Sprott’s Thoughts

 Focusing on Water

By Anthony Bevilaqua

Dr. Michael Burry is focusing all of his trading on one commodity: water.

– from the final scene of the hit film, “The Big Short”

Best-selling author Michael Lewis showcased Dr. Michael Burry in his book turned feature film, “The Big Short.” Burry was one of the first institutional investors to foresee the U.S. subprime mortgage meltdown in 2008 and – as the film highlights – he put his money where his mouth was by heavily wagering against the viability of the subprime mortgage market. The attention is back on Burry as he focuses his attention on concentrating his investment efforts on one commodity: water.[i]  
Sprott Chairman, Rick Rule, admits investing in water isn’t easy…spinning his pun that investing in water is “highly illiquid.” Considering that only 1% of the available freshwater is easily accessible, there are a few ways an individual investor or institution may participate in the water investment thesis: buying water rights; investing in water-rich farmland; and/or investing in water infrastructure.[ii]
I. Buying Water Rights

Water rights are designed to protect the use and enjoyment of water. You can own a water right by owning land that borders a watercourse or by entering into a contract, which is also known as buying/selling a paper water right. Buying paper water rights can be viewed as running an arbitrage because the purchaser can financially benefit from transferring those water rights to areas in more need. The value assigned to that need often depends on the water’s use, which begs the question of whether the true value lies in the paper right itself or in the practical use of the water.
Given that paper water rights originate from and are regulated by state and federal government bodies, the transaction is inherently political. Further, critiques of paper water rights investments are not shy about pointing out what Burry cites as the moral implications of selling to the highest bidder as the highest bidder doesn’t necessarily mean the most in need. Jim Rogers, famed commodity investor, put this concern well when he proclaimed, “don’t own water because, if you own water, the politicians are going to ridicule you and hang you in the public square. If you can solve water problems, they’ll put up a monument to you in the public square; but if you own it, they’ll take it away from you and accuse you of exploiting man’s God-given right to water.”[iii]

II. Investing in Water-Rich Farmland

In a 2010 Bloomberg article, Burry stated: “I believe that agriculture land, productive agricultural land with water on site, will be very valuable in the future…I’ve put a good amount of money into that.”
He further underscored this point in a 2015 interview when he explained, “what became clear to me is thatfood is the way to invest in water. That is, grow food in water-rich areas and transport it for sale in water-poor areas. This is the method for redistributing water that is least contentious, and – ultimately – it can be profitable, which will ensure that this redistribution is sustainable.”[iv]
Brandon Zick, Director of Acquisitions for Ceres Partners’ $600M U.S. farmland portfolio, underwrites many farm properties. In a recent conversation, Zick discussed Ceres’ investment strategy, which arguably could be seen as Burry’s 2015 statement coming to fruition.
In considering different investments, Ceres focuses on investing in regions that have plentiful annual rainfall and irrigation, such as the Eastern Cornbelt. Before buying a property, Ceres assesses the water potential based on factors such as underground rock formations and the recharge of the aquifer. According to Zick, areas where water is deprived – such as the Southwest (California in particular) and the Ogallala Aquifer – are regions to avoid unless you thoroughly understand the depreciation of that water resource over time, as well as the cost of water in those regions. Alternatively, Ceres focuses on areas where accessing water isn’t as onerous.
Now to contrast water-rich farmland investments to buying paper water rights, consider the question posed about how to assign value. Paper water rights make a prima facie case for determining that value is based on buying at a given price with the assumption that you can sell at a higher price to an area in more need. Burry cites this assumption as an example of the “greater fool theory” as the buyer assumes another party would be willing (or better yet, able) to pay the higher price.
Water-rich farmland investments also factor scarcity in determining value, but it’s factored in through a different lens. Farmland with plentiful natural water resources are more likely to benefit from water scarcity, aareas rich with water resources likely become more valuable than places with limited fresh water resources For example, crops that are grown where water is scarce, such as in the Central Valley, may look for property with access to more plentiful water resources, which will drive up the value of the land in areas like the Midwest, for example, where water is more naturally and readily available.

III. Investing in Water Utilities, Infrastructure, and Equipment

Rule, a natural resources investor with over 45 years of experience, pointed out that “maintaining water infrastructure (i.e., sewage systems, water treatment, and water delivery) isn’t something people notice until it isn’t available.” A great example of this is the 2016 crisis in Flint, Michigan where water infrastructure wasn’t a top priority until the need was absolutely dire, but the bureaucratic process couldn’t pull off the “about-face” necessary to adapt to the immediate need.
With this in mind Rule further stated that, “the trend in water utilities is becoming increasingly powerful across the world, which is the privatization of government held infrastructure.” As such, investment opportunities lie in companies focused on building water infrastructure and equipment.
While the need for water is something that has been engrained in all of us from a young age, the focus on furthering its availability is certainly a forefront issue, so we intend to continue this conversation on potential water-related investments.