Why water is energy, not an asset class | FT Alphaville

Why water is energy, not an asset class

On Thursday, the highly esteemed Willem Buiter, chief economist at Citigroup, declared boldly in a research note that water would soon become the next big thing when it comes to commodity asset classes.

As he envisioned:

I see fleets of water tankers (single-hulled!) and storage facilities that will dwarf those we currently have for oil, natural gas and LNG. I see new canal systems dug for water transportation, similar in ambition and scale to those currently in progress in China, linking the Yangtze River in the South to the Yellow River in the arid north.

But Reuters’ resident commodities guru, John Kemp, remains unconvinced.

While he acknowledges that trading firms have long dreamed about global markets in water — a dream that Enron momentarilly tried to propel into reality by buying a water utility in south-west England — there’s a reason why that dream died quickly, along with Enron. (And possibly also why Tank Girl bombed at the cinema.)

The reason: it’s hard to make a convincing argument that H2O really is a global commodity, let alone a tradable and investable asset.

As the columnist warned in a note on Friday (our emphasis):

Futurology is inherently dangerous. Forecasters predict continuation of existing trends and miss the disruptive technologies and turning points that remake the world.

Disruptive technologies and turning points are impossible to predict precisely because they are so unexpected and revolutionary. No one can know what the world will look like in 10 years let alone 25-30 years. Go back 25 or 30 years to 1981 or 1986 and the Soviet Union was still a superpower, Ronald Reagan and Margaret Thatcher were still fighting the unions, Paul Volcker was struggling to tame inflation, and the widespread take up of the internet was still 10-15 years into the future.

But it is a fair bet water will never be traded around the world in tankers and on futures exchanges. There will never an integrated global spot market in water let alone complex derivatives.

It does not have the right characteristics to be a global commodity let alone asset. For any plausible water price, the value-to-volume ratio would be too low to support an integrated global supply system.

There will not be an integrated global supply system for the same reason there is no global market in bread but there is in oil, copper and gold. It is not worth transporting loaves around the world by boat, plane and truck. Moreover, most of the value in water lies not in the commodity itself but the value added to it by various processes and services. The world has so much water it will never be in short supply at a global scale. There are literally oceans of the stuff as well as enormous amounts of brackish water underground. The value-added lies in extracting it, treating it to make it drinkable, extracting salt from sea water, transporting it to the place where it can be used conveniently, and disposing of dirty water to prevent the spread of disease.

So, because the ‘value’ in water is an add on, water can never really be treated as a commodity in its truest sense, says Kemp. Ultimately, there is not much extractable value in the water itself.

If there is money to be made it’s by providing water services, the same way it is attractive to provide power and gas transmission services.

Water is a ‘good’, not an asset.

That said, he says Buiter does make a fair case when he suggests that you can apply property rights to the resource. Its use by one person does after all preclude the use by another. It’s also fair, he says, to dispose of the argument that water is some kind of moral or merit good that should be provided free to all, especially with so much inefficient use (take golf courses for example).

Nevertheless, one major stumbling block remains: it still takes energy to make water usable.

As Kemp notes:

At global scale, water is really an embedded form of energy (an “energy vector”) as some commentors on Thursday’s FT Alphaville blog explained. The commodity is not the water but the energy.

Which means there may be a future in investing in boring old water services and infrastructure companies, but dreams of water markets will and always will remain just dreams (at least, for as long as fossil fuels dominate).

Related links:
Willem Buiter thinks water will be bigger than oil – FT Alphaville
Investors start to tap the vital commodity
– FT
African land grab could lead to future water conflicts – New Scientist