2011 Year in Review & 5 Trends for 2012

By China Water Risk 9 February, 2012

China Water Risk reviews the water space in 2011 and five trends for 2012

A lot has happened in the water space in the Year of the Rabbit. Water attained star billing in China’s No.1 Document in 2011, heavy mentions in the 12^th Five Year Plan (2011-15) and the State Council met over the summer just to discuss water. All three’s principal concern was China’s ability to meet the demand for water in the future, given current levels of water resources and pollution.

Exposure to water risk has resulted in disruptions to electricity, business operations and river transportation. There were also disruptions in supply chains with price volatility in raw materials. Last year also saw a rise in NGO activity with several successful naming and shaming campaigns conducted in China. The number of protests has also been on the rise and a few have managed to halt business operations altogether.

“Climate change will lead to severe imbalances in China’s water resources within each year and across the years. In most areas, precipitation will be increasingly concentrated in the summer and autumn rainy seasons, and floods and droughts will become increasingly frequent”.

2nd National Assessment Report on Climate Change

China faced more extreme weather events in 2011 than 2010. Already extreme weather in 2010 had resulted in direct economic losses of RMB500 billion. The Second National Assessment Report on Climate Change issued in November 2011, taking into account the period 2008-2011, states that “Climate change will lead to severe imbalances in China’s water resources within each year and across the years. In most areas, precipitation will be increasingly concentrated in the summer and autumn rainy seasons, and floods and droughts will become increasingly frequent”.

The report is a collaborative effort among various government departments, academics and scientists. Although it is not intended for use in policy setting, will have influence over policy given its participants – Ministry of Science and Technology, China Meteorological Administration and Chinese Academy of Sciences (CAS). In supporting roles were the Ministry of Foreign Affairs, National Development and Reform Commission, Ministry of Environmental Protection, Ministry of Education, Ministry of Agriculture, Ministry of Water Resources, State Forestry Administration, State Oceanic Administration and National Natural Science Foundation of China.

With climate change exacerbating water scarcity, water risks clearly are here to stay and businesses are starting to take notice as water, or rather the lack of it, affects their bottom-lines. The CDP Water Disclosure Report issued late last year on behalf of 354 financial institutions with assets of US$43 trillion, shows that boardrooms are behind on evaluating water risk. This is despite the fact that over one-third of the Global 500 respondents surveyed already have suffered recent water-related business impacts, with associated financial costs as high as US$200 million. Indeed, water-related issues receive less attention than climate change at the board level, with only 57% of Global 500 respondents reporting board-level oversight of water-related policies, strategies or plans compared to 94% reporting board-level oversight of climate change.

Although an increasing number of corporates are disclosing water-related information, with a 60% response rate to the survey, there still is a long way to go on corporate water disclosure. Are these risks properly disclosed, let alone adequately measured? The reality is, water may have a larger impact than expected. Puma in its inaugural environmental audit uncovered that their water use could cost them as much as EUR47 million of profits. Flip through “Risk Experts Environmental”, a research report quantifying environmental risks issued by BNP on all the companies they cover in Asia, and you will see water featuring prominently as either a direct or supply chain risk.

“In every sector, the demand for water is expected to increase and analysis suggests that the world will face a 40% global shortfall between forecast demand and available supply by 2030.”

World Economic Forum

Faced with this material impact, businesses and investors should be worried. Why then the disconnect? Why are more businesses and investors not worried? Do they not have a fiduciary duty to their shareholders / fund stakeholders? The recent gathering in Davos is a clear example of the disconnect. The theme was “The Great Transformation: Shaping New Models”. Whilst the water-food-energy nexus has been recognized by the WEF as one of the three important clusters of risks that have emerged in 2011, the report issued during the forum, New Models for Addressing Supply Chain and Transport Risk had little reference to water apart from a mention of flooding in Thailand and the fact that 30% of companies surveyed consider extreme weather a risk. Why is it so hard to understand water risk when it is something to which almost every business is exposed? You either have access to water or don’t; you either pollute water or not.

Beijing is clearly worried and placing importance on water. Isn’t it about time businesses started to pay attention too?

Here are five trends we see will continue into the next year…

1. Water remains a top priority for the Chinese government

Although agriculture regained the top spot in the 2012 No.1 Document released on 2 February 2012, we still see water as a priority for the government in the near and long-term.

With the Dry 11 accounting for 45% of the GDP of China, it is not surprising that the government will continue to focus on water especially when a growing economy and increasingly affluent society will continue to tax water supplies, be it demand from agriculture, industry or municipal.

Experts continue to believe that water is undervalued and that if business continues as usual, the supply of water will not be able to meet the demand for water by 2030. In order to ensure this does not happen, the government tackled this head-on in the 2011 No.1 Document, the 12^th Five-Year Plan and the State Council. There are clear policy implications for the next five to ten years:

Water, water everywhere

It is not yet clear how the new pollution targets will be achieved but early cost-benefit analysis conducted in Suzhou by the World Resources Institute show that it may be more efficient to focus on certain industries rather than fertiliser use in agriculture. (For more, read “New Strategies for Tackling Pollution”). There is no doubt that water policies and strategies set at provincial levels will have a clear impact on businesses. Companies that are better prepared could use this opportunity to gain market share.

As for the 2012 No.1 Document, the focus on agriculture and technology confirms that water-food-energy remains a concern. In “Agriculture: A Prosperous Ever After” we highlight the importance of technology as the main driver of strategies to ensure food security and a prosperous ever after. The government clearly is indicating support by financing agricultural, scientific and technological innovation to encourage sustained agricultural growth. The national government has also vowed to construct more water-conservation facilities in rural areas, with a view to improving rural living standards and easing rural-urban disparity.

2. More floods & droughts

Floods and droughts continued to dominate headlines in the past year.

In China, floods and droughts continue to wreak havoc. Agriculture is the most vulnerable and given that China is a large agricultural producer, too much or too little water has an impact on global food prices (click here for more on this). The figure below shows drought and flood-affected provinces of China. Note that the Top 4 Farmers – Shandong, Jiangsu, Henan and Hebei are all drought-prone. Henan, is also susceptible to floods.

“Climate change will lead to severe imbalances in China’s water resources within each year and across the years. In most areas, precipitation will be increasingly concentrated in the summer and autumn rainy seasons, and floods and droughts will become increasingly frequent”

The Second National Assessment Report on Climate Change, November 2011

It is not just food that is being affected by too much or too little water, the textile industry was also particularly badly hit last year. Drought caused the price of cotton to rise by more than 50% in 2010/2011 resulting in global textile companies like H&M seeing lower profits of 20% over the first 9 months of 2011 and GAP slashing its profit forecasts by 22% for the year. It is not surprising that water risks in China lead to price volatility as China is the largest producer of cotton globally. Cotton represents 90% of natural fibres used in the global textile industry. It doesn’t stop there – last year’s high cotton prices led manufacturers to switch to synthetics, and the higher synthetic prices in turn pushed up the prices of many base chemicals.

Floods and droughts are here to stay.

3. Low levels of water in lakes and rivers and potential diversions

Low levels of water not only mean that parts of rivers become unnavigable upsetting shipping routes but have also resulted in power outages.

Transport disruptions to continue with record-low levels of water

In May 2011, the water level in the Yangtze was so low it forced officials to close a section of the river from Wuhan to Yueyang. State media reported that more than 60 percent of goods transported on inland rivers in China travel through the Yangtze, with shipping volume at 1.33 billion tons in 2009.

Later in the year, another section of the Yangtze River which runs through Hunan, saw record low water levels at 24.77metres. These low levels appear to be here to stay. Chinese researchers recently have revealed that the amount of water entering the Yangtze River near its source on the Tibetan plateau has fallen by 15% over the past four decades, despite a 15% increase in glacial melt and increased rainfall over the same period. Wang Genxu, an ecologist at the Chengdu-based Institute of Mountain Hazards and Environment, part of the Chinese Academy of Sciences (CAS), says that the findings came as a surprise. “It is in contrast to results from the Arctic, where global warming has generally caused increased river discharge,” he says.

Separately, shipping traffic also has been affected in the south. In December 2011, more than 900 vessels were stuck on a section of the Xijiang River that runs through the city of Wuzhou in Guangxi. A lack of rain decreased the river’s runoff by more than 30 percent in that month. The Pearl River flood control and drought relief headquarters did not release water from the Changzhou Reservoir to relieve this as it had to ensure sustainable drinking water supplies for the cities of Zhuhai and Macao in January, otherwise, supplies would last only 12 days.

Saltwater intrusion

The low levels in the Xijiang River also brought about another problem – saltwater intrusion. As the river’s runoff shrank, seawater flowed back into the river, triggering a severe salt tide. Water management departments in Zhuhai and Zhongshan in Guangdong province detected excessive salinity levels in water samples taken from pump stations along the river. In this case, the river’s low water level was caused by lingering drought along the river’ supper reaches in the provinces of Guizhou, Yunnan and Guangxi. Note that none of these three provinces are in the Dry 11, and actually enjoy a “safe” level of water resources per capita and yet they are exposed to water risks.

China South-to-North diversion projects are touted to solve low-levels of water. However, droughts and low levels of water in the South are deepening skepticism over the viability of the diversion project.

Power outages put viability of hydropower in question

Power outages abound. With hydropower representing 22% of China’s total installed capacity, low water levels pose a problem. China Daily reported power shortages due to low levels of water in Anhui, Hubei and Guizhou. In May 2011, the water level of the Three Gorges Dam fell below 156 meters, the lowest requisite level for full power generation. According to the World Resources Institute, the lack of water to run hydropower dams has cut hydroelectric power production in China by 20%. They estimate that China may be forced to burn 1 million more metric tons of coal per week to cover the gap.

China is planning to double its hydropower capacity from 213,400MW in 2010 to 430,000MW by 2020 – is this a realistic proposition?

Diversion anxieties persist

The location of potential hydropower sites are another point of contention. Firstly, many potential hydropower sites are located in areas prone to seismic activity. Secondly, they lie on tributaries to transboundary rivers or the transboundary river itself. Fears arose in the summer over the tapping of the Brahmaputra which feeds into the Ganges for hydropower. The Economist reported that a growing rivalry between India, Pakistan and China over the region’s great rivers may threaten South Asia’s peace. Isabel Hilton thinks otherwise – read “Diverting the Brahmaputra – Much Ado About Nothing?”

Nevertheless, the fact that there are no trans-boundary river agreements with China means that the underlying threat of diversion will persist. (See “Geopolitical Risks: Transboundary Rivers” for more)

4. Reputation at risk with more pressure from naming-&-shaming campaigns & public protests

The past three decades of rapid growth at the cost of massive environmental degradation in China, coupled with a growing middle class, rapid urbanization and industrialization have meant people are no longer willing simply to accept their lot.

There are now many thousands of environmental NGOs nationwide, many of them organized around a single issue or established to protest excessive emissions from a particular plant or group of factories. People no longer believe what they are told, if their own eyes and ears tell them otherwise.

For example, China has long tried to play down a worsening smog problem that in 2011 left citizens gasping for much of the year while the government claimed 274 “Blue Sky” days. But following online citizen activism, the deployment of alternative means to measure the air quality by citizens, NGOs and the U.S. Embassy in Beijing, the government last month announced it would openly publish readings of the small and hazardous PM 2.5 particulates

NGOs and individuals increasingly are emboldened by significant wins such as this one, the closing of a polluting chemical plant in Dalian in August last year and other similar shutterings that followed pollution incidents. Estimates are that there were as many as 90,000 “mass incidents” in China sparked by environmental concerns in 2011, according to Foreign Policy magazine. We will be covering the growing numbers of protests in greater depth next month.

But what’s interesting about the current trend, and what really sparked the protest in Dalian, was not a specific incident but worry about future impacts of the plant on public health. And it was the local government’s failure to disclose information about the factory and efforts to stop any reporting on the real risks that fueled the anger.

Both government and the corporate sector are starting to take note. China in 2008 introduced a set of open Environmental Information measures that require government agencies to proactively disclose a range of environmental information.

This is being used by Beijing-based Institute of Public and Environmental Affairs, Washington D.C.-based Natural Resources Defense Council and others to gain additional information about corporate violations. IPE’s website is now populated with over 90,000 such citations In a disclosure report last month, IPE wrote that as of December 31st, 2011, a total of 548 companies had been in contact with environmental protection organizations in response to environmental violation records. In 2011 alone, 218 companies provided explanations regarding pollution issues and any corrective measures. “This progress has shown that China’s environmental information disclosure has already started to push companies to re-think their environmental responsibilities,” IPE wrote in the report, co-authored with the NRDC.

And as China Water Risk has reported in “Can Fashion be Green ”, in recent months, there have been significant commitments from key players in the textile industry, including Puma, Nike, H&M and Adidas, to encourage less polluting production by their supplier mills, largely in response to action by environmental groups. However, some remain skeptical about the real meaning of Zero-Liquid Discharge (read “Zero Liquid Discharge – A Real Solution?”).

Brands are recognizing the business risk to keeping polluting suppliers on their books – both in terms of reputational risk and actually losing a polluting factory to local action.

Patagonia recently took the bold step of announcing that it was refashioning itself under California’s new “benefit corporation” designation (B Corp). This creates the legal framework for Patagonia and other companies to reinforce their social and environmental goals.

As a B Corp, a firm must have an explicit social or environmental mission, as well as a legally binding fiduciary responsibility to take into account the interests of workers, the community and the environment as well as shareholders. China Water Risk will be writing more about Patagonia and the issues around fiduciary responsibility in future newsletters but we have written about the company’s environmental initiatives here.

5. Investors & Companies continue to play catch up

With water-related issues receiving less attention than climate change at the board level (only 57% of Global 500 respondents reported board-level oversight of water-related policies, strategies or plans compared to 94% for climate change), investors and companies will continue to play catch up.

Big brands in the textile and electronics industry have turned attention to their supply chains in China, thanks to NGO pressure and the threat of reputational loss. However, given that water risks have the potential for clear impact on the bottom-line, surely corporate management should have a fiduciary duty to stakeholders to proactively mitigate against water risks rather than merely react to NGO pressure or disasters such as floods and droughts? After all, a recent WEF report cites:

• “Changing consumer behavior: 80% of emerging market consumers say they have more trust in a brand that is ethically and socially responsible.”
• “Tightening social contract / license to operate – Fast-moving consumer goods companies that do not mitigate against risks posed by environmental pressures, including climate change policy, water scarcity and deforestation, will risk up to 47% of their earnings before tax and interest by 2018.”

The same report also recognizes the economic output risk associated with water. An analysis by Oxford Economics suggests that a “peak metals” scenario could put US$ 2 trillion (1.7% of GDP) of economic output at risk in 2030 if major global economies fail to respond to shortages in the supply of steel and iron. The report acknowledges that these numbers could be much larger if the analysis were extended to other key resources such as water.

Given China’s water crisis and its position as the “world’s factory”, most companies will be exposed to China water risk either directly or indirectly through the supply chain or through raw materials. Yet water largely remains under the radar – a report issued last year by Deloitte on “Eco-labels: Positioning your brand, product portfolio and supply chain” has not one mention of water. It is not the only one.

Putting on an “eco-friendly” face may not be enough in the future. Perhaps real change in the boardroom will come when water risks disrupt operations and eat further into profits. Companies will then have no choice but to start noticing and investors will to have to follow suit.

At the risk of sounding like a broken record, regardless of whether you care for the environment, water risks affects us all. Be prepared – it’s very clear they are here to stay.