Month / November 2016

by Frank Maduri

The Commodification of Water

Many people living in America and other Western societies tend to take for granted the resources that we have at our fingertips which require little to no effort to obtain. One of those resources is also the most critical one: access to water.

I have fallen victim to this situation myself, having lived in America my entire life, never having to think about where my next glass of water would come from, or if I had enough water to take a shower. I simply turn on the tap and have access to safe, clean, unlimited drinking water.

However, as my previous experience covering the severe drought conditions that have plagued the American West have taught me, not everyone in America has had that same access to water as my experience has afforded me. The limited supply of water in states such as California and Nevada, the dangerously low levels of supply at reservoirs such as Lake Mead, and the changes in the levels of snowfall in the Rockies have prolonged the severity of the drought. The associated snowpack melting in the Rockies is what serves as one of the main supply points for the Colorado River and other Western rivers which feed into Lake Mead.

The access to water is also severely limited in certain areas of the world from Developing World areas in Africa and South America; to areas with booming populations and commerce such as China, India, Russia, and parts of Southeast Asia.

The simple fact is that the demand for water is very strong and the available supply of safe, clean water is low in comparison. Then, the projected demand over the next several years demonstrates that this demand curve is only going to enhance the demand for water, and that creates the classic supply and demand scenario that has Wall Street as well as other commodity experts speculating about one big idea: the commodification of water.

Buying & Selling A Life-sustaining resource

This idea at the core is both controversial and extremely complicated, while at the same time contains far reaching potential consequences. The financial markets buy and sell commodity positions on all sorts of materials from cattle, to coffee and even orange juice. The thought of that sort of trading with water is unthinkable to some, and a natural progression in the trade of a valued commodity to others.

The rationale behind these feelings is pretty self-evident, water is needed for survival where other commodities are not. The thought process around water and the access to water is different too, with many people (especially in the Western societies) feeling that they are entitled to water, or that water should be provided and not bought and sold on an exchange. Those feelings are all understandable.

However, water is currently sold on commodities markets in the form of ETF (Exchange Traded Funds) types of arrangements. In fact, for all those out there that saw the film, The Big Short, starring Christian Bale, Ryan Gosling, and Steve Carell which revolved around the housing bubble bursting and the economic crash that followed. The real-life character Bale depicted in the film, Dr. Michael Burry, has already began focusing his purchasing efforts on buying commodity positions in water.

Dr. Burry was ahead of the curve on the housing market with the swaps and CDOs, and now is focused on water which is a scary proposition. The current ETF structure places various products having to do with water such as the makers of pumps, filters, or irrigation systems with those who make equipment for water utilities. The Palisades Water Index, Dow Jones U.S. Water Index, ISE-B&S Water Index, and the S&P 1500 Water Index are a few of the most well-known funds that deal with water related trading activity.

In North America, this issue has come to the forefront with the controversies surrounding Nestle and other bottled water companies being able to utilize water supplies from Indian reservations in California while the state is on a water restriction. I covered that issue as well as the drought impact on Lake Mead so I have read countless reports and studies about the water supply in the domestic United States.

Another controversy surrounding Nestle was the purchase of a large water utility in Canada which serves the public. It is a dangerous potential precedent which led to protests and a call for a boycott of Nestle bottled water in Canada. The company also has outbid locals in Ontario for use of well water supplies for the purposes of bottling water, and Nestle has a permit to take water from an Ontario watershed during a drought restriction in that part of Canada. These incidences have outraged the locals and has initiated much the same argument as I posed with my prior work on Nestle in California: should they be allowed to sell water for a profit during a drought? It raises some serious questions.

Check and Balance

The commodification of water is also very complicated and is viewed by some in the investing and commodity trading sectors as a scenario which will never reach full realization. This is due largely to the reality that water is regulated by utilities which are operated, in whole or in part, by the state or the county. The municipal and county government or state level government involvement in the water supply is seen as the major deterring factor to essentially “check and balance” the trading of water as a commodity.

While the role of government may be factor in the U.S. and some other countries, it is certainly not the case in every country that is either dealing with water scarcity now, or will have an issue with the supply of water in the future. The financial market news site, The Street, reports that infrastructure spending for water supply related projects is estimated at $22 trillion over the next 20 years. That spending figure is just to maintain the status quo and does not account for new demand areas in growing population centers which I mentioned earlier.

That same piece done by The Street goes on to explain that the future investment strategy with regard to water will involve the infrastructure companies. The rationale around that statement makes sense because most of those same companies are diversified, therefore they will be involved with other infrastructure projects in other industries, not just with water related projects.

The thought of brokers or other “power elite” types buying positions in the supply of water is a downright frightening proposition for many in the general public. Furthermore, there are those who had no idea that the trend toward the commodification of water was even on the horizon, which is part of the impetus behind my choosing to write this piece.

Frightening & Intriguing

The reality is that water scarcity is a real issue confronting our future. It will impact supply and demand to a level that speculators will take a run at investing in positions at least in the ETFs involved. The response of other Developing World countries and emerging market countries, such as the BRICs countries I mentioned earlier, remains to be determined. They may decide to privatize the supply of water, in a country like China they will most likely implement measures where the supply is completely controlled by the national government, and Russia could fall somewhere in between. That portion of this scenario bears watching.

The commodification of water is also seen as both frightening and intriguing at the same time: frightening because it is a life-sustaining resource that most people feel should not be consolidated into the hands of a few wealthy individuals or entities, and intriguing from the investment perspective because there is no substitute for water like there is with certain other commodities.

The argument could be made that other natural resources such as oil and gold are traded as commodities, but the converse side is that neither of those resources are critical to sustaining life which water is most certainly. There are others within the investment world which feel that the buying of positions relative to the market on water may be essentially a bunch of noise. This is because the investors and those making valuations have difficulty in measuring the profitability of the private companies involved in the water industry.

Moreover, there is a sentiment that water is strictly a niche commodity investment and does not have the return rate needed to be a stand-alone investment. All of these factors will serve as the backdrop to the future where water will be in decreased supply and increased demand, unless some other method or technology comes along relative to the desalination of saltwater. That would “change the game” dramatically given the immense amount of saltwater that could be utilized.

In the end, the debate over whether or not a life-sustaining natural resource such as water should be traded as a commodity will continue. The potential for water scarcity for nearly half the population of the globe will also be a pressing issue in the future. Should water be traded as a commodity? Should it be exempt? Should industry titans such as Nestle be allowed to profit from resources that could serve local populations and not serve their bottom line?

Those questions will face us now and in future, with drastic and far-reaching consequences.

(Background and some statistics courtesy of The Street, Investopedia, U.S. News & World Report, Forbes.com, and CNN.Money.com)

by Frank Maduri

Follow Up: Lower Food Costs and the Impact on the Restaurant Industry

In a follow up to my most recent piece on the lower cost of food commodities and the impact on the retail grocery channel; the Chicago Tribune published an interesting article on the relationship to those lower costs and the impact on the restaurant industry.

The article describes the fact that the falling food prices for staple items such as beef, eggs, and other commodity products has not translated into lower prices at restaurants. In fact, dining out is more expensive than it has been when compared to eating at home, that ratio is at the highest difference in three decades in the United States.

I was thinking about this connection myself last week when I was working on the piece on food commodities. It came about at a couple of different points last week: I had picked up some mail and the menus for some restaurants in my area were included in the ads and coupons. The prices on some of the menu items really jumped out at me for being expensive. Then, I stopped one day last week in a time crunch to pick up lunch and it was pretty expensive compared to the servings of what I had ordered.

I kept thinking about people that eat lunch out every day and how that cost will definitely add up over time. In keeping along that line, just take an example of ten dollars a day for lunch during the work week. That ends up being fifty bucks per week and two hundred dollars per month for lunch which will end up being close to two thousand four hundred dollars per year, give or take. That is for one person, for lunch, and an average cost of ten dollars. That is a lot of money for the average family.

The lower cost of food has had the reverse effect on restaurants because the cost of running and maintaining the business has not decreased. The restaurant has to be staffed and it has significant overhead costs with insurance, energy, and other costs associated with running that business.

In order to maintain profitability amid an increasingly competitive market, most restaurants have had to increase their menu prices. The other pressure point for restaurants, especially the traditional sit down places and the fast casual chains, is that the grocery store channel has become increasingly more relevant in the prepared foods area.

The local grocery store in your neighborhood and mine now has expanded upon the offerings for prepared meals to go which suit our active lives and are at a lower price point than going out to eat. I think we all can attest to a recent shopping trip where we have grabbed a cooked rotisserie chicken for dinner or put together a meal on the go from a huge selection of choices at a Whole Foods or a Shop Rite.

The numerous alternatives at the grocery store and the emergence of fast casual dining options such as Chipotle, Salad Works, and a few others have impacted the margins of the traditional restaurant channel as well. The Tribune article cites the troubles of Chili’s and a few other regional Midwestern chain restaurants in surviving this trend. The article as well as other industry resources mentions the higher minimum wage in certain states as another mitigating factor in the demise of certain restaurants in this climate.

The fast casual or traditional fast food options have lower overhead because the employees are members of a “crew” where each person is cross-trained and can complete a variety of job functions. This approach has helped them sustain profitability more than a traditional sit down restaurant but even the fast casual and fast food operators are encountering issues with falling food prices and an uncertain economy.

Many consumers are opting to save money in their budget and eliminate eating out and they are staying home. The more health conscious consumer prefers to make their own food at home with ingredients which they select, which is becoming a larger trend resulting in eroding profits in the restaurant sector.

The fast food channel has displayed several indications that they are at an oversaturation point. The industry is focused on rolling out new product offerings or seasonal products to attract new customers. The major players in the industry are putting together special promotions and full meal deals such as “4 for $4” or a “McPick Two”, to drive the value to the customer.

However, even with all of those efforts in marketing, the channel is hitting a point where it cannot grow profits. Therefore, they all made a push for breakfast and that is the final frontier, so to speak, for the fast food industry to grow profits. It is the last untapped revenue stream available to them where they can maximize the lower commodity prices for eggs and other staple items to put together a profitable set of menu offerings. The demand for a fast breakfast is also very robust for the American consumer that is seemingly always rushing around in the morning to start a very hectic day.

The traditional restaurants are going to struggle in this scenario because it is hard to compete on cost with other establishments and the fast casual/fast food/grocery prepared foods channels while maintaining their profits. It is a situation to bear in mind as the commodity pricing on food overall, and certain products such as beef and eggs in particular, will remain at a point where the restaurants and the grocery stores will feel the squeeze for the foreseeable future.

by Frank Maduri

Food Commodity Prices Drop

The average shopper in America has probably noticed the changes in price for several commodity items in recent months. The falling prices are due to a combination of factors such as decreased costs of fuel and product packaging materials. Some other areas such as with meat and eggs, those commodities are in a cost reduction due to some external factors surrounding supply and demand.

The egg market segment has seen prices drop about 50% according to industry sources. The price of eggs, as many consumers will recall, increased sharply due to the avian flu epidemic. I recall going to my local grocery store and the signs that were hung just about everywhere in the cases surrounding the eggs and dairy products regarding the shortage of eggs due to the rampant spread of that illness.

The price of eggs had to adjust and correct itself when the supply levels returned back to normal levels with the increased number of hens into the system. That is the rationale behind the drop in prices for eggs as well as the shift in overall global demand for the product. The demand curve surrounding eggs in China and other parts of Asia has flattened, it has decreased over the past several months which creates a supply abundance and consequently lower prices.

The pricing shift on meat is a similar scenario. The cattle population in the U.S. had some issues between disease and other factors which impacted the population and created a supply issue. This lead to an increase in beef prices that many of us remember between the grocery store butcher department and the menus of our local restaurants.

The supply of cattle has increased over time and the supply for beef as a commodity is oversaturated due to current market demand factors. Some of this is driven by the healthier eating trends of Americans where red meat is more limited than at other points. The industry experts have reported that the supply levels of beef are so high compared to the demand that the prices will remain low until 2019.

The price points of other food products have come down in relation to supply, lower delivery costs, and a host of other scenarios. The timing on the price changes as we head into the Thanksgiving/Christmas/ Holiday Season is fortuitous for the food product suppliers, the distributors, and the retail grocery as well as club store channels.

The retail grocery channel is a low margin business structure to begin with and these price fluctuations over the past few years on certain commodities have cut into those profit margins even further. The ability for them to turn around and sell these products at the holidays is going to help their revenue forecast to close out the year.

The price points on so many other products and services are going up, I thought it would be comforting to note that our food prices are coming down, and considering the necessity of food, that is some welcome good news heading into the holiday season.