A Growing Water Crisis Creates Investment Opportunities in Agriculture

by Geoffrey Lutz and Jon Brorson, Mesirow Financial

Water is ubiquitous, the ultimate source for life and the most important commodity for human existence. No less importantly, water is a critical input for food. Yet only a small fraction of total global water – less than 1% – is usable for food production, due to salinity and glaciers¹. As a result, water represents one of the single most important determinants of the value of today's investment opportunities in food production and farmland.

Water Crisis

Although water is used, it is neither created nor destroyed, meaning that the total existing amount remains constant. That total must be shared by a global population that is expected to increase from 7 billion today to more than 9 billion by 2050, according to United Nations estimates. What's more, over the past 100 years, increases in water demand have outpaced overall population growth by a factor of two². In 1990, 10,000 cubic meters of fresh water was available for each person; by 2010 that amount had dropped to 7,770 cubic meters³.

An equally powerful related trend is increasing urbanization, which can lead to higher pollution in fresh water supplies from the byproducts of industrialization and development.⁴ Half of the word's population now lives in an urban area, and that fraction is expected to grow to over 60% in the next two decades.

By the year 2025, an estimated 1.8 billion people may face water scarcity⁵ as world demand for water is expected to exceed supply by approximately 40%⁶, By 2050, the excess demand may be as high as 140%, according to the consulting firm McKinsey.

Strong desire by populations worldwide for on-demand water has led to widespread over-allocation of existing supplies. Three of the world's major rivers, the Nile, Colorado and Yellow, are now so heavily utilized that they often do not reach the sea⁷. Aquifers and other ground water sources are also being depleted – most notably in areas where water is most critically needed⁸. What's more, as aquifer water levels drop, the quality of the remaining water can become compromised by natural substances – such as salt, arsenic and fluoride⁹ – that can harm crops.

While attempts have been made to manage water flow systems and aquifers, the knowledge to successfully counter a growing water crisis remains woefully insufficient, even in the world's most developed regions. In Australia, for example, where water withdrawal is monitored through sophisticated accounting systems, engineers have not been able to prevent net losses in the country's important Murray-Darling Basin¹⁰. Closer to home, the well known and heavily used Ogallala Aquifer in the Western United States faces inexorable rates of depletion¹¹. Urban effluent and desalination may add to fresh water supplies, but these efforts are expensive and the quantities produced are insignificant relative to demand, particularly in the context of agriculture¹².

Water and Food Production

Food production requires significant amounts of water, in some cases as much as 1,000 times the weight of food produced¹³. But that water is needed at specific points in the production cycle – too much or too little at any given time can be catastrophic. That delicate balance is often achieved through irrigation, which is vital to agriculture. China, where 70% of grain production depends on irrigation, exemplifies the emerging threat. Currently China is home to 21% of the world's population, but only 6% of the fresh water, and its water resources are expected to drop 10% in the next 20 years¹⁴. But China isn't alone. Almost half of all irrigated land in the world¹⁵ is located in Pakistan, India and China. As nations are beginning to become aware of the risks of restricted water supplies, aquifers and dams in rivers that cross political boundaries may represent significant sources of potential conflict¹⁶.

As water becomes an increasingly scare resource, its allocation will likely be based on the highest return from use. In most cases, the value of output per unit of water will be higher for a factory or energy producer than a food producer. As a result, agriculture's claim on fresh water supplies will often be subordinate to that from industry, as well as from human consumption, sanitation, environmental and navigation needs. In other words, Los Angeles will get water for residents, at the expense of the farmers in the Central Valley.

Agriculture Opportunities

As these current global trends accelerate, we expect several significant shifts in farmland values over time.

1. Agricultural regions with adequate fresh water to grow food should experience greater demand for these products from consumers in water-stressed areas. Given its low value-to-weight and -volume ratios, food distribution may represent the most profitable way of transporting water (in some form) from regions with adequate supplies to those without.
2. Irrigated properties with a politically secure source of water should increase in value relative to water -deficient areas that are accessible to industry and urban populations.
3. Regions with adequate and reliable rainfall should experience an even greater increase in demand than irrigation-dependent regions.

Currently, water may not be fully priced into land valuations. This relative mispricing represents significant agriculture investment opportunities in areas where rainfall is frequent and predictable, and where there are no other claims on water. However, the calculus is not simple. When attempting to exploit disparities between water-constrained and water-abundant properties, it is critical to consider water from multiple perspectives – including historical sources, variability, quality and the potential for future access – as well as a variety of other variables. These factors will vary widely, not only between continents, but also within regions and even between individual properties. For example, in many locations, water rights may be determined by the political process, or subject to sharing arrangements with neighboring properties, or completely separated from the surface rights of the property.

¹ U.S. Geological Survey, Where is Earth's Water Located?
² FAO, United Nations, Water News: water scarcity
³ Bloomberg, Peak Water: The Rise and Fall of Cheap, Clean H2O, February 6, 2012
⁴ United Nations, International Decade for Action "Water for Life" 2005 - 2015
⁵ National Geographic, Water: Our Thirsty World, April 2010
⁶ Financial Times, Earth Talks "in need of vision and direction", April 24, 2012
⁷ Bloomberg, ibid
⁸ FAO, United Nations, Water Report: Climate change, water and food security
⁹ U.S. Geological Survey/FAO, United Nations ibid
¹⁰ FAO, United Nations, ibid
¹¹ USDA, NRCS, 2012 Ogallala Aquifer Initiative
¹² U.S. Geological Survey
¹³ United Nations, World Water Day 2012 and Farm Journal, January 2012
¹⁴ FAO, United Nations, ibid
¹⁵ FAO, United Nations, ibid
¹⁶ University of Nebraska, Cornhusker Economics, May 9, 2012

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