Perspectives: Opinions from our network of advisors, investors, operators and analysts on the risks and opportunities they see.

Eliecer Palacios is the head of North America Business Development & Principal Investments at LUKOIL Pan Americas, LLC. He is a seasoned investment professional with over 15 years of experience in origination and structuring of public and private transactions across in the natural resources sector.

Water management is a growing industry in the United States, primarily driven by the rapid increase of shale drilling across multiple geological basins. For every barrel of oil produced, there are between three and five barrels of water produced that need to be recycled or disposed, according to an industry report by Total. Some of this water is injected back into the oil reservoirs to increase well pressure; the remainder must be treated and subsequently disposed following strict environmental guidelines.

This link between water and oil barrels provides a unique investment thesis for growth capital. According to data from the Energy Information Agency (EIA), the Permian Basin is expected to produce close to 6 million barrels/day in 2025 from 3.9 million barrels/day today, or 53%. With this level of production growth, we expect that the need for water services will only increase, providing attractive returns to private capital.

Just as the oil and gas industry experienced a rush of private equity capital over the last decade, we anticipate that the water management business will follow the same path as investors look for above-market returns beyond the traditional energy industry. Given that water management is necessary for many industries, and requires specialized know-how, it will remain a lucrative industry for private equity investors, particularly those looking to back management teams or acquire and consolidate assets.

Market reports call for the global water and wastewater treatment market to reach $674 billion by 2015, with companies like GE, Siemens, Veolia and GDF Suez at the forefront of the global industry.

M&A activity in the energy industry and available capital for the water industry calls for an expansion in this sector.

Early Movers
Over the last several years, large private equity firms such as Blackstone, Global Infrastructure Partners and KKR, have allocated capital to sustainable energy and infrastructure investments, such as water management. This means that the sector is poised to receive more attention from private equity capital as companies grow and niche markets are created. Whoever controls the water management processes and resources will have pricing power as expertise is needed to handle such tasks.

Blackstone recently backed a water management company, Waterfield Midstream, to focus on the West Texas region. In past years, Blackstone also partnered with experienced management teams to create platforms, including Global Water Development Partners.

By contrast, KKR focused on public-private partnerships, working with industry participants to run the water and wastewater systems for cities and municipalities. In 2012, KKR, in a joint venture with Suez Environnement, entered water investments in Bayonne, New Jersey and Middleton, Pennsylvania, which the firm exited in 2018 for 36% IRR and 61% IRR, respectively.

In addition, middle-market and VC investors have also entered the water industry. For example, Tailwater Capital has backed Goodnight Midstream, a fluids management services provider and operator of water-gathering pipelines.

WaterBridge, a provider of water management services such as produced water, transportation, disposal, supply and recycling, operates in a socially and environmentally responsible manner addressing the growing needs of oil and gas companies in West Texas and New Mexico. WaterBridge is backed by Five Point Energy, a private equity firm focused on investments in the energy infrastructure sector.

In addition to water management, the US Department of Energy’s Water Energy Program has developed a portfolio of innovative technologies and market solutions for clean, domestic power generation from water resources across the United States. The program works with national laboratories, industry, universities, and other federal agencies to perform research and development activities to improve performance and the country’s ability to sustainably meet its growing energy demand, and to lower costs

Aside from traditional private equity and venture capital investments, asset managers such as Water Asset Management actively invest in publicly traded companies and private assets with a focus on sustainability, including water resources, infrastructure, treatment and technology.

Opportunities in the Permian Basin
Water management is not a new sector, but there are a range of opportunities for new entrants.

For private investors, growth opportunities remain available as various extractive and manufacturing industries, including oil and gas, petrochemicals, mining and petroleum refining, continue to demand environmentally-friendly, sustainable solutions for their water usage.

The biggest opportunity for investors today is in the Permian Basin in West Texas and New Mexico, where there are still only a few participants. Most of the water management is handled by energy companies as part of their production costs. A potential opportunity exists via buying out existing assets from privately-held companies looking to monetize non-core activities.

Remaining Risks
The biggest risk to the sector is federal level regulations. The growth of the water management industry is closely linked to the requirements set forth by energy and environmental regulators as well as the incentives given to private corporations to allocate capital to sustainable and environmentally-friendly activities.

Additional risks involve operations and liability having proper health, safety and environmental policies to help minimize potential damage to the environment and local communities where companies operate.

Although returns on individual private equity investments are seldom available, media outlets reported KKR’s returns when it sold its water assets to Argo Infrastructure Partners in 2018. KKR’s sale of Bayonne water netted a gross internal rate of return (IRR) of 36% and 2.8 times money on investment capital (MOIC), while its Middleton Water investment yield a 61% gross IRR and 3.3 times MOIC.

To date, most investments are still in growth mode with a few limited exits. For example, this week NGL Energy disclosed the purchase of Mesquite Disposals Unlimited, LLC, a privately held company, for $890 million, the latest transaction in wastewater disposal in the Permian Basin.

While there are limited options for private investors to participate in the water management sector, in particular the water disposal market, investors can get exposure to the overall water sector via publicly listed companies, such as Aqua America, Inc., a water utility company supplying water to commercial, industrial and public customers.