Milken Panel: The Economics of Worldwide Water

Jonathan Greenblatt, Lecturer, Anderson School of Management, University of California, Los Angeles: Why is this issue so important? As many of you likely know, there is a huge gap between the availability of clean water and the needs of the people on the planet. There are 1 billion people who lack clean drinking water, and about 2.5 billion who lack sanitation. That is challenging and maybe a little bit arresting, but most don't realize that only 2.45 percent of the water on the planet is freshwater. Of that 2.5 percent, only 30 percent is available in groundwater. The consumption needs of the 6.7 billion people on the planet are challenged by the lack of access to water.

The way that water is used is part of the problem as well. Most people don't realize that most of the fresh water resources are available to us today are consumed not by individuals or at the household level, but instead by agriculture and industry. This precipitates massive challenges....As water availability diminishes, it creates strains as populations move to accommodate their water needs, bringing with them infectious disease, political risk, and all kinds of social and economic challenges.

Energy bears some discussion because the nexus between energy and water is profound and will only increase as we look to new sources to alleviate the strain that we face vis-à-vis climate change, nuclear, and other sources.

For may of these reasons, many see water as an attractive and important investment opportunity. Water investments have outperformed global stock indices over the past ten years. There are investment opportunities along the cycle, thinking that the water we drink today has been around for millions and millions of years; it's a limited supply.

Overall, according to experts, it is about a $500 billion market. The size of this is really something to behold, and there are a lot of opportunities across that spectrum. Money will continue to be driven by this water/energy nexus because the production of energy requires massive amounts of water. How we do a better job of maximizing the water at hand will be a very important issue going forward...

It is worth noting that the Milken Institute, which does so much work on so many issues has been focusing on water for some time. The have done some very meaningful work specifically in the Middle East. They work in Israel around financial innovations and river restoration. They also look at financial facilities for fresh water revitalization, with an emphasis on the Middle East and trans-boundary issues. This exemplifies why water is so important...

David Henderson, Founder and Managing Director, XPV Capital Corp.: There is a lot of transition and change happening in the water industry, which is very important from a private equity standpoint. Our whole strategy is economic base. We are not based on regulations; we're not based on environmental good. Our strategy shows that the economics and water are the reason why this is going to change.

There are three big demand drivers. It is the convergence of these three together that make it so dramatic. You'll hear stats like, "Water is growing at two times the population." It is really the combination of urbanization-when people move to cities, we have two issues: one, we consume more water; two we have much more complex water issues.

The second one is industrialization, which is probably the most important one and the least looked at. That is, what happens when a nation industrializes? Two big things happen. One, people change their eating habits. They move from vegetarian-based diets to meat-based diets. And there are huge-30, 40 or 50-factor differences in the water consumed in a vegetarian diet versus a meat-based diet. A second one is what we consume. As we raise the standard of living, which is a wonderful thing for all the people in the world, we also raise the demand for freshwater because everything we consume uses fresh water, whether it is a pair of blue jeans at 2,000 gallons or a pair of shoes or the micro-chips in your phone or the cooling towers that cool this building. All of it consumes massive amounts of freshwater. As we industrialize this world, we build things that are pushing huge demands on freshwater.

You compound that on the supply side, which is looking at the infrastructure and climate change. I am not here to argue whether "the man" is behind climate change, but I can tell you it has had a dramatic effect on the hydrological system-how water moves around the world. Frankly, snowmelts are declining all over the world, and that is the biggest feeder into most rivers and most groundwater sources. Literally we are taking fresh water and transforming it into salty water. We are not losing that water, but it is going to become very expensive to move that water back.

The final one is infrastructure failure. This is particularly true in the developing nations, where we don't have the infrastructure. In the developed nations, we have infrastructure that is capacity and we have a distribution network that on average leaks 40 to 50 percent of the water. That is astounding if you think about it. In a modern or 19th century water system, which is what most of our systems are based on, we take huge amounts of water in, and then we take billions of dollars of energy, billions of dollars of chemicals, and all sorts of labor, to clean that water and send it out into a distribution network that then leaks. There are not too many industries in the world that could get away with that kind of loss.

We have started to see big trends. The economic impact of this is because you have a supply and demand imbalance. Whenever you have a growing demand and a limited and declining supply, economics start to kick in. The other thing that we found that is not so obvious is the input cost into water systems and water-driven processes is very important. Not only does the end value increase because you see water rates and the value of water increase in most parts of the world, and in some more dramatic in others, but the process itself. If you are an oil and gas company and you are extracting oil out of the ground, and suddenly water becomes a limiting factor on the oil you can extract, suddenly that process becomes extremely valuable....

Finally, there is a lot of data showing that this industry is going to double over the next ten years. At least $100 billion of that is new, innovative growth. We see conditions for what we do on the private equity, growth equity side. As a growth equity or a private equity investor this was one of our first "Ahas!" when we discovered this: we started analyzing the sector-looking at all the M&A and IPO-type transactions over the last ten or 15 years-and we discovered that over the last 15 years there really only were two big multinationals in this sector: the two French, Viola and Suez. Everyone else has recently moved in, like GE and Siemens. What they did when they moved in was a similar analysis, they saw a big trend, they typically take to a market aggressively-they acquire.

Where is the economic opportunity? This is very important. We started research and broke it down into five big areas: energy, bio-solids, chemical, productivity, and scarcity. These are the huge economic problems that water processes, especially mission-critical water processes, face. What we decided to do was break it down by actual application, whether it was municipal, industrial, commercial, agricultural, or residential. We started to see a pattern of areas that were very investable from the private equity side. We saw some areas that were so-so. There were some good things and some bad things about that application sector or challenge. And some areas just didn't make sense to make change in the future.

What we did is extracted this and developed five investment themes. The first one we call demand destruction, which is how you destroy the demand for water, chemicals, energy, and bio-solids in a mission-critical process without changing the output of that process. That is very important. So how do you make a pair of blue jeans without using the 2,000 gallons per pair and the 250 chemicals? How do you run a cooling tower with a lot less fresh water and without using the toxic chemicals to control the tower? How do you extract oil and gas out of the ground with a lot less water and lot less chemical additives? The idea here is to lessen these things without changing the output. There are incredible technologies that are addressing those processes, that reduce the water, chemicals, and energy in those processes.

Wastewater-to-product is one of my favorite ones. It means literally that we are transforming our wastewater stream, which we should change the name of it; frankly, it should be a "new water stream" or something like that. This where an industrial process or a municipal system will collect all its waste. Today we take huge amounts of energy and billions of dollars in chemicals to treat that wastewater discharge and send it back to the environment. What we are discovering is that there are huge amounts of value in wastewater. For every unit of energy that we use to destroy wastewater, there is ten units of energy you can extract, whether that is putting it into biofuels or different biogases. One of the world's largest deposits of phosphates is going to be the wastewater stream for the next 20-50 years. Also, you can extract glycerin.

We have seen technology that you can retrofit onto a wastewater stream-a highly organic stream-and goes through this process where out one end comes electricity, clean water, and hydrogen. Amazing technology. One of my favorite ones is one I just saw, where you can take high organics, put it through a process (they retrofit it on the system), and it creates a polymer that is almost the same as plastic that can be injected into plastic molding equipment and make all sorts of plastic devices. This is major stuff happening here, and this is happening today. This is not stuff that is going on in the future.

Water reuse is going to be bigger than desalination because it is always going to be much cheaper to clean the water close to its use than it will be to do something to it and ship it across a distance. The economics of pumping and shipping water are very challenging. You are going to see recycling in all parts of the water ecosystem, whether its recycling the water in the cooling tower in a hotel or recycling water off an industrial process for agriculture or landscape uses. How do we recharge aquifers? We are doing that in Orange County. There are a lot of technologies that you can move around the world when you look at Israel and Australia and the type of stuff they are doing.

Infrastructure renewal really comes down to this: most wastewater plants and treatment plants are at capacity and landlocked. Therefore you cannot build up. The New York Times ran a toxic water series that was amazing, talking about all the issues around wastewater. Now 20 minutes of rainfall will turn on the sewer overflow mechanism, which means we discharge wastewater directly into our lakes and rivers. Where do you expand New York's wastewater facilities? Now there is technology where you can extend the life of the pipes, extend the life of the plant. How do you expand capacity? How do you shrink it and make it more module? How do you distribute it? Because we are going to move to water reuse, we're going to move scalping plants up the chain. So, why don't we move technology into the basement of the building so we can recycle all that water, or how do we move closer to the use of that water?

Finally, we have to make it smart. IBM just entered the market this year. They are going to enable the devices in the water system to make it a smart system, which will bring huge energy savings and huge efficiencies.

Desalination is a very important technology, but it is not a silver bullet. It will be great for coastal cities and coastal use. The big challenge with desalination and modern technology is an energy problem. Fifty to 70 percent of your cost is going to energy. We know of two technologies that break that barrier, drop the energy use by 50 to 70 percent. That is a game-changing, disruptive technology. We are excited about getting into that early, because if you get your hands on that technology, I am not too sure you are going to see a commercial dollar before it gets bought. We have designed a private equity strategy that focuses on emerging trends.