Vertical Pulse

Notes on Water Technology

The following are some of my notes taken from recent research that we have conducted on the water industry:

• Desalinated water is roughly 30-50% more expensive than rainwater.
• Seawater desalination is more expensive than desalination from brackish water. This is because ocean water typically requires more power to bring the water up to the temperature where it will pass through the reverse osmosis membranes more easily. Also, brackish water is less salty than seawater. 
• While most desalinated water is piped from the desal facilities, some desal water may be placed in containers and delivered to distribution points that way in the future. The containerization of desal water would enable the desal facilities to be located further offshore. This could help eliminate the community opposition to desal facilities which are placed closer to the coasts. The environmentalists are concerned about the highly-saline concentrated discharge that comes out of the desal plant and has to go back into the bay or ocean.
• The salt that arises from the desal process has almost no commercial value. In fact, there is a cost to discharge it.
• Emerging countries that invest in their water infrastructure will not need to buy much equipment from American companies as most of these countries are quite capable of producing pipes and pumps.

These are some of the issues that are discussed at IncreMental Advantage's Water Conferences. For more information, please visit www.incrementaladvantage.com.

China's Water Problems

China is beset with nearly unquenchable water sufficiency challenges. For instance:

• The world's most populous nation has on average one-quarter of the per capita water resources of the world average; in Beijing, it is one-thirtieth. Some 136 cities face severe water shortages.
• More than 300 million people, almost a quarter of the population, lack access to clean drinking water.
• Because of pollution, one-quarter of China's waterways can't be used for industry or irrigation.
• Water shortages on average have reduced industrial output $25 billion a year, according to CLSA Asia-Pacific Markets.
• If no steps are taken, Beijing could face a water shortfall of one billion metric tons of water a year by 2010, estimates Ma Jun of the Institute of Public and Environmental Affairs.

These are some of the issues that will be addressed at IncreMental Advantage's Profiting in the Water Industry Conference which will take place in New York City on June 6. Further information can be obtained at www.incrementaladvantage.com/conferences or by contacting Neomi Barazani at neomi@incrementaladvantage.com.

Analyzing Metered Water Companies

I recently interviewed David Schanzer, Senior Analyst at Janney Montgomery Scott about methods of analyzing Water Utilities and the State of the Water Utility stocks. The following are some of the highlights from that interview:

• Roughly 65%-75% of the ownership of the publicly-traded metered water companies is in the hands of retail investors.
• Unlike their electric and gas brethren, the water utilities never, ever reduce their dividends.
• In general, the water companies have more amiable dealings with regulatory authorities than the electric and gas utilities.
• Water utilities that operate in states that have separate regulatory staffs that only oversee water companies - as opposed to also regulating electric and natural gas utilities - are typically at an advantage.
• While there are short-term savings to be had as a result of consolidation in the water utility sector, these savings typically get regulated away at subsequent rate case hearings.
• In terms of rainfall, water utilities are most advantaged when there is a lot of rain in the spring and winter and a lot of dry, hot weekends during the summer.
• Electricity is the largest expense that a water utility faces because that is what pumps the water from place to place.
• Organic growth for the average water company in most of the United States is about 1% a year.

Mr. Schanzer will speak at our Premier Profiting in the Water Industry Conference which will take place in New York City on June 8, 2006. Other speakers are CEOs, CFOs, and Presidents of publicly-traded water companies such as American Water, California Water Service, Consolidated Water, Southwest Water Company, SJW Corp., Artesian Resources Corporation, The York Water Company, American States Water Company, Pennichuck Corporation, and Pure Cycle Corporation.

These are some of the issues that will be addressed at IncreMental Advantage's Profiting in the Water Industry Conference which will take place in New York City on June 6. Further information can be obtained at www.incrementaladvantage.com/conferences or by contacting Neomi Barazani at neomi@incrementaladvantage.com.

Israel - A World Leader in Water Management

David Wanetick, Managing Director of The Wall Street Transcript, said “Israel is becoming a world leader in water management. Due to its population and industrial growth, scarcity and threats of having its water supply disrupted by Syria and Lebanon, Israel has been forced to become resourceful in its management of water.”

Interesting facts about Israel’s water management include:

• Ashkelon, Israel is home to the world’s largest operating desalination facility. 
• Despite its tiny geography, Israel’s climate is representative of half the world’s climates.
• Israel has 31 desalination facilities and 1,200 wells. Israel recycles 75% of its water. The second largest water recycler is Spain, with 12% recycling. Israel’s Water Commission anticipates that Israel will desalinate 20% of its water consumption by 2010.
• Israeli venture capitalists are becoming more active in investing in water-related technologies. For instance, the Millennium Materials Technologies Fund is reported to have allocated at least $20 million to the water sector. Also, Kinarot – The Jordan Valley Technological Incubator, which is active in water investments, is being privatized.  

Mr. Wanetick continued, “We are pleased to have interviewed Mr. Gustavo Kronenberg, General Manager and CEO of VID Desalination Company Ltd., the concessionaire of the 100mcm/year BOT seawater desalination project in Ashkelon-Israel. A great deal of progress in reducing the cost of desalination has already been achieved: Ten years ago, desalination cost $1.10 per cubic meter. It now costs $0.60, and growing demand and advances in technology will continue to drive costs lower.”

“China alone will propel tremendous demand for desalination: China’s goal is to produce 5.5 billion cubic meters of desalinated water a year, 55 times the capacity of the Ashkelon facility. China is expected to invest $18.6 billion a year in water desalination by 2020,” according to Mr. Wanetick.

Our interview with Mr. Gustavo Kronenberg will be made available free of charge to registrants for our Profiting in the Water Industry Conference which will take place in New York City on June 8. This interview can be purchased for $25 by contacting Naomi Barazani at neomi@incremendtaladvantage.com or 609-919-1895 x100.

About this Conference:

This conference is being chaired by IncreMental Advantage.

This conference is heralded as being the largest and best-attended event that focuses on strategies for investing in the water industry. Speakers include leading research analysts from Janney Montgomery Scott and Stanford Washington Research Group; senior executives from publicly-traded water utilities such as California Water Service, Consolidated Water, Southwest Water Company, San Jose Water Company, Artesian Resources, Pennichuck Corporation, American States Water Company, The York Water Company, and Pure Cycle Corporation. Other experts from the water industry scheduled to speak hail from the California State Water Resources Control Board, the South Central Connecticut Regional Water Authority, the New Jersey Environment Infrastructure Trust, and the Environmental Protection Agency.

Further information about our upcoming Water Industry Conference on June 6, 2007 in New York City, please contact Neomi at neomi@incrementaladvantage.com or 609-919-1895 x100.

Water Conference Highlights

The following are some of the highlights from our Profiting in the Water Industry Conference that was held in San Francisco on December 1, 2005.

According to David Schanzer from Janney Montgomery:

• The entire market capitalization of publicly-traded water utilities is $6.5 billion. The total trading volume of the sector is between 600,000 and 700,000 shares per day, about the same level of volume that Cisco trades during the first half hour of trading.
• This year two Unit Investment Trusts were formed and the American Stock Exchange formed an exchange traded fund - all of which were formed to invest in the Water stocks.
• Despite a great deal of consolidation among the publicly-traded water utilities, there remains a tremendous potential for further acquisitions by these companies. There are an estimated 55,000 potential acquisition opportunities for these companies. In Pennsylvania alone, there are roughly 450 potential acquisition opportunities for water utilities.
• The management teams of water utilities should be saluted for not making tempting mistakes such as diversifying by going into the bottled water business and not going into the heating and ventilation business.

According to Zane O. Gresham of Morrison Foerster LLP and Francesca McCann of Stanford Washington Research Group:

• One of the drivers for growing demand for water will simply be population growth. According to the U.S. Census Bureau, the American population is expected to grow 29.2% from 2000 to 2030. The Southwestern U.S., were water is particularly scarce, is expected to experience population growth of nearly 50% during the same period of time.
• Regulators in states such as California are requiring real estate developers to demonstrate that there will be sufficient water availability to service the communities that they wish to develop as a condition for receiving necessary zoning approvals.
• There is tremendous potential for desalinization. Estimates hold that desalinization will be a $95 billion market by 2015. In California, there are 19 proposed desalinization plants on the docket which would yield a projected 240,000 acre-feet per year. However, regulators in California do not want any new desalinization plants to be established along California's coasts.
• Water re-use is the most cost-effective method of generating new water since it is water that has already been extracted and collected and therefore transportation costs are not borne. However, water re-use has been ill-marketed under the banner of "Toilet to Tap" to promote water re-use. Also, health authorities often impose highly stringent requirements on the quality of recycled water.
• Water transfers are becoming a growing issue. For instance, there is expected to be 36% increase in urban water use in California by 2020 and a 7% drop in agriculture water use during the same period of time. Also, environmental regulations, such as those under the federal and California Endangered Species Acts, have resulted in the set aside of water for environmental protection purposes.
• According to the EPA, $151 billion in investment in infrastructure is required to meet legal environmental standards. Also, California public water systems are required to meet standards for 59 organic contaminants; 17 inorganic contaminants; 6 radionuclide contaminants; and, 8 disinfection byproduct contaminants. Further, new EPA drinking water regulations will be released on December 15.
• There are several problems in connection with upgrading or replacing water infrastructure. First, local water services will be responsible for such replacements. However, the projects are so large that state-wide or regional coordination is recommended since they are beyond the ability of local municipalities to finance. In California there is a $40 billion backlog of such upgrades. There is often community opposition and union opposition to such projects. This combination makes getting approval for municipal financing very difficult.
• Water systems are vulnerable to earthquakes and flooding. For example, during the Loma Prieta earthquake, 20 million gallons of raw sewage was dumped into the Oakland Estuary. Also, a flood in that breaks the levees around Sacramento could cause $47 billion in damage, partly because salt water could infiltrate the delta area.

Our next Profiting in the Water Industry Conference will take place in New York City on June 6, 2007. For further information, please visit www.incrementaladvantage.com/conferences or contact Neomi Barazani at neomi@incrementaladvantage.com.

Water Systems' Vulnerability to Earthquakes

Hurricane’s Katrina, Rita and Wilma are painful reminders of the ruthless destruction that natural events can wreck on crucial infrastructure. Statistically, California is long overdue for another significant earthquake. The impact of a 1906-magnitude earthquake could have catastrophic ramifications for California ’s water purity and deliverability. (It is important to note that California

is not alone in its vulnerability to earthquakes as there have been at least 26 American cities that experienced significant earthquakes and that are at risk for another earthquake.) 

In connection with our Profiting from The Water Industry – Tapping a Reservoir of Wealth Conference which will be held in San Francisco on December 1, we have undertaken quite extensive research into the impact of an earthquake in California on the Golden State’s water infrastructure.

We had the opportunity to interview some of the preeminent authorities on California’s vulnerability to earthquakes and on California’s water systems. These interviewees included Dr. Lucile M. Jones of the U.S. Geological Survey; Arthur G. Baggett, former Chairman and member of the California State Water Resources Control Board; Zane O. Gresham, Partner at Morrison & Foerster; and, Tony Irons, Deputy General Manager of Infrastructure at the San Francisco Public Utilities Commission.

Among the insights elicited from these interviews are the following:

• Because Southern Californiahas over 300 faults vulnerable to earthquakes, that region has about half of the nation's risk from earthquakes. The entire coast of Californiais really made up of a braid of earthquake faults, so there is risk all the way from San Diegoin the south to Crescent Cityin the north.

• California averages, at least, one magnitude 6.0 or greater earthquake every three years. So, the probability that California will have another significant earthquake within five years is between 80% or 90%. California is overdue for another major earthquake as it is rare that there is a five-year period without a magnitude 6.0 earthquake. The last one we had was a magnitude 7.1 in 1999.

• A 1906-magnitude earthquake happens about once every 200 years on average. One can not say it's been 100 years, we still have 100 years to go. It is a long-term average. Silicon Valleycould be paralyzed by such an earthquake.

• All major aqueducts (the California Aqueduct, the Los Angeles Aqueduct and the Colorado Aqueduct) cross the San Andreas Fault. So, when a major earthquake happens, every one of those aqueducts is going to be offset by 20 feet to 30 feet due to earthquake slipping.

• Coupling earthquakes with floods, the levy system would have by far the greatest single impact because of where the federal and state projects are pumping water out of the delta. And if there were massive flooding barriers, the salt water would be intruding all the way into those pumps.

• The consequences of there being catastrophic failure of the water system serving the San Francisco Bay Area are enormous because at present, if there was a major earthquake that severed the only transmission line that serves the Bay Area, it could result in at least two million people having no water for well over a month. Estimates indicate that this transmission line could remain out of service for up to 60 days and the economic impact would be in the range of $28 billion.

• One of the most serious problems lies on the water sewage treatment side. Electricity outages after an earthquake could both prevent the treatment and delivery of drinking water even if the pipes are intact and also will prevent the treatment of wastewater before it is discharged. According to a study that was completed just after the 1989 earthquake, about 20 million gallons of raw sewage simply had to be released into the Oakland estuary in the six-hour period after the earthquake because of a lack of electricity. That of course could happen in Los Angeles at their enormous Hyperion Wastewater Treatment Plant or even in San Diego or similar types of facilities.

• Earthquake preparedness has taken a bit of a backseat because the same emergency managers that are needed to respond to earthquakes are also responding to the terrorism threats.

These are some of the issues that will be addressed at IncreMental Advantage's Profiting in

the Water Industry Conference which will take place in New York City on June 6. Further

information can be obtained at www.incrementaladvantage.com/conferences or by

contacting Neomi Barazani at neomi@incrementaladvantage.com.

Katrina's Impact on Water Supply

My colleague, Richard Tullo, recently interviewed Zane Gresham, a partner at Morrison & Foerster. Mr. Gresham has several decades of experience in major water projects. Among the most interesting points to come out of this interview are the following:

·              California’s water supply is constrained by bumping up against its allotment of water from the Colorado River; intrusion of seawater into the groundwater where groundwater is being pumped more rapidly than it can be restored in parts of Northern California and Southern California; and, restriction on the amount of water that can be taken out of rivers or the Delta in Northern California, particularly for transshipment to Southern California. 

• Much of the infrastructure both for drinking water and for wastewater treatment was built in an area some 30 or more years ago in which there was very substantial federal and state funding. Up to 87.5% of wastewater treatment facilities in California in the late 70s and early 80s were built with grants or concessionary loans from the federal and state government. That funding has disappeared.

·              It seems very likely that there will have to be significant increases in charges for water (at least in California), particularly for agricultural use.

·              Among the factors causing severe water-related problems in New Orleans and other areas impacted by Hurricane Katrina are: a) The surface water is highly polluted because of the amount of flooding and what has been dropped into and brought into the water. b) In places further along the Gulf Coast, there has been greater intrusion of salt water and that is going to adversely affect the groundwater. c) The flat out destruction, the obliteration of a lot of facilities, which would otherwise be used to treat and to distribute water.

• Laws in California require developers to demonstrate that there is an adequate water supply to support a development before the local authorities will grant approval of the development.

·              Restoring adequate water infrastructure in the part of the country devastated by Hurricane Katrina will require something similar to the Tennessee Valley Authority. That is, the federal government will have to step in to provide water and energy for the development of a whole region, take the financial responsibility and take the lead role ahead of the states and local government in order to assure that an entire region will be developed and protected.

Mr. Gresham is speaking at, and Morrison & Foerster is a sponsor of, our Profiting in the Water Industry – Tapping a Reservoir of Wealth Conference which will be held in San Francisco on December 1-2. The entire interview will be included in our conference book which will be made available to conference attendees free of charge. This interview can be purchased by requesting it from neomi@incrementaladvantage.com. Our next Profiting in the Water Industry Conference will be held in New York City on June 6, 2006. Visit www.incrementaladvantage.com/conferences or contact Neomi at 609-919-1895 x100 or at neomi@incrementaladvantage.com for more information.

Where Venture Capital is Flowing in the Water Industry

We recently interviewed some of the nation's savviest water venture capitalists and portfolio managers in connection with our Profiting in the Water Industry: Tapping the Reservoir of Wealth Conference that will take place in San Francisco on December 1. The interviewees were Ira Ehrenpreis of Technology Ventures, Robert Day of Expansion Capital Partners, Warren Weiss of Foundation Capital and Rod Parsley of The Water Fund and Terrapin Partners.

The following are a few of the insights that these investors shared with us:

1)   Desalinization is being used not just in places such as the Middle East and on the coasts of the U.S. Rather, desalinization is increasingly common in the inland areas of the United States to deal with aquifiers that have become brackish and are only useful once the salt has been removed.

Note: While this wasn't discussed in the interview it is interesting to note that the largest desalinization initiative in the world--in Ashkelon, Israel--just announced that it is delivering 3,500 cubic meters of water per hour to the Negev. Capacity will be doubled to 7,000 cubic meters per hour, or 100 million cubic meters per year, by the end of 2005. This desalinated water is considered especially good, since it contains no contaminants, salts, or other substances. The water arriving at households is mixed with ordinary water, in order to restore substances needed by the body. Desalinated water is soft water, which saves use of laundry powder, fabric softeners, and substances to remove calcium deposits in pots, pans and pipes.

2)   Regulation is a driver of adoption of technology. According to environmental regulations, water must now be treated for some 90 contaminants, far more contaminants that had to be treated over the past 20 years. Water regulation is now dealing with issues beyond safety. These additional issues include taste and clarity. New arsenic rules that will come into effect in January should cause water companies--particularly in the Southwest--to adopt certain technologies.

3)   Tremendous opportunities for building infrastructure exist in countries such as India and China. For instance, the Chinese are planning to build 375 waste water treatment facilities by 2009.

4)   There is still an enormous demand to rebuild water delivery infrastructure in the U.S. There are more than 200,000 water main breaks per year. In many communities, as much as 30% of the water is lost before it even reaches the tap. According to the EPA, between $15 and $20 billion per year needs to be spent to address these issues. Currently, only $3 billion is being spent per year.

The entire interview will be included in our conference book which will be made available to conference attendees free of charge. This interview can be purchased by requesting it from neomi@incrementaladvantage.com.

Further information about IncreMental Advantage's next Profiting in the Water Industry Conference, which will take place in New York City on June 6, can be obtained at www.incrementaladvantage.com/conferences or by contacting Neomi Barazani at neomi@incrementaladvantage.com.