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Wednesday, September 17, 2008

Water: An Ocean of Opportunity

The Dow is bouncing up and down like a yo-yo. Every chart looks like a ski slope. A few investors are profiting from these wild market mood swings, while others are seeking refuge in industries that feature non-discretionary items, like water.

Approximately 40% of the world population lacks adequate fresh water. In the next decade an estimated $800 billion is going to be spent globally to bring fresh water to those who don’t have it. With that kind of money flowing into a sector, you can bet now is the time to start paying attention to water.

Water stress is severe in China, India, and Africa, and it’s also rising in developed nations. Sure there are infrastructure issues, but one of the biggest problems is simply a lack of water. Most of the earth’s surface is water, but less than 3% is drinkable.

The world’s freshwater resources are not sufficient to keep up with demand. As the world population grows and water tables decline, a solution has to be developed. Right now, that solution is desalination.

Desalination (removing the salt from ocean water) is a technology that is gaining momentum as a practical solution to the global water shortage.

This isn’t some hippy green-energy pipe dream that’s 20 years away from having a meaningful impact on the world. The National Academy of Sciences declared, “Desalination is a realistic option for increasing water supplies.”



Desalination is viable. In fact, there are currently more than 1,200 desalination plants separating salt and water in the world. Many of them are in the Middle East, but they are also in Europe and Japan. There are even a few in the United States. Las Vegas and San Diego are preparing for an inevitable water shortage and are already considering building desalination plants.

Right now, about 99% of fresh water comes from rivers, lakes, and reservoirs. The other 1% comes from desalination. Desalination creates 11 billion gallons of drinkable water per day. That’s enough to fill 18,000 Olympic-sized swimming pools, but it’s still only 1% of water used in the world.

That’s all starting to change. The beauty of desalination is that there will never be any shortage of raw product. So expansion is only limited to the amount of infrastructure. There is currently a 45% increase in desalination capacity set to come on line in the next seven years. That’s an addition of five billion gallons per day.

With something as important as water and hundreds of billions of dollars up for grabs, you can bet a lot of big companies are chasing after it. In the past few years most of the companies developing desalination technology have been gobbled up by big conglomerates, but not all of them.

For instance, General Electric (GE) is heavily involved in desalination technology. In the last eight years, the conglomerate bought out many of the smaller players. GE has bought an expertise by picking up smaller players like membrane builder, Zenon Environmental. Other big companies like Veolia (VE), Dow Chemical (DOW) and DuPont (DD) have also been moving into desalination.

There a number of construction companies who have created a healthy niche building desalination plants. These include Spanish companies, Acciona (ACXIF.PK) and Abengoa (ABGOF.PK), Italian builders Impreglio (IPGOF.PK) and a South Korean company called Doosan (DOHIF.PK).

Although U.S.-based “pure plays” are not easy to find, there are some companies poised to do well from the desalination boom.

Energy Recovery (ERII) is a good example. It makes seawater desalination products. Energy Recovery is exploiting one of the major drawbacks of the desalination process, energy consumption. Its leading product is the PX Pressure Exchanger which is a specialized pump that recovers energy from the desalination processes.

Energy Recovery did $45 million in sales last year. It has a very healthy operating margin for a manufacturing company of 26% and its revenues are growing at a triple-digit rate. Most encouragingly, the company just signed a contract with China’s largest desalination plant, the Tianjin Dagang Plant. Tianjin Dagang will produce about 26 million gallons of water a day.

China is expected to spend about $200 billion on water infrastructure in the next decade. You can bet there will be plenty more desalination plants like Tianjin popping up.

Energy Recovery is proving to be a great example for the rest of us. It sees where the action is and has already started to make its move into one of the highest growth markets for water infrastructure in the world.

In sum, the world needs more drinkable water. China has $200 billion earmarked for it. The rest of the world has an additional $600 billion set aside to build the systems necessary to get water to consumers. Global spending on desalination is set to more than double in four years.

Most importantly and what has attracted our attention at the Prosperity Dispatch, more water is a need. Traders and pundits can speculate all day which bank the Fed will bail out next, but they’ll never know for sure. When it comes to water, we pretty much know governments will spend any amount necessary.

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