Milken’s Global 2012 Conference Assesses Looming Water Crisis

Willow Bay, Moderator (Special Correspondent, Bloomberg Television; Senior Editor, Huffington Post): How close are we to a having a global water crisis? 

Jay Famiglietti (Professor and Director, UC Center for Hydrologic Modeling, University of California, Irvine): In my opinion we’re getting extremely close. In certain parts of the world, in particular the arid and semi-arid parts of the world, areas are drying out; access to water is going to be a huge problem for a big chunk of the world.

Evan Lovell (Founding Partner, Virgin Green Fund): For us, we look at everything through the lens of an investor and how do you make money in this. One of the big secular trends changing the face of water is that people live where water isn’t, so there are opportunities and emerging markets because of that. 

Agriculture is the single biggest user of water globally; energy is the second biggest user. It’s not just energy using water; it’s water using energy. Here in California, for example, 20 percent of all energy is used in the transportation of water. That is a significant aspect of energy use, and there’s a growing global backlog of critical infrastructure spending that needs to happen—some estimates now are up to $16 billion—required for critical infrastructure. That, in a post-recession environment, is creating an opportunity for private investors to step in where the public cannot operate to provide water solutions. 

The other big problem is that water is a fundamentally uncoordinated commodity; it tends to be very political. Water is not priced like oil or gas, and water is not priced like food-related commodities. We can turn our faucets, and it comes out, but very few people know what the actual cost of it is. Around the globe many people think that water is a God-given right and that it should be free. They don’t mind paying for their electricity and they don’t mind paying for their gasoline, but they do mind paying for water. That is both an opportunity and a potential risk, from an investor standpoint. 

David Beckman (Director of the Water Program and Senior Attorney, Natural Resources Defense Council): I think we are in crisis. The issue, however, about water to keep in mind is: what does it mean to be in a crisis? 

Water is local. We can look at regional, national, and global trends, but it’s fundamentally local. The critical thing is we have a number of people who are living or will be living in places that are water-scarce either because of the infrastructure or because of economic issues. Increasingly, people throughout this country—not only in the Southwest, LA, and other places that are familiar with drought—are going to be facing a water scarcity in ways that we can only imagine right now. 

Marc Nathanson (Chairman, Falcon Waterfree Technologies): I think if we focus only on water in the western states, including California, all the statistics clearly show we’re going to have drought for the next 20 years. This is not a problem that is going to get better or go away, at least as far as fresh water resources are concerned. Places that you think have plenty of water—Hawaii for example—may have a tremendous shortage of water. Let’s not confuse water with clean drinking water. There’s a big difference. 

Willow Bay: David Beckman, you’ve done some work that really takes us closer to home. 

David Beckman: NRDC with Tetra Tech, which is a consulting firm, took a look at water projections over the next 50 years. Modeling with 20th century assumptions of water and climate, they created the water risk index. Areas with a high degree of water risk are areas like the Southwest, Texas, and a little bit of Florida. A significant part of the country doesn’t have substantial water risk. 

A projection for 2050 using an ensemble of 16 different climate models, taking mid level emission assumptions, shows that 1000 US counties—a full third of the US—will have extreme water risk mid century. 

We looked at water risk using factors like susceptibility to drought and how much of the available groundwater is being pumped to get a sense of where we might see enhanced risk in the future. The thing that is kind of obvious is that it’s not just the West and it’s not just the South, it’s the East and around the Great Lakes. That has a lot to do with growth and some of the local issues that we’ve begun to touch on. 

Marc Nathanson: If the City of Los Angeles does what the City of San Francisco has done, which is to say that by 2017 every urinal in San Francisco has to be water free or low flush, then the other half of the water would be saved. Each urinal uses 40,000 gallons of water every year. There’s absolutely no reason to waste water in a urinal, yet in Los Angeles the Department of Water and Power will give you $500 right now as a rebate to change out your urinals. There are three or four manufacturers doing this. Very few companies are jumping on these rebates. It costs them nothing to change them, and each one save 40,000 gallons of water each year. 

David Beckman: There are two things that I observe all the time. One is we have “apparent abundance”—everybody in this room turned on the faucet this morning and it worked. You’ve got apparent abundance on the one hand, but then think about the cost. Water is basically “free”; it costs less than a third of a penny on average for a gallon. Apparent abundance and free don’t go with scarcity, and they create a culture and political economy that is not leading folks to think conservation is a good idea. 

Willow Bay: Marc, you have also suggested that the business community hasn’t exactly leapt on this issue. 

Marc Nathanson: Well, it’s not just the business community, and there are lots of exceptions. Government is so confusing on water and the regulations. The codes are done state by state, and often the codes are not created by water experts like we have on this panel but people like the unions. They are now becoming more enlightened, but they were more concerned about jobs in the past than they were about securing resources. 

I’m not just talking about states—I’m talking about the EPA. The Environmental Protection Agency, believe it or not, has a market on products that are called WaterSense. These are products that save water. So a company such as mine, that makes water-free urinals, may go to the EPA and ask for one of these labels. But because we don’t use any water, the EPA says, “oh no, you don’t save water—you don’t use water! Therefore we can let you use a ‘Water Sense’ label.” It doesn’t make sense to me. 

Willow Bay: Is there a way to channel growing awareness about our water crisis into better public policies - to get it front and center before policy makers? What’s an effective way to do just that?  

David Beckman: There are a couple of possibilities. The regulatory structure that creates the environment for investment is fragmented. Water at a quality level has a lot of EPA and Federal Clean Water Act involvement, but at a supply level it doesn’t. In fact, it’s mostly states and regions that control water supply. We need to get people interested and to channel that into some subset of rules that would make it easier for investment to occur. We need to send some price signals in appropriate ways and to create a framework. 

Evan Lovell: I also think there is industrial pressure that is going to happen. You can look today at what is called ‘produce water’ for the oil and gas industry and frack water. You read a lot about it; the New York Times has an article every other week about some of the problems with ground water. Whether there is an issue or not, whether it’s perception or not, there’s going to be an increased focus on regulating that. That’s going to create opportunities for companies providing solutions for the drilling companies to take care of their water, to treat their water when it comes out with the chemicals, to dispose of it in an environmentally friendly way, and even to provide them with water in areas that don’t have it. I think a lot of the issue is that, from an environmental and regulatory standpoint, while there are impediments to growth on one side, this can also create investment opportunities on the other. 

David Beckman: States can also play a big role. A couple years ago California passed a regulatory goal to reduce urban water consumption by 20 percent by 2020. That kind of a goal drives a lot of what the panel has discussed, whether it’s technology, involving utilities in conservation rate structures, or tiered rates that make you pay the more you use. 

Sacramento, the heart of a water-depleted area, will only start implementing water meters over the next few years. You don’t pay for what you use with water. Can you imagine going to the gas station, paying a dollar, and taking what you want? It’s unfathomable, but that’s how water has been treated. 

There should still be some free water because it’s a basic human need, but that’s different from irrigating an acre lawn. So higher rates drives a lot of the investment and technology that we’re talking about.

Willow Bay: From an investor standpoint, but also from a product development and business standpoint, how much does “uncertainty and a lack of a regulatory framework” limit investment in water?

Evan Lovell: Generally we try to avoid government like the plague in any of the businesses that we operate in. To give an example in the desalination area, we’re more focused on Texas and Florida right now where there is real industrial demand. The oil and gas guys are driving demand and the government is following them. We won’t touch California right now—the permitting process for a desalination plant could take 10 to 15 to 20 years, and that’s not really sustainable for our area. 

Willow Bay: In the overall area of clean tech investing, which is where water winds up, what is water’s slice of the pie? From what it sounds like, with all the limits and constraints, it’s pretty small.  

Evan Lovell: I forget the exact numbers, but last year it was probably 10-15 percent of the clean tech universe. I think of it as much more of an industrial area, not necessarily just a clean tech area. It’s growing, and the water industry tends to be very cyclical in terms of the growth in M & A. That’s an interesting area from an investing stand point. 

Over the last 20 years or so you’ve seen three or four cycles where large industrial conglomerates (the GEs and Siemens’ of the world) and global utilities looking to capture new growth have bought industrial operating companies. Then they tend to divest from those businesses, and those tend to trade out to private equity or get absorbed into smaller businesses. That’s a natural cycle that I think will occur again, and I think we’re just starting to reach that divestiture standpoint. So as investors it’s an interesting time to look for more middle market companies that are in this sector with the anticipation that at some stage you’ll be able to sell those out. 

I think the public market is very interested in the water sector. If you look at the public market water companies out there, they are either regulated utilities, they tend to have relatively low growth, they trade at high multiples, and then you tend to have cyclical capital equipment companies. New models for high margin, high growth businesses are coming out using new technologies or solutions, but there are not a lot of them that are out there. The ones that have garnered the most interest and the highest valuations over the last few years have focused on the consumer. They’re not necessarily the most interesting technologies, but they’ve focused on the consumer because I think there is a real interest on the street in providing these solutions that the consumer is adopting. We see a major trend away from bottled water and away from just the tap towards using technology that provides drinking water solutions that take care of quality and taste. 

Marc Nathanson: There will be more and more companies in the consumer area, and we’ll see even the big companies in these traditional areas invest more money in R & D. Companies like Niagara that only make water saving products for consumers, I think they will have a big growth factor in the future as more and more people become aware of these issues. 

Willow Bay: Is there a consensus on what fracking does to our water footprint? 

Evan Lovell: Just from the businesses we’ve looked at we can see that water will be used and transported in different ways. In places where they are drilling and there isn’t water available, they’re bringing it in using pipelines or trucks. I can’t speak to what that does to the ground water depletion, but it’s clear from over 100 businesses that we’ve looked at in the frack water produced area that it’s changing the face of how water is used in that industry.

David Beckman: For real reasons and for some that are still debated, water is probably the Achilles heel of fracking. Objectively, it uses a lot of water. You basically use a fire hose and shoot it at the rock to get the gases out, so water availability will be a big issue for fracking. 

The petrol contamination of ground water is a huge issue. A lot of the fracking is going on in places that are already water stressed and will likely become more so in the future. It’s a balance, and I imagine that if fracking will be used well into the future then it will become a lot more water efficient. 

Willow Bay: Isn’t this a place where technology should be able to help us out?

Evan Lovell: I think the big one on this is reuse and recycling. It makes no sense to bring new water in, use it, take the bad water out, and then bring new water in again. You can recycle and reuse that water very easily. It’s very efficient and can be done in a virtuous cycle. There are a lot of new technologies doing that, but it’s not an easy proposition. It’s not like one technology works for every shale plate. There are lots of different issues: water quality issues, different supply and demand for the local water, and there are different regulatory issues. As an investor, you really have to consider the various technology solutions. We haven’t made an investment there, but we’re looking at it actively. We just haven’t found the right dynamic quite yet. 

David Beckman: Fracking is a great example of what we were talking about earlier in terms of the big picture problem. What’s driving the concern isn’t water supply regulation, it’s the water quality side.