From a macro perspective, we find theoretical discussions about the securitization of water to be compelling, but unrealistic. Prominent economists have opined that “water as an asset class will... become the single most important physical commodity, dwarfing oil, copper, agricultural commodities and precious metals within 25 to 30 years. They anticipate that once the spot markets for water are integrated, futures markets and other derivative water-based financial instruments…both exchange-traded and OTC will follow[1].”

We disagree. Most of water’s value is not in the commodity itself but in the value that’s added to it by a range of services and processes: extracting it, transporting it, disposing of it and making it drinkable. The value to volume economic ratio in water does not support a global marketplace, where, for example, the rights for excess water in Canada could be sold to thirsty households or farms in China. Water has no pricing signals that are transferable on a global basis. On a global scale, water is really an embedded form of energy; it’s been referred to as an ‘energy vector’ by some observers. It’s a mispriced commodity and it will remain that way, largely because of market structure. Water is not priced on a market where sellers meet buyers, like most other commodities. And we see no catalyst for this to happen.

Water is mispriced

We have no argument with the declarative statement that water is mispriced. However, that’s a different standard from suggesting that water is a tradable global asset. Moving meaningful quantities of water from one country to another is an implausible concept that would defy physical laws. To be blunt, securitized, tradable global water markets will not be part of a solution to localized water shortages. Trading water rights within a common watershed or basin, however, is a different story. Yet it takes time to develop a market, as well as clear mechanisms to ‘adjust’ the rights during times of severe droughts.

For example, Australia passed laws in 1994 that codified the ownership and transfer of water rights. Primarily focused on the Murray River basin, water rights values are estimated at $3.0 billion on an aggregate basis. Water rights in the U.S. are able to be bought and sold but building a comprehensive platform for open dealing is complicated by a byzantine existing structure of first rights (in Western states) and riparian rights (primarily east of the Mississippi River).

An interesting story in this regard involves the legendary T. Boone Pickens, whose company, Mesa Water, started buying water rights northeast of Lubbock and Amarillo, Texas more than 15 years ago. In 2002, Pickens was predicting that he could start selling water in three years to the Dallas metro area, as he sought to build a $3.0 billion pipeline than would span some 350 miles. Pickens ended up selling the rights to local authorities in 2011 for $500 per acre, which was reportedly half his asking price.

Aside from being an absolute requirement for human existence, water is an impossible-to-replace input for the production of food, energy and basic materials. Therefore, attempting to discover a global market price on something where there are no alternative options, no substitution or switching choices in any conceivable form, is a debate best left for academic economists. As such, investors seeking to profit from water scarcity should turn to mediums other than direct ownership of water.

A man cools off in a water sprinkler in a park during a hot summer morning in central Kiev Thomson Reuters

A sprinkler ban does not constitute a crisis in America.

While droughts, dry marinas and sprinkler bans receive an inordinate amount of attention, the standard of living for U.S. households is not being threatened by water scarcity. We would emphasize that it’s important to distinguish between U.S. households and businesses that are not involved in agriculture and those that are. We’re not suggesting that severe droughts in key Western U.S. farm states and California aren’t problematic, but as we’ve said, water is always a local issue and the U.S. has the proven capacity to manage these structural imbalances.

The United States uses less water today than it did in 1980. And this is on an absolute basis, not in per-capita terms. Water use in the United States peaked in 1980, at 440 billion gallons a day for all purposes. Twenty-five years later, (the latest United States Geological Survey is from 2005) the country was using 410 billion gallons per day. While the decline in U.S. manufacturing activity is certainly part of the story, legislation and conservation have had a meaningful impact. Power plants now reuse and recycle nearly all their water needs. U.S. farmers use 15% less water now than they did in 1980, while producing a harvest that’s 70% larger. There are also some impressive examples of conservation at the local level. For example, Las Vegas, which is the driest city in the country, uses 240 gallons of water per person, per day compared to 348 gallons per person in 1989.

A well written and readable book that touches upon this issue (and global water scarcity in general) is ‘The Big Thirst’ by Charles Fishman. On the subject of water and energy needs, Fishman notes that:

"Many current energy debates have focused on the massive carbon footprint of fossil fuels like oil, coal and natural gas. But many renewable sources of energy, like corn-based ethanol, have a huge and potentially troubling “water footprint.” Corn ethanol made from irrigated crops, for example, can use more than 1,000 times more water than oil refining, according to calculations by Sandia National Laboratory. Industrial concentrated solar arrays can require 800 gallons of water to produce a single megawatt hour....the collision of water, energy and climate change will reverberate through public policy decisions for decades to come, with unintended consequences at each step. Congress effectively encouraged a giant sucking sound from Midwestern aquifers and rivers by creating massive subsidies for corn ethanol. Concentrated solar projects, which have received “fast-track” authority from the Obama administration, may run into water problems before the first watts are generated. Citizen opposition to new coal-fired power plants in places like Nevada and Montana has focused as much on water concerns as greenhouse gas emissions."

The fact that 50% of the drinkable water in Florida currently is used for watering gardens and golf courses is only one striking example that the basic principles of conservation - reuse and recycling primarily - are just beginning to be followed.

James McKeough is a market analyst at Pavilion Global Markets