Practical analysis for investment professionals
12 August 2015

Liquidity Risks of the H2O Variety

“Whiskey is for drinking; water is for fighting over.”

In these increasingly water-constrained times, this quote, often and perhaps erroneously attributed to Mark Twain, is as relevant as ever.

The fact is water — or the lack of it — poses investor risks. Companies and investors can no longer ignore increasing competition over limited water resources.

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Water risks from droughts and flooding have been the most common natural catastrophes since 1980, a troublesome trend for insurers and investors alike (see the blue and yellow lines in the chart below). Some investors view water as one of the many environmental, social, and governance (ESG) variables that can have very tangible payoffs — if studied and the lessons applied properly.

Natural Catastrophes Worldwide 1980–2010

Prolonged droughts in such economically important areas as California, Taiwan, and southern Brazil, among others, are already impacting corporate and bond issuer earnings and risk profiles, with Duke Energy, Smuckers, Illovo Sugar, and GrainCorp among the companies talking about drought impacts on earnings estimates. But the scope of escalating water risks encompasses much more than regional droughts alone.

The World Economic Forum recently named “water crises” the “top global risk,” and such publications as Institutional Investor, the Financial Times, and the Wall Street Journal have all highlighted increasing systemic water risks to both corporations and investors. A growing number of sell-side and ESG research providers are offering new tools and analytics to help investors navigate these risks. A recent Bloomberg webinar on the topic, for example, attracted dozens of investors interested in water risk analysis.

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Water Risks Come in Many Forms

Water risks are best understood by doing industry–specific risk analysis. The agriculture, coal, oil and gas, and utility sectors have been singled out for having the highest water risk exposure. A recent analysis of shareholder resolutions in the past decade found that investor water concerns were most often focused on these sectors.

Shareholder Resolutions in the United States That Mention Water, Sorted by Sector, 2005–2015

Shareholder resolutions in the United States that mention water, sorted by sector, 2005–2015

Source: Fund Votes and Ceres analysis

Water risks are not just about sourcing water but also about the ability to cost-effectively discharge wastewater and predict material regulatory changes. Regulatory impacts can come in many forms. During the recent Bloomberg webinar, a Coca-Cola executive said poor regulatory oversight of water resources was their top concern. Specific examples of material regulatory impacts include the following:

A company’s ability to maintain its social license to operate is another area of water risk exposure. Companies that lose water-sourcing rights can lose significant capital expenditures and, more profoundly, access to new and growing markets. Specific examples include the following:

Water risks are also embedded in supply chains, especially for food and beverage companies. Currently about one third of global food production is in areas facing high or extreme water stress. Another supply chain risk is farm-related runoff, which is considered the most common cause of water pollution worldwide.

Water-related supply chain risks ripple across other sectors as well. Taiwan’s recent drought, along with weak water regulations, has prompted significant questions about the ability of semiconductor chip manufacturers to continue business as usual. These chips are critical in everything from smartphones, to laptops, to video games.

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Threatened Groundwater Supplies Pose a Systemic Water Risk

Many companies and industries rely heavily on groundwater resources to maintain operations or for projected revenue growth. In the United States, for example, 80%–90% of available freshwater is from groundwater aquifers, many of which take decades to centuries to replenish. Some companies and investors are starting to more systematically assess exposure to at-risk groundwater regions, including California’s Central Valley and the High Plains aquifers.

A recent survey of 35 institutional investors across the globe on water integration practices indicated that many investors were still very new to considering water risk issues. The majority said that water was a material concern, especially in key sectors or industries (e.g., energy, mining, oil and gas, pharmaceuticals, semiconductors, and consumer staples), and that they were planning to include water analysis in their research processes in the near future. Of those investors who already had water analysis embedded in their research processes, the critical elements often included:

  • Prioritizing analysis of water risks and opportunities by sector and subsector.
  • Mapping their exposure to geographic regions of high water stress using a number of tools, among them Aqueduct, from the World Resources Institute (WRI); the World Wildlife Fund (WWF)’s Water Risk Filter; the Water Analytics platform of the Carbon Disclosure Project (CDP); and Blooomberg’s water risk mapping tool for the mining sector.
  • Recognizing that water risks are often linked to not just physical availability but also to reputational and regulatory risks.
  • Gauging whether company management is aware of and managing water risks.

In another blog post, I will go into more detail about water integration practices among leading investors, including water analysis not only in buy/sell decisions but across asset class analysis and into investment policies.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©©jssuley

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About the Author(s)
Monika Freyman, CFA

Monika Freyman, CFA, is responsible investment lead for Mercer Canada. She works with pension boards, trustee directors, CIOs, and C-suite as well international development and governmental agencies on environmental, social, and governance (ESG) topics, including climate change, water crisis, and social and governance issues. She conducts board education on ESG and climate change investment concerns for fiduciaries and helps institutions develop responsible investment beliefs and policies. She also helps them implement and execute on these policies and assists in the creation of benchmarking and reporting strategies for boards and committees. Freyman is passionate about educating and building capacity on ESG within the investment profession, including by supporting the CFA Institute.

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