China Water Risk: A Portrait

By CWR 18 October, 2011

Check out water challenges for each industry and be in a position to mitigate the risk in this in-depth review

Worldwide, almost 1 billion people lack access to safe drinking water yet 70 percent of industrial waste in developing nations still is dumped untreated into waterways, further limiting what is often already stretched supply.

As knowledge of this spreads, concern is growing globally about water resources and the potential for conflict in regions where these are scarce. A recent AC Neilson study showed that worry about water shortages has overtaken global warming as the top environmental concern, with 75 percent of respondents identifying water as top of their list. That represents an increase of 13 percent over the previous year¹.

In China, the water landscape is particularly stark. We hear much about that country’s economic growth averaging 10 percent over the past 20 years, the massive and wholesale transformation of the economy occurring at rapid pace, but little about the environmental cost of the country’s massive development.

We hear less about the dead and dying rivers, the over-pumped groundwater aquifers, the desertification in previously agricultural areas, the thinned soil from over-use of pesticides, the power plants without adequate water, the massive and growing health care costs weighing on GDP and spurring growing protests nationwide. We hear much less of the tightening regulatory environment, the moves toward real pricing of this precious resource, and the around an inevitable clean up.

There are clearly significant ramifications across a broad range of industries in China but are investors prepared? Are they considering water as the potential business risk it clearly is? Are companies engaged in the necessary due diligence and mitigation efforts to survive the inevitable and seismic shifts around water?  Are they looking at the opportunities?

According to the 2011 EIRIS Water Risk Report² only 36% of companies have acknowledged that water is a real risk they understand they must address. But are even these making the needed strategic adjustments to avoid potentially dire consequences for future profitability?

China Water Risk  aims to inform and in so doing help shape strategy, shifting the allocation of resources to ventures and investments that make good water sense. We want to help investors and business leaders stay ahead of the water risk curve, to make decisions from which to profit.

A Profile of China’s Water Risk

Per capita global water resources on average are 6,280 cubic meters but people in China have only 1/3 of that amount at 2,100 cubic meters.

Thus, the country with 22 percent of the world’s population has access to only 5 percent of global water resources, while an estimated 300 million people in the country lack access to safe drinking water³. And this is not just a problem for rural China. In 2007, research showed that 60% of China’s cities faced water scarcity and 110 cities faced serious water shortages.

Essentially, the Ministry of Water Resources in China has said that if China continues to consume and pollute its waterways at today’s rate, by 2030 demand will exceed supply⁴.

Pollution Exacerbates Scarcity

Besides scarcity, pollution is a problem central to any discussion about water in China. Three decades of rapid development that included a push toward grain self-sufficiency fueled by excessive pesticide use, massive construction of infrastructure, a city building spree and construction of China’s huge industrial complex have left the natural environment in tatters.

Despite already limited access to clean water in china, horrendous levels of pollutants spill untreated into waterways and seep into aquifers from agriculture and industry.  In all, an estimated 50 percent of groundwater in cities is considered not fit for human contact. ⁵

Pollution of groundwater follows from the low urban sewage treatment rate, which was only 73 percent in 2009, according to the same CBT article. And over the next five years, sewage treatment efficiency must increase by 67 percent just to meet demand. ⁶

The challenge for the country’s waterways is no better. CWR cites the Ministry of Environmental Protection as saying that 77 percent of 26 key monitored lakes and reservoirs, 43 percent of 7 major river basins are considered unfit for human contact⁷.  Meanwhile, 19 percent of monitored rivers and basins, 35 percent of lakes are reservoirs are considered unfit even for agricultural or industrial use.

The World Bank ten years ago warned of “catastrophic “consequences for future generations if the government did not act to solve quickly the acute water shortage and pollution problems. The 2001 report urged new pricing, management and regulatory strategies that have yet to materialize. ⁸

In part, despite historical scarcity, water challenges have been exacerbated by an unparalleled effort to, over recent decades, pull an estimated 300 million people out of poverty.

To achieve that herculean task, China has become manufacturer to the world and fed that largely by drilling precious ground water both for production and power instead of recycling surface supplies. And in the process, little heed has been paid to efficiency or pollutant emissions.

In July 2010, the International Energy Agency estimated that China was now the world’s largest consumer of energy as it continues its steady progress into position as the world’s second-largest economy behind the United States. Yet 95.6 percent of China’s electric power requires water to generate and 47 percent of electricity is consumed by water scare provinces. ⁹

With an expected doubling of installed capacity in the next years, China will have to manage this water-energy nexus carefully to keep its economy growing.

Agriculture: Overuse of Chemicals And Water Risk to Food Security?

In China, agriculture has been by far the largest consumer of water at 62 percent, and the largest polluter, with pesticides and fertilizers responsible for about half the contamination of waterways.

With water scarcity becoming more evident, fresh water resources increasingly unfit for irrigation coupled with the fact that China holds only 7 percent of the world’s arable land, food security has by all accounts become a national concern.

Part of the problem around agriculture and food security has been that Northern China, with 20 percent of the nation’s water resources, contains 65 percent of China’s arable land, produces half its grain and nearly all its wheat and maize. The region also accounts for more than 45 percent of the nation’s GDP. ¹⁰

Exacerbating the problem, the country is globally the largest consumer of pesticides and this has contributed heavily not only to aquifer and waterway pollution but to depletion of farmlands.

A China Daily article quoted figures from the Chinese Academy of Soil Sciences as showing that the average level of organic matter in soil is now 1 to 5 percent for northeastern China’s arable land, compared with 8 to 10 percent in the 1950s. ¹¹

Statistics from the Chinese Academy of Agricultural Sciences (CAAS) also shows that more than one-third of land now has harder and thinner tillage layers, meaning crops cannot be planted as deeply – a direct consequence of excessive pesticide use.¹²

According to Zhang Weili, a CAAS professor on soil and fertilizer China uses 1.3 million tons of pesticides annually on 300 million hectares of farmland, with a usage per unit area that is 2.5 times the global average¹³.  This over-usage in an effort to become self-sufficient in grain has lead to the eutrophication of 42 percent of China’s 26 monitored lakes and reservoirs.

“China can no longer boost grain production by relying on agrochemicals,” Zhang was quoted as saying. “More cultivated land will face risks of greater yield decreases in the next few years since the soil is too fragile to withstand natural disasters, which will become more severe and longer due to climate change.”

To illustrate Beijing’s growing concern, the last few years have been marked by myriad investments by Chinese companies in agricultural land overseas, most notably Brazil, Argentina and Chile, Africa, Russia and Australia to produce food for export to China.

Foreign Direct Investment Helping to Fuel Growth

Meanwhile, as environmental and labor regulations tightened in the West pushing up prices at home, Foreign Direct Investment has flooded into China, fueling the factories, building the industry that is now feeding, clothing and housing the world.

Last year, FDI was estimated at $105.7 billion¹⁴, surging 17.4 percent over the previous year. This is helping build a huge middle class and affluent consumer market in China that is expected to almost triple to 400 million by 2020.¹⁵ According to a recent HSBC report, next year China will replace Japan as the world’s largest consumer of luxury items – something unthinkable just a decade ago.

Water Pollution: A Drag on the Economy

A joint report published in 2007 by the World Bank and the Chinese government estimated the combined health and non-health cost of outdoor air and water pollution at approximately $100 billion a year, or about 5.8% of China’s GDP. Water pollution, meanwhile, worsens China’s severe water scarcity problems, with the overall cost of water shortages estimated at 1% of GDP.¹⁶

Growing Discontent

The weight on economic growth is certainly of concern to Beijing, but equally concerning is the growing discontent in China related to pollution incidents and scarcity. In 2005, the last year for which government figures have been released, there were an estimated 50,000 protests nationwide related to pollution incidents.

This comes in response to significant growth of so-called cancer villages, or clusters of cancers invariably located near heavily polluting factories, fast-growing rates of urban cancers and outbreaks of illness or poisonings related to drinking polluted water. Last year, China saw at least 14 major heavy metal pollution incidents, including nine involving lead poisoning, according to Li Ganjie, vice-minister of environmental protection. ¹⁷

IT and Apparel: Polluting Industries in the Public Eye

Among the more polluting industries have been the IT and apparel sectors and both have been hit hard by environmental activists for using suppliers who repeatedly violate air and water standards, illustrating a greater tolerance on the part of the Chinese government for criticism.

Ma Jun, perhaps China’s leading environmental advocate and a coalition of 34 of China’s NGOs, are engaging with IT companies, Apple in particular, in relation to egregious pollution incidents by suppliers. In some cases, the health of employees working for suppliers was also reportedly compromised.

Greenpeace, meanwhile, has issued two “Dirty Laundry” reports in recent months denouncing “toxic” water management practices of Chinese manufacturers working for several well-known brands, including Adidas, Nike, Puma, H&M among many others, underscoring he growing reputational risk of using polluting suppliers.

Factories making products for major brands were found to be discharging hormone-disrupting chemicals into major Chinese rivers and that branded clothing from 14 companies contained Nonylphenol ethoxylates (NPEs) that break down into the toxic, persistent and hormone disrupting nonylphenol (NP).

H&M, Nike, Adidas and Puma subsequently announced they would “detox” their supply chains and remove hazardous chemicals from their products as well as publicly disclose pollution information.

The growing unease around violations and willingness on the part of Beijing to tolerate criticism of brands and their producing factories points to a growing reputational risk for investors and companies connected, even distantly, to polluters.

E-Waste Disposal and Pollution

E-waste disposal is another area the government has identified as in need of reform, since the recycling process can cause the release of heavy metals including tin, lead and barium into waterways, aquifers and pollute the air to the detriment of local populations.

China generates 2.3 million tonnes of electronic waste domestically each year, according to a United Nations Environmental Programme (UNEP) report¹⁸. The United States, meanwhile, produces 3 million tonnes and much of that ends up in China for “recycling.”

According to the UNEP report, by 2020 e-waste from old computers is expected to jump 400 percent from 2007 levels in China alone, while discarded mobile phones will be seven times higher.   In January this year the State Council issued new regulations for disposal and recycling of e-waste, including a treatment fund that will be used for subsidies.

Climate Change Brings Drought

Among the consequences of climate change has been growing desertification in the country’s north and prolonged droughts in agricultural regions nationwide. Indeed, in China, drought affects on average 15.3 million ha every year, corresponding to nearly 13 percent of the total farming area.¹⁹

This year, in some areas, precipitation has been the lowest in 50 years and has led to imports of grain and other key foodstuffs and domestic food inflation.

A drought that began in June in southern China has affected 44 million people meaning billions of losses in agriculture and shortages of drinking water for people and livestock. Losses from the drought were estimated at US$4.5 billion, according to the Ministry of Civil Affairs.

The droughts in central China this year also meant that water levels in some of the country’s biggest hydropower producing regions fell to critical levels, affecting China’s ability to generate electricity.

12^th Five-Year Plan Takes on the Challenge

The Chinese government is starting to take note of its environmental challenges and the cost of unparalleled growth.

The 12^th Five-Year plan, adopted in March 2011, emphasizes attempts to balance economic growth with improved ecological conditions. Conserving and cleaning water have both been identified as priority areas for investment.  The Magic Seven Emerging Industries listed in the new plan and identified as core to the new growth plan include Energy Saving and Environment Protection.

Water crisis is clearly identified and the plan urges expanded construction of water conservation structures, improved and more efficient irrigation, expanded wastewater treatment and recycling, and the clean up of polluted waterways.

In all areas, the government has announced new investment, including RMB 1 trillion for waste and sewage treatment, 4 trillion on water conservancy through 2020 to help fight droughts and floods.²⁰

Expanded regulations for businesses that are heavy consumers of water or polluters have also been detailed since the plan was announced, including stricter policies designed to prevent waste and special attention paid to repeated violators.

Geo-Political Concerns

Among additional political considerations are concerns that as the water shortages are exacerbated by Climate change, the government sees the need to exert further control over domestic water resources with far-reaching consequences.

Of the 261 International rivers globally, 15 originate in China, including the Mekong, Ganges, Brahmaputra and Indus rivers. These international rivers span 16 nations and China has no formal agreements or treaties regarding the use of these rivers with any of its neighbors.

Similarly, of the world’s 2,000 large dams, 1,000 are in China²¹, meaning that country controls not just the water flow to neighboring regions but also the nutrient-rich sediment that flows from the upper waterways. A reduction in flow would mean that the regions along the lower rivers would see reduced soil fertility and possibly an increase in salinity, with potentially devastating effects to regional food production.

The Mekong River alone serves as a source of food and livelihood for about 70 million people on Mainland SE Asia, where most people still live below the poverty line. Laos, meanwhile, generates important foreign revenues selling electricity from dams it has built along its rivers and has few alternatives should those run dry.

Risk, But Also Opportunity for Investors and Business

Clearly, some investors already are experiencing the effects of China’s water challenges and some may even be looking for ways to mitigate water-related risk, which can negatively impact profitability and growth.  Earlier this year, the CDP Water Disclosure Project²² showed that in a survey of 150 large corporations worldwide, nearly 40 percent said they had already experienced disruptions in operations, cost increases and other negative impacts from water.

And yet while the risks for investors buying into China are clearly myriad, there are also opportunities around water scarcity and pollution. Certainly, financial services companies are starting to focus on these, the new government incentives and the opportunities that the challenges offer for investment. Many are expecting a massive expansion in the water sector, including the production of clean water, storage and transportation of water, water conservancy and recycling, among many others opportunities.

What is patently clear is that no investor or business leader should step into China without carefully considering the water challenges facing each industry and then position carefully to mitigate risk.