Gerry Sweeney FEb 0509

It is an honor to be associated with the GIC and the CFA Society of Philadelphia. Also, it is an honor and a pleasure to be associated with the panelists. Every time I turn around on Bloomberg T.V., I see Sean Egan discussing small, inconsequential companies like GE and Moody’s ratings of the companies. So, he is taking on some rather large questions and thinking outside the box and questioning some standards which our industry probably needs in these times. Also, Mr. Friedman—I have been reading his material for quite a long time. It certainly provides a better understanding of the subtle and not so subtle geopolitical moves that we see throughout the world and really sheds some light on material that you do not necessarily see in the general media. So, I would definitely recommend checking out his book which I have not read, but I definitely look at his website.

I am going talk a little about Aqua Terra Asset Management. We are an institutional investment firm that invests in public equities of companies with exposure to the global water complex, some other natural resources, and ancillary environmental companies. We manage money for high net worth individuals and institutions, generally through a separately managed account process. Aqua Terra is a subsidiary of Boenning & Scattergood. Boenning is a 94 year old broker/dealer investment bank, headquartered in West Conshohocken. It has around 175 employees. We have a lot of exposure to the water process. We have an investment banking group that specializes in it, and we have some equity research in sales, on the sales side that specializes in it. It is a very risky birth place. We have been around a long time. As our CEO and chairman, Harold Scattergood, said recently: we made money in 2008, we are going to make money in 2009, and we are going to be here for another 94 years, managing of risk and what we view as a risk as our clients and performing a good service for them. If we provide that service, we will be around for a long time.

What I am going to do is start off with painting a rather broad brush of what I deem as the water cycle in the investment process and then get into a little more bit more detail of some opportunities further on in the presentation. At the top level, water is a closed-loop system.

There is no more, no less water than a billion years ago. It is just being recycled through the hydrological system. Either it is in the ground, in ground water, streams, rivers, vapor, rain—and of all this water, this represents less than 1 percent of all the water on the globe. About 3 percent of the world’s water is fresh, but the majority is locked in polarized caps. The paradox of water is that even though there is a lot of it, there is a very finite amount of fresh water available for consumption.

This makes it a classic commodity—it is finite, it is unequal allocation, it is everywhere you do not need it be, and you are moving to places where it is not. Southwest United States is an example—one river feeds seven states. It is a huge issue in terms of water quality and the amount of water available. Above all else, it is a quality and quantity

issue. Most areas suffer from one or either of these issues, and, like most commodities, this leads to a supply/demand imbalance. Finally, I also like to look at water—the old saying, all politics are local. And for the most case, all water is usually local. Each area suffers their own specific issues around water. And so, the commodity nature that it name—it basically insures that a very difficult situation where a specific coordinated response will be difficult.

On the demand side, the quantity—population is a major driver of usage. Obviously, the world’s population is essentially doubled since 1950. It is going to grow another 50 percent in the next 30 to 40 years.

But along the way, even though the usage has doubled, the amount of water use has quadrupled. This is due to industrialization. As countries industrialize, emerging markets have a tendency to use more water because water is used in every process from steel, paper, and pulp manufacturing, biotechnology, and semi-conductors. So it is a main input into almost every process. Then you also have socioeconomic change or trends that also feed back to the industrialization side. As countries industrialize, a lot of their inhabitants are moving up the socioeconomic ladder. Their diets are changing from starch—diets of rice and potatoes—to more meat and chicken diets which, unfortunately, use more water because you use to feed the animals to create the food. Also, you have much more disposable income so they are buying more goods.

On the industrialization side, they are using more power electronics, air conditioning, and energy is a major user of water as well. Finally, agriculture—80 percent of the world’s water is used in agriculture. It is very inefficient; a lot of it is through flood irrigation. So, it is an area that has to be looked at as an area for improvement.

On the quality side, supply is diminishing. It is finite. On the diminishing, we continue to pollute our waterways through power plant emissions, acid rain, fertilizer runoff, poorly treated effluent from the industrial and domestic side. It is a huge problem in the third world. I think the World Bank estimated that half a billion dollars of the world’s potential economic growth gets lopped off just due to poor water quality.

And then, I think the UN also stated half the world’s beds are filled with people that have contracted diseases through water-borne pathogens. It is an area that a lot of these emerging markets have taken a look at, China paying particular attention to it. They look at it as almost a ticking time bomb on the health care side where you ingest this water, harmful particulates, over longer periods of time, it could be a major issue for their health care and health care systems 10, 20, 30, 40 years down the line.

Food, energy, and water are all interconnected and intertwined.

Overcoming shortages will result in some complicated processes of competition for resources and trade-offs. As I mentioned previously, all water is local. Creating a solution to the water problem will be difficult as there are so many stakeholders, whether it be an ideological standpoint

where some people believe water should be free, that they should not be charged for it—which really from an economic standpoint, it does not make sense because it will not induce conservation. You also have geopolitical issues. They talk about China being very interested in Tibet because of the water sources there. China is building long distance canals to transport water from the north and west down to the coastal areas. And then, I do not see an easy process overcoming a lot of the issues. California is another example. I do not see the water problems or the seven states out there being settled in California’s court system.

Energy requires large amounts of water for production. You use it in the steam turbines, you use it in nuclear energy, you use in the hydro side. You use it in finding coal and oil to produce the energy. Water is pumped into these reservoirs to increase the pressure, increase output.

At the end of the day, energy use is something along the lines of 25 percent of all non-agricultural water. And actually, in the state of Pennsylvania, it uses about 70 percent of the state’s water. So, it is a major use of water.

Seventy-five, eighty percent of all water goes to agriculture.

Increasing diets are going to use this disproportionately. They say up to 5,000 gallons of water is used to create one pound of beef.

Ethanol is also unsustainable in the Midwest. Ethanol requires the growing of corn to create fuel. To grow corn you must pump water out of the ground. The aquifers cannot support this.

The pumping, conveyance, and treatment, filtration of water all require tremendous amounts of energy. One example people use as a possible solution is desalinization. It certainly is a possibility, over 50 percent of the cost of de-sal is associated with energy in itself. A lot of desal plants that were built were not necessarily built using models that have the amount of energy variability that we have seen in the past year.

I keep referring back to California, but 20 percent of California’s electricity is used just to move water around, as well as 30 percent of natural gas. So, you can see the intertwining of all these areas and how difficult it will become to overcome.

So, what does it all mean? I do not think there is one single answer to the problem; everything is too intertwined. But what we do believe—it is going to be a portfolio approach to solving the problems. There will be a multitude of solutions to help manage the problem, including technology, infrastructure, equipment and engineering, and consulting.

There is no water industry, per se. Rather, it is a large group of companies from different industries or different verticals, however you want to phrase it, which sell into various levels of the complex. I look at it anywhere from the point of retention to the point of use. You have water utilities, engineering, consulting, you have chemicals, you have asset companies—companies that own land and water rights. They are all opportunities. From a global standpoint, there are about 400 companies that we have identified with some type of exposure to the

water side. Those 400 companies represent about a trillion dollars in market cap. In the United States, there are about 100 companies, with $500 billion in revenue. So, it is a significant amount of investment opportunity. And I always receive the question of how big is it? And it is overcoming that issue in terms for investment, we created this slide here which is really designed to show where water touches, not just from a vertical standpoint but from a geographic standpoint. **insert slide** We divided the world, the water world, into six areas,. But, again, you can see the water utilities, the engineering, and infrastructure side, but on the horizontal side, you see globally where they are. Now, all of these are classified generally by same market drivers or business practices. And what it does is represents—while water utilities may be a good investment in the United States, they may not be a very good investment in some other parts of the world, generally due to valuation or other concerns. But the point is, the opportunity is out there. You can look around the globe, and there is always opportunity to go after it. So, at the end of the day, our thesis is there will be multiple beneficiaries in overcoming the water crisis. But the spending will be measured in trillions of dollars over 20, 30, 40, 50 years, and well-positioned, wellmanaged companies will be in a position to essentially receive an economic tailwind.

These are the main drivers. We have spoken already about supply and demand. But on the infrastructure side, and then we have regulation and ancillary industries. Water has a huge asset base. Takes $3 of capital to create $1 revenue. So, on a global basis, you have a lot of money flowing in there. You have the opportunity for an installed base, and this installed base has actually been receiving less and less investment over the years. The Congressional budget office estimates that a trillion dollars between 2001 and 2019 would be needed just to upgrade the U.S. water and waste water system up to a mediocre standard which met all their requirements. And in the developing world, it is the exact opposite; you have almost no infrastructure. It has been increasing over the last few years, but at one point, 80 percent of China’s domestic water was released without any form of treatment. Seventy percent of their main river systems were actually harmful, for human contact, let alone consumption. And then moving over the regulation side—the Clean Water Act, sponsored by the Environmental Protection Agency in 1976, started with about 20 contaminants. It is up to about 98 now; they are adding a few more in the next few years, including pharmaceuticals. And then, on the ancillary industries—we went through energy and agriculture. The environmental technology side, we have clean technology and energy recovery devices that will better enhance filtration of water while lowering energy costs. So, there is a

myriad of different ways we can attack the problem, a myriad of different drivers, and a large opportunity for investment.

Some of the opportunities we see in the water investment area . . .

Personally, I like the water utilities—we are a value shop, so whatever we look at, we are definitely taking a value bent on it. The reason I like the water utilities is one—some of them are trading at ten year historical lows, but I look at them as not so much as owning the water, which they really do not, but I look at them as a process or almost like a visa. They stand in between where the water is and where it needs to be. They clean it and distribute it to you, and they get a guaranteed rate of return, set by the state. If they are good operators, that rate of return will be very beneficial over longer periods of time. It enables them to compound their returns, year in and year out, reinvest in the system, raise rates, buy underperforming assets and keep growing.

Infrastructure is expansive. There is over 800,000 miles of just drinking water pipe in the United States. A lot of it is coming to the end of its useful life. To replace one foot of it is $250. Two hundred and fifty times 5,000 feet times 800,000 miles—you are looking at an extremely large number. So you are looking at pipe companies, you are looking at different technology to replace the in-ground pipe. A company called Insituform actually puts liners into these pipes. You have companies that are increasing what they call asset management of the resources, where they can go in and track the pipes, see the quality so municipalities and water companies can go in and make prudent decisions in terms of managing their inground assets. Water meters—water meters have been proven to conserve water. After you install them, water usage declines 18 to 20 percent. There are a lot of companies involved in that space. There are the Itrons of the world, Roper, Badger Meter—so there is a lot of opportunity here. Water does not seep into the ground; it runs off, it runs into the river. It does not get captured into an area’s watershed.

I was actually standing on the train platform today in the East Fall section, and there was a billboard talking about the Philadelphia Watershed and digging up parts of your patio and putting porous rock and allow water to go into the ground. And this is for an area like Philadelphia which does not have much of a water crisis, per se, but just imagine the amount of work that could be done in less arid regions.

And then on the agricultural side—irrigation. There is going to be a need to move from flood irrigation to precision irrigation. Flood irrigation is completely inefficient, and the precision irrigation not only uses less water but it increases crop yields. And it is getting very scientific. You can put sensors in the ground that tell you exactly how much moisture is in there at the roots, how much you will have to add, so you can really pinpoint the amount of water that you need to increase yields to the highest level. Seed companies—they are able to modify seeds and plants so they use less water. And then finally, on the fertilizer side—fertilizer has its own issues in terms of not being very environmental in some of

the creation, but it is very necessary in terms of increasing crop yields, especially when water availability is lower.

So, that is just a little bit of background. I hope you enjoyed it. I hope it was not too broad brush, but I am around all day if anyone would like to speak about it further in detail. I did put up a couple of areas that I think provides some good information on what is out there—obviously the World Bank and the United Nations, they have pages and pages of information and reports that are thousands of pages long. Hopefully it is a little bit more beneficial than conferences and jobs, but there is a lot of data out there. And then, Pacific Institute and Circle of Blue are just two other websites that are non-government oriented that provide a lot of information—are actually very interesting if you want to preview this material further in-depth.