2023-04-12 12:47:01 ET
Summary
- The Colorado River is now at the point where it cannot provide the required level of water for the 7 states that rely on it.
- This is a significant macroeconomic event that negatively changes the economic picture for both producers and consumers in these 7 states.
- This water scarcity effect is economically significant because it has implications for both businesses and consumers.
- As such, it is quite likely that it will end up negatively affecting real estate prices in the long term.
- Since this is an unprecedented event, investors with exposure should remain vigilant and keep their eyes on relevant economic/demographic metrics as they evolve.
Overview
The recent news about water conservation for the Colorado River is undoubtedly significant. This vast river spans 1,440 miles and provides the entire freshwater supply to 7 US states. The water shortages - and associated changes in the law - indicate a once-in-a-lifetime shift for residents of these states as well as the businesses that operate within them.
This article will review exactly what's going on and provide a macroeconomic take on the long-term implications.
State |
Arizona |
California |
Colorado |
Nevada |
New Mexico |
Utah |
Wyoming |
Source: Author's Excel Spreadsheet
The Situation
The Colorado River is running low on water. After a couple hundred years of use, and a few decades of drought, it is now running low. The river can no longer provide the levels of water that it has for the 7 states that rely on it. A snippet from the recent New York Times article on this immediately shows how significant this is:
Overuse and a 23-year-long drought made worse by climate change have threatened to provoke a water and power catastrophe across the West. The Colorado River supplies drinking water to 40 million Americans as well as two states in Mexico, and irrigates 5.5 million agricultural acres. The electricity generated by dams on the river's two main reservoirs, Lake Mead and Lake Powell, power millions of homes and businesses.
To complicate matters, the 7 states that rely on the Colorado River cannot agree on how the cuts should be distributed. This has resulted in the prospect - and likely outcome - of the Biden Administration taking unilateral action. The latest proposal suggests even cuts across the board, although this hasn't been made final and won't be until the Summer.
The draft analysis did not formally endorse any option; a final analysis is expected this summer, and it could include still other approaches.
As such, we have a situation in which all seven of these states are suddenly going to be receiving a lot less water. This situation is further complicated by the uncertainty around exactly how these cuts will be distributed. The final allocation aside, we must remember that water is a fundamental economic resource. Indeed, it might just be the most fundamental economic resource there is. As such, this is a significant macroeconomic event that investors be aware of. The next section will outline the implications of scarcer water in more detail.
Economic Implications
Less water can play out in several ways or a combination thereof. If water usage for a given state remains constant, then each unit of water will become more expensive - making water more expensive for all users. If overall water use decreases, and prices remain constant, then overall water availability will have decreased - creating a hard cap on certain kinds of economic activity.
The reality for each of these states will end up somewhere between these two extremes, with less water overall as well as more expensive water. Given the primacy of water, this will have economic implications across the board.
Agriculture and Industry
Agriculture and industry are both very water-intensive. You need a lot of water to grow plants, and you also need a lot of water to operate machinery and produce things such as metal. Suddenly, these industries are going to be economically disadvantaged if they are to be located in any of these 7 states. Given the now-higher input costs, firms will be forced to raise prices or pack their bags.
Drinking Water
Less water, and more expensive water, means that it will cost more to provide drinking water for the population. This will stress state budgets and increase the cost of living, resulting in a new kind of pressure on consumers residing in these 7 States. Either through higher taxes or higher costs, at some point someone will have to pick up the bill. This will impact the desirability of living in these states and will constitute a negative demographic pressure over the long-term.
Electricity Prices
As mentioned in the NYT article, several of these states also leverage the river for power generation. If the river can no longer be used for this purpose, then electricity will also become more expensive in these regions. This will result in a complex knock-on effect, similar to water, in which the economic foundations for both businesses and consumers become worse.
The Net Result: Economic Activity
The net result of all of this is less economic activity overall. When the economic picture becomes more burdensome for both producers (businesses) and consumers (people), the net effect is squarely negative. Relative to other states, the water economics within each of these states will now be a relative disadvantage. It would be unwise to believe this will have no effect on their economies long-term.
The Net Result: Real Estate Prices
When there is less economic activity over the long-term, that means there will be less people. Less people, in turn, results in less economic activity. The two effects feed each other and create a self-reinforcing feedback loop; people flock to where the jobs are, and more jobs are created where people flock to. Here, we have a dual-sided effect as water impacts both the producer and consumer sides of the equation.
This will result in lower real estate prices long-term in my view. This effect is well-understood by real estate investors. The future growth prospects of an area, both from an economic and demographic perspective, are central to real estate prices. When there is less money in an area, both people and businesses can afford less rent - leading to lower prices.
Conclusion
As such I would advise certain types of investors to exercise caution going forward. For people with exposure to agriculture, manufacturing, or real estate/REIT's in these 7 states - stay on your toes. It's one thing if your holdings include some exposure to these areas, but it's a different matter entirely if they are concentrated there. I would advise against concentrated bets in these regions for the sectors mentioned above.
Furthermore, while I am confident in the overall negative implications of water scarcity for these regions, I am not certain as to the quantitative significance of it. Given that this is a new effect entirely, we don't have data with which to predict it, either. The best approach at present is to stay watchful and keep a close eye on the numbers as they evolve.
For further details see:
The Colorado River Water Shortages: What They Mean For Investors Long-Term