Five Ways to Play a Global Water Crisis

02/11/2011 12:14 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Water shortages threaten hundreds of millions of people around the world. Believe it or not, there is a way to invest in this trend. Hint: Consider ripple effects.

China, the world's largest wheat producer, is facing a severe drought in areas of the North China Plain that account for 67% of the country's wheat crop. In the 2010 harvest, China's wheat production fell to 114.5 million tons from 115.1 million tons a year earlier. This year's harvest could drop by an additional four million tons.

This is a big deal because China is also the world's largest consumer of wheat and accounts for about 17% of global wheat consumption.

The government is working to provide additional irrigation to mitigate the drought.

In Western Australia, across the continent from Australia's worst floods, drought has put the wheat crop in the country’s largest wheat-producing state in doubt. The impact of the decade-long drought is intensified by a battle for Western Australia's scarce water supplies between farmers and miners. New mining projects totaling about $170 billion are on the books for the next five years. All those mines need water to help dig out and process ore, to remove waste rock, and to suppress dust. Mining is already the largest user of water, taking 27% of the licensed supply, compared with 22% for agriculture. Six years ago, the proportions were reversed, with farming getting 37% of water and mining 26%.

I think you can see where I'm going with this, right?

No, no, not more about the increasing global squeeze on food supplies. I've dealt with that quite enough recently, thank you. (See my posts here and here.)

A Difficult Trend to Invest in

This time I want to talk about water scarcity, the trend that everyone sees but that is so difficult to invest in. I'm going to give you some stocks for investing in water—but not my usual ten, because, as I said, this is a tricky trend for investors. And I'm going to suggest how finding investment opportunities in water can serve as a model for investing in other trends that are difficult to invest in, such as food.

Let's start with the basic problem. The world, on average, has plenty of water. But the supply locations, populations, pollution controls, incomes, and the very local nature of water make that average meaningless. According to the World Health Organization, in 2009, about 20% of the world's population lived in countries without enough water for their needs. The World Bank does the calculations in a different way, saying 80 countries now have water shortages that are sufficiently dire to threaten health and economic activity.

And the situation is getting worse. Growing populations; rapid urbanization that concentrates more people in less space and that often eats up farmland; rising and competing demands from farming and mining; increasing pollution of water supplies; and climate change that is exacerbating the severity and frequency of droughts will all stress water supplies even more in the future.

According to the U.N. Food and Agricultural Organization, by 2025, 1.8 billion people will live in countries or regions with absolute water scarcity, while two-thirds of the global population will be under what the agency calls water-stress conditions.

Human beings being what human beings are, all that stress is likely to lead to conflict. More than a dozen countries—including Botswana, Bulgaria, Cambodia, Congo, Gambia, Sudan, and Syria—get most of their water from rivers that flow across the borders of hostile neighbors.

The biggest potential problem, though, is in Asia. Both China and India face severe water shortages due to fast economic growth, rapid urbanization, and pollution. According to the World Bank, China could face a supply shortfall of 201 billion cubic meters of water by 2030 (that's about 53 trillion gallons).

Many rivers that supply the bulk of water to India, Cambodia, Vietnam, and other countries in the region have their source in mountainous areas inside China's borders. China has been rapidly constructing dams on many of those rivers, and the region does not yet have a mechanism for resolving conflicts over water supplies.

And, of course, because most of the world's water goes to agriculture—about 70%, according to the United Nations, with 22% to industry and 8% to domestic use—the current food crunch is going to raise tensions further. Nothing like being thirsty and hungry to make a country cranky.

NEXT: Learn to Draw Profits from the Global Water Shortage

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How Does the World Fix This Problem?

The first and most obvious answer: Increase supplies. The easiest, albeit very expensive, way to do this is to turn seawater into fresh water. It's easy because constructing a desalination plant is a well-understood engineering task. It's expensive because building a plant runs $2 billion or so and because it takes about 14 kilowatt-hours of electricity to produce 1,000 gallons of water.

If you're looking for a desalination stock, look at the big engineering and construction companies. My pick is Singapore's Keppel (OTC: KPELY) (KEP.SP in Singapore). Desalination is a key business for the company, and Keppel has good penetration in markets in the Middle East and Asia.

The second answer: Move water from where it's plentiful to where it's needed. That's a hard task over extremely long distances, but again, it's just an expensive engineering problem over short and medium distances. You'll need lots of pumps and valves to get the job done. My favorite pick here is Flowserve (NYSE: FLS).

The third answer: Use water more efficiently. Big US-style center-pivot irrigation systems are efficient if you're measuring them against the cost of having your crops dry up and blow away in a drought. My pick here is Lindsay (NYSE: LNN). (For more on Lindsay, a holding in my Jubak's Picks portfolio, see my original buy post here.) If you want a more efficient way to irrigate, drip methods get the nod. The biggest player there is Jain Irrigation Systems. Unfortunately, the stock currently trades only on exchanges in India and Luxembourg, as JI.IN and JAISE.LX, respectively.

Those three suggestions make up the simple answers. From here, you have to get creative to invest in water.

More Ways to Draw Profits from Scarce Water

The fourth answer: Change the economics of water. Much of the world's water supply—especially, most surprisingly, in the world's developed markets—is unpriced because it's unmetered. On the other hand, if you buy your water by the gallon from a water carrier in an underdeveloped economy, it is most certainly priced. I can't think of another scarce commodity for which the consumer doesn't pay more for using more. To change this, developed countries have to add more water meters. Two meter-makers that I like are Badger Meter (NYSE: BMI) and Itron (Nasdaq: ITRI).

The fifth answer: Invest in sectors in which the scarcity of water drives up prices of what that sector produces. The biggest of these is food. Fertilizers, from this point of view, become a secondary play on water shortages because farmers who have water when other farmers don't see rising revenue and rising incentives to increase production. Among fertilizer producers, I like potash producer Potash of Saskatchewan (NYSE: POT) and, even more, the diversified fertilizer producers Agrium (NYSE: AGU) and Yara International (OTC: YARIY).

It's that last point—my fifth answer—that I'd like you to keep in mind when you're scouting around not just for water investments, but also for investments in any sector that's tough to invest in. Scarcity and surpluses ripple out from their sources in one sector to change growth and profitability in other sectors. So water ripples out to food. Or rising aluminum prices ripple out from the aircraft and auto sectors into the carbon-fiber industry.

These secondary plays won't go up initially as fast as the more obvious thematic plays, but the fundamentals will eventually assert themselves in share prices.

At the time of publication, Jim Jubak did not own shares of any of the companies mentioned in this post in his personal portfolio. The mutual fund he manages, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. The fund did own shares of Agrium, CVH, Deere, Flowserve, Keppel, Lindsay, Syngenta, Vale, and Yara International as of the end of December. Find a full list of the stocks in the fund as of the end of December here.

Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.

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