Quantifying Water Risk: What’s My Number?
By Hubert Thieriot 14 April, 2016
Water risks are omnipresent but their financial valuation is missing. CWR's Thieriot on existing initatives & gaps
Over the last few years, much research has highlighted the growing water-related risks for many industrial sectors. However, very little work exists on the financial quantification of these risks. To what extent are companies’ operations exposed? What are the potential impacts of water risks to their bottom-line?
Some initiatives recently emerged to answer these questions in a systematic way. These are still in their infancy and monetization of water risk remains a nascent art. As water woes are getting more severe and the water risks more urgent, companies and investors should join the conversation and contribute to further improve these tools.
Growing evidence of risks
The power industry is probably the sector getting the most attention. Already in 2012, HSBC wondered if China has enough water to fuel its power expansion. The year after, Bloomberg New Energy Finance warned that China’s power utilities are exposed to water disruption. Coal mining was also exposed as highlighted by the 2013 CLSA report “Water for Coal -Thirsty Miners will Share the Pain”.
And the discussion has been carried on ever since. In 2016, talking about the thermal coal industry, Oxford University concluded that “companies in China and India are most exposed to conventional air pollution concentration and physical water stress”. In a recent Nature Climate Change article, authors warn that 61-74% of the hydropower plants and 81-86% of thermal power plants could see their usable capacity decreasing because of climate change and its impact on water resources. Despite this evidence, a recent Greenpeace report showed that 55% of currently proposed Chinese coal power plants are located in areas with extremely high water stress.
Many of these studies measure the exposure to water risks through one main proxy: the water stress of regions where the companies operate.
Mapping water stress across sectors
In 2013, the World Resources Institute launched the Water Risk Atlas that maps water stress all over the world among other water risk indices. Water stress is defined as the ratio of water withdrawals to the renewable supply. The year before, WWF released the Water Risk Filter with a similar objective. The availability of these maps played a crucial role in moving the discussion forward by providing useful metrics.
Thanks to these maps, one can now compare companies’ respective exposure to water stress based on their share of output located in water stressed areas. The table below show typical maps and charts that can be drawn from such analyses.
|Coal bases and coal power plants||Shale gas development||Agriculture products|
|Source: WRI||Source: WRI||Source: WRI|
The underlying assumption of this approach is that water stress is a relevant proxy to measure water risk. And there are good reasons to think so.
Water stress as a proxy to measure water risks, physical and regulatory risks alike
Water risks can materialize in many different ways. Droughts, floods, rivers running dry, depleted groundwater are probably the first ones that come to one’s mind and these would indeed definitely affect companies’ operations. However, risks are not only physical.
Regulatory risks can also largely impact companies’ operations, through increasing water price of course but not only. For instance, obtaining water use and water discharge permits might prove more difficult as China is committed to cap its total water use and clean-up its rivers – more on recent key water policies here. As a consequence, companies might see their expansion plans constrained or more investment might be required for them to use water more efficiently and better clean-up effluents. Growing competition for limited water resources also threatens the future access to water for water-intensive companies: facing growing tension both on environment and economic sides, local governments may naturally favour industries that provide the highest economic returns and employment per drop of water.
The separation between “physical” and “regulatory” risks is tenuous. Regulations are precisely drafted in order to prevent physical risks from materializing. To a large extent, physical and regulatory risks are two sides of the same coin and using water stress as a proxy to measure these can prove a convenient option.
The dollar sign is still missing
However, this approach still falls short of indicating the potential financial impacts on the companies’ bottom-line. The dollar sign is still missing, and therefore so is the possibility to integrate water risks in financial evaluations.
Monetizing water risks – Different tools for different needs
Some existing initiatives are trying to fill the gap and provide a financial valuation of water risks (see the table below).
Some initiatives are trying to fill the gap and monetize water risks
|The True Cost of Water||Veolia|
|Water Risk Monetizer||Trucost, Ecolab|
|Corporate Bonds Water Credit Risk Tool||Natural Capital Declaration, GIZ, VfU|
|Water Risk Valuation Tool||Bloomberg LP|
Two of these tools, the ‘Water Risk Monetizer’ and the ‘Corporate Bonds Water Credit Risk Tool’, adopt a similar approach: a shadow-price of water is determined based on its so-called ‘Total Economic Value‘ (TEV), which considers the value of water for the ecosystem as well as for competing users.
These tools can gauge the financial impacts of water-related risks…
By integrating this ‘real’ value of water instead of its actual price into financial statements or project evaluations, these tools can gauge the financial impacts of water-related risks on companies’ bottom-line – read our interview of Corporate Bonds Water Credit Risk Tool’s developers here. Thanks to a partnership with Bloomberg LP, this approach is now available to investors through the ‘Water Risk Valuation Tool’ as part of the ESG suite on the Bloomberg terminal.
Veolia’s approach in its ‘True Cost of Water’ is slightly different, with a more bottom-up methodology – read more from Veolia on their tool here. Likelihood and impact of different water risks are assessed independently rather than blended in an overarching value of water.
…but face the eternal trade-off between simplicity and accuracy
These tools are facing the eternal trade-off between simplicity and accuracy. The Total Economic Value approach offers a convenient and systematic way to assess potential impacts of water risks with limited input, namely the location, water use and output of a company’s operation. However, the results represent an upper-bound which assumes that water price will ultimately reflect its value to society. Besides, this method still doesn’t account for water quality challenges.
On the other hand, Veolia’s tool offers more detailed and accurate results at the cost of more research, data and expertise. Because of these constraints, such an approach cannot be conveniently applied to benchmark companies.
There is no one-size-fits-all approach and surely different tools will better serve different purposes and different users, such as corporate management, investors and insurers.
Join the discussion
Development of such tools and methodologies should be further encouraged. Much room for improvement remains, for instance through a better consideration of local regulatory risks and water quality concerns. More generally, consistency is lacking across water risks frameworks, data disclosure and risk quantification metrics. This is why we urgently need more discussion on the water risk quantification and its integration within corporates and investors’ strategic decisions. With this objective in mind, China Water Risk is initiating a survey that aims at collecting feedback from investors on existing water risks valuation tools – see the text box below.
There’s a long road ahead before every company is required to assess its exposure to water risks. Yet just a few years ago no one thought “carbon stress tests” would be required from fossil fuel companies. It is in everybody’s interest that a similar fate happens to water.
|Call for participation – Financial valuation of water risks
China Water Risk is currently applying some existing water risks financial valuation tools to ten listed companies operating in coal mining and power generation in China.
|The detailed results will be available to investors participating in our survey. To find out more about this project and to participate, click here.|
- Corporate Bonds Water Credit Risk Tool – China Water Risk sat down with GCP’s Liesel Van Ast & GIZ’s Simone Dettling, two developers of the Corporate Bonds Water Credit Risk Tool to find out how it helps investors & banks mitigate exposure and impact on the bottom line
- Valuing The True Cost Of Water – Water-related risks can be numerous for any given operational site. Nina Cambadelis & Johann Clere walk us through how Veolia’s tool, “The True Cost of Water” can mitigate risks and show potential economic gains
- Coal: The Great Water Grab – Globally 45% of existing and 44% of proposed coal power plants are in located in high water stress areas. Greenpeace’s Harri Lammi on how this can exacerbate conflicts between agriculture, industry & urban water use
- WWF’s Stuart Orr on the Water Risk Filter – WWF’s Stuart Orr on the newly launched Water Risk Filter Tool. The tool is free and helps companies & investors assess exposure to water risks in their industry and basins where they operate and invest
- Mapping Water With Aqueduct – With a water supply crisis as a top five risks facing the world, WRI’s Tien Shiao walks us through how Aqueduct can help companies and investors gain perspective
- Water Stewardship: Actions Must Match Risk – Despite acknowledgement of water risks, 58% of companies in CDP’s 2014 Global Water report do not have a public commitment to water. We expand on actions needed in China & globally to match the risk
- Investors Value Fuller Disclosure – PwC partner, Gayle Donohue argues that existing corporate reporting with undue focus on financial aspects of the business model is outdated, and outlines research which shows fuller disclosure of ESG information could translate into more BUY recommendations
- Bloomberg’s Views on Water – Bloomberg’s Liu & Bullard, discuss the importance of ESG analytics and why water use & efficiency data is crucial in the face of an increasingly water-insecure future in identifying portfolio risk
- US$1.9tn – The True Cost of Water – New TEEB report estimates the unpaid environmental cost of capital at US$7.3 tn of which US$1.9 tn is water. Chaoni Huang of Trucost tells us why this is this is the unpaid natural capital cost of water
Read more from Hubert Thieriot →