3 Ways to Profit from "Blue Gold"

Years ago, when my cousin Andrea was in law school, she and my dad were talking about the "hottest" area in the law -- water rights. This was probably 15 years ago and today Andrea is one of the nation's leading experts on the death penalty. Dad and I were joking the other day that if she had gone into water law, her house would probably be a lot bigger.

In general, water rights and the field of water delivery is a huge topic, with many big players, from G-7 nations to large municipal water utilities to industrial equipment makers to smaller concerns, which actually buy up water rights and sell the commodity to water systems. T. Boone Pickens, the legendary oilman and dealmaker, is one huge player. And when fortunes like that get into "developing" sectors, I tend to take notice.

The rise of the middle class in emerging markets in India, Asia and Africa is typically seen as great news for the consumer products and automobile sectors, but it's also a boon to basic service providers. People who have lived their lives in abject poverty and gain wealth want iPods and Buicks, sure, but there are a lot of steps in between. One of those steps is to ensure access to basic services like potable water.

The result is that total worldwide water demand is growing by about 6% a year, which is far faster than the aggregate growth in worldwide economic output. The bottom line is that water demand is outrunning the market, and it will be a major source of profits in the decade to come.

Here are my three favorite ways to play the boom in "blue gold" spending...

Opportunity #1 -- turning salt water into potable water
The first is desalinization (aka, desal), the process of removing the heavy salts from seawater. For years, this process required water to be boiled and the steam left behind the salts was then collected.

But this is a very expensive way to get water on a large scale. What was needed was a way to get water on a larger scale at an affordable price, one accessible to the budget players in addition to the oil sheiks. That process is called reverse osmosis, which is when water is blasted a high pressure through a series of special filters.

Most people assume -- wrongly -- that desal is needed on desert islands and on seaports, where an ample supply of saltwater is readily available. While that's true, the process is also needed in areas that are on the brink of exhausting their existing supply, such as California, and in areas in the middle of the country where groundwater resources have, for one reason or another, become brackish.

The fourth market is in areas where water supplies are potentially controllable by a hostile neighbor. This is especially true in the Middle East, which exists on 1% of the world's freshwater supply and where every major water source crosses at least one international boundary. The market for desal plants is huge.

The trick to building a desal plant is to either have an unlimited supply of energy to power the robust pumps that force the water through the filters or, failing that, to use a special bit of equipment that recycles the energy within the plant. This piece of equipment, almost shockingly, is supplied almost universally by one company.

Investing in this company and in others that own and operate desal plants, is one of my favorite areas of water investing. But water treatment, not just for saltwater but in general, is also a huge area of growth. Some 20 public companies are involved in this sector.

Opportunity #2 -- track China's spending
The other area that has game-changing potential isn't really a sector but a country -- China. Firms that supply China with water, water equipment or both are going to see significant growth in coming years.

For example, for years China denied it was building a major dam on the Yarlung Tsangpo River. It wasn't until April of last year that they finally came clean -- after satellite images had been released of construction taking place. China officially told its Indian neighbor that it had begun this massive project. Even then, Chinese officials were quick to say they wouldn't be diverting any water; the dam is purposed to create electricity. I think that's a farce.

China is the world's fourth-largest water customer, consuming 2.8 trillion cubic meters a year -- a number that will rise as more and more citizens are elevated to the middle class and will be able to afford a municipal water hookup, which, though it seems strange to Americans, is still something of a luxury in thousands of Chinese villages and cities.

About 100 cities in China -- today -- face severe water shortages. That's not because China lacks the physical water but because much of China's water is heavily polluted by industry and rapid urbanization or otherwise, so getting the world's most populous country "up to code" is going to provide dozens of companies with billions of dollars in revenue. China spends an astonishing $200 billion a year on water infrastructure.

Opportunity #3 -- thinking like Pickens
Another area I like is companies that do what Pickens has done: securing the legal right to water in areas where it's scarce and so that they can name their price. This is an especially promising play in the Southwestern and Western United States. An acre-foot of water -- enough water to cover an acre of ground with one foot -- can cost $1,000 in Dallas but it can bring three times that in Nevada or Arizona. The companies that control the water market in these areas will be able to name their price. All those lawyers that my cousin should have emulated have made sure of it!

Action to Take --> Investors interested in profiting from these trends could consider the Powershares Global Water ETF (NYSE: PIO), which invests at least 80% of its assets in companies that generate at least 50% of revenue from water or water-related activities.