The planet has plenty of water. In fact, more than 70 percent of the Earth’s surface is covered with it. But digging further into the issue of water reveals a global crisis that is generating massive investment opportunities for infrastructure investors.
Experts agree the need for investment in water infrastructure globally is at an unprecedented level. According to the Global Commission on the Economics of Water, up to $400 billion of additional investment per year is needed in low- and middle-income countries to achieve universal access to clean drinking water, sanitation and hygiene by 2030. In the United States, the American Society for Civil Engineers (ASCE) has been grading the drinking water infrastructure in the country at D- or D consistently for more than a decade. The ASCE and the U.S. Environmental Protection Agency (EPA) also determined a need for an investment of almost $743 billion to improve the water infrastructure.
The water crisis is sparking more interest from private equity. When Water Asset Management started almost 20 years ago, the amount of interest in water as an asset class was almost nonexistent. That investor interest is obviously increasing, says Matt Diserio, president of Water Asset Management. “As we recognized early, a capital investment supercycle of additional spending is under way after generations of underinvestment in water infrastructure,” he says. Water Asset Management has both a global listed equity strategy that invests in water infrastructure and water-related companies around the world, and a private equity focus in the United States.
Water is an asset that has been taken for granted historically. In addition, water industry economics tend to be less understood by investors compared with the fundamental economic models of many other industries. That picture is changing because of the massive amounts of capital needed globally to solve problems around the freshwater supply. Trillions of dollars are needed to address inadequate infrastructure, and governments alone don’t have the resources needed to make water and sanitation reliable to support growth, serve communities and sustain the environment. “Water is now much more broadly recognized as a way to invest and generate very good long-term returns, while also having very clear positive measurable impact,” adds Diserio.
The U.N.’s Sustainable Development Goal No. 6 is helping to push water to the forefront. The goal is to ensure availability and sustainable management of water and sanitation with an emphasis on the quality, availability and management of freshwater resources. “We’ve been pounding the table for years that by emphasizing investment in SDG 6 you’re able to make real progress on virtually all of the other 16 SDGs,” says Diserio. Clean, reliable water can have a positive impact on a variety of other areas, such as poverty, food security, health, education and gender equality. “So, in addition to good, stable long-term returns, investing in water provides great outcomes in being able to benefit society, the communities and the environment,” he says.
AMPLE ENTRY POINTS
Water infrastructure has a variety of entry points globally, which include areas such as pumping, transporting, storage and treatment, along with opportunities to upgrade and expand infrastructure and invest in desalination and clean water technologies.
Water represents an attractive sector for Ridgewood Infrastructure. Its lower-middle-market infrastructure fund focuses on investments within the United States. One of the reasons Ridgewood likes the sector is because it’s a massive market that has seen a tremendous amount of underinvestment. A second compelling factor is that the water infrastructure industry in the United States is extremely fragmented. For example, there are roughly 65,000 regulated water utilities in the United States, compared with 30 in the United Kingdom. “That underlying fragmentation creates a deep opportunity set for Ridgewood and others to invest capital and service those communities,” says Michael Albrecht, a managing partner at Ridgewood Infrastructure.
Ridgewood views water infrastructure investment from two perspectives, regulated and nonregulated opportunities. In the United States, there are businesses or projects that are governed by state utility commissions and typically operate under what is known as a cost-of-service business model. Under that business model, costs are recouped from customers, and capital investment that is made in underlying property, plant and equipment earns an allowed rate of return. According to Albrecht, this segment of the water market is typically exemplified by stable, uncorrelated cash flows that offer an opportunity to invest materially in areas of the water market that have traditionally seen underinvestment and are in need of capital.
On the other end of the spectrum, there are nonregulated opportunities, which include a broader set of business models ranging from water transmission to water efficiency and everything in between. Ridgewood Infrastructure focuses on those nonregulated opportunities that are essential to underlying customers and offer resilient uncorrelated cash-flow generation, such as providing potable water to a large diverse set of customers under a long-term contract with an investment-grade counterparty that could be a public-private partnership.
Another area where Ridgewood believes there is tremendous opportunity is water distribution and transmission. “Investor-owned utilities are investing billions of dollars every year,” says Albrecht. “But given the historic underinvestment, it’s really a drop in the bucket and more dollars are going to be required.” As an example, Ridgewood made an investment in the Vista Ridge water transmission pipeline in 2017 that provides potable water to approximately 20 percent of the community of San Antonio. “It’s the largest water PPP in U.S. history, and our expectation is more opportunities like that will present themselves in the future, given the underinvestment that exists,” says Albrecht.
WEATHER EVENTS DRIVING DEMAND
A common theme in developed countries is the huge amount of investment required for the upgrade and maintenance of existing water infrastructure, which in some areas is nearly a century old. Water also has been getting more attention because of environmental factors that range from drought to flooding.
Two of the big drivers fueling water infrastructure investment in northwest Europe are the growing challenge from the environment and extreme weather events, notes Jordan Cott, a partner and head of logistics and industrials at Arcus Infrastructure Partners in London. For example, the water utilities in the United Kingdom have had huge challenges in dealing with the increasing volatility in weather patterns. In a summer that is extraordinarily dry, reservoirs that previously provided clean water for homes or industry are lower, and there is a need to start pumping water from one area to another. “There’s a lot of management of the water network that is required in those areas, which has put a lot of stress on the infrastructure that’s in place,” says Cott.
Arcus addresses water and wastewater within its logistics and industrials vertical. “When we zoom out on where we see it fitting within our strategy and why we like it, it’s that fundamentally there are very strong tailwinds that require investment going forward, and leading players in the space are best positioned to provide the infrastructure for the system to operate effectively,” says Cott. Investment in water infrastructure also can contribute toward various sustainability and SDG goals.
The firm’s first major investment in water infrastructure came a year ago when its Arcus European Infrastructure Fund 3 acquired an 83 percent interest in Workdry International, the United Kingdom’s leading leasing provider of water pump and wastewater treatment assets. The company’s assets are critical to managing the maintenance lifecycle of the United Kingdom’s water infrastructure network, supporting the region’s wastewater treatment network through periods of high demand and maintenance, and for general water displacement needs related to large-scale infrastructure and construction projects. “We see this business as sitting at the nexus of some of those major environmental and industry trends that we wanted to gain exposure to, as well as the broader asset leasing business model, which fits well within an infrastructure investment strategy,” notes Cott.
AGING INFRASTRUCTURE, NEW REGULATIONS
Investors recognize that water is essential and water infrastructure is critical. “Capital providers, whether they be allocators on the LP side, or deployers on the GP side, have historically and continue to be really interested in the sector,” says Allison Kingsley, a partner and co-founder of NOVA Infrastructure. “That being said, it’s a tough sector to invest in because there are few large-scale opportunities, and with the smaller-scale opportunities there is sometimes technology risk involved, which is not everyone’s thesis,” she adds.
A number of megatrends are driving greater focus on water infrastructure investment. Aging water infrastructure in the United States is resulting in water leaks and water main breaks with water infrastructure that is continuing to deteriorate. On top of that, there is increasing regulation around the quality of water and the source of water, creating further constraints. This landscape is creating a broad set of investment opportunities around clean water technology and increased infrastructure spending. “We focus on finding ways to solve this critical infrastructure problem, which is now intersecting with tightening regulations around water quality that create demand for new ways to think about water,” says Kingsley.
Another hot topic in the United States is the challenges being made to its longstanding, often antiquated water rights models. This issue is playing out in real time around the Colorado River, where demand is outpacing supply. The Colorado River and its tributaries provide water to nearly 40 million people in seven states, as well as supply water to irrigate agricultural land and hydropower facilities. Greater intensity of water scarcity, coupled with increasing demand for water in those western and southwestern states, is contributing to a situation where available supply is not sustainable throughout the long term. The Colorado River Basin Fund is one private equity fund that is investing in water technologies addressing water scarcity and quality issues in the basin.
Regulation is another megatrend impacting water infrastructure globally. For example, the European Commission and the United Kingdom are tightening oversight on water utilities and the water networks for losses and disruption events, as well as overflows and wastewater treatment incidents with fines that have gone up substantially. The European Commission is continuing to find new chemicals that one would typically find in water or wastewater that need to be treated out, and that’s creating more demand for wastewater infrastructure. This creates another huge white space where private equity investment funds see more investment opportunities ahead.
“All of the environmental regulations around water and wastewater are creating investable opportunities, certainly, but also some uncertainty,” adds Kingsley. In the United States, the EPA has proposed National Primary Drinking Water Regulations that include new drinking water standards around “forever chemicals” or per- and polyfluoroalkyl substances. The EPA also is tightening water discharge requirements, which is creating more constraints on producers of wastewater. That regulation has been spurred by some very high-profile contamination lawsuits involving the likes of 3M, Dow and others. “There are a series of problems that are breaking open the sector, some of which are creating investment opportunities,” she says. “So, you can be opportunistic about helping solve those problems, knowing that some of them are going to be really hard problems to solve.”
Beth Mattson-Teig is a freelance writer based in the Minneapolis area.