Agriculture-Related Water Risks: Understanding the Threat
Growing competition for water, climate variability, pollution from agricultural runoff, weak water management and regulation, and aging infrastructure all contribute to a water availability crisis that was recently named the top global risk in terms of impact by the World Economic Forum. From farm to factory, food production is the most water-intensive business on earth, with 70% of the world’s water used to irrigate crops and raise animals. A staggering 15,000-plus liters of water are required for one kilogram of beef, 10,000 liters for cotton. Even the humble potato requires over 280-plus liters.
Abundant clean water is also essential to food processing — for cleaning and moving raw materials, as an ingredient, and as the principal agent used in sanitizing plant machinery. This high level of water use becomes even more significant in light of the fact that 56% of total food production is currently in areas of high or extreme water stress.
Water Risks Are Not Coming Out in the Wash
These water risks are already affecting corporate income statements and balance sheets in a variety of ways:
- Increased competition for water is leading to steep water-rate increases and rationing. In areas of Mexico, water demand is far outstripping groundwater supplies, leading to price hikes as high as 300% for industrial users and new regulations and water fees for food manufacturers (such as Kellogg (K), among others).
- Water shortages can lead to reputation risks and loss of ability to grow revenue for companies who are seen as competing with local communities for access to water supplies. This can lead to the loss of a company’s social license to operate, business disruption, and brand damage. The Coca-Cola Company (KO), for example, decided not to move forward with the development of an $81 million bottling plant in southern India due to resistance from farmers over the strain on local groundwater supplies and competition for water.
- Decreased agricultural productivity can impact procurement costs. Although few companies grow their own inputs, margin risks rise as commodities are affected by weather patterns and water scarcity. Weather-related price shocks are not new, but increased weather variability, coupled with growing competition for water in most major agricultural production regions, increases the risk of commodity price volatility. Unilever (UN) reported that natural disasters linked to changing climate decreased food security and reduced productivity in many parts of their agricultural supply chain, costing the company an estimated $400 million annually.
- Water risks can impact on company revenues and earnings. Landec (LNDC) recently revised its revenue growth forecasts downward due to the impact of crop disruptions in California on the company’s produce packaging subsidiary. The Campbell Soup Company (CPB) saw a 28% drop in its California carrot division profits recently due to variability in water supplies. The share price of Illovo Sugar Ltd. (JSE: ILV), Africa’s second-largest sugar producer, dropped 35% in the fourth quarter of 2015 due in part to lower earnings caused by drought.
Although investors are increasingly aware of water risks in their portfolios linked to agriculture, there is still work to be done to improve risk analysis and mitigation strategies. Several investors have begun by simply asking companies for better disclosure of agriculture supply chain risks.
Inability to Mitigate Risks Leaving Companies All Wet?
Increasingly, companies are highlighting their exposure to water risks. For example, in 2015, 30% of large, publicly traded US food companies cited water as a material risk in their 10-K filings. Also, 43% of consumer staples companies surveyed by CDP in 2015 reported detrimental impacts due to water issues.
Business and Financial Impacts of Key Water Risk Drivers in Agriculture
Despite the increasingly open discourse by many companies that water risks exist, overall disclosure on how those risks materialize — and how they’re being mitigated for the future — remains poor. In a recent study on how well food sector companies are managing water risks (see company rankings below) and disclosing information to investors, 38% of the 37 companies surveyed had not evaluated water risks at all, and two-thirds had not evaluated risks in their agricultural supply chain (or, if they had, did not disclose this information).
Company Rankings on Adequacy of Water Risk Management*
* The higher the score, the better the water risk management.
Source: Feeding Ourselves Thirsty: How the Food Sector is Managing Global Water Risks, Ceres
Many investors in these companies are beginning to engage corporate management on these issues. For example, investor signatories of the UN PRI are actively engaging food companies on their water management strategies in their agricultural supply chains. Recently, 64 institutional investors managing $2.6 trillion in collective assets sent joint letters to 15 low-scoring food companies asking for additional information on their exposure to and management of water risk.
*Where ownership is greater than 5%.
Investor Engagement on Water Risk is Yielding Results But There Is Further to Go
This letter illustrates the potential effectiveness of investor engagement: Roughly half of the targeted companies have since committed to improve their water risk management disclosure to investors in the coming year.
While the water risk data drought is far from over, continued improvements in corporate supply chain water risk disclosure will help investors assess how their portfolios will withstand exposure to physical droughts — and other water risks.
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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: ©iStockphoto.com/Marjan_Apostolovic