Investors Can No Longer Ignore Water Risks
Water – or lack of it – is becoming a bigger financial issue for investors. The World Economic Forum recently named water availability as the “top global risk.” Often overlooked by investors, and society at large, is that very little of water is readily available for human use and even less is truly renewable. For example in the United States 80-90 percent of available freshwater is groundwater, taking often centuries to replenish, and we are drawing down this account to a zero balance. Historic droughts in Australia, California, Texas, New Zealand, Taiwan and Brazil – to name a few – are also raising investor concerns and risk exposure.
Over half of Brazil’s GDP comes from three states with water reservoirs at less than five percent capacity. Many large publically listed Brazilian companies across the food and beverage, electricity and mining sectors are increasingly likely facing significant financial impacts. The drought in California has impacted many industries and sectors. One example is that electric utilities have had to spend $1.4 billion more due to low levels of water in hydropower dams. Taiwan’s drought along with weak water regulations have put into question the ability of the largest semi-conductor chip manufacturers in the world to continue business as usual – with each microchip requiring over a thousand of liters of water for fabrication. These chips are critical components in the supply chain of everything from iPhones, laptops to video games and much in between.
“The drought in California has impacted many industries and sectors.
One example is that electric utilities have had to spend $1.4 billion more due to low levels of water in hydropower dams.”
Investors’ exposure to risks to grow as society increasingly recognizes their role in the value chain
Investors and companies face reputational and social license to operate and human rights risks by competing for water with communities. Case in point Newmont mining having to abandon a multi billion dollar mine in Peru and Coca Cola being asked to leave regions of India over ground water abstraction concerns. Investors also face abrupt and rising water rate hikes. For example China is expected to raise water tariffs 30 percent in the next three years.
Not only are investors exposed directly to these risks but also increasingly society will connect the drops (or dots) and recognize companies and investors’ role in the value chain. For example in Santa Barbara locals are angry at an out of state university endowment for buying water intensive vineyards and water rights while California is facing a historic drought. Companies and the pension funds, endowments, foundations as their owners increasingly recognize that they must more proactively deal with water issues and risks (reputational and otherwise). And most importantly investors must realize that they face these risks in real time – time zero – now – they are at their doorstep.
Investors still only on first base for water management despite major risks in portfolios
Through extensive interviews with three-dozen major global investors Ceres found investors need to better manage water issues. Quite simply, there are major water-related risks in their portfolios but too often investors feel they are still on first base in managing these risks.
Three key challenges were highlighted as barriers to more efficient inclusion of water in investment decision-making in the report. These are:
- Lack of clear mandates from many asset owners and clients for fund managers to prioritize water risks, with carbon often being a larger priority due to regulatory and other drivers;
- Lack of consistent, comparable data on corporate water performance and contextual water risks; and
- Lack of an effective investor water risk analysis framework.
However there are pockets of leadership that highlight that analyzing water issues in investment decision-making can be done and that it can be of great benefit. Investors actively doing so spoke of benefits through better risk management and returns, along with client relationship building benefits and more productive corporate engagement discussions. Many investors found that understanding water risks was a good way to understand the resilience of business models and corporate practices and a businesses ability to respond to stresses.
Creatively embedding water analysis in investment decision-making & recommendations
Investors were creatively embedding water analysis in a variety of ways. Leading and innovative practices include applying a shadow price – or higher value of water – in financial modeling and scenario analysis, of companies in high-risk water regions. Another approach is to map sectors and regions of high water risk exposure and compare this to sector and company response rates in managing these water risks. Some investors were conducting portfolio water footprint analysis and comparing their water risk exposure to their benchmarks. Embedding water risk analysis expectations in RFPs, investment beliefs, guideline documents or proxy policies is also becoming more common and sends signals to data and research providers and beyond that this information is important.
There is no one-size fits all approach to ESG and water integration but below are 10 recommendations (click on image to enlarge) Ceres identified as the most critical for asset owners and managers to advance water risk integration in the near- and long-term. They can be selectively or collectively considered. For more on these see the full report.
As we become used to the term megadrought – decades long droughts – and face a world of ever more strained water resources, investors will have to put more of their own research resources toward mitigating exposure to these risks. They simply will have to.
The status quo of conducting fundamental analysis without consideration of these types of environmental factors will come at an increasing cost to investors and their clients.