CLEAN WATER CRISIS

 
by Chris Mayer

Reprinted from Gary North's Reality Check newsletter, 6/29/06.



Clean water is quietly becoming one of the most critical resource issues
in the world economy...

Researchers at the Center for Strategic and International Studies predict
that by 2025 water will be the most grave resource problem in the global
economy. In many parts of the world, it is already an undeniable problem
of growing importance.

First, there is the issue of polluted water. This is already the biggest
cause of sickness and death in the world. Second, there is the problem of
getting it where it needs to be. Population growth has not followed the
location of water resources. The most obvious example is China, which has
more than 20% of the world's population and only 7% of its water. And a
good chunk of China's population is in the dry northern regions.

China is not alone in this. India is no better off. The southern city of
Chennai (once known as Madras) is a typical example. Technology companies
are setting up shop here and money is flowing in from abroad. This rapid
growth hides a festering problem below the surface prosperity. As the
Financial Times reports:

"Anyone who stands at the edge of Marina Beach and watches the stinking,
black and lifeless water of the Cooum River befoul the blue-green sea at
the river mouth can hardly fail to notice that Chennai has a problem with
its water.

"Only a third of the city's waste is treated. The rest flows into the
rivers and to the sea. These polluted waters pose enormous health risks.
And Chennai is typical of Indian cities, and of cities in other emerging
markets."

The World Bank's recent report on India warned, "Unless dramatic changes
are made - and made soon - India will not have the cash to maintain and
build new infrastructure, nor the water required for the economy and its
people."

Today, we'll take a look at blue gold and the mounting crisis in water
resources, and specifically at what's happening in Peru. In miniature,
Peru shows all the growing pains of emerging markets. These are problems
confronted on a much bigger scale in China and India.

The ruins and relics of ancient civilizations riddle the lands of Peru,
once the heart of the magnificent Inca Empire. After the fall of the
empire, the country endured the heel of Spanish conquistadors and
centuries of Spanish rule. Since 1821, Peru has been an independent
country. Its abundant material riches, the goods of the earth, are what
sustained the Incas and attracted the Spaniards. Yet this mostly poor
country has never seemed able to harvest these bounties into a consistent
prosperity.

Peru is best thought of in three pieces. There are the dry coastal plains
in the west, providing a plentiful fishing area with the vast South
Pacific Ocean at its doorstep. Then there is the middle part of the
country - the jagged, ice-capped Andes, chockablock with minerals and
metals. Finally, there are the lush Amazonian lowland jungles in the east
- filled with copious amounts of fresh water.

And here is the problem. More than 70% of Peru's 28 million people live on
the narrow coastal plains in the west, the busy hub of Peru's industry and
its export agriculture. The watershed flows east, where the Andes
mountains divert all rivers toward the Atlantic. (The growth of human
populations does not always follow Mother Nature's markers. And while
nature is kind in some ways, she is difficult in others. Earthquakes,
floods, landslides, occasional tsunamis and even mild volcanic activity
rack Peru.)

Nonetheless, the water issue seems to be nothing more than an engineering
problem. Simply move water from the wet east to the drier west. Yet
political toxins - namely, populist politics - poison the easy solutions.
The state owns and runs most of Peru's water system. Government investment
has severely lagged the growing and pressing need for water.

Lima, the capital city, is often threatened with water shortages and
rationing. About one-quarter of all Peruvians have no access to piped
water. About half have no access to sewage. These numbers are the worst in
Latin America - save for Bolivia.

The crisis here, as in many parts of the world, is reaching a breakpoint.
They need the investments in water infrastructure now. Estimates for Peru
range north of $4.5 billion. And that would bring it only to regional
standards.

It won't be easy in Peru. One reason is the hostile political climate. It
is election season. A controversial challenger has scored an early season
victory, ensuring a place in the runoff election in late May. His name is
Ollanta Humala, a 42-year-old former army officer. He is a populist
rabble-rouser in the spirit of the region's best rabble-rousers, like Hugo
Chavez of Venezuela and Evo Morales of Bolivia.

Humala's solutions are the same tired ones tried by dictator wannabes over
the years. Raise taxes - particularly on foreign mining and oil companies.
Nix existing trade pacts with the United States. Legalize coca, used in
the production of cocaine. Give the government greater reigns over
business. Haven't we seen this movie before?

Humala casts himself as a Robin Hood. His flag-waiving rhetoric has
rallied impoverished Peruvians to his cause. If Humala wins, then Peru too
falls to populist politics - joining Venezuela and Bolivia. Indeed, much
of South America can't seem to shake its neo-Marxist ghosts.

Heavy-handed policies in these countries could easily quell any economic
rebirth of South America. Investors will need to keep a close eye on these
developments.

These populists do not come out of the ground from nowhere. They grow in
seedbeds of frustration and poverty. Unfortunately, poverty is still
widespread in South America. Peru is no exception. For many, life is hard
there. Polls indicate 75% of Peruvians between the ages of 15-29 want to
emigrate - with popular choices being the United States, Chile and Spain.

This despite brisk economic growth in the last four years - better than 6%
by most estimates in 2005. Yet prosperity does not fall equally on the
shoulders of all people. And success by some Peruvians creates widening
gaps of wealth with others, cracking open fissures between the haves and
have-nots. The escaping gases of envy and resentment seep into the
political discourse.

Amid this political swirl, private companies are working on solving the
problems. Some places have already made great strides. Ten years ago, in
Colombia's two principal cities, for example, more than 1 million people
had no water access and most had only intermittent access. Today, 98% have
running water and 90% have sewage lines.

What happened? The government essentially hired private companies to run
the service. Yet it maintained a controlling stake in the business. This
brought world-class water technologies and managerial talent to Colombia's
water systems. The result paid off. The system ran efficiently. As Luis
Alberto Moreno, president of the Inter-American Development Bank, reports,
"The company now collects payment on 92% of its billings (up from 45% in
1995)." The system pays its own way.

Moreno also writes of "numerous instances of private ventures that are
successfully meeting people's drinking water and sanitation needs. In
Brazil, 63 concessions serve 7 million people in medium and small
municipalities." Other large cities in Honduras and Ecuador "rely on
private water providers under a variety of contract and concession
models."

This is the same way many airports, marine ports and toll roads operate.
Perhaps a similar system of concessions will play a role in Peru.
According to The Economist: "The government wants to offer private
investors long-term contracts, known as concessions, to operate some of
the country's 45 water and sewerage companies." The problem is that such
an idea is a hard sell politically.

The outcome of the Peruvian elections will surely have some impact on the
debate. Then again, the crisis is becoming so acute that Peru, as with
most governments, won't have a choice.

Getting clean water to growing populations - that is the nut that has to
be cracked. Whether you're building a new suburb in the States or piping
water through the Andes, there is a tremendous amount of build-out
required.

The construction of these waste and water systems means that companies
providing the tools and building blocks have a long bull market ahead of
them. The wind is fully in their sails. One interesting sector to look at
is the pump industry.

There are more ways to use these pumps than there are ways of eating an
Oreo cookie. In fact, there are so many applications it is hard to give
them justice in a small amount of space. Critically, water systems all use
these pumps. Pumping stations and a variety of aboveground and belowground
systems use them to provide water services.

The pump market is a $27 billion industry, expected to grow to $31 billion
by 2007. As Stephen Hoffmann of U.S. Water News, says: "While these
estimates include a number of other industrial applications within the
chemical and energy industries, for example, it is safe to say that the
market for the enormous range of pumps in the water industry is at least a
multibillion-dollar market and growing."

The industry is highly fragmented, filled with lots of little and big
fish. The defining trend lately has been for the big fish to swallow up
the little ones.

The boom in infrastructure has set off something of a scramble for
companies with product and know-how in this business. There is a big need
for global and full-service providers, which is driving the industry to
consolidate around fewer - but larger and more capable - companies.

Beyond the drive for building water infrastructure, a number of other
factors also propel the industry. For example, new regulations require
landfills process leachtate - the contaminated fluid produced in
landfills. This requires the installation of systems that collect and pump
this stuff so it doesn't seep into your groundwater.

The drive for water filtration in residential and commercial properties
has also created a boom in specific kinds of pumps, used in the process of
purifying drinking water.

And in developing markets, including India and China - and Peru - pumps
are needed for building water and wastewater systems. As Hoffmann says,
"China and India will show the most rapid gains based on ongoing
industrialization and increasing fixed investment. China, for example, is
expected to be the fastest growing market for pumps, with an estimated
growth rate twice that of the total market."

The result of all this consolidation is that only a few major publicly
traded independents remain. If you're thinking like an investor, your ears
should have perked up by now. Here, in the table titled "Last Pumps
Standing," is a look at three major independent pump companies:

Pumps and pumping systems are the heart of the world's infrastructure. If
not the heart, the pump industry must be close - like the liver or lungs.
It is amazing the full range of activities these companies perform.

Hurricane Katrina relief efforts used pumps in draining New Orleans. The
largest pumps can move 40,000 gallons of water per minute!

Pump companies also tie into the energy market. The extraction of crude
oil from the tar sands of Canada uses pumps. And relief efforts in
Afghanistan and Iraq use pumps to provide for the distribution of water.
All this only scratches the surface of pumps' wide range of uses.

Beyond the independents, there are pump operations in diversified
manufacturers. Two interesting possibilities include Met-Pro Corp. and
Robbins & Myers. Both of these companies are showing strong earnings
growth and have good balance sheets. Both are too illiquid for me to
recommend in C&C.

The pump industry is a little-known corner of the market, buried in the
inky crevices overlooked by the big-money investors. However, it has not
escaped the attention of the pump consolidators - like ITT - who are
buying these things up. And it seems clear to me that the pump industry
should have a place in the sun for years to come.

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