💧 Your Guide To Investing In Water, An Increasingly Scarce Commodity

Brief Background

Water is arguably the most important substance on earth. Although you and I don’t think twice about water insecurity, there are some areas where water scarcity is increasingly becoming an issue. Although the earth is mostly covered with water, only a tiny percentage is usable to us humans. Furthermore, although water treatment & filtration research & development has come a long way, meeting the increasing demand to sustain human populations, in addition to climate change effects, has proven to be more and more of a challenge, with effects already being seen in some parts of the world.

What Can It Do For You

🧺 Portfolio Diversification. As always, adding commodities to your portfolio can help diversify and lower risk. This also includes water. Bundling water with a number of other commodities to your portfolio can be a good way to diversify your portfolio since it acts differently to other asset classes.

💰 Profit. Everyone needs water, and demand for it will only increase as the world’s population increases. This will mean more water used for agriculture (including irrigation, livestock & aquaculture), industry, & domestic supply. Furthermore, in the long term, climate change can certainly have an impact on prices since rising temperatures could dry up fresh water sources. Last but not least, as emerging economies grow & modernise their infrastructure, the demand for fresh water & its associated industries (such as water equipment manufacturers) will certainly grow too. Of course, there will be other factors at play that can put a cap on prices, depending on which investment instrument you choose.

Price chart of the recently launched water futures contract.

What Affects Water Prices

Compared to other commodity markets, the water market is still relatively niche, with its futures market recently launched. Before this, the only way you could trade in water is to buy shares in diverse companies with activities related to water (not necessarily just clean water treatment & distribution), or ETFs that buys shares, which means it’s relatively hard to pinpoint exactly what drives water prices.That being said, here are several key factors that are involved in moving the price of water since they directly affect supply & demand dynamics at a large scale:

  • ☀️ Climate Change. Arguably the most pressing concern, climate change is leading to unpredictable & extreme weather conditions such as extreme drought to flooding, which leads to uncertainty regarding water availability.
  • 🗺️ Population Growth. As one might expect, when the world’s population grows, demand for food and water will also grow.
  • 🌾 Agricultural Demand. Further expanding on the point above, as demand for food increases, more crops & livestock will need to be produced to meet this demand, which will certainly increase water consumption.
  • 🌏 Emerging Market Demand. As emerging economies grow, demand for clean water will also grow as these countries improve & upgrade infrastructure to support an increasing population and/or growing wealth.
(Source: Food & Agriculture Organisation of the United Nations)

What Is It Used For?

Quite obviously, we know water is for drinking. But it’s also used in agriculture, public & domestic supplies, & in industry as well.

  • 🌾 Agriculture. This includes livestock, aquaculture for fish farming, & irrigation for crops. Apart from Europe, most of the world’s water consumption is for agriculture, as seen in the chart above.
  • 🏭 Industry. As the second largest consumer of fresh water, a variety of industries use water as part of their production process. This includes industries such as metals, chemicals, oil & gas, and more.
  • 🚰 Public & Domestic Supply. In third place, water is used for our domestic & public needs, like drinking, showering, doing laundry & dishes, etc. Also includes water systems in public places like offices, official city/government buildings, etc.
(Source: Food & Agriculture Organization of the United Nations)

The Case Against Water

You’re pretty limited with how you can invest in water. Even though there’s a recently launched futures contract for water, it’s still a pretty illiquid market. Realistically, you’ll have to either invest in ETFs, or shares in companies in the water industry. Furthermore, companies that directly offer water service will most likely be classified as utilities, which are regulated companies. This means that they will have rules & regulations on the prices they charge, potentially capping prices.

The Case For Water

For the long-term, global warming & climate change can certainly impact fresh water sources & could potentially restrict supply here. Furthermore, population and emerging market growth will mean increased demand for water, since this means more crops to grow and more livestock to sustain, all of which require water. With an increasing population, comes infrastructure challenges to be able to meet the demand. Upgrades in global infrastructure should benefit water equipment manufacturing companies.

Popular Ways To Invest In Water — Pros/Cons of Each

As mentioned above, the water future market has just been launched (December 2020) and is still relatively illiquid compared to other markets. So, you’re pretty limited in how you can invest in water. If you’re still confused about how any of these work, refer back to our basics newsletter for a refresher.

  • Water ETFs. You can invest in ETFs that invests in a number of companies involved in the water industry. This doesn’t necessarily mean they’re directly involved in water treatment & distribution (i.e. they could be involved in water equipment manufacturing, wastewater disposal, etc.). They’re traded on stock exchanges, so they’re very easy to buy and sell. Depending on which broker you go with, you may be charged with trading commissions. ETFs also charge an expense ratio, or management fee that gets taken out of their total holdings and is then reflected on your account. Whichever ETF you choose, be sure to know which companies they invest in, the percentage allocation, & as always, just be sure to read the fine print.
  • Water Stocks. A popular way for investors to get into the water market. These are companies that are involved in the water industry. You won’t have direct exposure to water prices since other factors will need to be taken into account, such as costs, products, revenue streams & competition. As always, whichever company you’d like to invest in, you may want to consider looking at the company’s annual reports (especially operational costs), the region they operate in, their competitors, dividends they offer, and any other activities they do.
  • Water Futures Contracts. A binding agreement traded on futures exchanges between two parties where they agree to buy/sell water at a specified time in the future with an agreed-upon price. Recently launched on December 2020, these futures contracts are financially settled based on the California Water Index (the water futures contract is based in the US) after the contracts have expired. The minimum contract size is 10 acre-feet of water, or about 3.26 million gallons of it! Since it is quite new, the market may still be in its early stages, lacking the liquidity required to be able to easily place trades. Furthermore, because you are using a significant amount of borrowed money, even small price changes in water can either lead to massive profit, or massive losses beyond what you paid for, potentially leaving you in massive debt. They are certainly high-risk and not recommended for beginners. Further, fees associated with futures trading include broker commissions, and exchange/clearing fees.

TL;DR — Is It The Right Investment For You?

As always, it depends on what your aims are. Water is a relatively niche market, mostly characterised by ETFs & shares of companies in the water industry, since its futures contract is still pretty nascent. Although you won’t have direct exposure to water prices, depending on the companies you choose, you are still able to enjoy dividends, and the potential for share prices to increase should water prices also rise. Furthermore, like other commodities, water can bundled up with a number of other commodities to diversify your portfolio since it acts differently with other asset classes. Everyone needs water, and demand for it is projected to increase due to an increasing world population, increasing demand from agriculture, industry & public & domestic supply, as well as supply constraints due to climate change.

🧺 If you are considering bundling up water with a number of other commodities to your existing portfolio, you may want to consider doing dollar-cost averaging (regular investments over time) to build your water position so you can take advantage of the volatility in the market.

💰 If you are considering adding water for speculation and profit, you may want to consider a longer term approach, as all factors that drive water prices are all large-scale measurements. That being said, demand for water will always exist, and will continue to grow as the world’s population grows. Whether you’re investing in shares of companies or ETFs that invests in shares of a bunch of different companies, always do your due diligence before committing to an investment decision.

As always, if you are unsure, check in with a professional financial advisor before making any moves.

Thank you for reading! Let us know if you found this helpful. You can connect with us @VNewsletters, or check out our website for more information @ vaultcomms.com.

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