Water Scarcity: The Falling Costs (And Rising Profits) Of Water Desalination

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The twin pillars of global population growth and economic development are leading to concerns about water scarcity.

In the inaugural article of this three-part series, I painted the issue in broad strokes. Part two delved into the world of irrigation technology and how outdated and inefficient methods are slowing being replaced with modern, conservation-oriented systems.

Agriculture and irrigation currently account for a bulk of water usage and that is unlikely to change (for the better) any time soon. Over the course of coming decades, natural fresh water sources will be depleted in various regions across the world, and the only solution is to invest in efficient, renewable sources of potable water.

However, at current spending levels, the world is ill prepared. In a 2009 report, the United Nations estimated that the annual global water infrastructure financing gap (between what is required and what is currently being spent each year) may be as high as $85 billion, with over a third of that attributed to developed Asia and China.

A Salty Problem
Earth's surface is dominated by water, 97% of which is salty. If even a fraction of that can be converted to drinkable water for municipal purposes and usable water for agriculture and industrial applications, then water scarcity becomes a far less daunting crisis.

The process of separating clean water from its contaminants, such as salt and other impurities, is called desalination. The most basic method is to evaporate the salt water, resulting in clean water in the form of condensation -- but that is inefficient on an industrial scale.

Most modern desalination plants use a process called reverse osmosis, where saltwater is forced at high pressures through a membrane filter. Salts and pollutants are trapped in the filter, and pure water passes through.

As of 2013, there were more than 17,000 desalination plants worldwide, with a total daily output of more than 21 billion gallons of pure water. Membrane-based reverse osmosis desalination has far outpaced its thermal-based desalination competitor in terms of newly-installed annual capacity growth.

So why isn't desalination more prevalent in the fight to combat droughts and water scarcity?

Desalination has a clear drawback: it consumes huge amounts of energy.

The companies that can develop the most cost-effective and energy-efficient desalination solutions should be able to reap the long-term benefits of large government contracts. In fact, analysts at market research firm Technavio estimate that the global water desalination market will grow at a 9% compound average growth rate from 2014 to 2018.

Let's dive in and see which of these desalination companies look most promising for shareholders.

Consolidated Water Co. Ltd. (Nasdaq: CWCO )
CWCO designs, builds, operates and finances reverse osmosis desalination plants and water distribution systems in the Caribbean, including seven plants in the Cayman Islands and three in the Bahamas.

The company focuses on areas with rapid population growth and high tourism levels, but with little-to-no sources of fresh water. These factors create urgent demand for drinking water. Management also aims to expand into new water-strapped regions.

Currently, the company is developing a 100 million gallon-per-day desalination plant in Rosarito Beach, Mexico, which will eventually supply fresh water to northern Baja California, Mexico and San Diego. CWCO may also expand the capacity of its desalination plant in Bali, Indonesia, a popular beach resort tourist destination whose existing water supplies will soon be unable to meet increasing demand.

Consolidated Water's business is divided into three segments: a retail water segment, which produces and supplies water to residential, commercial and government end-users; a bulk water segment that produces and supplies water to government-owned distributors; and a services segment that provides management and engineering services for desalination plants.

Shares of Consolidated Water Co. hold clear value: They sport a 2.3% dividend yield and trade for less than ten times trailing cash flow. Announcements about future desalination plants will be a key catalyst to send this stock moving higher.

Tetra Tech, Inc. (Nasdaq: TTEK )
Tetra provides consulting, engineering and managerial services for clients that are addressing water, environment, energy and infrastructure needs. The company is currently building a large desalination plant in San Antonio, Texas, which is expected to produce 12 million gallons of drinking water a day.

The company doesn't always serve as a prime contractor. For example, privately-held IDE Technologies is building a $1 billion, 50 million gallons-per-day desalination plant in Carlsbad, California (which will supply 7% of San Diego County's water needs). Tetra designed the conveyance pipeline that will link the plant to the regional water supply. Tetra Tech also provided preliminary designs for the plant, as well as agency coordination services and flow regulation structures.

The company's expertise as a prime contractor, sub-contractor or technical consultant, sets the stage for rising revenues in coming years as desalination plants start to cover the global landscape.

Energy Recovery, Inc. (Nasdaq : ERII)
Lastly, as energy intensity is a key concern for desalination plant operators, investors should consider ERII. The company is providing 144 PX Pressure Exchangers at the desalination plant in Carlsbad, which will allow the plant to save an estimated 116 million kWh (kilowatt-hours) of energy, or roughly $12 million, per year, by capturing and harnessing hydraulic energy typically lost in the high-pressure streams of reverse osmosis.

With a market value of just $140 million, ERII is a micro-cap stock. But the company appears well-positioned to benefit for the steady projected growth of desalination. For a deeper look at this company, you can view my colleague Andy Obermueller's analysis here .

Risks To Consider: A spike in energy prices would make energy-intensive desalination plants less feasible, unless companies can develop further energy-saving technologies. Over the long-term, global water scarcity issues will compel investments in such water-saving technologies.

Action To Take --> With each passing year, desalination technologies benefit from incremental improvements, and as operational costs fall, demand for these massive complexes is bound to rise. These companies represent a spectrum of ways to play the trend, each with a distinct risk/reward profile.

As I mentioned above, Game-Changing Stocks' Andy Obermueller recently recommended ERII to his readers. But that's not the only game-changer he's been talking about lately. Andy has written extensively about the profit potential for Apple's newest technology Apple Pay -- and more importantly the company's key suppliers. If you haven't heard about this opportunity yet, then I urge you to check out his comprehensive report on how to profit from this technology, by clicking here .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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