The economics of Water

Why do we worry about water so much? Even in the UK we talk about droughts a lot – just to get news on historic floods a day or month later. Isn’t water really a regional issue or should we trade water cross border thus water rich countries helping water scarce economies? We are positive that many people have never really thought about whether water is tradable like any other commodity. And, is it?

Who owns the right to water: the government, companies, or land owners? Generally speaking, governments own the rights to water. But water is tradable and the market distinguishes three levels of water permits. Below we will investigate what it means with respect to the pricing of water and how we can benefit as financial investors.

Source: ADB, 'Water rights and Water Allocation', 2009

Source: ADB, 'Water rights and Water Allocation', 2009

The three levels are tradable water abstraction rights, tradable rights to water-based resources and tradable water pollution rights. We kick off the article by assessing both how water is priced and which factors need to be considered. Before we start, we hope that our readers can generally agree that “water should have a price in order to achieve two objectives, namely recovering the cost of providing the particular water service and giving a clear signal to the users that water is indeed a scarce good that should be used wisely” (Van der Zaag, P. and Savenije, H.H.G. (2006) ‘Water as an economic good: The value of pricing and the failure of markets’).

Water Pricing in the EU
The European Environmental Bureau published a report on the pricing structure of water back in 2001. The EEB report opens by saying that “60% of European cities over exploit their groundwater resources. Along the coastlines in Southern Europe and on many islands, seawater is already intruding into the depleted underground aquifers, making them unusable as drinking water.” The issue of pricing water focuses on what to include in the total cost of water. The concept of Full Cost Recovery (FCR) includes various factors but ensures that (i) Operation and Maintenance Costs, (ii) Capital Costs, (iii) Opportunity Costs, (iv) Resource Costs, (v) Social Costs, (vi) Environmental Damage cost as well as (vii) Long-Run Marginal Costs (LRMCs) are included, at least in theory. Further, the ‘Polluter Pays Principle’ (PPP) ensures that it is the one who pollutes pays instead of the society as a whole. That way it is possible to create incentive structures for polluters to reconsider whether to pollute or to enhance the discharge to minimize pollution. So far the theory.

Fact is water is non-substitutable and irreplaceable which makes the calculation, in practice, challenging. For example, calculating marginal costs could be solved, or at least addressed, by smart metering although it would be near impossible to achieve a 100% service ratio.

How does the EU assess water pricing then? Essentially three levels persist: tariff structures and levels, charges and subsidies. Those are then applied across three sectors (a) households, (b) industry and (c) agriculture. Tariff structures enable utilities to collect a relatively stable revenue base and thus minimize their business risk. It probably does not inspire ‘market’ forces and the need for innovation is somewhat arbitraged away as revenues are surely coming in. Further, the issue of regional monopolies may impact the pricing behaviour of municipalities and utilities. We can distinguish between two charge systems: abstraction charge and pollution charge. The former collects payment at point of abstraction and aims to demonstrate that by minimizing leakage money can effectively be saved and the ecological benefit is obvious. Some countries trade in water abstraction rights (FAO, 2006). The latter does what is says on the tin: it charges a price for polluted waters. Germany is leading the initiative but many other European countries have adopted a similar concept. It is the closest to the Polluter Pays Principle. Subsidies prevail on many levels but the most obvious is tax reductions for new water treatment plants et al. Although the cost-benefit analysis is difficult, the water sector generally charges below its FCR principle.

Tradable Water Pollution Rights
In an report (2004) published by the Inter-American Development Bank the authors Andreas Kraemer, Eleftheria Kampa and Eduard Interwies conclude that “[e]xperience with tradable permits for water pollution control is accumulating primarily in Australia and the US, which are both advanced economies with long regulatory history in water management and pollution control. The introduction of trade for water pollution control has benefited in these cases from solid scientific understanding of the pollution problems in question, existing monitoring infrastructure and enforcement capacities”.

However, the market is still relatively young and the authors admit that it is too early to know whether the economic benefits can be explained systematically.

Conflict Potential
We are not in the position to comment on the various conflicts associated surrounding water rights. However we point out that whenever cross-country/cross regional water flows tangent on various jurisdictions, conflict is pre-programmed especially in water scarce regions. We suggest this paper by the Munk Center for International Business in Canada on issues surrounding the US-Canadian relationship on water. Other prominent research has been conducted around the River Nile and the water abstraction issues from countries further upstream. A very good report was published by the Asia Development Bank.

Further reading:
http://www.ucowr.siu.edu/updates/pdf/V109_A2.pdf
http://ageconsearch.umn.edu/bitstream/19790/1/sp02ha02.pdf
http://www.uwsp.edu/cnr/uwexlakes/economicsOfWater/documents/34_waterRights_weber_paper.pdf

Collapse

Instead of Clean Technologies- let’s talk oil. Why? Because oil competes with clean technologies, affects government and consumer choices and in large part determines the success or lack thereof of much of what we discuss here. Consumers are much more willing to pay premiums for electric vehicles, biofuels or renewable energy if it does not have the burdensome variable cost of crude oil attached.

Many well qualified geologists and experts are claiming that the Earth has already given us her easy to find oil and that we have peaked.  See this video for a good summary. Probably the most famous detailed review of our Earth’s supplies can be found in Matt Simmons’ book “Twilight in the Desert” or also in Jared Diamond’s “Collapse.” Peak oil is a controversial idea to many that draws passionate disagreements from those in the oil industry. Let’s take a more reserved approach to this giant question with facts we can understand much easier than how much oil exists miles beneath the surface: Oil Demand.

Fact #1: If oil demand outpaces oil supply, more people bid for the less per capita supplies. Oil prices increase.
Fact #2: We all know the global population is increasing but that’s not the issue. What matters more is that the per capita oil consumption is increasing. Developing countries, are- developing.

Population projections

Fact #3: If oil supply is to continue to increase, it’s got a lot of work to do to replace maturing oil fields. If it can increase, good luck keeping pace with demand. The IEA has been warning about sluggish supply growth, and if Saudi Arabia has so much oil in reserves- why are they spending billions to drill off shore now?
Fact #4: Oil prices have remained constant, at relatively higher prices during one of the world’s worst recessions in memory. Imagine what price it would be if oil demand had not actually dipped two years in a row! Where do prices go when the economy recovers, never mind the other above issues? Demand down 4% in 2009 and 5.4% in 2008. We have no substantial reason to believe that demand won’t recover when the economy does.

Rebuttals: What about horizontal drilling, new discoveries and those Canadian Oil Sands? Those are accounted for in the both the IEA and all three studies linked to in the first paragraph of this blog. Secondly- if the Canadian Oil Sands are depended upon as a significant source of future, global oil supplies- then we’re still in very bullish oil pricing territory given the very high variable cost to procure a barrel’s worth of oil from Alberta.  And that ignores the logistical and environmental issues of the oil sands. See the Cambridge Energy Research Associates supply curve posted below. The easy oil has already been found. The expensive oil is now depended upon to take up the slack of a flat supply curve.

Projected Global Demand. Source: EIA

Conclusions: Oil prices are bound to increase significantly. The price of oil largely affects the economics (consumer choices and firm profitability) of many CleanTech related firms in areas of electric transportation, electricity generation and energy storage.

Chinese Consumption increasing faster than population

Think of oil consumption occurring by two different groups of people- those from developed countries (4.7 bbl/day) and those from developing. As countries develop, so do their consumption rates. Welcome China, India and Brazil to the developed world (slowly!). Again, while very few people have the information, expertise and experience to speculate on global oil supplies, it is much easier to grasp the demand side and consequently oil pricing and its impacts.

I strongly suggest the above two books by Matt Simmons and Jared Diamond for anyone with a relevant career in Clean Technologies or even just Energy.

Coincidentally, a documentary is being released today covering this exact topic and is receiving great reviews. It is called “Collapse” and is narrated by Michael Ruppert. See reviews here and here.

Courtesy of the Oil Drum

The easy, cheap oil has been found. (Courtesy of CERA)

The Great, Fake Lithium Supply Scare

“But there’s not enough lithium for all those batteries- and now you’ll switch dependency to a few lithium supplier countries!” That is the claim less informed journalists and hacks often make when they need a counter point to balance their first article on the emerging, electrified transportation sector. Why do we care? Because if true would significantly affect the battery, transportation, grid storage and electronic appliance sectors. Let’s try a fact check:

1) Claim: Dependency on 2-3 countries for lithium (similar to oil dependency)
Fact:
False. This table from the USGS best answers this claim:

Country Reserves (000’s ton Li) Reserves Base(000’s ton Li)
Argentina 2,000 2,000
Australia 170 220
Bolivia NA 5,400
Brazil 190 910
Canada 180 360
Chile 3,000 3,000
China 540 1,100
Portugal NA NA
USA 38 410
Zimbabwe 23 27

Plus, ore deposits in these plus other countries bring the total to over 17.1 million tons of reserves.

2) Claim: Lithium is the sole material these sectors must have to advance.
Fact:
Yes and no. Shorter term most known batteries for next gen autos and electronics will use lithium (bar the also popular nickel metal hydrides.) Longer term- let us not ignore 15 start ups that are readying ultracapacitor break throughs, 27 manufacturers and 29 other companies that have recently developed ultracapacitor technologies plus 52 research institutions working on advancing ultracapacitor technology. We do concede however that lithium will play by far the largest role for at least the next 15 years.

3) Claim: All of the suppliers in the world won’t be able to keep pace with demand & thus prices will skyrocket.
Fact:
There are an estimated 17.1 million tons of contained Li in reserves worldwide. In 2008, total global demand was 100,000 tons and of course projected to grow significantly. Lithium can be recycled. Do the math with your own assumptions and it appears we have a few years before supply concerns arise. One may even want to account for new, future reserves of Li to be discovered.

Additionally- advances in nanotechnology as noted here, here and here are making the current battery chemistries that do incorporate lithium much more powerful, economic and robust.

Let’s make money: 77% of lithium carbonate currently comes from 3 companies which are SQM of Chile, Germany’s Chemetall and FMC of the USA. Talison Minerals, a private Australian firm, is the largest spodumene producer and accounts for about 23% of global contained lithium. However, only 15% of this production is sold into the lithium chemical markets via Chinese lithium carbonate converters. (Special thanks to Dundee Capital Markets for the above research, “Lithium- Hype or Substance?” October, 2009. )

Conclusion: If you are bullish on the technology advancing, you likely believe the improved economics offered by advanced lithium batteries will enable stronger investments in the related sectors of grid storage, consumer electronics, military applications and of course transportation. The sky is falling claims should not play a role in any related investment decisions.

Kleiner makes first water investment

According to VentureBeat’s report on 31 Jul 2009, Kleiner Perkins Caufield & Byers has backed its first water-related cleantech company, Applied Process Technology (APT). This is a significant milestone for the firm and a sign that floodgates may finally open in water investing in the US. APT makes water remediation technology that removes agricultural nitrates from well water.

Apart from VentureBeat’s report, there’s no other news related to this investment. Websites on both Kleiner and APT did not have any press release on it. Furthermore, Kleiner is the first major firm to take interest in the private company APT, reported by VentureBeat. It previously raised $1 million and hoping for $7 million more, according to a regulatory filing with the SEC. APT claims it has already brought in $10.5 million in equity.

Europe has been leading the pack in the water space while US focuses on cleantech investing on renewable energy, transportation applications and smart grid. Few firms in the same tier as Kleiner have invested in water. Mayfield Fund and Sequoia Capital do not invest in cleantech outside of the energy space.

Comment: It is significant for more VC firms to be involve in the water industry and invest in water infrastructures and technologies. Water crisis, as many doomsayers say, is more acute than energy crisis. We can live without electricity, although somewhat more primitive, but we can’t live without water. Water is really underpriced and underappreciated in the US (hence less attention to the water space there?). The fact that such a big VC firm like Kleiner starts to take notice of the water industry speaks about either its foresight of the good investment in the industry or the severity of the water problems in the US.

Company overview:
Applied Process Technology, Inc. develops and manufactures water treatment technologies for drinking water, industrial process water, wastewater, environmental remediation, and homeland security markets. Its products include HiPOx that performs multiple treatment functions, such as disinfection, taste/odor/color removal, and volatile organic compounds or micro contaminant destruction; PulseOx that injects oxidizing agents directly into a subsurface formation to treat groundwater and saturated soils; and Membrane Bio-film Reactor that removes oxidized contaminants from water through microbial catalyzed reduction. The company provides preliminary engineering analysis, laboratory/bench scale testing, pilot/field testing, equipment installation and start-up, and operations and maintenance services. Applied Process Technology, Inc. was founded in 1996 and is based in Pleasant Hill, California.

www.aptwater.com

Key Personnel:
Terry Applebury, Co-Founder, President & CEO
Dr Reid Bowman, Co-Founder, VP of R&D & Chief Technology Officer
Douglas Gustafson, Co-Founder, Director of Field Development
Douglas A. Liddie, Executive VP & COO

apt

The Electric Drive Battery and Component Manufacturing Initiative

I don’t want to have to import a hybrid car. I want to build a hybrid car here.” – President Obama in Warakusa, Indiana, 5 Aug 2009.

On 5 Aug 2009, the Obama administration announced the recipients of the grants for the electric vehicle industry, i.e. the $2.4 billion Electric Drive Battery and Component Manufacturing Initiative (part of the American Recovery and Reinvestment Act). Barack Obama was in Indiana while Joe Biden was in Michigan, the 2 states getting the most electric vehicle money, to announce the list of 48 grants that will be administered by the US Department of Energy (DOE).

The biggest individual grant, at $299 million, went to Johnson Controls, a Holland, Mich., firm that has struck a deal with Ford to provide batteries for future vehicles. The second biggest grant, at $249 million, went to startup A123 Systems, a Romulus, Mich., company with links to Chrysler.

It’s significant for A123Systems since the program’s goal of getting technology into large-scale production within 2-3 years and the requirement for awardees to share costs tends to tilt the scales away from younger ventures. A123 has requested as much as $438 million but the $249 million grant could help bring the GE Energy Financial Services’ backed company closer to its long-planned IPO.

The Big Three automakers will also receive the grants. GM is receiving 3 grants totaling $241.4 million, Ford will get 2 grants totaling $92.7 million and Chrysler will get 1 grant of $70 million.

You can view a list at WSJ here or the full original DOE list here.

The announcement came after several intense months of applications and lobbying. About 257 companies applied, seeking $9.6 billion total. Among those companies were a number of venture-backed startups. Analysts and investors said the DOE seems to be playing safe in selecting the 48 companies, picking big names and companies that plan to build plants in Michigan, the home of the ailing US automobile industry which won 11 grants.

For the smaller companies including venture-backed firms, the outcome was a let-down. Many of those left out of the awards have production lines in Asia and were willing to start up manufacturing in the US to support the deployment of electric-transportation technologies.

Boston-Power was one of the companies to lose out on the DOE grant with its $100 million application. It already has manufacturing facilities in Taiwan and is currently building another plant in China. It has now applied for a $100 million grant from the US Department of Defence, which is likely to announce the recipients in October.

Another company, International Battery Inc, whose main investor is Digital Power Capital, an affiliate of PE firm Wexford Capital, did not get the grant. It will continue to expand its capacity in the US and still hopes the DOE will make some funding available for entrepreneurs.

If you look at the maps here and here, you will see that while Michigan is a winner, California is a loser (comment: I’m surprised!). No awards were made to companies planning to set up manufacturing plants in the state.

“The decision is a real blow to California’s clean transportation technology industry and the state’s clean energy initiatives,” said Paul Beach, president of Quallion LLC, in a statement. Quallion’s bid to help it build a $200 million plant in Palmdale, Calif., wasn’t selected, and it will continue to pursue that plan with other funding opportunities, both from the government and private sector. The company is controlled by billionaire Alfred E. Mann, and is already a supplier for military vehicles and medical devices, and it has been profitable for the past six years, said Beach, in an interview.

battery_awardee_map

battery_awardee_map2

Sources:
Boston-Power Loses Out on DOE Grant, Aims for DOD Fund
Battery Grant Winners!: A123Systems Rakes in $249M
Feds Give $2.4B to 48 Auto Battery and Electric Drive Projects
DOE juices battery companies with $2.4B in stimulus funds
The real reason for Obama’s $2.4 billion electric car grants
VC-Backed Companies Left In The Cold By DOE Battery Grants

US cleantech investments move to smart grid and energy storage

A Reuters article on 18 Aug 2009 wrote that the US greentech sector, which suffered a drop in funding early this year, is seeing renewed interest with venture dollars flowing in once again to promising startups and some companies looking to resurrect public offerings that had been set aside.

Investment is seen shifting from capital-intensive energy generating technologies such as solar and wind to those associated with energy storage, transportation and efficiency, particularly lithium-on battery makers and startups in smart grid sector.

Cleantech investments is expected to see a significant pickup as early as this fall, with continued improvement through 2010 but unlikely to reach the $2.6 billion peak seen in the 3rd quarter of 2008. Aggressive stimulus from the US Department of Energy (DOE) is also providing a big boost.

Vollen of Robert W Baird & Co said investors now are more interested in technology that was less capital intensive, such as those associated with the smart grid infrastructure and energy efficiency. “Everybody still recognizes that energy storage is the holy grail of the sector,” he added.

That quest helped lithium-ion battery maker A123 Systems attract $69 million last quarter to expand battery manufacturing, while residential smart grid company Tendril attracted $30 million in June. Energy efficiency company CPower and Grid Net, which builds software for smart meters, also were successful in raising money.

Some companies like A123 Systems and biotech firm Codexis are actively monitoring the markets to launch their initial public offerings.

FT: Which country has the greenest bail-out?

There is an interesting interactive graphics posted on FT (Mar 2009, updated Aug 2009) about the countries with greenest bail-outs. It reported that governments around the world have committed over $512bn of the global economic stimulus outlined so far to green projects, with 22% to be spent in 2009, HSBC estimates.

While we know that this is good for green businesses, there are proponents of a green stimulus who claim that there will be serious consequences if the money is misspent and countries could be committed to a path that has already led to a growth in greenhouse gas emissions. Interesting argument as we know some clean technologies can be capital-intensive such as solar and biofuels – it can take a lot of energy and materials to produce them.

I am somewhat unsure about the title “greenest bail-outs”. Is it really bail-outs or is it really green investments/stimulus package? The authors did not give explanation for the title.

By volume, the “greenest bail-outs” are:
1. China ($218bn)
2. US ($117.2bn)
3. South Korea ($59.9bn)
4. Japan ($36bn)
5. EU ($24.7bn)
6. Germany ($13.8bn)
7. Australia ($9.3bn)
8. France ($6.1bn)
9. UK ($3.7bn)
10. Canada ($2.8bn)
11. Italy ($1.3bn)

By percentage, the “greenest bail-outs” are:
1. South Korea (79%)
2. EU (64%)
3. China (34%)
4. Australia (21%)
5. France (18%)
6. Germany (13%)
7. US (12%)
8. UK (11%)
9. Canada (9%)
10. Japan (6%)
11. Italy (1%)
FT greenest bailout