Will water outperform as the outlook turns bitter?

Published January 14th, 2016

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Insight from Christopher Gasson, GWI publisher

It looks like the Federal Reserve’s decision to raise interest rates will not be the first step towards a world of higher interest rates. Instead, the rapid appreciation of the US dollar, assisted by a rush of capital out of emerging markets, $30 oil and China’s market turmoil have changed the outlook. The next interest rate move may be down rather than up.

It is an important point for water industry people. Water is a capital-heavy industry, and when the cost of capital starts to rise, so does the cost of water infrastructure.

China’s failing economic growth, Europe’s sluggishness, and the loss of confidence in emerging markets take us into a new world of economic uncertainty, in which low interest rates seem perhaps the only sure thing.

Actually, there is one other sure thing: the need for water. We are sitting in an industry in which demand for the product is almost immune from boom and bust economic cycles. It begs the following question: is this the moment for the water industry to outperform the rest of the global economy?

The answer obviously depends on where you sit in the water industry. Clearly if you are a utility operator, you can expect to hold on to revenues in a way that businesses which depend on more discretionary expenditure cannot. This does not hold much benefit for the large proportion of the private businesses involved in the water space, which are dependent on capital spending on water infrastructure rather than revenues from drinking water sales.

Back in 2009-10, the capex-dependent side of the water industry outperformed mainly because of the large amounts of stimulus money being injected into the infrastructure sector. That is not going to happen this time around, not least because of the high level of public sector indebtedness. Will private sector investment step in instead?

The threat of deflation and continuing low interest rates means that investors’ search for better yields is getting more intense. At the same time, governments around the world seem to be looking more seriously at ways to bring more private capital into the water sector. Emerging markets from Vietnam to Iran via Nigeria have decided that private finance is the solution. Even Japan and the US are beginning to open up to private money. The opportunity is there for water businesses which are currently tied to trends in capital investment in water to get a larger share of those beautifully steady water sales revenues.

The big obstacle is, however, currency risk. Private investors in water assets have very little comeback when they invest dollars in emerging market water assets, and then watch helplessly as the local currency in which they earn their revenues devalues. Addressing this challenge is one of the issues on the agenda at this year’s Global Water Summit in Abu Dhabi in April. We are bringing together the various bilateral and multilateral agencies which promote international investment in water infrastructure to help develop new approaches for risk management in water finance. Other issues on the agenda include opportunities in climate change adaptation, and how the water industry can help the oil industry to cope with $30 oil. I have a feeling that it is going to be a landmark event. In my experience it is when the global outlook looks least clear that we get the most value from getting together at the Global Water Summit. See you there: the early bird offer ends soon.