a valuable resource and has said that, during this century, so-called "blue gold" is destined to become as precious as oil was in the last.

After all, shortages previously seen only in the heart of Africa, Asia and the Middle East are now beginning to make an impact closer to home, with London's average rainfall falling below that of Nairobi, earlier this year.

Even closer to home, the issues surrounding the lack of clean drinking water in Galway have further highlighted the need for something to be done to secure the nation's fresh water supply.

"There's no doubt that the value of water in people's minds is much higher following the more severe weather conditions experienced over the past few years," says Regina Finn, previously head of market operations with the Irish telecommunications regulatory authority and now chief executive of Ofwat, the UK water regulator. "Last summer, we had a drought in London; this summer, we have had flooding. Everybody's awareness is raised that this is a valuable thing and that, from an economic point of view, it is something worth having."

While the predicted water shortages is bad news for the consumer, it is seen as good news for investors.

Unlike other commodities, water isn't traded on an exchange, but many utilities that provide water are. In addition, companies that are involved in water-related activities, such as desalinisation and transportation, are also becoming increasingly attractive, according to Eoin Kennedy, head of product development at New Ireland Assurance.

In fact, the increased popularity of water-related investments caused New Ireland to launch a special Water Fund last month.

Previously, water-related investments had made up part of New Ireland's Innovator fund, which focuses on alternative energy and emerging markets.

"Water has been very popular amongst the investment community for a while now and it is starting to filter through to other investors," says Kennedy.

He believes the events in Galway and debates about how Dublin is going to address the water shortages - anticipated if the city's population exceeds two million by 2015, as predicted - have proved a catalyst for increasing awareness of the importance of water.

As a result, he says many Irish investors are now looking to put their money into water-related investments, despite there actually being any opportunity to invest in the Irish water industry itself.

In its prospectus for the Water Fund, New Ireland says that the fundamentals for the global water industry are very strong. Last year, the fund, which invests in companies ranging from Southwest Water in the US to bio-Treat Technology in China and Veolia Environnement in France, grew by 17 per cent, compared to growth of 7.4 per cent in global equity markets.

"Water stress is increasingly affecting developed, as well as developing, economies. The combined factors of population growth, industrialisation and climate change will mean that the supply-demand fundamentals will continue to deteriorate," says Kennedy. "We believes that this provides an opportunity for investors to benefit from long-term cyclical growth."

For Kennedy, however, the value lies in investing not just in water companies themselves, but also in firms that service the water industry, such as technology companies. This may come as a relief, given the spate of consolidation seen in the European water sector recently, whereby the number of publicly-listed water companies in the UK has dwindled to just five.

However, the raft of takeover activity - Thames Water was last year bought out by Macquarie Bank for £8 billion (€11.6 billion), Osprey Acquisitions, which includes venture capital group 3i, took over AWG, the owner of Anglian Water, for £2.25 billion (€3.25 billion) and Royal Bank of Scotland Group has put Southern Water up for sale - is not all bad news. It has, in fact, helped to fuel share price rises and valuations as analysts and investors price in possible takeovers.

Mark Freshney, a utilities analyst at Credit Suisse, in London, believes there is still value to be had in the sector. "There is still some outperformance potential," he said in a research note published back in January. "The sector has had a strong run over the past five years. However, based on 2008 earnings, our analysis suggests that the market is still not heavily overvaluing stocks, except in the case of United Utilties."

And even with the extreme volatility seen in global markets recently, Freshney still believes the sector offers opportunities. "Given the upcoming flow of catalysts, we believe that there is further potential in the sector over coming months," he said in a note released last month.

Moreover, Freshney attributes the underperformance of one UK water company, Kelda, to a fall-off in takeover activity and says that the recent speculation surrounding the future of Southern Water may well help to boost Kelda's share price.

So why are these companies so attractive? The answer lies with pension funds, which need steady, reliable, long-term cash flows to match their liabilities.

As a result, they have pumped a lot of money into infrastructure funds because incomes at infrastructure companies are also steady and reliable, but a bit higher than the return that can be had from bonds.

With debt so cheap (despite the rises, interest rates are still at relatively low levels), buying a water company and gearing it up will net returns that look pretty attractive in the current environment.

Whilst, privately, many Irish investors have missed the bandwagon as far as investing in this type of stock is concerned, publicly they will be pleased to hear that the National Treasury Management Agency (NTMA), the group responsible for overseeing the management of the National Pensions Reserve Fund, has not.

According to the NTMA's annual report for 2006, it has investments in several UK and European water companies, including Kelda, Severn Trent, United Utilities, Penon and RWE. (Penon is currently Credit Suisse's preferred pick in the sector, while Citigroup believes Severn Trent is the most likely of the UK water companies to next receive a takeover approach.)

While investing in these companies is good news from a funding point of view, there is no doubting the fact that, in the future, there will be significant supply and demand issues. The real challenge going forward will be resource, says Ofwat's Finn, adding that we either need to develop more resource or learn to balance the demand.

This is where she believes the industry has been rather slow and where it now must rise to the challenge. "There are a lot of opportunities for innovation in this sector and it is a challenge we must rise to," she says, adding that this is where the regulator can help. "If you don't have competition, there is no need for innovation and companies don't feel the need to be creative. That is our job - to facilitate competition and hope it brings with it innovation."

So, while investing in the water industry may not sound quite as sexy as, say, the airline or retail sectors, there is no doubting its value is on the rise. There are plenty of analysts and investors who are already choosing the former over the latter options and if you yourself are interested, then the advice is to act quickly.

WATER IN NUMBERS

1%

Amount of the world's water currently fit for human consumption

97%

Percentage of earth's water that is saltwater

6%

Amount of world's fresh water that will originate in desalinisation facilities by 2015 (double the current amount)

2 billion

Number of people the UN estimates will lack sufficient water by 2050

2015

The year Dublin City Council predicts the city will experience water shortages if population grows as expected

€1.50

Average cost of a litre of water in a Dublin convenience store, compared to €1.16, the average cost of a litre of unleaded petrol in Ireland in September, according to the AA

42%

Amount of Dublin's water lost through leakages in mid-1990s

28%

Amount of Dublin's water lost to leakages today

35%

Annual return on the Bloomberg World Water Index every year since 2003 versus 10 per cent for the Standard & Poor's 500 Index

17%

The return seen on New Ireland's Water Fund in 2006 versus 7.4 per cent from global equity markets

75%

Percentage of America's water supply that is used on watering the grass

$150 billion

The amount of money committed to preserve water quality in the US over the next decade

'Whose water is it anyway?' - Joe Humpreys in Johannesburg

Rocky, mountainous Lesotho is one of the world's poorest countries. Spanning an area about a third of the size of Ireland, it has traditionally relied on indigenous farming and a small textile industry to make ends meet.

But close to 20 years ago, it realised it was sitting on a potential goldmine: not oil, or diamonds (although it has some of the latter), but water.

Since the first phase of a major dam-building project was completed in 1998, Lesotho has become the main supplier of water to South Africa's industrial heartland. Thousands of megalitres are pumped across the border each week to service the needs of up to nine million people in Johannesburg and neighbouring cities.

The project is the biggest of its type in Africa, and it is set to get bigger - with at least two other dams set for construction in the Lesotho highlands as demand for water rises in South Africa's expanding economy.

Not for nothing is water being called "the next oil". In southern Africa, as in other part of the world, water is rapidly becoming more scarce, and thus more highly-valued as a tradable commodity.

The World Health Organisation estimates that more than 1.5 billion people currently lack access to an adequate water supply. This figure is set to rise to 2.3 billion by 2025, raising the prospect of increased conflict over water resources.

The UN already cites lack of adequate water as a factor in dozens of conflicts around the world, including in the Darfur region. "It is no accident that the violence in Darfur erupted during the drought," said UN secretary general Ban Ki Moon. "For the first time in memory, there was no longer enough food and water for all. Fighting broke out."

Despite being known as the "blue planet", earth has a surprisingly small supply of usable water. Some 70 per cent of the planet is covered with water but less than 3 per cent of this is fit for human consumption - the equivalent of one tablespoon per gallon.

The remaining 97 per cent of the Earth's water is salt water, which cannot be used for drinking or agriculture without first undergoing an expensive desalination treatment.

Spotting a lucrative market in the area, several major multinational corporations have invested heavily in water purification and wastewater treatment in recent years. General Electric (GE), Siemens and Tyco are among the big players today in a global industry valued at over €200 billion.

Governments are increasingly turning towards such companies to help improve both the quantity and quality of water supplies. Public-private partnerships are in vogue in Ireland but the trend internationally is towards the privatisation of water - a hugely controversial phenomenon especially when it is accompanied by consumer charges for domestic households.

In South Africa, there have been growing protests about water charges since they were introduced on a phased basis in 2002.

Under the South African scheme, each household is guaranteed 6,000 litres of free water per month, but campaigners claim this is too little to meet basic needs.

The Anti-Privatisation Forum, a lobby group which holds near-weekly rallies in Soweto and other such townships, says people are forced to introduce radical water-conservation measures, like sharing baths or flushing the toilet just once or twice a day, because of the tariffs.

Other campaigners believe the water charges are undermining the health system, making it more difficult for people to prepare food and medication effectively. The United Nations Development Programme (UNDP) is also somewhat uneasy about water charges, arguing that "across the world, the poor are forced to pay much more for clean water than their affluent neighbours".

In its 2006 report, Beyond Scarcity: power, politics and the global water crisis, it notes that slum-dwellers in Nairobi pay five to 10 times more per litre of water than wealthy people living in the same city.

The contrast is even greater from an international perspective, with the poorest households of El Salvador, Nicaragua and Jamaica spending, on average, over 10 per cent of their income on water. In the UK, "spending more than 3 per cent of family income on water is considered an economic hardship", the UN agency comments. The organisation is now campaigning for access to clean water - and specifically 20 litres a day - to be recognised as a fundamental human right. It argues poor households should have access to a minimum amount of water for a very low price, or for no charge.

Industry may have a growing role to play in providing solutions to the water problem. GE, for example, recently announced an innovative "rainwater recycling scheme" to be unveiled at Beijing's National Stadium for the opening of the 2008 Olympic Games. According to GE, the scheme "will use underground pools that process up to 100 tons of rainwater per hour, 80 tons of which can be re-used for landscaping, fire-fighting and cleaning - a direct way to lower the stadium's water consumption".

Whether or not water is better utilised in future, there is a pressing need for increased supply today. The WHO estimates that at least 1.6 million people die each year from drinking contaminated water, and 90 per cent of these are children under five.

With rapid population growth, and possible negative effects from climate change, the situation is set to become even more critical. According to one UN estimate, global demand for clean water will increase by 20 per cent for agriculture, 50 per cent for industry and 80 per cent for domestic consumption by 2025.

Thoughts of countries going to war over water may, today, seem far-fetched. But tensions are already bubbling under the surface. Just ask the farmers of Lesotho's highlands who have seen their local rivers being diverted for a water-export programme at a time when the region has undergone some of the worst droughts in living memory. In Lesotho, as in other parched locations, the cry is getting louder: whose water is it anyway?