Asia's Food Supply Chains at Risk
By CWR 21 April, 2010
China Water Risk reviews World Resources Institute’s Weeding Risk, published April 2010.
Water scarcity and climate change are complex, long-term and inter-related environmental trends that experts anticipate will impact companies and sectors worldwide. The consequences and the financial implications will vary for investors by company, sector and country.
Particularly vulnerable is the food and beverage (F&B) sector because of its close ties to agricultural productivity and shifting consumer preferences:
- Access to water supplies and stable climatic conditions are prerequisites for the reliable production of the agricultural inputs required for the food and beverage industry.
- The agricultural sector’s high reliance on chemical inputs and mono crops, which require growing the same crop every year on the same land, has made food systems more at risk for disruption from water scarcity and climate change.
- Consumer trends in the region towards more processed foods and increased meat and dairy consumption are requiring more resources, including water, per unit of food produced.
Together, these trends are increasing the sector’s use of natural resources at the same time that water scarcity and climate change threaten to reduce their supply.
In an attempt to quantify the water-related investment risks for the food and beverage sector, the World Resources Institute (WRI) published a report identifying potential financial impacts arising from water scarcity and climate change on publicly listed companies in the F&B sector in South and Southeast Asia. Weeding Risk, released in April 2010, focuses on domestic companies in this USD $40 billion industry that process and package foods and non-alcoholic beverages in India, Indonesia, Malaysia, Philippines, Thailand, and Vietnam.
Weeding Risk examines the potential impact of water scarcity and climate change on three key value drivers (agricultural inputs, operating efficiency, and reputation) for each of the seven most important F&B subsectors — aquaculture, beverages, confectionary, dairy/poultry, edible oils, starches, and sugar. WRI concludes with a road map for analysts and investors seeking to factor environmental trends and their potential financial impacts into their analysis of companies’ strategic positioning in this sector and region.
While WRI’s Weeding Risk report excludes China, water-related risks in the food and beverage sector is an issue very much relevant to the mainland: Its agricultural sector accounts for approximately 13% of its GDP, and even as late as 2006, almost 56% of China’s working population remains active in agriculture1. With a decreasing supply of soybeans, corn and wheat, and a growing population, China has shifted from being a net exporter to a net importer of major agricultural crops2. The Chinese government continues to heavily subsidise the sector.
Water and Asia’s food and beverage sector
Water scarcity is a growing concern for the countries covered in WRI’s report, and in India in particular. High demand for water, coupled with water pollution, means that water reserves are being used faster than they can be replenished. This trend will accelerate in some areas, as population and economic growth lead to higher water consumption in the region. The figure below shows the annual renewable freshwater availability per capita in the six countries.
As a large water user, the F&B sector is at risk from decreasing water supplies in parts of emerging Asia. The F&B sector is a significant water user, especially in its supply chain, as agriculture comprises the largest user of water in the six countries (as is the case in many countries). Water usage is greatest in the growing, harvesting, and rearing phases of production. The sector’s high water dependency makes the impacts of water scarcity more pronounced.
Water quality is also an important factor during processing activities1. Water is a key ingredient in many products, and is used extensively as a cleaning and processing agent, requiring high quality water to maintain food safety standards.
Maintaining reliable water supplies for the F&B sector will be a challenge due to the following factors:
- Physical water scarcity: Most F&B companies draw their water from the local groundwater, as well as rivers. Groundwater can become scarce when withdrawals are greater than the recharge rate (i.e., quantity of water per unit of time that replenishes or refills an aquifer). Water renewals in the region tend to be seasonal, such as rainy seasons (e.g. the Monsoons in India) or snow and glacial melting (e.g. the Himalayas).
- The Himalayan glaciers continue to melt. Though the complete disappearance of the glaciers is not imminent, changes in river flow patterns might arise.
- Decrease in water quality due to pollution: Water pollution in the six countries, from a variety of industrial and household sources, has been worsening in recent years. Water pollution, which F&B companies also contribute to, can reduce the amount of usable water available, which increases the cost of filtration (if filtration is possible).
- Increased conflicts with other users: Water allocations to the F&B sector and supply chains are often determined by the local legal structure governing water access. As water scarcity increases, competition for water resources will become more intense from domestic and industrial users. For example, Coca-Cola’s perceived over-extraction of groundwater in some parts of India has made it the target of local communities and activist groups.
The magnitude and scope of water scarcity and climate change trends will influence the continuing transformation of the F&B sector in emerging Asia.
Source: 1Kirby et al, Water in Food Production and Processing: quantity and quality concerns, Elsevier Science Ltd., July 2002.
The most financially material impacts of water scarcity and climate change on the F&B sector are increased agricultural input prices and increased processing costs (see figure above).
- The impact of water scarcity and climate change on agricultural input prices and processing costs affects all F&B subsectors examined in this report.
- The significance of the impact depends on a number of factors, including location of suppliers and factories, ability to pass costs onto consumers and the sustainability of supplier cultivation practices.
Water scarcity and climate change can raise agricultural commodity prices and increase price volatility by decreasing yields.
- Water scarcity and climate change can have a direct impact on the availability, quality and price of key food commodity inputs by negatively impacting animal and crop yields.
- Food commodity prices are particularly vulnerable to the shocks of unpredictable extreme weather events, while animal yields are most at risk from increased water temperatures (aquaculture) and access to clean water supplies.
Water scarcity and climate change can increase processing costs through operational disruptions and treatment costs.
- Water scarcity can create operational disruptions since water is 1) a base ingredient and 2) integral to production processes. Water pollution, which contributes to scarcity, requires investments in filtration technology.
- Climate change can create operational disruptions by damaging manufacturing plants and infrastructure.
Water scarcity and climate change can create food safety and stakeholder challenges.
- Climate change and scarcity of clean water can increase exposure to diseases and contamination, especially for animal-based products, increasing food safety risks.
- Competition for water is a source of tension between food processors and stakeholders, creating reputational risks.
Spotlight on Aquaculture Vulnerability in Thailand
The increased risk in food safety issues in Aquaculture due to increasing water pollution and climate change is a real threat to the subsector, especially as disease incidence and compromised yields are already prevalent due to over-harvesting, misuse of antibiotics, tourism, and over reliance on a few species. Suppliers can help mitigate this risk through maintaining high food safety and water quality standards.
Aquaculture is a significant contributor to Thailand’s economy, with exports increasing rapidly over the last decade and a majority of the listed packaged F&B companies involved in aquaculture-related businesses. The potential for increased flooding and droughts resulting from climate change is likely to affect the industry negatively, particularly in the face of intensive commercial farming.
Intensive shrimp farming in Thailand has contributed to lowering the water table and created salinity problems. Salinization reduces water availability for agricultural as well as industrial uses. Under climate change scenarios that increase the frequency of drought, there may be conflict between the aquaculture, agriculture and industrial sectors in Thailand.
Thai aquaculture businesses may benefit from higher fish prices, but will also face higher input costs (as fish oil and fishmeal are used as feeds) and the inability to pass costs onto consumers in light of lower aquaculture vulnerabilities in major export markets like the US and Europe.
Source: Handisyde et al. Department for International Development,
“The effects of climate change on world aquaculture: a global perspective,” 2006, and WRI.
Roadmap for investors and analysts
First step: Investors and analysts need to engage F&B companies to obtain facility data, local water availability data, and information about supplier cultivation practices and technology.
- Is the facility (or supplier facility) located in a water scarce or climate change prone region?
- What factors threaten the facility’s water supply? Are these threats growing in significance? Has the risk of climate change been taken into account?
- What is the facility’s water usage? If not reported, what water reducing technologies are in place?
- How is the facility’s water supply secured? What degree of volatility exists under this arrangement? Which water users are given priority in scarcity situations?
- What are the supplier practices in the areas of food safety, fertilizer use and crop rotation
Second step: Utilising the aforementioned dataset, investors and analysts conduct either a sensitivity, scenario or management quality analysis to build water and climate factors into their investment case for the F&B sector.
- Sensitivity analysis: For facilities dependent on freshwater resources, conduct a facility level sensitivity analysis of financial impacts (on costs and sales) of water supply distributions. This will reveal which companies have the highest financial risk tied to disruptions.
- Scenario analysis: Develop scenarios around water availability at the river basin level for a given facility based on future projections (if available) or key risk factors present at the local level. When combined with the sensitivity analysis above, this provides insight into which companies are most at risk from water constraints and the potential magnitude of financial impact.
- Management quality analysis: Assess and rank companies based on the ability of corporate initiatives, including comprehensive water management strategies, and advanced technologies, such as water reuse and recycling, to mitigate water risk. Use this information to appropriately adjust conclusions from the sensitivity and scenarios analyses.
This section was based on World Resources Institute’s Weeding Risk, published April 2010.
1Responsible Research, Water in China: Issues for Responsible Investors, 2010.
2Seeking Alpha, “China’s agricultural sector is ripe for investment”, April 2008