Farmland is parched. Companies are worried. The global demand for water will soon outstrip supply. What’s the solution? Simple, say some business leaders and economists: Make people pay more for the most precious commodity on earth.
FORTUNE — Sarah Woolf’s 1,200-acre farm in Cantua Creek, Calif., sits in the Central Valley, which runs in a narrow stretch more than 400 miles through the middle of the state, covering an area about the size of West Virginia. Hemmed in by the Cascade Range to the north, the Tehachapi to the south, and the Sierra Nevada to the east, the valley has long been one of the most bountiful farming regions in the country. Though it has less than 1% of America’s farmland, according to the U.S. Geological Survey, it supplies a quarter of the nation’s food.
And for the past three years it has suffered the worst drought in almost anyone’s memory. In January, with California’s river and reservoir levels at record (or near record) lows, Gov. Jerry Brown declared a state of emergency. By March the drought was so severe that the state and federal governments, which both run systems that transport water from the Sierras to the valley, cut off supplies to farmers. That left many of them with two unpleasant options: Buy water on the spot market for up to four times the normal price or cut back sharply on planting.
Woolf, a third-generation farmer, grows tomatoes, onions, and garlic that typically end up as ketchup, salsa, and other products made by Heinz, P&G, and other big names in the food industry. Her choice was to farm only half of her land. “Customers are asking for our produce,” she says, “but we can’t deliver because we don’t have the water.” Officials say that more than 500,000 acres of otherwise rich, arable land in Central Valley will likely be left fallow this year. Acres of fruit and nut trees will die from lack of water. And in keeping with the laws of supply and demand, food prices have already risen.
Drive five hours south on I-5 from Woolf ’s farm, and the ground feels almost as parched. San Diego is living through one of its worst droughts in 1,200 years and now has to import 90% of its water. Likewise, nearly all of Texas is drier than tumbleweed. In April, 240 of the state’s 252 counties were designated disaster areas. Because of the “exceptional drought,” as the U.S. Agriculture Department calls it, folks in Wichita Falls, a city of more than 100,000 people northwest of Dallas, will soon have to bathe and brush their teeth in recycled sewer water. Freshwater is scarce these days in big swaths of Oklahoma, Kansas, Colorado, Nevada, and New Mexico too.
Water, as any physicist will tell you, doesn’t simply vanish from the earth. It exists in a state of flux: as glacial ice, cloud vapor, salted sea, the sweat of a brow. In whatever phase, the water leaving one domain — by evaporation, precipitation, consumption, or flow underground — inevitably shows up someplace else. Drought in California resides in the same earthly sphere as the storms that have battered the United Kingdom this year in the wettest winter on record.
But that said, the water scarcity problem is real … and serious … and global. Since the 1970s, droughts worldwide have gotten longer and more intense over wider areas, according to the UN’s Intergovernmental Panel on Climate Change. Throw in the effects of pollution, overconsumption, and relentless population growth, and there is little for the political left and the right to debate: We have a genuine, burgeoning, boundary-crossing crisis over water.
That isn’t new, of course. NGO types, geologists, and climate scientists have been warning about freshwater scarcity for some time. What’s striking today is the sheer number of gray suits who are sounding the alarm. “Water now gets discussed at the board level,” David Grant, the senior manager for water risks and partnerships at SAB Miller, tells Fortune. (That Miller has a senior manager for water risks is telling in itself.) PepsiCo PEP CEO Indra Nooyi says, “The world water crisis is one of the most pressing challenges of our age.”
Flip through the latest 10-Ks of companies from Coca-Cola KO to Campbell Soup CPB and you’ll find water-related worries enumerated among the possible hazards to operations. Coke lists “water scarcity” as a risk factor behind only “obesity concerns,” which the company warns might reduce demand for some of its products. Nestlé chairman Peter Brabeck-Letmathe, who heads the 2030 Water Resource Group, a public-private collaboration among leading beverage companies, development banks, and several government agencies in Asia, Africa, and Latin America, has even dedicated a personal blog to global water issues.
All of the corporations above, to be sure, have an obvious stake in the issue. Nestlé is the world’s largest food company by sales and a dominant bottled-water seller in the U.S., with brands like Poland Spring and Perrier in its fold. Each year Miller sells more than $34 billion worth of Miller beer, Coors Light, Peroni, and some 200 other beer brands. Coke and Pepsi? Again, their interest in getting enough clean, fresh water to make their products is crystal clear.
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Dozens of other industries, however, from chipmaking to fracking to meatpacking, also depend on having water aplenty. The long drought in Texas, for example, forced Cargill to close a beef-processing plant in Plainview last year as the number of cattle in the U.S. herd dropped to its lowest level in more than six decades. Dry pastures hurt grain output, pushing up prices for feed — which, along with smaller herds, has led to sky-high prices for beef today.
“We’ve always thought about how water was important for beverages or chemicals,” Goldman Sachs GS senior investment strategist Abby Joseph Cohen tells Fortune. “But how many other industries depend on water in the supply chain, for their workforce and production and to maintain a healthy environment around where they’re operating?”
The answer may be virtually all of them. Which is why legions of business leaders, economists, and think-tankers are coming to reclassify water as a kind of buried treasure: “blue gold.” Willem Buiter, Citigroup’s chief economist, sums up the thinking of many these days: “Water as an asset class, in my view, will eventually become the single most important physical commodity — dwarfing oil, copper, agricultural commodities, and precious metals.”
And that makes the next question a humdinger: If water is so incredibly valuable, why is it so cheap?
To produce one half-pound cheeseburger, it takes 968 gallons of water, based on data from Water Footprint Network, a nonprofit group in the Netherlands, and Fortune’s analysis. The slice of cheese (24 gallons), wheat bun (19 gallons), and tomato and lettuce (under two) are a relatively small part of the total. The eight-ounce patty, by contrast, requires an estimated 924 gallons to produce when the amount of water needed to grow the feed for the cow is included.
If all that water somehow came out of a home tap in Atlanta, the cost to produce that cheeseburger would be on the order of $23. Atlanta, you see, charges residential customers $6.30 for each cubic meter of water (equivalent to about 264 gallons) they use. In New York City, the rate is about half that ($3.27 per cubic meter). In Chicago ($1.46) and Miami ($1.15) it’s a lot less.
But most of the water that’s used in the world doesn’t come out of a kitchen or bathroom faucet. Seventy percent of it is consumed in agricultural production — and most of that, in turn, is free or dirt-cheap (provided by rain, well water, and government agencies). When farmers do have to buy water on the spot market, it’s sold in acre-feet (enough to cover an acre of land with a foot of water) and a lot cheaper than the municipal tap. So in the absence of drought, pestilence, and other agricultural plagues, farmers can produce those cheeseburger components for very little water cost.
That’s a lucky thing if you’re a parent feeding a family on a modest income. But many business leaders, economists, and other academics say water is so inexpensive that there’s no incentive to conserve or protect it. The price in the U.S. — once agricultural, industrial, and residential use is averaged out — is an almost laughably cheap four one-thousandths of a cent per gallon, according to the American Water Works Association, a Denver group that has been studying water issues since 1881.
One could argue that the answer to water scarcity is simple: Let water’s price swim closer to its value. Let the invisible hand do its job, and water prices will rise, demand will fall, and this precious resource will be saved. If water’s price were truly reflective of its value, the argument goes, investors would pour in capital for projects ranging from desalination plants to gray-water recycling systems to repairs on leaky municipal water pipes. These would help us increase the global supply of freshwater as the world’s population soars.
The idea of treating water as a commodity like oil or gold might seem disturbing on its face. Access to clear water ought to be a human right, many contend — and, indeed, the UN passed a resolution in 2010 confirming the same. Letting market forces take over, moreover, could put in jeopardy billions of people who barely have enough clean, drinkable water to begin with.
In developed countries, local politicians balk at the notion of raising voters’ water bills. Family farms might be driven out of business, food prices would rise — as would the end products for every device that uses microchips, things that take vast amounts of superclean water to produce. That’s the counterargument, anyway.
But supporters of the idea say you can have both human protections and Adam Smith: Preserve a certain amount of water for everyone for free (or at almost no cost) and have a mostly free market for the rest. “Water needed for drinking, cooking, and basic hygiene as a basis for survival must be available even for a person unable to pay,” wrote Nestlé chairman Brabeck-Letmathe on his blog. But “there must be limits: Water to fill a private swimming pool or to wash a car, for instance, is not a free public good; rather, it should be a normal commercial good covering at least the full cost of infrastructure, not subsidized or even distributed for free.”
This is radical talk, no doubt. The question is whether the global water situation is so dire that we need a radical solution to address it.
In China that would seem to be the case. The country has 19% of the world’s population and only 7% of its freshwater. Tianjin, a city of 7.5 million on the northeast coast, now has a per capita water supply lower than Saudi Arabia’s.
Rivers in the country, meanwhile, are dying off like black flies. In the 1950s the country had 50,000 rivers. Since then industry and agriculture have siphoned off so much water that only 23,000 remain — and many of them are unfit for drinking. A few years back the Yellow River Conservancy Commission, a Chinese government agency, concluded that a third of the water in this massive, 8,000-mile system was too polluted even for agricultural use.
So China is taking a leap into the water-pricing pool. In early January the government announced that by the end of the year it would roll out a wide-reaching program in which the wealthiest urban consumers would pay higher amounts for water.
Here in the States, drought-racked San Diego — where a typical residential user now pays about $40 a month for water, one of the highest rates in the nation — recently put in place a tiered pricing system as well. The city is also hiring IDE Technologies, an Israeli firm, to build a $922 million desalination plant, which would be the largest in the Western Hemisphere when complete.
Bone-dry Australia is taking a different tack. Its government has established a cap-and-trade system, similar to the one used for carbon, which is encouraging industry to conserve water and invest in water-saving projects.
Whether such local-market price tinkering will make more than a dent in the global water crisis is too early to tell. Water scarcity, caused naturally or otherwise, has already brought businesses and local communities on a collision course, as Coca-Cola discovered in 2008 in the arid Indian state of Rajasthan. Farmers there angrily claimed that Coca-Cola’s bottling factory in Kala Dera drew too heavily from aquifers. To irrigate their fields of barley, millet, and peanuts, the growers complained that they had to drill deeper and use heftier pumps to water their fields — raising the cost of their water. Coca-Cola denies the claim and has tried to work with the community to solve the problem. Even so, the controversy lives on.
“When you take a broader look at the value of water, you look at reputational risk as well as supply dependability,” says Jason Morrison, program director of the Corporate Sustainability Program at Pacific Institute, a nonprofit that works with Fortune 500 companies on water solutions.
Many companies are calculating that it’s worth investing in water-conservation efforts even with water’s market price near zero. Asks Will Sarni, a consultant specializing in water practices at Deloitte: “Water might not cost much, but what is its value if the lack of it can shut down your entire operation?”
Many big corporations are obsessed with the question. Brewing giant SAB Miller, working with the nonprofit World Wildlife Federation, has been a pioneer in measuring its so-called water footprint. The company conducted a detailed assessment of its water use, taking into consideration the impact of droughts and looking at a range of other risks, from population growth to climate change to urbanization. David Grant, Miller’s point man on water risk, and his team looked at what part of the company’s value chain used the most water and the least. They now track a wide range of metrics — how much goes in and out of each beer facility, the wastewater, the price of raw water, the cost to treat it, and the cost of energy to move it around. Miller’s breweries, on average, now require only 3.5 liters of water to produce each liter of beer, down from 4.8 liters in 2008.
That’s a mere drop in the bucket compared with what their suppliers use. Those numbers can vary depending on a range of factors like climate and soil conditions, but each liter of beer SAB Miller makes in South Africa, for example, requires 155 liters of water — most of it for growing the hops, barley, and other grains for the beer. But here, too, corporations including Miller, Nestlé, Coca-Cola, Unilever UL , and Dow Chemical DOW are investing in ways to conserve, typically through what are grandly called water stewardship programs.
Most farmers and local governments can’t afford to invest in technologies like desalination and drip irrigation systems. So corporate stewardship teams are partnering with them. Nestlé has been one of the companies leading the way in this regard, experts say. As with SAB Miller, Nestlé has reduced its water footprint: It now uses three liters of water per kilo of product in its factories, down from eight liters a decade years ago, says Claus Conzelmann, Nestlé’s global head of safety, health, and environmental sustainability.
Conzelmann says the company began reaching out a few years ago to farms that were providing it with raw materials in an effort to help them save water. To produce those raw materials, per kilo, requires up to 3,000 liters of water. In Punjab, India, for instance, where Nestlé has food factories, the farmers were mainly growing rice — one of the most water- intensive crops — and fodder to feed dairy cows. The Punjab is a water- stressed area, and many of the farmers were seeing their yield fall or their costs for water rise because they had to drill more wells or improve irrigation. Nestlé worked with the UNaffiliated International Water Management Institute in Sri Lanka, which recommended that the farmers in that region raise more dairy cattle, which was a more productive and economic use of water. The rice and fodder could be grown in eastern India, which has a wetter climate. Many of the farmers shifted to dairy, relieving stress on the local aquifer.
Nestlé now has roughly 1,000 agronomists helping farms improve the quality of their produce while better managing water. The effort hasn’t always worked, however. Several years ago Nestlé realized that water tables around some of their Indian factories were dropping dramatically. The agronomists studied the problem and found that farmers in those regions had no economic incentive to put in cheap, water-saving fixes like drip irrigation. Why? The Indian government subsidizes farmers with cheap oil and electricity to run their old-fashioned irrigation pumps, which wastefully flood their fields. Says Conzelmann: “When water has no value, even a low-cost technology will never get implemented.”
If there’s one group of optimists on the water front, it’s a handful of big-money investors. The Koch brothers, who own Koch Industries, a $115-billion-a-year energy and chemical company, have been investing in water purification and desalination technologies. Jeremy Grantham, the co-founder of GMO, one of the world’s most successful investment firms, is betting on rising agricultural commodity prices because of future water scarcity.
Investment analysts at several big institutions, including Citibank C and Goldman Sachs, have been consistently bullish on H2O, projecting growth in areas like desalination, nano-water- filtering technologies, and big-data companies that track water usage and leakage, as well as the construction firms that will rehab our old water infrastructure and build anew. But they’ve been consistently early too: Wall Street has been waiting a long time for water stocks to gush.
It may be a $600-billion-a-year industry, but companies have had a tough time making money in it. In fact Siemens SI last year pulled out of the water business. Says Goldman’s Cohen: “There’s no market price for water. Decisions are made by politicians on how water should be priced, which makes doing business tough.”
One challenge with investing in water is that there’s no global market for it as there is with oil, copper, and other commodities. The reason? It’s expensive and difficult to transport. China is in the midst of building an aqueduct to move water from the Yangtze River, in the south of the country, to the water-starved north. Some 2,700 miles long, it is expected to be one of the most expensive civil-engineering projects in history. The price tag? Upwards of $60 billion.
Strangely enough, a number of academics nonetheless view water as an increasingly important commodity in international trade. That’s because when nations trade grain, produce, or even timber, they are in effect trading water, since agriculture is so water-intensive. This concept — dubbed the virtual water trade by Tony Allan, a professor at King’s College London — will become increasingly important as water grows scarcer. Says Allan: “Food security is totally connected to water security. We’re going to have to get it into our heads that if we are going to have cheap food, we have to help farmers save water.”
Back in the Central Valley, the land is still parched, even after some late-April rains. And the ground is sinking under Sarah Woolf ’s feet. It is the result of sucking out water from her own property wells. Her family began using well water some decades ago, but after a while there was a problem. In a classic case of the tragedy of the commons, they and other farmers in the area were drawing so much water from the aquifer that the soil started dropping about a foot a year. Since the 1930s, the ground level at her farm has dropped 80 feet. “You’re depleting a natural water source that can be replenished only if you take small amounts out,” explains Woolf. “If you take water out fast, the pockets in the aqueduct that hold the water collapse and you can never get that aquifer back.” Furthering the destructive cycle, the sinking ground plays havoc on the wells themselves, which can cost half-a-million dollars each to dig. Woolf has three on her farm.
There is yet another catch. Unlike the water from the Sierra runoff, the groundwater here is saline. Thousands of years ago the Central Valley was an inland sea, and as a result, its soil contains saline, boron, natural salt, and selenium. Not all crops can handle that — boron, for instance, will cause almond trees to defoliate. Eventually the salt will build up in the soil, harming yields, says Woolf.
Standing at the edge of her sunken, salty fields, Woolf is at the center of a problem that won’t go away anytime soon: How do you feed the world without enough water?
This story is from the May 19, 2014 issue of Fortune.