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Supplements » ESG Report October 2021

ESG talking heads: Future risk - Pricing in water scarcity

 

My-LinhNgoMY-LINH NGO, HEAD OF ESG INVESTING AND PORTFOLIO MANAGER, BLUE BAY ASSET MANAGEMENT

Saving life on Earth
Water scarcity is defined as the lack of freshwater resources to meet water demand. Scarcity may occur either due to a physical shortage, where there is not enough water to meet all demands; or be linked to economics, where scarcity of access is due to failure of institutions to ensure regular supply or due to a lack of adequate infrastructure.

The implications of water scarcity are vast and countering this issue is literally critical to sustaining life on Earth. A renewable resource, it is easy to easy to forget that despite water covering 70% of our planet, only 3% is freshwater, of that only 1.2% can be used as drinking water as the rest is locked up in glaciers, ice caps and permafrost, or buried deep in the ground.

Water scarcity already affects every continent, with water use growing globally at more than twice the rate of population increase, and an increasing number of regions are approaching a point at which water services can be sustainably delivered. Drivers of increasing water scarcity trends include rapidly growing urban areas which place pressure on neighbouring water resources, as well as climate change and agricultural demands. Some sobering statistics include the following:

  • Water scarcity affects more than 40% of the global population and is projected to rise. It could displace 700 million people by 2030.
  • Globally, one in three people do not have access to safe drinking water, and two out of five people do not have basic handwashing facilities.
  • More than 80% of wastewater resulting from human activities is discharged into rivers or sea without any treatment, impacting human as well as ecosystem health, whilst further degrading the quality of available water supplies.

All of this obviously has a significant impact on people’s health and wellbeing, as well as an impact on other living things on the planet. Actions need to be taken by governments and companies to urgently tackle the water challenge before there is a global water-shortage issue. Water needs to be treated as a scarce resource, with a stronger focus on managing demand more effectively as well as on using what we have more efficiently. While progress has been made in increasing access to clean drinking water and sanitation, billions of people – mostly in rural areas – still lack these basic services that are critical to fighting disease. A point which will surely resonate, given the current Covid-19 pandemic.

A threat to multiple industry sectors
Risks from increased water scarcity and uncertainty of water supply cut across many industry sectors, with varying vulnerability depending on their dependence on water consumption. Usage ranges from those which use water intensively as an input into the production of its services (such as the agricultural/food industries) or those which use it as part of the processing or for the manufacturing of their products (this includes extractives, manufacturing, and consumer goods industries).

Shortages can affect operations by limiting production and disrupting supply chains. Companies may also face risk of stricter regulations – which could take the form of higher water prices, reduced rations, stricter emissions permits or mandatory adoption of water-saving technology. Water shortage can also potentially lead to conflict with other water users in the local area, and damage corporate reputations if businesses are shown to have an irresponsible approach to water management. Longer-term, water scarcity ultimately has the potential to undermine future economic growth and socio-political stability, which will have significant and wide-ranging implications for businesses.

On a human biology level, and from the perspective of labour force management, one of the implications for all businesses are the material financial costs associated with lack of access to clean water and sanitation. These are linked to lost economic productivity due to – for instance – associated ill health and time off work.

Pricing in water scarcity
Some managers are already proactively integrating water shortage challenges into their investment analysis. As a minimum, this is being considered through the lens of an investment risk, but some are also recognising the challenge is also an opportunity for alpha generation. Identifying companies which are managing water usage efficiently and effectively, as well as those offering products and services to enable more efficient and effective usage of water, increases the potential for such investments to perform well over the long term. For sovereign investors, understanding which governments are managing their stock of water resources most sustainably will also help identify those which will be less vulnerable to shocks to the economy due to water shortages.

Investing in sustainable water solutions is critical, as water remains an undervalued and yet increasingly scarce and challenged resource, vital to all life on Earth. And there lies the investment opportunity set.

In order to meet the UN goal for water and sanitation, US$735 billion will need to be invested by 2030 (according to the Sustainable Development Solutions Network). Yet (the UN states that) some countries experience a funding gap of approximately 60% for achieving water and sanitation targets.

This points to the private sector needing to play a greater role to fill the gap, and the need for innovating financing solutions, such as ESG-labelled issuances like green or blue bonds potentially from corporate as well as sovereign issuers in the debt market.

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