Water Resilience, Disclosure & Mismatch

By Wai-Shin Chan 4 February, 2013

Wai-Shin Chan, Director of Climate Change at HSBC on why water is more important than oil

Water risk is already disrupting company operations and the growing number of water extremes – droughts, floods, storms – is making water management a key issue for long-term investors.  Climate change which alters historical patterns of water availability, coupled with rising water demand and poor water management, is conspiring to accentuate the risks for companies and hence investors.

Ability of investors to evaluate water risk is improving

The ability of investors to evaluate the contribution of water to corporate risk and reward is improving steadily. Key to this is the Water Disclosure Project, which, like its parent the Carbon Disclosure Project, deploys global investor concern to expand reporting. In 2012, 470 investors with assets of US$ 50 trillion asked 318 major companies from water-intensive sectors to participate. Around two-thirds – or 191 companies – responded. Just over half of these (99) revealed that they were already experiencing negative water impacts on their businesses. Negative water impacts include shortages from drought or poor municipal infrastructure; regulatory drivers such as rising compliance costs; uncertain policy direction as well as more stringent water withdrawal, recycling and discharge guidelines; and reputational issues such as community opposition to water source changes or complaints over water infrastructure development.

To assess the future potential disruption of water shortage on companies, we think investors should start with the most intensive users in the most stressed locations.  We analysed water data of the MSCI World Index using data provided by Thomson Reuters Datastream to determine the most water-intensive sectors and found that utilities account for 75% of MSCI water use, with materials accounting for a further 17%. However, for utilities, we noted that water exposure is tempered by location. For example, a power facility situated near the coast is less at risk than a facility further inland. Beyond this, indirect supply chain risks are greatest for the food and beverage value chain; globally, agriculture accounts for about 70% of water use. Historically, water availability has been crucial in determining food production and trade, and we expect this to heighten in the future.

Need for improved disclosure is obvious

The need for improved disclosure is obvious. However investors cannot wait for comprehensive, universal reporting before they integrate water into portfolio risk management. In the interim, investors need to know that their holdings in water-intensive value chains in water-stressed regions are able to generate robust cash flows into the future. The CERES Aqua Gauge provides a useful, common sense four-step approach for institutional investors to compare water risk management: 1) measure; 2) manage; 3) engage; and 4) disclose. We think companies need to communicate their understanding of water exposure and how they are managing it to various stakeholders; governments could help in mandating water disclosure.

Disclosure in China is still in its infancy yet nearly half the nation’s GDP is earned in water-scarce provinces. The government is imposing tough new water quotas, as well as pollution reduction targets. We examined levels of disclosure among utilities in China and found that only 6 out of 105 listed utilities had historic water data disclosed on Bloomberg. Looking ahead, China plans to add more power capacity than exists in the US, the UK and Australia today and this will require large amounts of water. For those new facilities able to access seawater, there shouldn’t be a significant problem, but for new facilities further inland, water availability would be a crucial factor in determining the location of power stations.  Groundwater availability will also become an issue given the need for pure process-water at power stations.

Mismatch of macro risks: Energy & Water

It is difficult for investors to assess corporate water risk when the companies themselves cannot always assess macro water risks. For example, China recently announced its 12^th Five-Year Plan on Energy Development which puts a non-binding cap on total energy use by 2015 of 4 billion tonnes of coal equivalent.  This Development Plan expects the growth of natural gas to be higher than that of coal.  From a base of virtually zero in 2012, China aims to produce 6.5bcm of shale gas annually by 2015, rising a further ten-fold by 2020.  At the same time, the government has brought in water quotas at national and provincial levels as climate change alters China’s historical patterns of water availability. Although the shale-rich southwest provinces are not technically water-stressed, certain shale fields are located far from water sources, and the surrounding areas have suffered severe droughts as recently as 2010. We believe that China’s environmental and water laws will tighten as the ‘Beautiful China’ policy is pursued – a change from historically weak enforcement as evidenced by the recent and very public domestic debate concerning China’s off-the-dial air pollution. Hence, we think there is a mismatch between China’s shale and water ambitions which could result in a slower-than-planned development of shale.

Moreover, water availability is dependent on both quantity and quality. Hence there is the thorny issue of potential groundwater contamination – especially in China where groundwater supplies two-thirds of the population’s drinking water. In late 2011, the State Council earmarked RMB34.66 billion (US$5.48 billion) to restore the country’s groundwater supply through prevention, remediation, monitoring and pollution control.  The 12^thFive-Year Plan for Shale Gas Development offers another mismatch as it believes that contamination of groundwater is unlikely; that strict enforcement of drill casing can eliminate water pollution; and that there have been no documented and proven cases of groundwater contamination due to shale production around the world. In contrast, in the United States, Maryland is debating the harm to drinking water from fracturing and the EPA of New York City has called for a ban because of the threat to the city’s drinking water. We think if the Chinese public start to demand the release of timely water pollution data, in a similar vein to air pollution data, then the enforcement of water quality regulations could be the next big public debate in China.

“Water is more important than oil”

HH Sheik Mohammed bin Zayad al Nahyam, Crown Prince of Abu Dhabi

We think investors should take note of the words of HH Sheik Mohammed bin Zayad al Nahyam, Crown Prince of Abu Dhabi, a country that produces around 3.3 million barrels of oil a day, where oil and gas contributed US$129 billion or two-fifths to the UAE economy in 2011, quite simply: “Water is more important than oil”.

HSBC Climate Change Strategy released three reports in January 2013:

• 17 January 2013 Shale: water first, leak later
• 22 January 2013 – “Water is more important than oil”
• 22 January 2013 : Water: resilience in a thirsty world. Where to focus and what to look for with this slippery issue

Additional Reading

• China Water Risk’s 2012 Review and 5 Trends for 2013 – Stay on top of water risks and trends for 2013
• Water Fees & Quotas– Set for Economic Growth? Debra Tan reviews the new joint standard on pricing and other measures by government to manage water resources in 2013