Tuesday, February 9, 2016

Water Focused Hedge Funds: Liquid Assets or H2OhNo?

I think this will become our standard intro to water as an asset, originally used to introduce "A Look at the World's First Water-focused Hedge Fund" in 2014:
Since the first Earth Day in April 1970 and more importantly since the establishment of the EPA in December of that year, folks have been trying to make money out of water in the U.S..
Put simply, the returns have not been market-beating.

Because so much of the opportunity was my-little-crony stuff, at the whim of politicians, there was no consistency of growth at a time when other portfolio investments offered very competitive comparisons.
The alternative was to own the cash flow, private equity style, but unless one felt a passion for grit chambers and sludge pans it was pretty pedestrian, utility type ROI.

In fact the most reliable water investment in the U.S. has probably been York Water Company of York PA.
They've been paying dividends for 199 consecutive years and just announced their 575th divi.
The announcement carries the boilerplate "This release contains forward-looking statements"....
I won't use the 'Liquid Assets' schtick ever again, promise.

Just so you know where we stand on the meta-issue: The American West was called The Great American Desert for a reason and building cities in the desert is stupid.

Where this gets really interesting is when you throw a historical perspective on the current California drought:

-San Jose Mercury-News "California drought: Past dry periods have lasted more than 200 years, scientists say"

That little red blip at the far right side of the timeline is the current drought.
You could make a reasonable argument that for the last 150 years Californians have been living in a fool's paradise.
Here's another fund we looked at a year ago, this time at ProPublica, Feb. 9, 2015:

Liquid Assets
A maverick hedge fund manager thinks Wall Street is the answer to the water crisis in the West.
On a brisk, cloudless day last January, Disque Deane Jr. stepped out of his SUV, kicked his cowboy boots in the dirt, and looked around. He had driven two hours from Reno on one of the loneliest stretches of interstate in the United States to visit the Diamond S Ranch, just outside the town of Winnemucca, Nevada. Before him, open fields stretched all the way to the Santa Rosa mountains, 30 miles away. But the land was barren. The fields had been chewed down to the roots by cattle, and the ranch’s equipment had been stripped for parts. A steel trestle bridge lay pitched into the Humboldt River.

Surveying the dilapidated structures and the gopher-riddled soil, Deane saw something few others might: potential. The ranch and an adjoining property, totaling about 11,400 acres—14 times the size of Central Park—were for sale for $10.5 million, and he was thinking about buying them.

Deane is not a rancher or a farmer; he’s a hedge-fund manager who had flown in from New York City the previous night. And as he appraised the property, he was less interested in its crop or cattle potential than in a different source of wealth: the water running through its streams and coursing beneath its surface. This tract would come with the rights to large amounts of water from the region’s only major river, the Humboldt. Some of those rights were issued more than 150 years ago, which means they outrank almost all others in the state. Even if drought continues to force ranches and farms elsewhere in Nevada to cut back, the Diamond S will almost certainly get its fill.

Deane looks at the drought, the perennial mismanagement of water in the American West, and the region’s growing population, and believes a reckoning is coming. Rising demand and shrinking supply virtually guarantee that water’s value will increase. Anticipating that day, he’s racing to buy up as much of it as he can.
According to water investors, the West’s millions of acres of farmland account for less than 2 percent of the region’s economic 
output, and moving just 10 percent of the water off farms would likely resolve the region’s current water shortfalls
That the West had a limited supply of water was understood from the start. In 1869, John Wesley Powell ran a pioneering expedition down the region’s largest river, the Colorado. He eventually reported back to Congress that the West was an inhospitable desert split by that great gushing river, which was so difficult to access—cut off by cliffs and canyons and mountains—that its bounty was out of reach. Growing food in much of the West would be almost impossible. “Many droughts will occur,” he warned. “Many seasons in a long series will be fruitless.”

But the allure of all that land was irresistible. “The western half of the United States would sustain a population greater than that of our whole country today if the waters that now run to waste were saved and used for irrigation,” President Theodore Roosevelt declared in 1901. The next year, he signed the Reclamation Act, paving the way for the creation of the federal bureau charged with reshaping the western landscape.

Within a year, four federal dams and a major river-diversion project had been planned. In the ensuing decades, concrete barriers were erected across rivers from Montana to Mexico, magnificent canyons were flooded, and tunnels and canals were built to reroute water under the Continental Divide and across the Mojave and Sonoran Deserts. By the 1980s, the Colorado River had been turned into one of the world’s largest plumbing systems—a web of infrastructure designed to distribute the region’s water as widely as possible and encourage settlers to move west and take advantage of it.

It worked. Since 1960, tens of millions of people have migrated toward the Pacific, settling in Las Vegas and Tempe and Boulder. Denver has tripled in size. Phoenix, having added some 3.6 million people, has more than quintupled. Today, one in eight Americans depends on water from the Colorado River system, and about 15 percent of the nation’s crops are grown with it.

But the demands on the river were never sustainable. In 1922, the seven states in the Colorado River watershed signed a compact dividing its water. With little historical data, they calculated the river’s capacity after a decade of unusually wet conditions. In an average year, the river flows with less water than the states and Mexico—which was later promised its own share—count on taking out of it. Since the current drought began, in 2000, that shortfall has averaged 25 percent. Instead of adjusting their allotments, states have drawn down the nation’s largest reservoirs, which are quickly draining. Even this winter’s El NiƱo weather pattern won’t bring enough rain to restore the region’s supply, and federal officials are bracing for the possibility that Lake Mead, the largest reservoir in the U.S., could reach a record low as early as next year, which would trigger emergency rationing.

To determine who gets water and who doesn’t, states rely on a system that originated more than 150 years ago—when water was plentiful and people were scarce. During the Gold Rush, prospectors staked claims along western streams, only to find themselves robbed of the water they needed in order to mine as competitors upriver laid new claims and diverted the stream’s flow. The courts, hearing the miners’ grievances, settled on a system called “prior appropriation,” which promised rights to use a share of water based on who got there first.

Prior appropriation became the foundation of western water law, and it established order in the West. Today, though, state water laws are largely to blame for the crippling shortages. Because water rights were divvied up at a time when few cities existed west of the Mississippi, some 80 percent of the region’s water goes to farmers, leaving insufficient supplies for growing cities and industries. And farmers must put all their water to “beneficial use” or risk losing their allotment—a rule that was originally intended to prevent hoarding but that today can encourage waste. Many farmers have not adopted modern technology that can cut water use by up to 50 percent, in part because they need to protect their water rights.

Farmers might prefer to sell their extra water rather than letting it soak into the ground, but there, too, the laws get in the way. Not only is it difficult to prove that water sales satisfy standards for beneficial use, but they are generally forbidden across state lines. Where intrastate trades are allowed, they are conditioned on not causing harm to other rights holders in the surrounding area. That’s a laudable intention, but it forces farmers who want to sell their water to spend thousands of dollars on engineers and lawyers.

The West’s cities, meanwhile, are forecast to add at least another 10 million residents over the next three decades. Where the water to serve those people will come from is anyone’s guess. City and state leaders have seriously discussed building a pipeline from the Missouri River, seeding clouds with silver iodide to create rain, and towing icebergs from the Arctic. Their most pragmatic hopes lie in desalinating ocean water, an expensive and energy-intensive process.
Something has got to give.

In theory, states could step in and reallocate water according to modern economic priorities. After all, the West’s millions of acres of farmland account for less than 2 percent of the region’s economic output, and moving just 10 percent of the water off farms would likely resolve current shortfalls. Few things are more controversial in the West, though, than even minor meddling with water laws. Canceling or redistributing rights that are more than a century old would be political suicide in a part of the country where personal property is sacrosanct and farmers wield a lot of influence. As water shortages have slowly worsened over the past two decades, politicians have done little to avert the crisis.

Where government has failed, Deane believes capitalism offers an elegant solution. Allowing people to buy and sell water rights is a more expedient way to redistribute the West’s water, he argues. Waste would be discouraged, water would shift to where it’s needed most, and farmers would be compensated. He’s convinced that this is our best hope for ending the West’s water shortage—and that it could make him and his investors very, very rich....MUCH MORE
 Previously on the Water Asset Management fund (we got to use the boilerplate for the second time):
April 2015
A Look At A Second Water Focused Hedge Fund 

And on water in general:
August 2012
It's So Hard to Find a Decent Bet on Water (investment vehicles)
Water has confounded smarter people than me.

Enron's adventure in H2O is a cautionary tale, they bought Wessex Water in England, bought water concessions in Argentina and had a long term contract in Cancun.
Enron partially spun out the water sub, Azurix at $19.00. Within 18 months it was trading at $3.50 where Enron tendered for the 34% of the company that the public owned.

Not a very sweet deal for anyone involved. Water is tough business.
And, of course, Enron being Enron, they bid 100% more than any one else in the business to get the Argentina deal to have some big pre-IPO news.
From FT Alphaville:
In search of liquid water (investment vehicles) ...MORE
May 2013
Swiss Private Bank Pictet Making Money in the Water Biz (XYL; DHR)
July 2013
"Can Powdered Water Cure Droughts?"
October 2010
Muni's: "Water Scarcity a Bond Risk, Study Warns"

Always remember: "California: The Last 200 Years Were The Happy Time For Weather, Get Ready For A Return to The West Without Water".