More Than a Trickle: Investment Implications of the Cape Town Water Shortage

Apr 4, 2018 @ 12:01 am

By Andreas Fruschki, CFA, Portfolio Manager, Director of Equity Research Europe
February 2018

The water crisis in Cape Town, South Africa, has been making the news in recent weeks with headlines like “Drought-hit South African city risks becoming world's first big metropolis to go dry”1 leaving many stunned.

As Cape Town approaches critically low levels of water in its reservoirs, we are reminded that there is neither a substitute for clean drinking water–nor a short-term fix to deficits. Mirrored in cities across the globe, water shortages are the result of inadequate preparation for three structural developments:

Urbanization: Population growth coincides with the global trend of urban mobility, especially to areas with sunny climates located near coast lines. In Cape Town, for example, the influx of new citizens exceeds the locally available water resources, and investments in water infrastructure and water supply storage have failed to keep pace. Over the last 20 years, the city has seen population growth of close to 40% and even 70% when accounting for the larger area of the Western Cape, while additions to water-storage capacity have only increased by 15%.2 Plus, aging of existing infrastructure further stresses the system: as more pressure is needed to supply growing city limits, more water is lost through leaks and water main breaks.

Water Consumption Increases: As living standards rise, so does water consumption. While agriculture and industry are the main users of water in cities it is personal consumption behavior that drives this demand. While drinking water is critical, its impact is minimal. Water use for activities like sewage, cleaning, washing and outdoor watering represents some of the biggest drains on supply. That said, Cape Town has, in fact, managed that part well by keeping water consumption per capita under control, an effect best achieved by metering and charging for water to avoid excessive consumption and wastage.

Industrialization and Farming: Farmers are the largest water users, especially those growing nonnative, water-intensive crops that require artificial irrigation. The growing demand for meat rather than vegetables has also given rise to cattle and poultry farming, which require substantially more water, as their operations generate significant waste. Further, industries such as mining, manufacturing and electricity generation all rely heavily on water, competing with farmers and cities like Cape Town for limited water resources.

Long-awaited rainfalls have most recently provided some – albeit small – relief for Cape Town. While “Day Zero”, when critical reservoir levels are expected to materialize, has been pushed out from April to May, should the day come, the city plans to restrict water supply to just 25 liters per person per day. This water supply will be provided at 200 designated distribution points only – in a city of 1.3 million households covering 2,400 square kilometers.3 City clinics are planning to hold regular health talks about the prevention and signs of water- and foodborne diseases.

While everybody watches the situation in Cape Town unfold, observers should be reminded that we have already seen similar crisis situations in other urban areas. For example, in Los Angeles the incongruence of time between water supply (winter peak) and water demand (summer peak) has triggered the construction of long-distance aqueducts from Northern California and the Sierra Nevada. In 2015, São Paulo ran into a significant water shortage, driven by a combination of factors including growth, pollution and deforestation.

Across the globe, water security is becoming a pressing issue:

  1. Populations living in arid regions are increasing
  2. Water use for industrial and farming purposes is growing
  3. An expanding middle class requires more–and cleaner–water
  4. Infrastructure is aging and faltering approaching the end of its usable life
  5. Existing water resources are depleted

While solutions exist, none are short-term fixes. Investing in water storage capacity, along with water treatment facilities, and ensuring drinking water supply chain integrity requires careful planning and substantial infrastructure investments. Forecasting demand and supply has become more difficult, especially in the case of Cape Town where a two-year drought has resulted in only half of the normal annual rainfall. Water is heavy, so pumping it from underground reservoirs or across long distances is requiring large amounts of pumps and electricity. Desalination plants might be the only option for locations like Cape Town, but these, too, are very energy intensive and expensive.

There are three ways to address water scarcity:

  1. Invest in additional water supply
  2. Encourage water efficiency
  3. Preserve existing water-resource quality

Several companies have technologies and products that support these areas, which should see higher demand as cities like Cape Town increase direct spending toward improving water resource management.

AllianzGI Global Water Fund provides equity investors the means to contribute to solutions for water scarcity as we focus on companies that look to improve water supply, efficiency and quality, solving problems while supporting growth opportunities, examples of our investments include:4

Xylem, US-based company and leader in the water industry, delivers innovative water technology solutions throughout the water cycle. The company's products include water-pumping stations, desalination technology, and technology for water metering and monitoring. Like the company says, “We transport it [water] to places it needs to go, we treat it to make it clean, and we test it to ensure its quality.” Xylem is an important provider of water-supply enhancing products and services.

Geberit is a leading provider of sanitary technology and bathroom ceramics, based in Switzerland. The company aims to, “continuously improve the quality of people's lives with innovative sanitary products.”

Water-efficient household appliances will likely be an important vehicle managing water supply.

1Financial Times, January 31, 2018. 2GroundUp, “What's Causing Cape Town's Water Crisis?”, May 16, 2017. 3 itvnews, “Cape Town Drops Daily Water Limit in Bid to Stave Off 'Day Zero'”, February 2, 2018. 4 This is for illustrative purposes only and is not a recommendation or advice to buy or sell any particular security.

Andreas Fruschki, CFA, Lead Portfolio Manager, Analyst, Director of Equity Research – Europe andreas.fruschki@allianzgi.com

Mr. Fruschki, CFA, is the lead portfolio manager and Director of Equity Research – Europe with Allianz Global Investors, which he joined in 2005. He has 12 years of investment-industry experience. Mr. Fruschki previously held various legal positions in Berlin and also worked as a consultant in the corporate-finance practice at PriceWaterhouseCoopers in Hamburg, Germany. He has an M.B.A., focused on investment management, from the University of Western Sydney. Mr. Fruschki also has a law degree from Humboldt University, Berlin, and passed his judicial bar exam in 2004.

us.allianzgi.com

1 800 926 4456

Investors should consider the investment objectives, risks, charges and expenses of the fund carefully before investing. This and other information is contained in the fund's prospectus and summary prospectus, which may be obtained by contacting your financial advisor and should be read carefully before investing.

A Word About Risk: Investing in a limited number of issuers or sectors may increase risk and volatility. Investing in the water-related resource sector may be significantly affected by events relating to international political and economic developments, water conservation, the success of exploration projects, commodity prices and tax and other government regulations. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets. Derivative prices depend on the performance of an underlying asset; derivatives carry market, credit and liquidity risk. As of 12/31/2017 AllianzGI Global Water Fund held 8.17% in Xylem and 6.82% in Geberit. The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation. 459614 © 2018 Allianz Global Investors Distributors LLC,

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