World Water Day: A drought in your portfolio?

Investors should understand the water exposure in their portfolios

Without doubt the world’s most essential commodity is water. But despite its critical importance to life on earth, water is taken for granted and the impending issue of water scarcity remains largely invisible and neglected. However, leading experts are in agreement that water scarcity is set to become the foremost global environmental challenge of our generation.

Investor-led initiatives related to water risks have begun to gain momentum. In 2010 the UN PRI cited water scarcity as a critical challenge to be addressed and called upon its signatories to engage the world’s largest corporations.

Typical perceptions of water scarcity conjure up pictures of sub Saharan Africa but the issue reaches far further. According to the UN, two-thirds of the worlds countries will be moderately to severely water stressed by 2025 and by 2030 it is predicted under a business as usual scenario that actual global demand for water will outstrip supply by 40%. Simply put there will not be enough water to meet human demands.

The business implications of climate change have gained considerable recognition amongst businesses and investors alike. So far much of the focus has been on energy and greenhouse gas emissions whilst ignoring the changes to precipitation patterns and water sources. However, there is a growing consensus that the availability of freshwater will be extremely vulnerable to climate change.

The era of cheap and easy access to water for companies is coming to an end. This poses a potentially greater threat to businesses than the loss of any other natural resource, including oil. Businesses rely on water to grow and remain financially competitive. Additionally, companies’ supply chains can be heavily reliant on water as a raw material which means the risks from water scarcity can be spread across the entire value chain. Businesses therefore face clear physical, reputational and regulatory risks which in turn will have an impact upon their bottom line.In terms of physical risks, companies will face declines or disruptions to their water supply. This may undermine their operations, their suppliers and in some cases also potentially their energy supplies. Under the predicted 40% supply-demand gap there will not be enough water to grow the food needed to sustain population growth or to provide raw materials such as cotton or timber. The world could face annual losses of grain production equivalent to the entire grain crops of India and the US combined by 2025. Water shortages in the USA have constrained growth of the agricultural sector by 5-10% per annum; in Australia water shortages have constrained growth of the national GDP by 1% annually.

Water is also key to energy production. In 2003, France was forced to shutdown 58 nuclear power stations responsible for supplying 75% of the nation’s energy because of severe water shortages. Similarly, in 2001 in Sao Paulo, Brazil the city was forced to ration out energy as a result of severe droughts resulting in estimated financial losses of USD 20 billion or 2% of total GDP. In the USA many power plants are now being denied planning permission because of a lack of available water supplies to run them.

In 2010, the UN declared access to clean water to be a ‘fundamental human right’. ’According to the World Economic Forum, 1.1 billion people currently live without clean drinking water and 1.8 million people die every year from a lack of adequate sanitation and safe drinking water. Whilst these problems are largely a result of poverty and government inaction, those companies which use water irresponsibly or pollute water sources will increasingly come under attack from the public and civil society and could therefore face severe damage to their reputation. In 2003 in Kerala, India, both PepsiCo and Coca-Cola bottlers lost their licenses to use groundwater after droughts and increased competition for local aquifers resulted in public protests not only in Kerala but in regions across the whole of India.

The physical and reputational pressures of water scarcity and water pollution will eventually result in stricter regulations for companies including. This tighter regulatory environment will likely focus on requirements for higher water quality, capping how much water businesses can withdraw and potentially limiting licenses to operate. Water scarcity will also increase water prices. In some cases water prices have been kept artificially low. However, this is now being phased out and global water prices are now on the rise in some areas.

Water scarcity will impact the profitability of companies; investors who do not take account of these companies will leave their portfolios vulnerable to risk. In addition, research suggests water risks pose a commercial opportunity to investors. The S&P Global Water Index has outperformed the wider stock market as demand for improvements in water infrastructures continues.

In response to water risks, investors should be seeking to better understand potential water related exposure in their portfolios by demanding more meaningful corporate water disclosure, encouragingcompanies to incorporate water issues into their environmental strategies and emphasising the opportunities of better water management.

EIRIS research continues to evolve to meet the needs of investors and we will soon launch new global research criteria on water. This research will measure corporate exposure to water risk and assess the extent to which companies are adequately managing these water risks.

Water Scarcity will not only threaten businesses it will threaten the world economy. Under a business as usual scenario there will not be enough water to grow the food or agricultural raw materials that will be required and there will not be enough water to effectively secure the energy supplies of some countries. In addition, as countries use more water than they actually have and damage the environment, the economic value of ecosystems will be lost. In short, companies and investors that continue to ignore these risks will put themselves at significant risk.

Ran Sanghera is Lead Water Analyst at EIRIS