Planning for Uncertainty

If there is only one thing that can be agreed on with respect to the impact of global warming on the water business, it is that the element of uncertainty associated with variations in weather is increasing.While it is not the intent of this book to debate the causes of global warming, there are a number of statistics that cannot be ignored by water providers: greenhouse gases exist at higher levels than in the past 650,000 years,¹ the last eight 5-year periods ended with 2006 were the warmest pentads in the last 100 years of national records,² and the western United States is experiencing less precipitation as snow and more as rain. Changes in seasonal precipitation can be more important than annual averages. Even if precipitation is unchanged, higher temperatures make conditions drier by reducing soil moisture, stream flow, and lake levels through increased evaporation.

Water planners take historical statistics into consideration when developing their forecasting models. To the extent that long-term patterns such as temperature, stream flows, snow pack, and the like are impacted by climate change, the assumption of stationarity no longer holds. This has major implications for plant design, capacity considerations, system reliability, and water quality.

Impacts on Water Quality

Few scientists today doubt that the atmosphere is warming. Most also agree that the rate of climatic change is accelerating and that the consequences of this temperature change could become increasingly disruptive. Climate changes can significantly affect the hydrologic cycle and therefore water resources. And while much of the attention has been directed to localized droughts and floods, falling reservoir levels, and strings of record high temperatures, there are more than just quantity issues at stake. There is mounting concern and evidence that atmospheric warming has a negative impact on water quality and will increase the global incidence of waterborne disease.

Weather becomes more extreme and variable with atmospheric heating in part because the warming accelerates the hydrologic cycle. A

warmed atmosphere heats the oceans (leading to faster evaporation), and it holds more moisture than cooler air.When the extra water condenses, it more frequently creates a dramatic storm event. While the oceans are being heated, so too is the land, which can become extremely dry in areas. This dryness enlarges the pressure gradients that cause winds to develop, leading to other powerful storms. The altered pressure and temperature gradients that accompany global warming can also shift the distribution of when and where storms, floods, and droughts occur.

Human-induced climate variability is associated with the addition of greenhouse gases that diminish the ozone layer and change the radiation balance of the planet. The more predictable consequences of an atmosphere heated up by a thinning of the ozone layer include warming oceans, shifting agricultural patterns, melting glaciers, and rising sea levels.Yet less familiar effects could be equally detrimental. Revised weather patterns, by upping the frequency and intensity of floods and droughts, promote the emergence, resurgence, and spread of infectious disease. Some of the worst are waterborne.

Warming itself can contribute to the change, as can a heightened frequency and extent of droughts and floods. It seems perverse that droughts would favor waterborne disease, but they can diminish supplies of safe drinking water and concentrate contaminants. Further, the lack of clean water during a drought interferes with good hygiene and safe rehydration. The increased climate variability accompanying warming will probably be more significant than the rising heat itself in fueling outbreaks of waterborne diseases.

Floods favor waterborne disease in different ways. They wash sewage and other sources of pathogens (such as Cryptosporidium) into drinking water supplies. They also flush fertilizer into water supplies. Fertilizer and sewage can each combine with warmed water to trigger expansive blooms of harmful algae. Some of these blooms are directly toxic to humans who inhale their vapors. Others contaminate fish and shellfish that are consumed. As algal blooms grow, they support the proliferation of various pathogens, among them Vibrio cholerae, the causative agent of cholera.

Drenching rains brought by a warmed Indian Ocean in the late 1990s set off an epidemic of cholera in the Horn of Africa. In the after-math of Hurricane Mitch, Honduras reported thousands of cases of cholera; floods created by unprecedented rains and a series of cyclones has spread cholera in countries such as Mozambique and Madagascar. In the United States, cholera is not as much of a threat as other etiological agents. Nonetheless, as many as 900,000 cases and 900 deaths from waterborne disease occur annually in the United States. Dramatic outbreaks affecting a community’s water supply have been linked to both droughts and floods. Massive flooding also results in contamination from spilled sewage. The largest outbreak of waterborne disease in recent U.S. history (400,000 illnesses and 100 deaths) was due to contamination by Cryptosporidium after spring rains in Wisconsin.

The U.S. National Assessment on the Potential Health Impacts of Climate Variability and Change has specifically identified the effect of climate on waterborne disease outbreaks as a research priority. Rainfall and runoff have been associated with individual outbreaks of waterborne disease caused by fecal-oral pathogens. Fecal-oral microorganisms originating from human or animal wastes include bacteria such as Escherichia coli (E. coli), Campylobacter, Salmonella, and Shigella; viruses such as Norwalk virus, small round structured viruses, and hepatitis A virus; and protozoa such as Cryptosporidium and Giardia. The transport of water contaminated with these microorganisms is enhanced during periods of drought and flooding.

The effects of extreme weather on municipal water supplies is a growing problem. Meteorological data for the United States show that downpours averaged less than 8 percent of the total annual precipitation at the beginning of the twentieth century and that they had increased to 10 percent of the total at the end of the century.³ It is not clear whether this increasing trend will continue. However, if the projected changes in global warming translate to climate variability resulting in changes in the frequency, intensity, and geographic distribution of extreme weather in the United States, there is likely to be a significant effect on both drinking water and wastewater systems.

In a recent analysis⁴ of waterborne disease outbreaks in 2,105 U.S. watersheds, between 20 and 50 percent were associated with extreme precipitation. The relationship between waterborne disease and storm events was found to be statistically significant for both surface water and groundwater, although it was more apparent with surface water outbreaks. The health toll taken by global warming will depend to a large extent on the steps taken to prepare for the dangers. Many of the current regulatory themes focus directly or indirectly on these issues.

The Safe Drinking Water Act and the Clean Water Action Initiative have both emphasized the need to focus on watershed management. Stormwater runoff is the subject of a great deal of industry discussion. And the control of pathogens is central to numerous regulatory requirements and technological initiatives. Spending on water and wastewater infrastructure is also likely to be influenced by climate variability. When a system is built or upgraded, billions of dollars can be saved if the potential for extreme weather is taken into account. In short, the ramifications of greater climatic variation and intensity will drive demand across the board for the products and services of the global water industry.

Occurrence of Drought

As investors ponder the potential associated with water, one of the first things that comes to mind is drought. In Texas, the summer of 2006 entered the meteorological record books.The National Weather Service reported that the January-through-June period of that year was the hottest since 1895, the year it started keeping records.The average temperature for the period was 5.7 percent above the norm. Precipitation statewide was the lowest since 1998 and 25 percent lower than the 100-year average for the first six months of the year. In fact, the entire Great Plains as well as Arizona and Alabama experienced intensity levels from moderate drought (D1) to exceptional drought (D4). Fully two thirds of the United States experienced abnormally dry, or worse, drought conditions in that year.

And drought is not limited to the United States. According to the Chinese Ministry of Water Resources, hot weather and severe drought recently left 18 million people in 15 Chinese provinces and regions short of drinking water. Although possessing the fourth-largest freshwater reserves in the world, China, by virtue of its burgeoning population, has the second-lowest per-capita water stocks in the world, averaging about 2,200 m³ of water per person. A generally recognized measure of water “stress” (defined as water scarcity manifested as increasing conflict over usage, a decline in service levels, crop failure, and food insecurity) is 1,700 m³. By 2025, China, as well as India, will be below that threshold.

From a global perspective, one of the first impacts of drought is on agriculture. The drought in China was reported to have damaged millions of hectares of cropland.As previously written, agriculture (read irrigation) is by far the largest consumer of available freshwater worldwide.

Under the pricing schemes imposed by many water utilities, the more water used by consumers, the greater the revenue generated by the utility. Common sense would dictate that in a drought situation consumers would require more outdoor water and therefore revenue for the utility would follow. In fact, water utility stocks traditionally rose and fell according to the precipitation patterns within their service areas. This was why the large, geographically diverse utilities are often a preferred way to mitigate climatological risk. Before the audacity of imposing restrictions on water, the stock price of water utilities was often correlated to the particular amount of rainfall in their operation regions.

The bottom line is that water utilities can no longer be perceived as beneficiaries of drought conditions. Not only do droughts often lead to usage restrictions, but many utilities have rate structures in place that penalize extreme usage to encourage conservation. “Regulatory lag” associated with rising costs ahead of rate relief will increase only for utilities in drought-plagued regions that are constrained by the price granted by regulators as costs are spread over a dwindling consumption base.

Drought conditions also presuppose that a way to alleviate supply shortages is to drill more wells. Pertinent to the prospects for drillers, such as Layne Christensen, demand for water-well-drilling services is driven by the need to access groundwater, which is affected by many factors, including shifting demographics and regional expansions, new housing developments, deteriorating water quality, and limited availability of surface water. Groundwater is a vital natural resource that is withdrawn from the earth for drinking water, irrigation, and industrial use. In many areas of the United States and other parts of the world, groundwater is the only reliable source of potable water. But it is also the main source of irrigation for agricultural production.

Again, droughts can be a double-edged sword. In the United States, the recent droughts in the Great Plains have focused attention on the limits associated with the production of wheat, beef, corn, and other crops. An initial response is to drill more wells, a situation that has clearly driven interest in the stock of Layne. But water costs and conflicts over the vast but shrinking Ogallala aquifer have prompted restrictions on irrigation. For example, Nebraska has put a moratorium on new wells and taken farmland out of production in the Platte River Valley to limit the draw on the Ogallala Aquifer. As demographics shift to more water challenged areas combined with an increasing amount of regulated contaminants and impurities, the demand for water recycling and conservation services, as well as new treatment media and filtration methods, is expected to remain strong.

Investing in Drought

Ruled by the emotion associated with the “preciousness” of water, and without adequately reflecting on just what that means from an investment perspective, many assume that drought equals scarcity equals opportunity. It is prudent to put droughts into investment perspective. It is a far more complex issue than it seems to be on the surface. The occurrence and frequency of droughts dictate that investors understand the implications for water stocks over and above the simplistic notion that scarcity means increased value. Just as the occurrence of widespread drought varies greatly across the planet so does the impact on companies engaged in the water industry. It is the institutional response to drought or water shortage conditions that is likely to determine the extent of the opportunity.

It is important to put the perceived investment opportunities derived from drought conditions in perspective. As we have learned from other resources (oil comes to mind), “scarcity” does not equate to an unbridled shift in economic rents from one group to another. Even with a resource such as oil, which is governed by sophisticated market mechanisms, a point can be reached wherein the structure of the market itself comes into question. This is why it is said that institutional responses to severe droughts, especially under the auspices of global warming, may in some respects serve to shift the financial “windfall” of droughts from one sector to another: that is, from water drilling to integrated resource management and from the depletion of groundwater sources to reuse/recycling and desalination.