As the broad-ranging effects of climate change become progressively more apparent, the importance of water security will grow in prominence. Natalie Stafford, ESG Director and Markus Korhonen, Senior Associate, Strategic Intelligence, discuss the breadth of challenges organisations need to navigate in managing water security concerns.
We live on a blue planet, but global access to water resources is becoming more precarious. France is experiencing its driest winter in 60 years. 63% of English rivers were below normal levels at the end of February. And an extended drought in the United States has seen the water levels in lakes Mead and Powell, the country’s largest reservoirs, fall to their lowest ever levels in 2022. These are not isolated incidents, with long-term studies finding a pattern of changes to rainfall, and by corollary, water security. But changes to water (in)security are uneven, with data showing that high-latitude regions (which includes the northern parts of the US and Europe) and low-latitude regions (the global tropics) are getting wetter, while arid and semi-arid mid-latitude regions (for example, parts of the central US, Europe and Asia) are getting drier. This is contributing to, according to some estimates, two-thirds of businesses facing substantial water risk, either in direct operations, or in their value chain.
And the problem is getting worse. A growing global population, inadequate infrastructure, and the impacts of climate change will only increase unpredictability in water availability in the coming years. The World Economic Forum has predicted that by 2030, the demand for water will exceed supply by 40 percent. As a result, while macroeconomic volatility, inflation, geopolitical conflict, and cyber security are likely to dominate most companies’ risk registers in 2023, and many companies’ ESG priorities are still focused on greenhouse gas emissions or a growing range of social issues, the pressures brought on by dwindling water supplies and growing demand will become an increasingly high priority concern for businesses looking for long-term sustainability and growth.
ON THE GLOBAL AGENDA
On 22-24 March this year, the UN will hold its first global conference on water in almost 50 years. The intent of the conference is not to negotiate new actions, but rather to add momentum to the Water Action Agenda, a collection of voluntary commitments to accelerate the progress of the Water Action Decade 2018-2028 and the 2030 Agenda for Sustainable Development, which are both striving to “combat global water challenges”. While the world has a much better understanding of global water challenges today than it did 50 years ago, progress towards meeting a range of targets has been slow. The Sustainable Development Goal 6 on water and sanitation, for example, is estimated to require a fourfold increase in effort to reach.
At the state level, solid commitments to achieving water-related goals are still limited, with a preference to issue non-binding objectives or to look towards supranational initiatives. However, the US has recently come to the fore in leading the way in terms of global policy. In June 2022, the US announced that it will approach water security as both an all-government effort and a national security issue, elevating it to an international priority in the White House Action Plan on Global Water Security. This comes on top of the Biden administration’s 2021 Bipartisan Infrastructure Law, which saw the government commit to funding USD 63 billion in investment to address such domestic issues as lead contamination in pipes and building drought resilience.
"In order to fully understand and mitigate the risk, a business should look at water consumption, withdrawal and intensity, as well as how water security could disrupt its supply chain, drive competition for resources, and affect government water policies."
Approaching water security through an ESG lens, the issue has typically been underrepresented in both disclosures and materiality assessments, in favour of more regulated and ‘popular’ issues such as decarbonisation. However, according to the CDP, an international non-profit focused on environmental impact disclosure, in their recent campaign to pressure investors to ask companies to report on water security, this issue is rocketing up the agenda. The number of companies being asked to report on water security was up by 51 percent in 2022. But any company looking at water risks as part of its ESG programme needs to move beyond just measuring and reporting on direct water usage. In order to fully understand and mitigate the risk, a business should look at water consumption, withdrawal and intensity, as well as how water security could disrupt its supply chain, drive competition for resources, and affect government water policies.
Beyond adherence to regulatory requirements or investor, public or consumer pressure, water shortages are likely to have wide ranging and accelerating impacts, both direct and indirect. Against this backdrop, nation-states, cities, businesses, and society at large need to adapt to manage water security challenges and mitigate against the associated risks. Purely from a cost perspective, this is the smarter choice. The CDP suggests USD 301 billion worth of business value is at risk should companies fail to adapt their water management processes, whereas the cost of taking action amounts to the relatively much smaller sum of USD 55 billion.
Water security management presents a plethora of challenges for businesses, though industries will be differently affected. Manufacturing, for example, will likely face a more complex range of challenges than professional services, whilst agribusiness and energy face some of the most pressing concerns. Estimates suggest, for example, that a single cup of coffee requires 140 litres of water to grow, process, and distribute the coffee beans, while making a pair of jeans requires 10,000 litres through the manufacturing process. But the scale of the issue will result in the need for operational and strategic considerations across all sectors.
Most immediately, reduced availability to water will have a direct impact on companies’ operational costs. Higher water prices, increased transportation costs when, for example, falling water levels disrupt shipping routes, supply chain disruptions along the full value chain, and the impacts of water shortages on power production will all contribute to the bottom line. Secondary considerations, such as the potential reputational impacts related to consumer perceptions around unsustainable water use, or the management of community relations around water resource competition will become increasingly pertinent.
No small beer: Water use in the Mexican brewing industry
In Mexico, an estimated 75 percent of the country is suffering from drought. Northern Mexico in particular, where several large international brewers concentrate their production facilities, has been struggling with drought-like conditions since at least 2015, exacerbated by a high density of manufacturing and associated population pressures. Today, residents face chronic water shortages, with use limited by the state, whilst businesses are guaranteed a steady supply.
However, these brewers are still facing a range of water security challenges, from business continuity to reputational concerns and community relations issues. Although some of the breweries have deployed expensive machinery to improve water efficiency, bringing down the amount of water used to produce one litre of beer from seven to three litres of water, beer is still a water intensive product.
Residents have been holding demonstrations and organising road blockades outside the breweries in protest against what they perceive to be a prioritisation of business over lives, causing operational problems. In March 2020, in the city of Mexicali, the local community itself was given a vote on whether a water permit should be granted for a proposed USD 1.4 billion brewery. The brewery’s expected use of 25 percent of the city’s water reserves was crucial in the no vote, which resulted in the company’s shares losing 10 percent of their value and it eventually abandoning the project.
Sustained pressure has caused the federal government to announce that it will issue no new permits to produce beer in northern Mexico. Yet, this gives little consideration to the estimated 900,000 people in the region who rely on the beer industry for their livelihood, either directly or indirectly, and there is still no indication from the government that it has any policies planned to tackle the fundamental issue of water scarcity itself. Furthermore, confusion persists over whether those production facilities already in the north will be allowed to remain, how their water supply may be restricted, and whether local Mexican craft breweries will be exempt from these new rules.
For businesses, the financial costs of mitigating water risk issues may be borne out in increased capex, infrastructure investment, R&D for mitigation measures, pollution abatement, and compliance with regulatory requirements. The price of water itself will also rise.
"The first step is to evaluate the materiality of water security risk to your business, including exposure to water scarcity risks across all aspects of your operations and supply chains, and customer vulnerability to price shocks."
The costs mount up: Semiconductor manufacturing in Taiwan
The semiconductor industry is having to consider the costs it faces in dealing with water insecurity, exacerbated by an unstable market caused by global shortages and the chips themselves forming part of a geopolitical battle between China and the US and Taiwan. Semiconductor production is particularly water intensive, but Taiwan, where some of the largest production facilities are concentrated, has recently experienced its worst drought for 50 years. As a result, in order to keep the country’s vital and strategic sector functioning and avoid relocation to a more water secure location, in 2021 the government and businesses were forced to throw money at the problem. This ranged from mitigation measures such as lowering the water pressure and restricting water supply, which damaged other valuable sectors, to businesses being forced to pay for such basic measures as trucking more water into manufacturing sites. One estimate for the largest chipmaker suggests it spent over USD 2.5 million on water trucks in that year alone. Other costly measures deployed include investing in new reclamation facilities and R&D spending on water efficient process development. Whilst the semiconductor market may be able to absorb such costs in the near term, it raises questions for the sustainability of the sector in Taiwan itself, and how other sectors, not considered to hold such strategic value, could cope under a similar scenario.
MANAGING THE RISK
The complexity of water resource management means that individual organisations can mitigate only some of the aspects of growing water scarcity; sustainable solutions require governmental or international interventions. At the organisational level, one of the challenges is understanding the full water footprint of your company, which across the supply chain can be up to a hundred times bigger than your direct operational footprint. The first step, then, is to evaluate the materiality of water security risk to your business, including exposure to water scarcity risks across all aspects of your operations and supply chains, and customer vulnerability to price shocks. This may involve investigating the regulatory intentions of local and national governments in the face of water insecurity and the competing interests of different stakeholders, as well as the impact this could have on operations and investment.
Against this mapped out exposure, companies are then in a position to consider their tolerance towards the risks, and put together appropriate mitigation strategies in line with their overall enterprise risk management framework. Here, we examine water security through the 4T risk management framework: Tolerate, Treat, Transfer and Terminate.
- Tolerate: Where do costs of intervention outweigh benefits? To what degree can less exposed areas of your business “carry” more exposed elements? Understanding the full water footprint of your operations is a crucial component of making this calculation.
- Treat: What steps can be taken to bring the risk to an acceptable level by, for example, implementing water saving or recycling measures? Risk can also be converted to opportunity, particularly targeting the ‘green’ consumer or investor. For example, the popularity of “waterless” jeans in the fashion industry, or the substitution of broad beans over other legumes in supermarket stock due to their considerably lower water requirement.
- Transfer: Can aspects of the risk be insured against? While drought insurance might traditionally be a particular consideration for agriculture, as we have described above, the implications of diminishing water security are much broader than that. Insurers are increasingly recognising this.
- Terminate: Are there elements of your exposure to water security issues that are too high risk to mitigate, and therefore the lower cost / impact option would be to terminate the activity?
However, because of the accelerating nature of water security concerns, and the evolving legislation and regulation to manage the problem, risk mitigation processes cannot remain static. Growing investor, public and consumer scrutiny on the role your business plays amid the risks of water security also means you should consider building water security into your ESG programme and disclosures. Ongoing awareness and monitoring of developments – both in terms of the regulatory space and environmental conditions – will remain a critical aspect of a comprehensive risk management approach. This is likely to mean onboarding appropriate intelligence tools specifically focused on water security that feed into your existing risk and opportunity monitoring, both at the operational and strategic levels.
While the river running dry may cause a challenge to your business and water security risks cannot be mitigated in isolation, understanding your risk exposure and being prepared means it need not spell an end to your business.