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Patrick Goldin
Patrick Goldin

PICO Holdings: Buy Sell Short, or Neither? Part 1

October 02, 2010 | About:

A number of articles, books and documentaries have highlighted the upcoming shortage of potable water, both here in the United States and abroad. If one believes that the value of water rights will rise in the near future, the best way to gain exposure to this upcoming trend would be to buy water rights located near a major metropolitan area with a limited supply of water at a cheap price. However, for a small investor, the only way to gain exposure to water is to purchase shares in a company that would benefit from a water bull market.

One of these companies is PICO Holdings (NASDAQ:PICO). PICO is a holding company with four distinct segments: water resource and water storage, real estate, run-off insurance operations and corporate, which consists of cash, fixed-income securities, a 37% equity interest in spigit Inc., and other assets and liabilities. The Water Resource and Water Storage Operations are conducted through Vidler Water Company, which comprises 40% of book value.

According to their latest 10-K, Vidler:

“Is a private company in the water resource development business in the southwestern United States. We develop new sources of water for municipal and industrial use, either from existing supplies of water, such as water used for agricultural purposes, or from acquiring un-appropriated (previously unused) water. We also develop water storage infrastructure to facilitate the efficient allocation of available water supplies. Vidler is not a water utility, and does not currently intend to enter into regulated utility activities.”

In this two part analysis, I will first present two articles and one presentation that support allocating capital to water. In the second part, I will provide an analysis PICO Holdings.

First, the two articles from Bloomberg:

As Colorado River Dwindles, Homes and Farms Face Supply Cuts

“Farms, businesses and residents who rely on the Colorado River may face water supply cuts as early as next year as drought and global warming reduce snow-melt while demand rises, a study said.

The water supply for 27 million people in the southwestern U.S. and Mexico can’t be sustained, said Tim Barnett, a marine physicist with the Scripps Institution of Oceanography, a research center in San Diego. Supplies will fall short even with new conservation rules, said Barnett, who co-wrote the study appearing today in the Proceedings of the National Academy of Sciences.

Storage reservoirs along the 1,450-mile (2,330 kilometer) river that flows through the Grand Canyon are at 54 percent of capacity, down from 89 percent in 2000, according to the U.S. Bureau of Reclamation. Drought has reduced snowfall in the region the last nine years to the lowest of any period that length in the past century.

“It’s clear with natural climate change or human-induced climate change that we’re not going to be able to deliver all that water,” Barnett said today in an interview. “The only way out of these climate-change impacts is simply not to take as much water out of the river.”

Global warming from fossil fuel emissions such as coal- fired power plants will reduce rain and snow runoff 10 percent to 30 percent by 2050, Barnett said in the study. A 20 percent reduction in runoff may lead to water shortfalls in one of every three years beginning in 2010, Barnett said.

Missed Deliveries

By 2050, river managers will have to cut supply about 88 percent of the time, with an average shortfall of about 1.26 million acre-feet of water annually, the report said. The river provides about 12.7 million acre-feet of water a year to homes, businesses and to irrigate 3 million acres (1.2 million hectares) of farmland, including California’s Imperial Valley.

An acre-foot of water is 326,000 gallons, enough to supply two households for one year.

“We’ve published these kinds of results before,” Terry Fulp, the U.S. Bureau of Reclamation’s deputy regional director for the lower Colorado region, said in an interview. “The bottom line is, as we know, the system is over-allocated.”

The Colorado River starts on the western slope of the Rocky Mountains and empties in the Gulf of California, passing through five U.S. states. Heavy use for farm irrigation has desiccated the lower river in Mexico and it no longer consistently reaches the sea.

Seven states are allocated a portion of the river’s water, including California. In February, Governor Arnold Schwarzenegger declared a state of emergency, saying three years of drier-than-normal weather have intensified the state’s drought.

River Is ‘Fully Subscribed’

The four states in the upper basin of the river, Utah, Colorado, Wyoming and New Mexico, will by 2060 be seeking an additional 1.5 million acre-feet of water a year to meet urban demand, Fulp said.

“From our numbers, the river’s being fully subscribed right now,” Barnett said. “I don’t see where they’re going to get that water.”

In late 2007, California, Arizona and Nevada took measures to prevent large reservoirs, including Lake Mead and Lake Powell, from dropping too low. The states agreed to supply cuts if the water level in Lake Mead falls to 1,075 feet. The reservoir is now 29 feet above that.

The soonest river managers are likely to cut supplies under the agreement is between 2011 and 2012, Fulp said.

Rising Temperatures, Earlier Snowmelt

The Colorado River Basin, which stretches from Wyoming to Mexico, is at the center of climate change in the western U.S., according to the Natural Resources Defense Council, a New York- based environmental group. Since the 1970s, rising temperatures have contributed to earlier snowmelts and the basin has warmed more than any other area in the contiguous U.S., the group said.

As a result, the volume of water in the basin is decreasing. Lake Powell is only 52 percent full and Lake Mead is 46 percent full, according to the Bureau of Reclamation.

A 2008 Scripps Institution study said Lake Mead had a 50 percent chance of going dry within 20 years without conservation. In today’s study, Barnett and co-author David Pierce, a Scripps climate researcher, focused on how global warming will affect water supplies.

“We may be sustainable now, but we won’t be for very much longer,” Barnett said. “I’d like to see people sit down and start taking this seriously now before there’s a crisis at hand.”

Las Vegas Running Out of Water Means Dimming Los Angeles Lights

This article is quite long, so rather than include the entire article, here are a few quotes:

“On a cloudless December day in the Nevada desert, workers in white hard hats descend into a 30- foot-wide shaft next to Lake Mead.

As they’ve been doing since June, they’ll blast and dig straight down into the limestone surrounding the reservoir that supplies 90 percent of Las Vegas’s water. In September, when they hit 600 feet, they’ll turn and burrow for 3 miles, laying a new pipe as they go.

The crew is in a hurry. They’re battling the worst 10-year drought in recorded history along the Colorado River, which feeds the 110-mile-long reservoir. Since 1999, Lake Mead has dropped about 1 percent a year. By 2012, the lake’s surface could fall below the existing pipe that delivers 40 percent of the city’s water.”

“Water upheavals are intensifying because the population is growing fastest in places where fresh water is either scarce or polluted. Dry areas are becoming drier and wet areas wetter as the oceans and atmosphere warm. Economic roadblocks, such as the global credit crunch and its effects on Mulroy’s attempts to sell bonds, multiply during a recession.

Yet local governments that control water face unyielding pressure from constituents to keep the price low, regardless of cost. Agricultural interests, commercial developers and the housing industry clash over dwindling supplies. Companies, burdened by slowing profits, will be forced to move from dry areas such as the American Southwest, [Brad Udall, director of Western Water Assessment], says.”

‘“Water is going to be more important than oil in the next 20 years,” says Dipak Jain, dean of the Kellogg School of Management at Northwestern University in Evanston, Illinois, who studies why corporations locate where they do.”

“In 2002, 8 percent of the world suffered chronic shortages. By 2050, 40 percent of the projected world population, or about 4 billion people, will lack adequate water as entire regions turn dry, the UN predicts.”

The article in its entirety can be found here.

Embeded below is a presentation that Matthew Simmons, of Simmons & Company, presented earlier this year, titled “Twin Threats to Resource Scarcity: Oil & Water”:

Matt Simmons on energy & water

About the author:

Patrick Goldin
Patrick Goldin is the General Partner of the Alain Value Fund LP, a limited partnership exercising a value-focused and bottom-up securities approach. In addition to his duties as general partner, he is a student in high school. He can be reached at [email protected]

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