Lack of Water Management Poses Risks for Capital Markets

Water doesn't usually appear on corporate balance sheets. But, that may change in the near future as investors begin linking water responsibility to companies' financial risk and overarching health. The increasing demand for clean water due to population growth, ecosystem pollution and disruption, economic development, changing consumption patterns, rapid industrialization and lack of sufficient wastewater treatment facilities isn't only hurting the developing world. It's beginning to take its toll on business and the economy. We not only need water to survive and for the global food chain, we need it for virtually all production processes. For example, a recent report by Ceres, points out that "vast quantities of ultra clean water are used to make the silicon chips that help power our computers, servers, and cell phones. Electric power plants depend heavily on water, and account for a staggering 40 percent of freshwater withdrawals in the United States."

The report benchmarks 100 companies to examine their water practices, management, and what's becoming, an increasing risk for all companies and the economy as a whole. There's a ton of fascinating information on trends, issues that arise due to increasing water costs, and what could result in a new trend for corporate responsibility. Investors are beginning to take notice because it effects their bottom-line. For example:

In August 2009, Norges Bank Investment Management (NBIM), which runs the $415 billion Norwegian Government Pension Fund, announced that it would begin evaluating the water risk management practices of 1100 companies it holds in the agriculture, food, manufacturing, power, mining, pharmaceuticals, pulp and paper, and water supply sectors. NBIM manages the third-largest sovereign wealth fund in the world, which at the time of the announcement represented approximately one percent of the global equity market.

NBIM cited poor disclosure and growing water-related risks as the driver for this policy shift. "Many companies in risk sectors and regions do not have a proper water policy with risk assessments and performance reporting. Shortcomings in companies' water management reporting makes it difficult to assess the degree of risk exposure resulting from their own operations or their supply chains," said NBIM's Head of Governance, Anne Kvam.

Companies in the Ceres report were scored on a 100 point system outlined by a variety of assessment criteria. (The report is attached if you're interested.) Out of the 100 companies, not a single one passed 43 points. Below is a chart that summarizes the scores by averages and ranges (shown by the vertical line) for each industry.

The findings in general point to an overall need to rethink what corporate reporting should be comprised of. It's almost scary to think we've come to a point where water may very well be added to balance sheets. At the very least, the report makes a strong case for increasing corporate responsibility and careful management of water resources. While adding new accounting structures have their investment costs, better water management will likely reduce costs and risks long term. 

The key findings by sector section is particularly interesting. It shows how recent water trends create different risks for industries ranging from food and beverage to electric power and semiconductors. Here are a selected few:

Beverage: Beverage makers face risks of agricultural commodity shortages and higher prices due to drought. In 2009, global sugar prices reached a 28-year high, due in large part to lower production in drought-stricken India, the world's second-largest sugar producer. 

Chemicals: The chemicals sector's reliance on high volumes of water makes it vulnerable to water scarcity. Increasingly, the industry is expanding from its historical base in North America, Europe, and Japan to more water-stressed India, China and the Middle East.

Electric Power: Hydropower will be most directly affected by climate change because of its vulnerability to the amount and timing of natural water flows. In the Atlanta area, hydroelectric power generation declined 51 percent in 2007 due to drought, forcing South Company to buy $33 million in fossil fuels to replace the lost power.

Food: Food commodity shortages due to drought or changing weather patterns can lead to significant price volatility, as seen by recent spikes in global rice prices due to drought-induced production collapses in Australia.

Homebuilding: Existing or anticipated water shortages may lead regulators to restrict or prohibit housing development in certain regions. In California, state laws require water agencies to withhold approvals until determining that sufficient water resources exist to serve large new developments for at least 20 years.

Mining: The Obama administration seeks to curtail mountain top removal by coal miners because of water quality concerns. In October 2009, the EPA vetoed a water permit for the country's largest-ever proposed mountain top coal mine in West Virginia - the first time the agency has taken such action since the enactment of the Clean Water Act of 1972.

Oil & Gas: In the United States, federal and state governments will likely increase their oversight of potentially water-contaminating chemicals used for deep shale natural gas drilling. Federal legislation to regulate fracturing is currently being considered in the U.S. House of Representatives and the Senate.

Semiconductors: Semiconductor manufacturing is highly water-intensive, requiring large volumes of water of the highest industrial quality. At the same time, a large number of semiconductor factories are located in arid or semi-arid regions of the world, such as the American southwest.

"It could be said without exaggeration that our economy runs on water. And that economy is increasingly at risk."

Ceres is a national coalition of investors, environmental groups, and other public interest organizations working with companies to address sustainability challenges such as water scarcity and climate change. Ceres directs the Investor Network on Climate Risk, a group of more than 80 institutional investors and financial firms from the U.S. and Europe managing over $8 trillion in assets.

A special thanks to Warren Anderson, founder of Hydrolosophy, for his research contribution to the report and for sharing the PDF that you can download from this article. His startup is developing a water management application for corporations to monitor and reduce their water footprint. I initially wrote about Hydrolosophy on College Mogul.