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Water: An Illiquidity problem

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28 Mar 2022

Droughts are a threat to economic growth, so are investors taking corporate water usage seriously? Mark Dunne reports.

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Droughts are a threat to economic growth, so are investors taking corporate water usage seriously? Mark Dunne reports.

Water

California has travelled 1,200 years back in time. The Mayans were the most advanced civilisation in the Americas the last time the availability of fresh drinking water was as low in the state as it is today.

The Golden State has been drought-stricken for two decades.

But the levels of water in reservoirs and moisture in the soil means the situation has hit a 12-century low, research led by the University of California Los Angeles (UCLA) says.

This problem is not limited to the west coast of the US.

Evidence of extreme water stress can be found in other parts of the world. Reservoirs in Brazil and South Africa, for example, have reportedly come close to running dry in the past few years.

Rising temperatures and lower rainfall have been blamed in all of these instances and are issues largely driven by climate change.

Indeed, the burning of fossil fuels is believed to be behind almost half (42%) of the soil moisture deficit in California during the past 20 years, the UCLA report says.

Water access

The situation is only expected to deteriorate. Demand for water is forecast to increase by half in the next 30 years, largely due to population growth and climate change, which is making dry areas of the world even drier.

This could leave 3.2 billion people without access to clean water by 2050, the UN says. A certain irony is that water is all around us covering two-thirds of the Earth’s surface. Yet almost all of it is undrinkable.

Indeed, around 97% is not fit for human consumption as the salt in sea water would create other health problems.

Of the remainder, only around 1% is accessible as some sources are deep underground, making it difficult to tap into them. What we can consume is reduced further by pollution or wastage through burst pipes.

Then there is demand from industry, especially agriculture, which uses around 70% of known supply to grow food.

Water fight

Water stress is not as high up the agenda as greenhouse gas emissions when institutional investors discuss the environmental aspects of their portfolios.

This is probably due to water being a local problem. Whereas carbon emissions and their impacts do not recognise land borders.

The economic impact is not just having enough water for companies to operate, but also dealing with the ill health caused by a lack of quality drinking water and sanitation.

Pollution does not help and comes in many forms.

Rising sea levels, for example, mean that rivers are overflowing, and you cannot grow rice in salt water. These problems hit productivity and push healthcare costs higher.

So, a lack of freshwater threatens economic growth. The question is: are asset owners aware of the issue and using their influence to help companies conserve water?

After all, having access to clean water and sanitation is one of the UN’s sustainable development goals.

Indeed, the issues reported in the west coast of the US, South Africa and Brazil – based on each citizen having access to less than 1,000 cubic metres of drinking water a year – will not be found in Canada or New Zealand where there is an abundance of the mineral.

Material risk

Yet a shortage of freshwater is a material risk for investors. Food and clothing are particularly high consumers of the mineral.

Indeed, it takes almost 2,500 litres of H20 to grow 1kg of rice, while 22,500 litres of water are needed to produce 1kg of cotton in India.

The economic consequences of water stress may also encompass in the political sphere. Thirsty citizens could cause political crisis, a collapse in social order or wars as countries fight over access to supply.

This has already happened with the Iran-Iraq war in the 1980s being partially fought over water rights, while Israel was pitted against Jordan, Syria and Egypt in the 1960s after there were moves to divert its water supply.

There have been border clashes between Kyrgyzstan and Tajikistan, disputes over access between farmers in Sudan while India and Pakistan clashed over water rights as far back as the 1940s.

As the effects of climate change increase and populations explode, expect to see more instances of conflicts caused by H20. Mark Twain once said: “Whiskey is for drinking; water is for fighting over.”

Perhaps a quote pointing out that we might be better off creating a market for water as we have for other commodities rather than letting politicians control our supply.

Corporate awareness

Corporate boardrooms are being made aware of the importance of having an adequate supply.

More than 700 of the world’s largest listed businesses reported $40bn (£29.8bn) of collective water-related losses in 2018, says CDP, a sustainable data provider.

Unfortunately, data like this is scarce.

It is just as difficult to get accurate and comparable information on a corporate’s water use as it is on their carbon emissions, although it is fair to say that monitoring and reporting on a corporate’s carbon footprint is more advanced when it comes to disclosure.

Yet corporates are doing their bit.

Examples include Nestlé making saving water one of its operational aims for each of its products. In the US, Brazil and South Africa, it reclaims the water that evaporates from making milk products.

This policy was made in response to claims it was using too much water.

Consumer goods specialist Unilever has a goal to limit the water used in its manufacturing processes to the levels recorded in 2008, despite increased production. It has since cut its water usage per tonne of production by 39%.

Governments are playing their part, too.

US president Joe Biden’s $2.2trn (£1.6trn) infrastructure plan includes a $55bn (£41.2bn) investment to create greater access to drinking water.

The plan also focuses on improving the US’ water infrastructure. Welcomed developments, if such projects are completed.

Check the index

Water as an investment theme is not a new concept. There is the S&P Global Water Index, which is tracked by two ETFs, with both of which having more than £1bn of assets.

“We have also had interest from structured product users. We have seen numerous requests,” says Ari Rajendra, senior director for strategy indices at S&P. “We have continued to see more interest this year in water,” he adds. “It is a theme that is of interest at the moment.”

The index has performed better than the S&P Global Broad Market Index by around 3% a year since its inception towards the end of 2001.

Rajendra says the Global Water Index has been constructed through two clusters.

The first is water utilities and infrastructure, which includes treatment, purification, drilling and supply. The other is water equipment and materials: water treatment chemicals, pumps, pipes and motors.

“This is one step further in the value chain,” he adds.

Cross country

Water is finite. It is not about making more of it but managing what we have effectively.

Protecting and increasing supply creates an opportunity for investors. One is investing in technologies and projects that increase access through purifying dirty water.

Another move would be to reduce wastage by helping corporates to use less of the mineral in their operations. Then there is halting losses.

Burst pipes are a problem technology is working to fix. I have read of devices that flow through pipes to test their strength by testing for vibrations.

A weak response may mean a weakening pipe that could potentially burst.

Other solutions to droughts include finding new sources or transporting it from other areas. China’s answer is to transport water from rural areas to Beijing, which increases supply in the capital by more than a third, but is expensive to transport.

Water shortages could be another reason driving urbanisation. As people leave drought-stricken provinces to make a new life in the capital, which increases the concentration of demand.

As science has not worked out how to make it, and diverting it cross country is expensive, perhaps the best option is to encourage lower use, to collect and use rainwater for functions such as flushing toilets or industry to recycle it where they can.

Lessons from history

But could cutting water in your business expand to your supply chain?

Investors have to assess the carbon emissions released at various parts of the chain, including use by the consumer, such as with cars, for example.

So, could companies be responsible for their entire water footprint?

If they are importing products, such as food or clothing from countries suffering from water stress, should they be responsible for increasing instances of drought? Should they have to pay towards easing the problem? Are they part of the problem despite reducing usage in their own operations?

It appears that reversing the severity of water stress will not be easy. One of the authors of the UCLA report into the drought in the west coast of America, said in a statement that: “It’s extremely unlikely that this drought can be ended in one wet year.”

The worry, and investors with the influence they have over corporates and sometimes governments should take note here, is that more than a millennium ago it is believed that the Mayan civilisation ended due to drought.

A lack of freshwater killed the Mayans. Think about that when you are running a bath.

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