Water is the elixir of life. Finding ways to ensure that enough drinking water is available to sustain the growing global Population requires a change in thinking – including among investors.
Fresh water accounts for only around 3 per cent of the estimated 1,386 billion cubic kilometres of water on our planet. On a smaller scale, this means that there is roughly one tablespoon of fresh water for every pint of sea water. On the back of rapid global population growth and rising consumption, water has become a valuable commodity and the effects of climate change are making it increasingly scarce in many regions around the world. According to United Nations estimates, global demand is likely to exceed the amount of fresh water available by 40 per cent by 2030.
Water management as a risk factor
Companies with a business model aimed at providing a reliable water supply, or technologies that enhance water efficiency, are becoming an increasingly attractive option for investors who are mindful of the growing importance of the ‘blue gold’. Based on its global structural significance, water remains a topic that is better suited to the requirements of long-term investments. But water is also a resource that entails quite a large number of risks: “Water scarcity and the challenges it poses for production processes are particularly relevant and often underestimated by the public,” says Jennifer Paffen, a sustainability analyst at Union Investment. The effects of climate change, however, are increasing the need for action. “Water is among the first resources to reflect changes in climatic conditions,” explains Paffen. While some parts of the world are experiencing floods and heavy rainfall, other parts are stricken by drought and struggling with supply shortfalls, as recently seen in Cape Town, South Africa. “Such conditions drive up the price risk for products that require a certain quality or quantity of water in their production process,” Paffen continues. “The value of the water used for production is often not fully priced in, especially by companies whose business model and production methods rely on the use of large quantities of water.”
#Water in the spotlight
at the UN
The Sustainable Development Goals (SDG) adopted by the UN member states in 2015 also call for a safe and sustainable supply of clean drinking water.
#Water management key figures
The method used by Union Investment to analyse the water management of individual issuers is based on a combination of quantitative and qualitative indicators. Examples include:
Total volume of water used, provenance, purpose of use, method of disposal
Water intensity of the company‘s operations relative to its revenue
Reduction targets and implementation plans
Strategy for long-term approach to water management
Technology: use of new Technologies to increase efficiency in water consumption and in the recycling of waste water
Corporate citizenship: Management of relationships with local stakeholders such as indigenous communities
Based on these indicators, our analysts conduct a risk assessment of the company in question. As part of this assessment, they also take account of future opportunities in relation to water management that
Prices do not reflect the actual value
The use and consumption of water is currently effectively subsidised across nearly all countries and industries, because the majority of prices currently do not reflect the degree of long-term availability. The main beneficiaries of this are companies with high water consumption. “That is the case at the moment. But based on further steady growth in demand and a simultaneous increase in supply shortages, it seems unlikely that this situation will persist in the long run,” Paffen concludes. A rise in the price of water towards its real value would pose a potential risk. Companies could become unprofitable, because their production costs – formerly based on a low water price – would suddenly shoot up. Supply chains and operating licences will also be subject to increasing risk as water becomes increasingly scarce, especially in regions where water is already in short supply. This context is of particular importance for long-term investments. Union Investment has been focusing on the issue of water management for some time as part of its engagement activities. “From our point of view, it is important that companies analyse their actual water needs and make them transparent,” says Florian Sommer, Head of Sustainability Research at Union Investment. It is the only way for portfolio managers to arrive at a reliable assessment of risks in relation to this resource. “In addition to establishing the status quo, we are also very interested in plans that companies might have for future improvements of their water management,” explains Sommer. In a constructive dialogue, Union Investment urges companies with water-intensive business models to put a stronger strategic focus on resource-related risks and the possibilities of increasing efficiency through the use of new technologies. Its aim is to make this topic a boardroom issue.
Water is indispensable in many areas of the industrial sector, for example at this rolling mill of a steel manufacturer.
A lack of proper water management can create a
fundamental business risk for companies.
Current negative examples
Some recent real-life examples show that there is still a long way to go towards sustainable water management. Germany and France had to switch off power stations on several occasions because nearby rivers had heated up too much during the hot summer months. This limited the functionality of the plants’ cooling systems and also meant that the water used by the plants for cooling could not subsequently be fed back into the rivers, because it had been heated up to levels that would have put fish populations in the affected rivers at risk of dying from oxygen depletion. Incidents like these clearly show that a lack of proper water management can create a fundamental business risk for companies. “Mining is another area where reputational risks linked to water are a frequent issue,” Paffen points out. Gold mining, for example, involves the use of cyanide. Just a few millilitres of this substance can be fatal for humans, but some players in the mining industry nevertheless use millions of litres of cyanide. When this poisonous liquid leaks into the groundwater from its protected underground storage facilities, it is extremely difficult to contain the harmful effects in the long run. Those most affected by such incidents are predominantly indigenous communities in many African and Latin American countries whose people live near and work in the mines. Last year, El Salvador imposed a blanket ban on mining gold and certain other metals amid concerns about environmental protection, but also because protests among the population had repeatedly led to social and political unrest.
CDP study examines ‘the next CO2’
Experts have been predicting for a while that water could become the next global issue on a scale akin to CO2. A reliable supply of water is becoming increasingly expensive, pricing is complex, and fierce competition is springing up between a wide range of stakeholders. The Carbon Disclosure Project (CDP) is also taking a close look at water as a resource of relevance to climate change. Supported by a network of more than 800 investors, the CDP calls on companies and countries to publish more detailed information on their use and consumption of resources closely linked to climate change, such as water and timber, alongside data on their greenhouse gas emissions. In 2017, the CDP surveyed nearly 5,000 of the largest companies with global operations on the topic of water. The study focused on identifying how companies manage their water resources and what management approaches they had already developed in relation to future water-related risks. With feedback from more than 2,000 companies, the participant response rate was nearly double that of the previous year, which can be seen as indicative of the increasing strategic importance of the topic. Based on the data collected by the CDP, companies invested more than US$ 23 billion in more than 1,000 water-related projects in 91 countries in the past year. Of the companies participating in the CPD survey, 70 per cent addressed water management at board level in 2017. 63 per cent reported that they were measuring key figures such as water consumption and the quality of their waste water on a regular basis, while 41 per cent confirmed that they were also scrutinising their suppliers more closely over this issue. More than half of all participants set themselves targets in relation to relevant ecosystems, as well as for levels of pollution in the water they use and efficiency improvements in their use of water. However, only one in five companies conducts a comprehensive risk assessment on this issue.
Fresh water is needed for the production of nearly all foodstuffs and consumer goods. The illustration below shows the H2O footprint of a few popular products.
Experts calculate the amount of water required over the life cycle of a product. This is referred to as 'virtual water':
In conversation with Philipp Wagnitz, expert for global fresh water resources at the World Wide Fund for Nature (WWF) Germany
Mr Wagnitz, in a WWF study you refer to water as an ‘imported risk‘. What does that mean?
People in Germany use around 120 litres of water per day. But our indirect water footprint comes to more than 5,000 litres, because water is used to produce nearly all the things we use in everyday life. The bulk of the water consumed in this indirect way is not sourced in Germany. If water scarcity and pollution cause disruption in the value chain in the affected regions, consumers as well as companies and investors are faced with serious issues. Risks of this kind are likely to increase in future. Situations like the one in Cape Town at the moment or in São Paulo and California in 2016 speak for themselves.
But how can investors protect themselves against these risks?
The key is to understand how necessary and irreplaceable a resource water is in terms of a company‘s ability to operate profitably. The first step in this context is to analyse water-related risks in the portfolio. The WWF‘s water risk filter is a tool that allows you to carry out a portfolio scan without a great amount of input. Ultimately, investors have to decide for themselves how they want to handle water risks in their portfolio. Some may want to find sustainable solutions, others may prefer to avoid such risks altogether. There is a wide range of possible approaches.
The WWF has developed a water stewardship concept as a means of reducing water risks. Can you describe this concept?
Our water stewardship concept aims to support companies in their handling of water risks by focusing on key questions. What risks is a company exposed to? How can these risks be reduced directly? Are there opportunities for cooperation with the financial sector? There are already more than 100 major companies around the world that make strategic use of our water stewardship concept.
The German branch of the WWF is a charitable foundation that has been supporting the global efforts of the World Wide Fund for Nature to preserve our planet‘s wildlife since 1963.
Many companies are not yet fully informed
A critical examination of companies’ approaches to water management forms part of the engagement activities of Union Investment. We focus primarily on sectors where water is an indispensable resource in the production process with a decisive role in the business model. This includes – amongst others – companies from the energy sector, where water is required to cool power plants, and mining businesses, where water mixed with specific chemicals is a key tool for extracting ores and metals from the excavated rock. The overriding objective is to hedge against two categories of risk. Firstly, careless and unsafe ways of handling waste water can lead to pollution of the soil and groundwater, which in turn poses a threat to the supply of food and drinkable water in local communities. In addition to the environmental damage caused, such practices also entail litigation and reputational risks for companies. And secondly, some companies operate based on business models that would be no longer viable if their water sources ran dry. Unfortunately, it often turns out that companies are not very well informed. When we raise the subject of water risks, many managers do not know what to say. It seems that the importance of prudent water management has not yet become a boardroom topic at these firms. As a result, many companies only react to emerging issues in this area rather than adopting a proactive and forwardlooking approach to water management. We therefore expect water to remain a hot topic in the coming years.
Sustainability Analyst in Portfolio Management at Union Investment