Water is so essential that its
shortage will impact the world in ways we cannot yet accurately predict. It
will affect countries differently, depending on context (geography, demography,
etc.) and the actions they take. For politicians, the peak oil crisis will seem
quaint in comparison.
This paper will seek to address
the economic consequences of the global water shortage. These are already being
witnessed and have led to financial innovation in the area of efficient water
consumption, some of which is analysed here. The hope is that these innovations
are a trickle, which turns into a stream that becomes a mighty river.
Go long on water
The Dow Jones Index (DJIA)
reached a new all-time high at the end of August 2014.[iii] However, its
impressive growth is put in context by that of the Dow Jones Water Index, which
contains water-related stocks only. In chart 1 below, the DJIA is in red and
the Dow Jones Water Index is in blue.
If we agree that stock market performance
is based on the accurate expectations of future earnings, chart 1 tells us that
we can reasonably expect water prices to rise dramatically in the near future.
This prediction even allows for a significant margin of error in the stock
price.
In fact, according to data
provided by the Bureau of Labour Statistics[iv], water prices have
been outpacing the general basket of consumer goods – the consumer price index
(CPI) - in the United States for at least 30 years. Figure 1 below shows cumulative
inflation of water against the CPI from 1984 to late 2013.
The graphs above probably only
indicate that water has been extremely under-valued until now. However, the justifiable
argument that water needs to be priced better needs to be balanced with the
equally justifiable “water is a human right” argument: A change of thinking is
called for.
An extremely liquid asset
The return on US Treasury bonds
has traditionally been used as a measure of the risk free interest rate. “Risk
free” is not to be taken too literally here. The American government has
defaulted on its debts at least twice[v] but the idea serves
to promote confidence in the financial system. Besides, the risk associated with these bonds is generally negligible.
In the highly unlikely event that
the US Treasury disappears along with the risk free rate tomorrow, we can be
certain of one thing: everyone will still require water. That is literally a
“risk free” assumption. Taking this into account, might risk free water bonds
offer a solution?
On August 26th of this
year, the city of Detroit sold slightly under $2 billion in bonds tied to their
water and sewer system[vi]. A city whose debt
is classified as junk[vii], has now issued
water bonds which currently allow the city to refinance at a 10-year rate of
3.24%[viii] - less than 1% above the yield for so-called risk free government bonds for the same period.[ix]
This is a more sensible solution
from a societal standpoint than the profiteering from water that seems
inevitable on the stock market. In theory, the demand for a true risk free return could push the
yield on these bonds to below that of a treasury bond with the same time to
maturity (although given how bad we have been at valuing water until now, it
may take a while).
Detroit aims to save $11.4
million a year from the initiative as well as raise $150 million to update the
city’s sewerage system.[x] It is hardly going
to provide a panacea for Detroit or the water crisis, but the adoption of a new
mindset is encouraging.
A
new mindset
It is reasonable to suggest that
businesses should pay more for water than consumers. One company in Canada was
able to bottle 265 million litres of fresh water and pay nothing.[xi].It’s easy in cases
like this to point a finger at corporations but an antiquated way of thinking about the
value of water effectively gave the company a green light to do it.
Encouragingly, the same Canadian
state where this occurred will put into force a Water Sustainability Act in
2015 to ensure it doesn’t happen again.[xii] No doubt other
jurisdictions will follow suit: a growing consensus is emerging which recognizes that,
where water is concerned, people and companies have different consumer
surpluses.
Consumer surplus is the amount a
buyer is willing to pay for something less the amount the buyer ends up paying
for it. For companies, given their incomes next to the typical individual’s
income, this surplus has to be much more. On that basis alone, they should be
charged more.
Hopefully, the introduction of
taxes like these would provide an incentive to big business to innovate new,
more efficient ways of consuming water. The precedent of Australia’s water market
might provide a blueprint for how water is allocated to corporations.
This system operates much like
the carbon trading scheme, where companies trade carbon emissions permits;
Australia’s water market provides businesses with water entitlements beyond
which, if they wish to consume more water, they need to trade entitlements with
other businesses.
The Water Commission of Australia
estimated at the end of 2011 that turnover of entitlements amounted to AU$ 2.7
billion annually.[xiii] The system means
that the government can limit the quantity of water consumed on the macro
level, while a fair price is being paid on a micro level.
Conclusion
The economics surrounding water currently
make grim reading (unless you happen to own shares in the Dow Jones Water
Index). Economics teaches us that a shortage of anything with a demand causes
its price to rise. Clearly, this is the case for water in the midst a global
shortage.
Recognizing a problem is the first
step to finding a solution, however. The example set by both Detroit and
Australia, who are using financial tools to address their individual issues is
encouraging and offers a template for others to follow. Hopefully, these
represent just the start of the financial innovation that will emerge: water
futures markets are an undeveloped area, for example.
Water is above all a human issue
rather than a financial or economic one. Unfortunately, as with many global
issues, decision makers often only begin to really take notice of the human
perspective when they are confronted with the gravity of the economic
perspective. For all of our sakes, let’s trust that time is now.
[i]
Franklin, Benjamin (1746), “Poor Richard’s Almanack,” accessed 24/08/2014,
available online at: http://internet.savannah.chatham.k12.ga.us/schools/DeRenne/staff/gelagay/Shared%20Documents/The%20Hobbit%20Plans-Units%201-3/Poor_Richard's_Almanack_by_Franklin_Benjamin.pdf
[v] http://www.washingtonpost.com/opinions/americas-default-on-its-debt-is-inevitable/2013/10/10/1451d416-302c-11e3-bbed-a8a60c601153_story.html
[viii]
http://online.wsj.com/articles/bankrupt-detroit-sells-1-8-billion-in-new-water-and-sewer-bonds-1409092035
[ix] http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield
[x] http://www.bloomberg.com/news/2014-08-26/detroit-1-8-billion-water-bond-sale-said-to-set-initial-prices.html
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