Running on empty

11 Mar 2021

The world’s population is growing and so is its thirst. How are institutional investors improving access to freshwater as demand continues to rise?

Asia is in the middle of a crisis. The region is home to two-thirds of the world’s citizens, yet they only have access to less than a third (28%) of the planet’s drinking water. This supply-demand imbalance is expected to widen and it is not exclusive to Asia. Indeed, the UN estimates that around 2 billion people globally do not have access to proper sanitation or clean drinking water. That is one in every four. By 2050, this is expected to be three in every four.

The issue is that although freshwater is replenished by rain and snow its supply does not grow. Yet the world’s population is. So is migration to urban centres, pollution, poor farming practices and droughts. These factors could lead to demand for freshwater being 40% greater than supply in the next nine years, the UN believes.

“We have to live each year with what nature provides us with, but you have population growth, industrialisation and more intensive farming,” says Andreas Fruschki, head of thematic equity and managing director at Allianz Global Investors. “Demand is growing, supply is not.”

Another issue is that we do not drink most of the clean water we have access to. Agriculture consumes 71% of it, which is unsurprising given that it takes 1,000 tons of water to produce a ton of rice. Other large consumers include the paper, semi-conductor, fashion, manufacturing, energy and beverage industries.

The widening supply-demand imbalance could lead to global instability with wars fought to control dwindling supply, rising global hunger and further health crises.

“ESG risks are not only about climate change and the E is not only about carbon,” says Tim Currell, Aon’s head of investment for insurers.

A local issue

Water is a more complex problem than carbon, which is a global concern. There is no escape, whereas water stress is a local issue. You have to draw it from local sources and it cannot be dispersed around the country in the way that electricity is. It is also difficult to measure the impact of a water footprint. For instance, a business which uses a large amount of water in an area where it is abundant and with little competition, is not the same as a company drawing modest amounts from stressed sources.

Identifying areas of water stress is one thing, dealing with it is another. “It is not like other infrastructures which are simple to build, such as rail, roads, electricity and telecommunication networks,” Fruschki says. “Water is heavy, it takes a lot of energy to pump up and down hills, through filters and then bring it back to treat it. Water infrastructure takes time and needs massive investment.”

He points to the emerging world to support his argument. There are huge problems with water quality and access as well as proper sanitation, yet mobile phone use is high. “It is no surprise that emerging markets advanced quickly in terms of access to mobile phones and the internet,” Fruschki says. “But it takes a decade or two longer to get everyone connected to a water supply.”

But does the size of this task strengthen the investment case? “The problem of accessing quality drinking water is that it takes time,” Fruschki says. “That is the beauty for those who want to invest in something that has a high certainty of playing out. We know 2 billion people still need access to clean drinking water and there is no competing product or viable alternative for it.

“The attractiveness of investing in water is the element of certainty and predictability,” he adds. “You can invest in water today and not have to look at it for the next 10 to 20 years because you know those investments are going to come through.”

Another benefit is that water is not a traded commodity. There is no market for it. It is not traded in the way oil, gold and coal is. “It makes sense to drill for oil on one side of the planet and ship it to the other and make it work financially,” Fruschki says. “Water has to be available locally because you cannot ship it long distance at commercial rates. You could build a pipeline, but that is expensive because it needs a lot of electricity as water is heavy and perishes quickly.”

As an example, he questions the credibility of Quantum of Solace, the James Bond film where the villain’s aim is to take control of a local water supply. “This notion that anyone could buy water physically, store it and sell it at double the price later is not realistic. You cannot transfer it or auction it on an open market as it is not transferrable,” he says. “Water is free, it’s the service of delivery that is costly.”

Efficiency, supply and quality

This is as big an issue for long-term investors as climate change, so reducing water stress in portfolios is as crucial as cutting harmful emissions. Investors need to raise the issue during engagement meetings or make it a condition when lending money.

“The focus is on incumbent companies that are looking to bet- ter manage their reliance on water,” says Ian Burger, head of responsible investment at Newton Investment Management. “I can think of a beverage company which has multiple beer- brewing operations across the world. In one part of Europe, it uses two litres of water to make one litre of beer.”

“In South Africa, where water is more scarce, they are using 14 litres to produce one litre of beer,” he adds. “They have been focusing on how they can be more efficient.”

Another option is to invest in companies which have technologies that improve the quality or management of the mineral. But this might be more accessible for schemes with private equity portfolios, says Robert-Alexandre Poujade, an ESG analyst at BNP Paribas Asset Management.

“We should be modest on the impact that we could have today when it comes to water consumption, as we mostly have aggregate data at company level, as opposed to a private equity investor that can have access to project-level data,” he adds.

For those who do not have private equity managers or who are approaching water stress reduction as an investment theme should look for companies that help to solve one or more of the following three problems:

The first is water efficiency. Invest in companies that fix leakages, provide smart metering or invest in drip irrigation rather than flood irrigation equipment. Essentially, anything that helps companies meet their needs by using less water. Second, companies that increase supply. These include desalination plants, which turn sea water in drinking water, or companies that own the pumps and pipes that access groundwater and move it around.

Third, invest in businesses that preserve quality, by treating wastewater to stop it infecting drinking water. “This is all we can do because the water that we have today is static,” Fruschki says. “It is the same amount of freshwater that we have always had. It does not rain more today than it did 100 years ago.”

A thirst for knowledge

Measuring the water footprint of your assets under management is a tough task as the information is difficult to come by. Indeed, Poujade admits that his team are having to assess water stress from “data sources we find here and there”.

This includes CDP, an environmental impact specialist, which has helped the asset manager collect water stress and intensity data. Highlighting the lack of disclosure in this area, CDP’s research only applies to a quarter of BNP Paribas AM’s corporate assets under management. “25% is not ideal,” Poujade says. “We would like it higher, but it is something.”

The data that BNP Paribas AM has found shows that the average corporate in its portfolios draws 6% of its water from stressed areas. But there are disparities. For where BNP Paribas AM has data, on average, companies withdraw 6% of their water from water-stressed areas but this figure masks large disparities at the individual company level.

In particular, 26 companies with extremely high-water intensity (over 100,000 cubic meters for every €1m of revenue) withdraw more than 10% of their water from water stressed areas. This provides the insight that quality data offers at a granular level in a particular region, in a particular river basin. “The aim is to go deeper into the analysis with our portfolio managers and understand how we can engage companies with high exposure,” Poujade says.

For Tim Manuel, Aon’s head of sustainable investment in the UK, a lot of work is needed to achieve this. “Data is an obstacle for investors to get a better handle on where they might be exposed in terms of their water stress risk.”

“There is a weak understanding of the financial materiality of that exposure and what it means for an investor,” he adds.

But the level of water usage disclosures is not the only issue. The type of information released is a concern. More data is needed on how much of the water bought by corporates is consumed. Usage in supply chains is another factor that must be examined.

It appears that data standards on water usage need to mature, and it needs to fast. Currell says that water conservation is not top of the ESG agenda among his clients, but it is coming into conversations more and more and he is seeing corporates setting water reduction targets.

Investors are becoming more sophisticated when it comes to sustainable issues, adds Manuel. “They understand how environmental risks connect with each other,” he says. “Water stress as an environmental risk is gaining more prominence.” This is not an area Newton routinely takes questions from its clients, but, according to Burger, if it does come up in conversation, it is as part of the general realm of climate change, but this could change. “There is an obvious link between water stress and climate change.”

“Water stress is a key theme under biodiversity, so we are expecting more queries concerning our thought processes on water scarcity from our clients going forward,” he adds.

A bigger issue

To solve water stress, it is perhaps best not to look at the problem in isolation. There are several layers to environmental risk and they are connected, including climate change and deforestation, so a holistic approach is needed.

“It is not helpful to isolate environmental risks to single topics,” Manuel says. “It is better to broaden out the consideration of all the components that make up that mosaic of environ- mental risks that pension plans should be concerned about.” The issue is that there is the lack of an established universal framework to help approach this. “It is a failing that we do not have an impetus by way of a framework to understand risk better,” Burger says.

There are, however, some initiatives designed to increase the levels of non-financial reporting, including the TFCD, which will shed light on water as a risk and potentially increase reporting on consumption. Then there is SBTN (Science-Based Target Network), a consortium working to set scientific water usage standards. “That is going to be a game changer but takes time,” Poujade says.

It is clear that the issue needs more awareness of the need for more efficient usage of water and improving access of its quality. This could come via a pressure group, investor partner- ships with non-government organisations or regulation. “Regulation is a key driver to ensure the consistency and quality of reporting,” Burger says. “We can get to a better place more quickly with the right regulations.”

However, regulation may help when it comes to climate change but on water conservation businesses in some countries have not been fully compliant. “Regulation can be interesting but is not a silver bullet,” Poujade says. “We need to build a new approach with investors, municipalities…everybody.”

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