Here’s How the Drought Is Impacting Investment Markets
For those with a financial stake in water, drought can mean boom or bust, depending on the investment. And even without a specific market to trade water, there are numerous ways to invest in it – from buying land with water rights to stocks in water-dependent companies to municipal bonds.
Take Michael Burry, for instance, the hedge fund manager featured in the book and movie “The Big Short” who outsmarted the subprime housing market crash. The end of the movie includes the line: “Michael Burry is focusing all of his trading on one commodity: Water.”
“I believe that agricultural land, productive agricultural land with water on site, will be very valuable in the future,” he told Bloomberg in 2010. “And I’ve put a good amount of money into that.”
Burry further elaborated in a 2015 interview with New York magazinewhen he said, “What became clear to me is that food is the way to invest in water. That is, grow food in water-rich areas and transport it for sale in water-poor areas.”
This idea has driven a lot of investments in California over the years, but is coming under greater scrutiny as drought lingers into a sixth year and climate change is expected to make the state’s water budget even tighter in coming decades.
One of the hottest investments in California in recent years is the almond business. In the late 1990s, the industry was shipping less than 600 million pounds (270m kg) a year. Since 2012 (and despite California’s drought), it’s shipping more than 1.8 million pounds a year – most of that to overseas buyers.
While California has many family farmers growing almonds, it’s caught the eye of big investors, too. One of them is the retirement and investment firmTIAA (formerly TIAA–CREF), which owns 37,000 acres (150 sq km) of farmland in the state, and claims to be one of the top five biggest almond producers in the world.
“We see agriculture, and farmland in particular, as more than a diversification opportunity and a hedge against rising prices,” the firmreported on its website in 2013. “In 2011, we produced more than 18 million pounds of almonds, enough to circle the world more than nine times.”
If you have water rights, almonds aren’t the only cash crop. At the beginning of 2016, the Saudi company Almarai bought nearly 2,000 acres near Blythe, California, in Riverside County to grow alfalfa that will be shipped back to Saudi Arabia to feed dairy cows.
And of course, in California there are always grapes. Harvard Management Group, which invests Harvard University’s $36 billion endowment, made land purchases made in 2012 to 2014 on California’s Central Coast. Somespeculated it was after the wine market, but others believed it was only investing in the water rights themselves, which could be worth more in the future if water continues to become scarcer.
From a business perspective it may seem like a win to grab agricultural land with water rights in California with a current shortage and more predicted in the future. But companies cashing in on water scarcity aren’t always viewed favorably among the public – and that extends beyond the water rights issue to other business investments in water. Remember when Nestle was slammed for bottling water piped from public land (with an expired permit) during California’s drought?
Water is not just an economic resources; it’s also a natural resource and a necessity for life.
“A lot of water risk is really related to the social license to operate and the reputational risk,” said Monika Freyman, director of the water program atCeres, which advocates for sustainability leadership. “Investment in water isn’t necessarily a good thing – you may be either investing in a poor water solution or you may be actually investing in a region where there is high competition for water. If that water is not necessarily stewarded well, you’re walking into a hornet’s nest of taking water away from other users.”
That’s why E.J. Reinoso, CEO of the investment firm Castleton Partners, advocates for investing in municipal bonds, which are sold to finance myriad public projects, such as highways, libraries, schools, power and water projects.
“You are investing in a security that, by definition, is already achieving funding the public good,” said Reinoso. A growing interest in the investment world is “impact investing” where money is invested with the hope of increasing environmental or social good, and Reinoso said that municipal bonds for water projects should be considered in this category, although there is not yet an official way to verify them as such.
Municipal bonds, however, may not be wholly without controversy either. “A critical piece of any bond deal we look at is the essentiality of the project,” said Kevin Lehman of Breckinridge Capital Advisors. “If it is a contentious thing that maybe half the community is opposed to, all else being equal, that’s not something we like to see in a bond deal. We look at local news stories and voting results, and layer that qualitative on top of quantitative metrics.”
Lehman said he has seen a number of utilities with really good bond deals to fund large infrastructure projects that have helped diversify their water supply or make them more drought resilient. “We view that as a positive,” he said.
Municipal bonds are popular with high net worth individuals because the bonds are exempt from federal and state taxes. And they tend to be safe investments, according to Reinoso. But Lehman cautioned that things like California’s drought can change the landscape.
He has seen water utilities taking on significantly greater debt burdens because of the drought to fund needed infrastructure at the same time that revenue is decreasing because of conservation.
“The number one metric that we look at for a water utility is debt service coverage – how much revenue after they pay all their operating expenses are left over to pay for debt service,” he said. In the past, most California water utilities had good debt service coverage, but it is “deteriorating because of the drought and so they are becoming less self supportive of operations and have to issue more and more debt,” he explained.
California’s drought could be taking its toll on stocks in water companies as well. The investment site the Motley Fool explained, “Water utility stocks are particularly attractive because their core businesses are monopolies and they pay modest dividends.”
But California’s drought has impacted water companies who operate in the state, and the Motley Fool warned readers in October against American States Water and California Water Service, blaming mandatory water conservation requirements for reducing revenue and “drought challenges and the uncertainties surrounding rates.”
While drought may be on the radar of investors, the impact of climate change on water resources is still something most don’t think enough about. Concern from investors on that front “is still not there yet,” said Freyman.
And as water gets more expensive, which is the current trend, Lehman said that people profiting from it will become more controversial, and we will see more of a debate over the merits of privatization of water resources.