The future of the blue economy

People born in Europe have probably never had particular difficulties in obtaining water. In most of our homes, it’s possible to access an unlimited amount of drinking water by simply turning on a tap. We have an abundance of water not only for personal hygiene but even for washing our cars.

Not content with this, many choose to pay a little extra to consume water sourced from Alpine springs. This is a luxury that would be considered exclusive for other consumer goods but has become the norm when it comes to water, given its affordable cost.

Entire cities and urban areas have been built in arid regions, diverting rivers and constructing impressive infrastructure. In many of these places worldwide, water consumption happens without friction. In other words, in a significant part of the world, access to water is taken for granted, but how long can this situation last?

The water crisis

We need to ask the billions of people who, in recent years, have had to grapple with a water crisis that is already underway. It’s not just a problem confined to the driest areas of the planet: entire regions that have thrived around natural or artificial water basins have started dealing with rationing, drought, and new laws and restrictions limiting water consumption in the last 20 years.

Megalopolises like Cape Town or São Paulo have already had to turn off the taps for millions of people. In Nevada, the state is implementing draconian measures, at least by American standards, to ration water and prevent the depletion of Lake Mead, a water reservoir that has transformed a desert into an urban and agricultural area where 20 million people live.

A NASA study, conducted with high-precision satellites, evaluated the 37 largest water basins in the world and discovered that in 21 of them more water is leaving each year than entering. This trend is not sporadic but rather continuous, and has been accelerating in recent years.

Over the past 20-30 years, according to many reputable studies, the exploitation of water resources as planned in the last century would have surpassed the point of sustainability in many areas. This necessitates a complete rethinking of the system and poses a concrete existential threat, if not to the entire species, but certainly to the ability to inhabit areas of the planet where millions of people currently live.

The reasons for the water crisis

But why has this crisis intensified in recent years? In this case, the usual suspects are also the culprits. We do not intend to delve into scientific details in this article, but it is generally recognised (and supported by numerous studies) that three factors are worsening the global water crisis:

Overpopulation: The growth of the world’s population implies a greater use of water resources. Water basins are water reserves that have sometimes formed over thousands of years of rainfall and are sometimes natural or artificial bodies of water that are replenished each year by precipitation and rivers. If a larger number of people or agricultural businesses draw from these basins, it’s evident that they will be depleted sooner. According to the World Economic Forum, by 2030, it is estimated that the demand for drinking water will have exceeded the supply of sustainable drinking water by over 40% (https://www.weforum.org/impact/sustainable-water-management/).

Climate change: A normal yet fragile water cycle has been jeopardised by global warming. The planet’s higher temperature leads to increased evaporation, affecting global precipitation patterns and causing an increase in extreme weather events such as droughts and heavy storms. This makes water cycle management very complex because, on one hand, rarer rainfall makes the replenishment of water basins slower, while on the other, intense rainfall events do not always compensate for geological reasons.

The third issue to consider is pollution. Human-generated waste has rendered many drinking water basins unusable, further exacerbating the problems created by overpopulation and climate change. The United Nations tested 85,000 water sources globally and found that 40% of them can be considered severely polluted.

The birth of the ‘Blue Economy’

The combined effect of these three factors is causing complex water crises in numerous areas. Like in many other aspects related to climate change and resource utilisation, both government and business are working to find solutions. This new sector is referred to as the “blue economy”.

Unlike other raw materials, the peculiarity of the water problem is that there is no substitute. While alternatives to oil can be found, and even laboratory-made substitutes for food can be imagined, water remains a crucial element for the development of society and human communities. Human development is not possible without the proximity of easily accessible sources of renewable drinking water.

As is often the case with a new industry, there may be investment opportunities. Some sectors related to the water economy could thrive in the coming years, and innovative new companies could emerge. Similarly, it is highly likely that governments will allocate substantial resources to promote new laws that could rejuvenate the sector.

But what kinds of companies are we talking about? There are utilities: public, semi-public and private. These are the companies responsible for delivering water to households. These companies often find themselves in a natural monopoly situation, but it’s not uncommon for them to face increased costs and make substantial investments to address the new challenges of water management. End users are also noticing this, with water bill costs generally on the rise.

Of course, there are numerous questions for these types of companies: What role will they play in a future where access to water could become more of a commodity than a utility? And how are these individual companies exposed to the climate risk that could disrupt the water cycle in entire regions?

Another growing sector is that of ancillary services related to water transportation and storage. In this field, we can find companies that test and treat drinking water, as well as companies that manufacture equipment capable of intelligently measuring and managing water flows. All these services could become more central in a world where water becomes a scarcer resource.

There are also companies that specialise in infrastructure construction, ranging from large engineering firms to companies involved in the installation and production of components for agricultural systems used in farming or for private use.

Additionally, there are private companies that sell bottled water or are involved in transporting water to areas not covered by public networks, a significant reality in many countries.

Lastly, there’s the entire desalination industry. Considering that 97% of the planet’s water is found in seas and oceans, it’s evident that increased domestic use of desalinated seawater is one of the possible strategies to address the water crisis. However, these processes require advanced technologies and, most importantly, a significant amount of energy, which has been a challenge that has slowed down and may continue to impede the development of this sector in the future.

Investment approach

These are just some of the sectors within the broad ecosystem that we could define as the “blue economy” and could become increasingly important if the water crisis continues to intensify.

But is it a good idea to invest in this sector? To answer this question, we won’t rely on a specific analysis, as that goes beyond the scope of this article. In general, we believe that investing in trends, themes or megatrends can allow long-term investors to ride these social or economic phenomena and generate enhanced performance. However, investing in frontier sectors also comes with specific risks, such as fragmentation, the difficulty of predicting which companies will become future leaders in that field or the risk of overvaluation based on future results.

Therefore, in our opinion, the most appropriate approach for the majority of investors to include these types of investments in their portfolios is a diversified approach. Diversification not only among geographies and companies (which can be achieved through ETFs) but also among various themes.

Another important aspect of theme-based investing is managing volatility within one’s overall strategy. Generally, thematic investing is associated with higher expected volatility, which is why it’s important to allocate an appropriate portion of your portfolio to it (at Moneyfarm, we advise our clients on the maximum portfolio allocation that can be dedicated to thematic investing).

This is the philosophy with which we have built our thematic investment proposition. Within our Sustainability and Multitrend pathways, we have exposure to the blue economy through the L&G Clean Water ETF.

This fund tracks the Solactive Clean Water Index and invests in a range of global companies involved in the construction of industrial water systems and infrastructure or water treatment (accounting for over 50% of the exposure). A significant percentage (approximately 25%) of the fund is also invested in public, semi-public, or private water companies responsible for water management at the local level.

We believe that investing in themes like water with a diversified approach and effective risk management can yield better medium to long-term results for the investor.