Bizarre? “Michael Burry is focusing all of his trading on one commodity: Water”

The 88th Academy Awards will be held this Sunday (February 28th) at 8:30PM.

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Over the course of the evening actors, actresses, directors, and producers will gather to celebrate the best films and performances of 2015, with the night culminating in the awarding of the Oscar for Best Picture.

One of the eight films that is up for contention of this year’s award is The Big Short.

The movie, based on Michael Lewis’s book The Big Short: Inside the Doomsday Machine, tells the story of four investors who predicted the credit and housing bubble collapse in 2008 and decided to bet against Wall Street, earning billions of dollars in the process.

The first of these investors that predicted the housing bubble was Michael Burry, who is portrayed in The Big Short by Christian Bale.

While the movie does a great job explaining how Burry was able to make nearly $1 billion betting against the housing market in 2008, it left many viewers very puzzled about a completely different issue – the last line of the movie, printed on a placard, is:

Michael Burry is focusing all of his trading on one commodity: Water.”

This is a perplexing statement, because unlike other commodities like oil, cotton, or silver, there is no market to trade water.

So how can someone invest in water? Should you just buy a rain bucket?

Well, you have 3 different options if you want to invest in water:

  1. Purchase water rights
  2. Invest in water-rich farmland
  3. Invest in water utilities, infrastructure, and equipment.

But first, let’s talk about why you might want to invest in water in the first place anyways.

Michael Burry - WHY INVEST IN WATER?

Depending on where you live, you might take fresh, clean water for granted. I know that I normally do.

We often spout off the fact that 70% of the Earth’s surface is covered in water – something we probably all learned in kindergarten. While this is true, freshwater – the kind we care about – actually only represents 2.5% of that amount. On top of that, only 1% of our freshwater is easily accessible, with most of the other 99% trapped in glaciers and snowfields. In the end, only 0.007%of the planet’s water is actually available to fuel and feed the world’s 7 billion people.

We all know that water is essential for life. But 0.007% of the world’s total water is still a lot of freshwater. So what’s the problem here?

According to the U.N., water use has grown at over twice the rate of the world’s population increase in the last century. Today, we use about 30% of the world’s total accessible renewal supply of water. In less than 10 years, that percentage could reach 70%. By 2025, an estimated 1.8 billion people will live in areas plagued by water scarcity, with 2/3rds of the world’s population living in water-stressed regions.

Making matters worse, the water infrastructure in most developed countries is aging… and we haven’t taken any steps to upgrade it yet. The American Society of Civil Engineers (ASCE) predictsthat at current rates there will be an $84.4 billion gap by 2020 between what we’re spending on water infrastructure and what is needed. Without upgrades, the U.S. is facing a loss of $416 billion in GDP.

Still don’t think access to freshwater is an issue?

  • Just ask anyone who lives in California, which is in the 5th year of one of the worst droughts on record.
  • Or ask anyone who’s witnessed one of the 195 conflicts since 2000 that have been caused by water.

  • Or ask the residents of Flint, Michigan, who are experiencing firsthand the effects of America’s aging water infrastructure.

Clearly there’s a growing and critical demand for access to freshwater and for related products and services. So how can an intelligent investor profit from it?

Michael Burry - HOW DO YOU INVEST IN WATER?

Michael Burry - OPTION #1: PURCHASING WATER RIGHTS

A water right gives the owner the right to use water from a water source (e.g., a river, stream, pond, or source of groundwater).

An investor who buys a water right can make money by selling (or in some states renting out) the water right for a higher price than was originally paid. Buyers might be municipalities, farmers, or corporations.

Obviously, prices depend on the demand for the water, which itself is a function of the need for water and the water’s use. For example, hydraulic fracturing generates massive demand for water as the development of an oil well requires 3-5 million gallons of water, and 80% of that water can’t be reused. Fracking companies, therefore, pay as much as $3,000 per acre-foot for water rights – compared to only $50 per acre-foot paid by farmers.

Setting aside the moral implications that might arise from choosing to sell water solely to the highest priced bidder, the economics of making money from water rights faces other issues as well.

The main issue is that it’s a perfect example of “greater fool theory.” The water right itself doesn’t provide any value. Consequently, the only way to make money from water rights is to find someone willing to pay a higher price for it than you did. Sometimes this might work out. Sometimes it won’t.

Here’s a perfect example:

T. Boone Pickens owns more water rights than anyone else in the United States. In 2011, while Texas was suffering through one of the worst droughts in more than 50 years, Pickens was trying to sell his rights to the Ogallala Acquifer (one of the world’s largest) to the Dallas-Fort Worth area. Talks with Dallas were dependent on the area’s drought situation. Every time it rained, negotiations fell apart. Pickens eventually sold to the Canadian River Authority for half of his asking price. He later compared the deal to buying and selling a boat: the happiest two days of owning a boat are the day you buy it and the day you sell it.

In addition to the greater fool theory, the right to water is a highly political and litigious issue. T. Boone Pickens has huge political influence in Texas and owns enormous amounts of water rights, which is why he is pursuing his particular strategy. Additionally, water laws are very complicated and vary state-by-state – and raise the issue: how can someone own, buy, or sell a resource that is a human right and is necessary for all forms of life to survive?

In any case, the barriers to entry here mean buying water rights just doesn’t make sense for the average investor.

OPTION #2: INVEST IN WATER-RICH FARMLAND

farmland photo
Photo by Unsplash (Pixabay)

2,000 years ago the ancient Romans built aqueducts to transport water from higher elevations to lower elevations. Aqueducts – combined with pipelines and pumping systems – are still used today in some geographies, including California, Australia, and Libya.

However, transporting water is not an easy feat – nor does it entirely solve problems without creating new ones. Here are some of the issues:

  1. The actual construction of a pipeline is extremely expensive, often costing billions of dollars.
  2. Maintenance expenses to keep the pipelines going are also incredibly high.
  3. Just like any oil pipeline, the
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