Water Shock

By Michael Schaffer

Water shortages could be the next political and economic flashpoints — and Wharton alumni and faculty are working towards solutions.

Is Water the New Oil?

That’s the consensus of a wide range of economists, business leaders, environmentalists, and geopolitical strategists, who argue that we’ll soon be forced to stop taking for granted the substance that covers 70 percent of the planet and makes up a similar proportion of the human body.

Just as the late 20th century saw an oil shock, the early 21st century may feature a water shock, where scarcity leads to a sharp price hike on a resource that has always been plentiful and cheap. Such a scenario could plausibly have an even bigger impact than the 1970s-era original, transforming markets, governments, and ecosystems alike, creating a new set of regional and global conflicts.

The Dry Facts

The world may be blue, but 97 percent of its water is salty. Human use of the remaining three percent has boomed, the result of population growth, industrialization, and the need to produce more food to feed a growing, wealthier population.

In 1900, global water consumption totaled roughly 770 cubic kilometers. Today, the figure is 3,840 cubic kilometers. It is projected to grow to over 5,000 by 2025. That’s well under the 9,000-12,000 cubic kilometers of annual rainfall that lands where humans can access it. But pollution, waste, and inefficient delivery take a big bite out of that figure, as does climate change, with its attendant droughts and early snowmelts. From Californian water-rationing to the occasional drying up of China’s Yellow River, the consequences are increasingly visible. By 2030, estimates the Organization for Economic Cooperation and Development, more than half the human population will live in areas where the water supply is stressed.

“This is a massive challenge,” says Wharton management professor Witold Henisz, who sits on a panel looking into global risks for the World Economic Forum. He expects water to be a major theme at the forum’s annual gathering this year in Davos, Switzerland.

Thus far, the issue — and its impact on economies, populations, and businesses — has drawn little attention. A 2007 survey sponsored by the Marsh Center for Risk Insights reported that while 40 percent of Fortune 1000 companies believed the impact of a water shortage would be severe to catastrophic, only 17 percent said they had prepared for such an eventuality. “The one thing that I came across is that a lot of companies hadn’t begun to think of this as a major issue,” says Howard Kunreuther, codirector of Wharton’s Risk Management and Decision Processes Center and a former advisor to the Marsh Center. The same goes for the general public, he says: “I think that the one thing that we’ve always tended to think about is water as a free good. It pours out of your sink, you take long showers, you get a bill every three months and you pay it and don’t think about it.”

Now that may be changing — with price effects you’ll notice not just when you pay your water bill but when you buy everything from beef to plastic toys, all of which require a great deal of water. This fall, water scarcity got its own version of An Inconvenient Truth with the nationwide release of the endangered-water documentary Flow, which Wired magazine dubbed “the scariest movie at the Sundance Film Festival.” Are we doomed to a thirsty future? Not necessarily, experts say. But plain old water is fast on its way to becoming “blue gold,” a commodity to be sought out, fought over, trundled from country to country, and possibly sold to the highest bidder — a situation that represents a threat and an opportunity all at once.

In the Developing World, Water Scarcity and Crisis

For most of the global population, of course, water scarcity is first and foremost a humanitarian crisis. According to the World Water Council, 1.1 billion people worldwide lack adequate drinking water — one-sixth of humanity. Some 2.6 billion lack adequate sanitation. A United Nations study reported that 1.6 million lives could be saved each year by providing clean drinking water and sanitation. Such problems, of course, have long been linked to the poor infrastructure of underdeveloped nations. But with the global population forecast of 9 billion largely urban people by 2050, the idea of water as a costly substance further compounds these challenges.

The crisis has already arrived in much of the world, says Larry Bouts, WG’76, one of the principals in a firm that develops new ways of locating groundwater in parched countries in Africa and the Caribbean. “Think about this. We have cities and countries, small ones and big ones, around the world, where people themselves are rationed water throughout the day. That has big impacts about how people plan their day. What kind of productivity loss is that? What kind of distance do people have to travel? And then you get into not the third world but the second, where people are rationed on water throughout the day, which means industry must cut back on its expansion plans or is not sure how to plan for its needs. What’s the impact on the economy? It’s a huge deal.”

Bouts says he was drawn to the issue after a corporate career at firms like Pepsico and Toys “R” Us, when he decided to do something more entrepreneurial and more critical to the welfare of humanity. Teaming with a pair of partners, Bouts set up a firm called Bedrock Exploration and Development, or BEAD. Mining is rarely seen within philanthropic ventures. But BEAD is no ordinary mining concern. Using a proprietary technology that seeks out previously unexploited hydrogeologic formations beneath mountains, BEAD sets up new wells that tap the groundwater that flows into underground rock fractures and fault planes. The idea is simple: Clouds drift along until bumping into mountains. Eventually, they condense as rain. Some of the water runs down into the rocks to untapped deep “megawatersheds.”

The trick — a complicated feat that substitutes modern technology for the divining rod of old — is locating the streams. “What we do is we find renewable water,” Bouts says. “Our technology is a very green technology. To build a well, we can pull hundreds of thousands of gallons a day of a renewable resource.” One project on the tiny Caribbean island of Nevis last year, he says, doubled the supply as BEAD found deep groundwater and built the system for getting it onto the national grid. “We form a little utility, essentially, and sell water to the local authority,” he explains.

They’re currently negotiating four other contracts in the Caribbean, where growing populations and the thirsty needs of tourist-oriented golf courses represent a strain on the water system — and a threat to economic development in a region where the only other way to add water would be to invest in wildly expensive desalination facilities.

For Industry, Unquenchable Demand

The same growing need for water in the tiny countries where Bouts has done business also faces the world’s biggest nation. In China, pressure on the water system comes less from pure population growth than from urbanization and rising wealth.

Chinese urbanization reflects the explosion in the manufacturing center. And the nation’s resulting affluence has left people with a taste for more meat, a food that requires vastly more water than other agricultural products. The self-perpetuating cycle means China needs a rising amount of water — and faces major economic risks if those needs aren’t met. Beyond that, industrial pollution from the growth in manufacturing threatens the supply intended for human drinking.

“The issue is still quality perhaps much more so than quantity,” says Wharton management and sociology professor Marshall Meyer, who has studied China’s water-scarcity troubles. “Most experts will say that most Chinese rivers are contaminated. The quantity problem is desertification in the north of China, of Inner Mongolia, and that’s encroaching on Beijing.” For a nation that needs water to run its booming manufacturing sector, the threat represents a national-security priority.

“Besides Canada, which has rich water resources, every country in the world faces water shortage problems,” says Ding Wang, WG’09, a second-year MBA student and a staffer at China’s Ministry of Water Resources. “The importance is getting bigger and bigger in China. With the development of the cities most of the large enterprises will move outside the city to get it.” The ministry has also responded by sending its employees abroad for training, in business or in managing large utility systems. “Every employee in Beijing headquarters has an opportunity to have foreign training every two or three years,” Wang says. “We need expertise for the specialty knowledge. The common knowledge received is how to manage infrastructure and operations.” China has also created a water market and the trade in water rights to help with distribution, she says. “Ten years ago, all the water plants were owned by the Chinese government. But since 2005, the local governments want to privatize the water utilities. So many foreign companies have come in and want to do the mergers and acquisitions for water resources.”

That’s easier said than done — water prices in China are currently very low. “It is very hard to increase the water prices,” Wang says. “It is such a part of people’s lives.”

A look at water privatization elsewhere reveals that it bears little resemblance to selling off an inefficient state-owned cement factory. In wealthy and developing countries alike, private water supply concerns have run into public and political troubles. In Bolivia, price hikes after the privatization of the water system in the city of Cochabamba led to riots in 2000 and the eventual ejection from the country of Bechtel, the engineering firm running the system. In subsequent years, governments nixed water-privatization schemes in nations from Tanzania to Holland. “Water cannot be turned over to private business,” firebrand Bolivian President Evo Morales said while celebrating the departure of the multinational water concern Suez, 10 years into what had initially been a 30-year contract to run the water supply for his nation’s capital.

“People are used to the price of food going up when food is scarce,” says Wharton’s Henisz. “I don’t see a lot of willingness to pay more for water. I don’t think there’s a willingness to look at a market solution on a large part of the population. I think people would rather overthrow their government than pay for water. Morales is president because he led the opposition to water privatization in Cochabamba.” Instead of a simple market solution, Henisz says, problems of water scarcity will require cooperation among governments, businesses, and NGOs.

Elsewhere, the government utilities have simply been instructed to behave more like businesses — without engaging the political symbolism that comes from selling a country’s water system. “We have a mandate to become a commercial entity,” says Jacqueline Cameron, WG’88, corporate planning manager at Jamaica’s National Water Commission. “The government doesn’t support us anymore. Before, the government would make up the shortfall.” But price hikes remain risky in a state-owned utility, even one where 94 percent of customers aren’t metered and thus pay only what bureaucrats estimate as the average use.

‘It’s Not Like We are Making Widgets’

The effects of supply and demand on water can be equally discomfiting for Americans, ostensibly more accustomed to free markets. In fact, only 16 percent of Americans get their water from private firms. The price, likewise, reflects just the cost of getting the water from the source to the home or factory. Pipe maintenance, purification, and burgeoning environmental regulations are part of the price, but not any intrinsic value of the water itself.

Sharon Reishus, WG’90, who regulates her state’s water industry as chairman of the Maine Public Utility Commission, says Maine has ample water and thus no scarcity-induced price hikes. But the idea of for-profit concerns buying a publiclyowned essential can still be awkward. “The sources of water in Maine are really secure,” Reishus says. “The only questions that I find significant that have put into question supply issues are a couple of places where the utilities supply water not just to the towns but to bottling companies. There’s been a fair amount of local resistance, with the idea of corporate water being purchased that will ultimately deplete the local resource.” The resentment reflects a cultural attitude towards water — that it isn’t just another item to be sold, like corn or microchips. “It ultimately comes down to a very human concept, the idea that this is our resource and it could be depleted,” Reishus says.

That’s even truer in the parched half of the country west of the Rockies. “It’s a given that water quantity out here is not what it is in the east coast,” says Carl Gowan, WG’80, a water engineer with the Marin Municipal Water District. “It is not going to get better. It only means conflict between the users.” In a growing suburban county with fresh memories of droughts, Gowan says, prices have risen over time largely because costs of treatment chemicals have risen and regulatory requirements have tightened, making water conservation an appealing concept even to those without Priuses in their garages. Per-customer use has dropped by around 20 percent since the 1970s.

Of course, many economists would argue that the best way to oblige Americans to be careful about water would be to take it out of the hands of municipal utilities, whose bosses must answer to a public that doesn’t like seeing bills go up. Texas oilman T. Boone Pickens is banking on that idea, buying up a huge portion of aquifer under the Texas panhandle and building a pipeline to trundle the stuff to Dallas. While the city isn’t a customer yet, Pickens calculates that it will be eventually, and he’ll be able to charge his own price — a price that, if it doesn’t spark a Bolivian-style backlash, would at least encourage locals to be more judicious when watering their lawns.

But elsewhere, private-sector water suppliers have to deal with price controls unknown to most businesses, says William B. Davis, WG’76, president of Aqua New Jersey. “The difference is that it’s regulated,” Davis says. “It’s a totally different perspective of needs and interests that you might not address until you meet with a regulator. There are economic regulations, environmental regulations, and the communities you serve. It’s not like we’re just making widgets.” These days, most of Davis’s costs are in long-term infrastructure rather than paying for or anticipating higher costs of actual water.

Finding Solutions Technology

Water scarcity’s impact can be eased through an array of conservation and efficiency measures, such as steps to improve rain-fed agriculture, to discourage the plowing that leaves soil thirstier, to develop hardier plants that can withstand longer dry spells, to replace wasteful “flood” irrigation systems with more efficient “drip” systems, to upgrade aging infrastructure that wastes oceans of water a year, and to encourage individual conservation.

To management professor Henisz, the public-sector portion of the task of dealing with a stressed water system is symptomatic of a larger problem bedeviling economies, especially those in the third world: building an infrastructure. “You have to come up with a financing mechanism with a 20-30 year lifespan that people believe in. In developing countries, it’s hard enough for people to fork out for five years. … Investors don’t believe anything the government says about what the policies will be in even five years. Water’s just the extreme case for the infrastructure problem.”

But in at least some places on the cutting edges of the $500 billion global water industry, technologies to deal with scarcity — or just to deal with governments that want to encourage conservation and discourage pollution — also represent a significant business opportunity around the world. In California, where green legislation prods developers and industries towards less wasteful water use, Peter Balas, WG’88, and a few friends started Integrated Water Systems, which builds on-site wastewater systems that prepare water for reuse. “There’s a growing emphasis with the state legislature to try to reuse water,” he says. “People are interested in green approaches. It’s happening, but it’s going to take time. A lot of developers get points for being green. That doesn’t hurt us one bit…We’re part of the solution. In many cities in California, it’s mandated that you have to meet certain environmental goals. Oftentimes, for areas that aren’t quite with the program, it helps if it gives the developer an opportunity to get his project moving, to get it approved.”

Of course, for business customers, droughts have a way of focusing the mind in a way that government can’t. “It was, ‘We may not have water to operate our facility,’” Balas says of one vineyard customer. “That gets people’s attention immediately.”

At Colorado’s Eltron Research and Development, Len Dolhert, WG’01, commercializes an array of the firm’s innovative water-purification technologies, items that help ships dispose of wastewater in port or deal with the “produced water” thrown off by oil and gas production. “That water cannot just be poured onto the ground,” he says, though until not so long ago that’s exactly what might have happened. “Now, there are regulations, and on top of that, if that water could be converted into something that could be used or sold for irrigation or drinking, it would be especially valuable.”

Says Henisz, “I don’t think you can point to any one thing and say that this is the end of the world as we know it. [But] there will be big spikes in the price of water. There will be some rivalries between countries over access to water. And the incentives to come up with solutions will go up.”

Writer Michael Schaffer has written on water issues and other related topics for Knowledge@Wharton and other business publications.

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