The best way to invest in water

Clean water is quietly becoming one of the most critical resource issues in the world economy.

Researchers at the Center for Strategic and International Studies predict that by 2025 water will be the most grave resource problem in the global economy.

In many parts of the world, it is already an undeniable problem of growing importance.

First, there is the issue of polluted water. This is already the biggest cause of sickness and death in the world. Second, there is the problem of getting it where it needs to be.

Investing in water: the threat to China and India

Population growth has not followed the location of water resources. The most obvious example is China, which has more than 20% of the world's population and only 7% of its water. And a good chunk of China's population is in the dry northern regions.

China is not alone in this. India is no better off. The southern city of Chennai (once known as Madras) is a typical example. Technology companies are setting up shop here and money is flowing in from abroad. This rapid growth hides a festering problem below the surface prosperity. As the Financial Times reports:

"Anyone who stands at the edge of Marina Beach and watches the stinking, black and lifeless water of the Cooum River befoul the blue-green sea at the river mouth can hardly fail to notice that Chennai has a problem with its water.

"Only a third of the city's waste is treated. The rest flows into the rivers and to the sea. These polluted waters pose enormous health risks. And Chennai is typical of Indian cities, and of cities in other emerging markets."

The World Bank's recent report on India warned, "Unless dramatic changes are made - and made soon - India will not have the cash to maintain and build new infrastructure, nor the water required for the economy and its people."

Investing in water: Peru's problems with populism

Today, we'll take a look at blue gold and the mounting crisis in water resources, and specifically at what's happening in Peru. In miniature, Peru shows all the growing pains of emerging markets. These are problems confronted on a much bigger scale in China and India.

The ruins and relics of ancient civilisations riddle the lands of Peru, once the heart of the magnificent Inca Empire. After the fall of the empire, the country endured the heel of Spanish conquistadors and centuries of Spanish rule.

Since 1821, Peru has been an independent country. Its abundant material riches, the goods of the earth, are what sustained the Incas and attracted the Spaniards. Yet this mostly poor country has never seemed able to harvest these bounties into a consistent prosperity.

Peru is best thought of in three pieces. There are the dry coastal plains in the west, providing a plentiful fishing area with the vast South Pacific Ocean at its doorstep. Then there is the middle part of the country - the jagged, ice-capped Andes, chock-a-block with minerals and metals. Finally, there are the lush Amazonian lowland jungles in the east - filled with copious amounts of fresh water.

And here is the problem. More than 70% of Peru's 28 million people live on the narrow coastal plains in the west, the busy hub of Peru's industry and its export agriculture. The watershed flows east, where the Andes mountains divert all rivers toward the Atlantic. (The growth of human populations does not always follow Mother Nature's markers. And while nature is kind in some ways, she is difficult in others. Earthquakes, floods, landslides, occasional tsunamis and even mild volcanic activity rack Peru.)

Nonetheless, the water issue seems to be nothing more than an engineering problem. Simply move water from the wet east to the drier west. Yet political toxins - namely, populist politics - poison the easy solutions.

The state owns and runs most of Peru's water system. Government investment has severely lagged the growing and pressing need for water.

Lima, the capital city, is often threatened with water shortages and rationing. About one-quarter of all Peruvians have no access to piped water. About half have no access to sewage. These numbers are the worst in Latin America - save for Bolivia.

The crisis here, as in many parts of the world, is reaching a breakpoint. They need the investments in water infrastructure now. Estimates for Peru range north of $4.5 billion. And that would bring it only to regional standards.

It won't be easy in Peru. One reason is the hostile political climate. It is election season. A controversial challenger has scored an early season victory, ensuring a place in the runoff election in late May. His name is Ollanta Humala, a 42-year-old former army officer. He is a populist rabble-rouser in the spirit of the region's best rabble-rousers, like Hugo Chavez of Venezuela and Evo Morales of Bolivia.

Humala's solutions are the same tired ones tried by dictator wannabes over the years. Raise taxes - particularly on foreign mining and oil companies. Nix existing trade pacts with the United States. Legalize coca, used in the production of cocaine. Give the government greater reigns over business. Haven't we seen this movie before?

Humala casts himself as a Robin Hood. His flag-waiving rhetoric has rallied impoverished Peruvians to his cause. If Humala wins, then Peru too falls to populist politics - joining Venezuela and Bolivia. Indeed, much of South America can't seem to shake its neo-Marxist ghosts.

Heavy-handed policies in these countries could easily quell any economic rebirth of South America. Investors will need to keep a close eye on these developments.

These populists do not come out of the ground from nowhere. They grow in seedbeds of frustration and poverty. Unfortunately, poverty is still widespread in South America.

Peru is no exception. For many, life is hard there. Polls indicate 75% of Peruvians between the ages of 15-29 want to emigrate - with popular choices being the United States, Chile and Spain.

This despite brisk economic growth in the last four years - better than 6% by most estimates in 2005. Yet prosperity does not fall equally on the shoulders of all people. And success by some Peruvians creates widening gaps of wealth with others, cracking open fissures between the haves and have-nots. The escaping gases of envy and resentment seep into the political discourse.

Investing in water: South American success stories

Amid this political swirl, private companies are working on solving the problems. Some places have already made great strides. Ten years ago, in Colombia's two principal cities, for example, more than 1 million people had no water access and most had only intermittent access. Today, 98% have running water and 90% have sewage lines.

What happened? The government essentially hired private companies to run the service. Yet it maintained a controlling stake in the business. This brought world-class water technologies and managerial talent to Colombia's water systems. The result paid off. The system ran efficiently. As Luis Alberto Moreno, president of the Inter-American Development Bank, reports, "The company now collects payment on 92% of its billings (up from 45% in 1995)." The system pays its own way.

Moreno also writes of "numerous instances of private ventures that are successfully meeting people's drinking water and sanitation needs. In Brazil, 63 concessions serve 7 million people in medium and small municipalities." Other large cities in Honduras and Ecuador "rely on private water providers under a variety of contract and concession models."

This is the same way many airports, marine ports and toll roads operate. Perhaps a similar system of concessions will play a role in Peru. According to The Economist: "The government wants to offer private investors long-term contracts, known as concessions, to operate some of the country's 45 water and sewerage companies." But the problem is that such an idea is a hard sell politically.

The outcome of the Peruvian elections will surely have some impact on the debate. Then again, the crisis is becoming so acute that Peru, as with most governments, won't have a choice.

Investing in water: the sector you should be investigating

Getting clean water to growing populations - that is the nut that has to be cracked. Whether you're building a new suburb in the States or piping water through the Andes, there is a tremendous amount of build-out required.

The construction of these waste and water systems means that companies providing the tools and building blocks have a long bull market ahead of them. The wind is fully in their sails. One interesting sector to look at is the pump industry.

There are more ways to use these pumps than there are ways of eating an Oreo cookie. In fact, there are so many applications it is hard to give them justice in a small amount of space.

Critically, water systems all use these pumps. Pumping stations and a variety of aboveground and belowground systems use them to provide water services.

The pump market is a $27 billion industry, expected to grow to $31 billion by 2007. As Stephen Hoffmann of US Water News, says: "While these estimates include a number of other industrial applications within the chemical and energy industries, for example, it is safe to say that the market for the enormous range of pumps in the water industry is at least a multibillion-dollar market and growing."

The industry is highly fragmented, filled with lots of little and big fish. The defining trend lately has been for the big fish to swallow up the little ones.

The boom in infrastructure has set off something of a scramble for companies with product and know-how in this business. There is a big need for global and full-service providers, which is driving the industry to consolidate around fewer - but larger and more capable - companies.

Beyond the drive for building water infrastructure, a number of other factors also propel the industry. For example, new regulations require landfills process leachtate - the contaminated fluid produced in landfills. This requires the installation of systems that collect and pump this stuff so it doesn't seep into your groundwater.

The drive for water filtration in residential and commercial properties has also created a boom in specific kinds of pumps, used in the process of purifying drinking water.

And in developing markets, including India and China - and Peru - pumps are needed for building water and wastewater systems. As Hoffmann says, "China and India will show the most rapid gains based on ongoing industrialization and increasing fixed investment. China, for example, is expected to be the fastest growing market for pumps, with an estimated growth rate twice that of the total market."

The result of all this consolidation is that only a few major publicly traded independents remain. If you're thinking like an investor, your ears should have perked up by now.

Pumps and pumping systems are the heart of the world's infrastructure. If not the heart, the pump industry must be close - like the liver or lungs. It is amazing the full range of activities these companies perform.

Hurricane Katrina relief efforts used pumps in draining New Orleans. The largest pumps can move 40,000 gallons of water per minute!

Pump companies also tie into the energy market. The extraction of crude oil from the tar sands of Canada uses pumps. And relief efforts in Afghanistan and Iraq use pumps to provide for the distribution of water. All this only scratches the surface of pumps' wide range of uses.

The pump industry is a little-known corner of the market, buried in the inky crevices overlooked by the big-money investors. However, it has not escaped the attention of the pump consolidators - like ITT (ITT)- who are buying these things up. And it seems clear to me that the pump industry should have a place in the sun for years to come.

By Chris Mayer for The Daily Reckoning. You can read more fromChris and many others at www.dailyreckoning.co.uk.

Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr Mayer's essays have appeared in a wide variety of publications, including the Mises.org Daily Article series. He is the editor of 'Capital and Crisis' - formerly the US edition of the Fleet Street Letter.