As dry as dust: water scarcity and its investment implications

31/03/2017

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​Hamish Chamberlayne and Nick Anderson, managers of Henderson’s global sustainable equity strategy, detail how water crises have become the world’s #1 risk. They explain why mega trends such as climate change, population growth and urbanisation could trigger a supply crisis as industrial activity competes with human consumption. They outline the potential solutions and discuss the investment implications.

Water, water, everywhere…

To those living in the developed Western world, it isn’t immediately obvious that humanity faces a water supply crisis. We are taught that seas cover 71% of the world’s surface, and we can quench our thirst by simply turning on a tap. We are more likely to fear a sudden cataclysmic end to life, of the type perpetuated by disaster movies, rather than the incremental threats to life and economic prosperity from resource scarcity. It may therefore come as a shock to hear that the World Economic Forum (WEF) has listed water crises as the number one risk facing economies, environments and people for the next decade (1).

Water is vital for transformative processes across all business sectors. Everything we consume uses water for extracting, fabricating, processing, washing, diluting, cooling, or transporting. Moreover, water, energy and food exist in a ‘nexus’ of interdependencies, and what affects one will affect one or both of the other two. Water is an input for producing all our agricultural goods and along the entire food supply chain. Energy is required to produce and distribute both water and food. Agriculture is by far the greatest user of water, at roughly 70% of global withdrawals (2) – raising cattle requires c1,800 gallons per pound of beef – with food production and supply accounting for 30% of total global energy consumption (source: UN Water). In turn, energy from coal, nuclear and natural gas cannot be produced without water.

Water appears to be ubiquitous, until one realises all of these industries are almost entirely dependent on the same type of water – freshwater, as opposed to ocean water – in direct competition with human consumption. Freshwater comprises a meagre 2.5% of our global total water (3). And of that figure, even less is accessible. A not-so-blue planet after all.

Figure 1: How much water is there on, in, and above the Earth?


Source: Principles for Responsible Investment (PRI), adapted from data sourced from the US Geological Survey’s Water Science School, as at July 2014.

…nor any drop to drink

The looming crisis remains largely invisible due to what is happening deep beneath the earth’s surface. The vast majority of our liquid freshwater comes from aquifers – sponge-like underground reservoirs. These vary in size and depth, with the deepest aquifers containing ancient water that was locked into the geology thousands, or even millions, of years ago. These deep aquifers are not quickly replenished by precipitation or via river systems. Research suggests that up to 70% of the world’s aquifers have reached ‘peak water’, the point where humans pump out the stored water faster than nature replenishes it (4). The consequences are disastrous: at the country level, Yemen is expected to run out of water within a few years, with Pakistan, Iran, Mexico, and Saudi Arabia also at risk. Close to 50 countries are now defined as being water stressed (5) (see box 1).

‘Dubai skyline from the desert’, source: iStock by Getty Images

Box 1: UN definitions of water stress

Water stress = between 1000 and 1700 cubic metres (m3) per capita

Water scarcity = between 500 and 1000 m3 per capita

Absolute water scarcity = under 500 m3 per capita

1 m3 of water is equivalent to 1000 litres and weighs a metric tonne

The effects of climate change are also fundamentally changing our relationship with water. Global warming is producing disturbances in hydrological cycles, affecting the way volumes of water evaporate, precipitate, and condense – a warmer atmosphere can hold more water. Too much water vapour in the air triggers extreme weather events, observable in the increasing frequency and severity of floods and hurricanes worldwide, as well as prolonged periods of drought in some geographies. Alarmingly, we have already passed 1 degree Celsius of global warming above pre-industrial levels, and no model can accurately predict the extremity of weather patterns as warming approaches 1.5 degrees. At the same time, sea ice is shrinking and we are irrevocably losing snow cover and sources of freshwater snowmelt.

State of emergency

By 2050, the strain on water supplies exerted by a growing and urbanising global population could mean that one in four people will be living in a country affected by chronic or recurring shortages of fresh water (6). Climate change will exacerbate water-related migration and socio-economic unrest as water supplies dwindle and nations argue over ownership rights and access.

The warning signs about water scarcity, control, and resource mis-management are already here. Ethiopia’s construction of a major dam across the Nile has caused, periodically, severe diplomatic tensions with Egypt and Sudan given downstream supply scarcity fears. In the US, the state of emergency declared in Flint (Michigan) was the result of a cost-cutting decision to switch the city’s water source from Lake Huron to the Flint River. A lack of appropriate water treatment, together with ageing infrastructure (lead pipework) began poisoning the residents and exposed them to legionella bacteria.

Even more recently, infrastructure vulnerabilities came to the fore again as a spillway at California’s Oroville Dam threatened to collapse following extremely heavy rainfall. The sudden breach triggered the frantic emergency evacuation of nearly 200,000 people. Oroville, like many other major dams in the US, is more than 50 years old; these structures simply were not designed to cope with today’s climate threats. Operational stoppages are also likely to become more common globally, like that seen in Nabarun, India when low water levels forced authorities to temporarily shut down the Farakka thermal power plant.

Oroville Dam spillway damage, source: California Department of Water Resources, as at 27 February 2017

Lifting the curse

Faced with such enormous challenges, what can be done – and what role can investment play – to help solve this ensuing global water crisis? First, when considering potential solutions, we have to recognise that water systems are vast, complex and dynamic, and that water risk needs to be considered across a spectrum of authority and responsibility: whether global, local, industrial, and/or corporate.

Enormous hydraulic engineering feats are well within human capability – the Hoover Dam and Panama Canal projects testify to this – but they cost vast sums of money and, even then, are not always the most water efficient. For example, Mexico City’s biggest single source of water – the Cutzamala basin – lies more than 100km from the city itself: it is an extremely expensive and energy intensive operation to pump water from such distance. Close to 40% of that supply is lost to leaks and, once used, the majority of industrial waste and municipal sewage is untreated. Indeed, it is disturbing to realise that well over 80% of the world’s wastewater is not collected or processed (7).

This lack of efficiency alongside dwindling supply therefore demands that cities, and increasingly megacities, re-engineer their water and wastewater systems. It will require trillions of dollars of capital raising and investment, by national and local government, with public-private partnerships looking set to become more heavily involved in water projects.

Investment risks and opportunities

There are plenty of ways to invest in water as a theme, with many listed companies globally that operate in the fields of water management, treatment, infrastructure and supply (some areas are detailed in Table 1). This isn’t just about more pumps and pipes, reservoirs and dams. New techniques and technologies offer hope across the spectrum of water demand and supply, and exciting innovations include solar-powered desalination, filtration using nanotechnology, smart monitoring, and precision agriculture.

Table 1: Potential water investment areas

Infrastructure and supplyEngineering, procurement, construction, consulting, pipes, pumps, valves, utilities for water and wastewater treatment.
Water treatmentMunicipal wastewater treatment, industrial wastewater treatment, desalination, analytics, testing, inspecting and certifying.
Water management/efficiencyDrought resistant seeds and crops, ‘more crop per drop’, irrigation, precision agriculture, household metering, education, big data, water pricing models.

Exposure to water risk should also be considered across all the stocks held in a portfolio: how dependent is the company on water; how secure is that supply; and what is management doing to measure, manage and mitigate water risks? Alongside physical water risk, there are growing reputational and regulatory risks, as public water supplies are safeguarded, and as policies on climate change and environmental pollution are enacted.

Over the past few years companies have reported increased impacts to their bottom line from water-related causes, such as groundwater pollution and effluents not meeting regulations. As water risks increase, shareholder engagement alongside initiatives such as the CDP ’s water disclosure project (8) will be crucial in catalysing companies to better understand, manage, and report on their water risk.

We work with Henderson’s Governance and Responsible Investment (GRI) Team to assess, monitor, and engage with companies on the water risks they face. Traditionally, large-cap companies have focused on their direct consumption of water, rather than looking closely at the risks to their supply chains – eg, through increased input prices, disruptions or reputational damage. Agricultural supply chain risk has been a key focus of the GRI’s Team’s work, and with their help we have been encouraging companies such as McCormick & Company, a global leader in herbs and spices production, to integrate water prices and scarcity models into its decision-making processes.

Stock in focus: Xylem

Within the Global Care Strategy we favour NYSE-listed Xylem as a global ‘pure-play’ on water. With a corporate mission statement of “Let’s Solve Water” the firm works with corporate, municipal and governmental clients across a broad spectrum of industries, designing and manufacturing water solutions across every part of the water life cycle. Their four operations units comprise: water and wastewater treatment solutions, analytical instruments, controllers and pumps & accessories. In August 2016, Xylem announced that it has struck a deal to acquire Sensus, a provider of smart meters, network technologies and advanced data analytics. We believe this has the potential to generate significant additional revenues for the company as demand grows among utilities and energy clients for greater water efficiency, conservation and improved life-cycle costs.

UV disinfection system, source: Xylem, reproduced with their permission

As freshwater becomes an increasingly scarce resource, the disruption to industry through many different avenues will only continue to grow; we will continue to assess the investment opportunities and threats that this produces, assisted by the research, analysis, and engagement work conducted by Henderson’s GRI Team. We believe the effects of water scarcity are already in train, and that investors ignore the warning signs at their peril.

 

Sources and further reading:

1) WEF, Global Risks 2016, Water crises are listed as the number 1 global risk for the next ten years.
2) The Economist, Liquidity Crisis, http://www.economist.com/news/briefing/21709530-water-becomes-ever-more-scant-world-needs-conserve-it-use-it-more-efficiently-and, 5 November 2016
3) Principles for Responsible Investment, PRI-Co-ordinated Engagement on Water Risks in Agricultural Supply Chains, investor guidance document, 2017, https://www.unpri.org/news/pri-leads-engagement-on-water-risk
4) Bank of America Merrill Lynch (BofAML), Global Water Primer, 10 July 2015
5) BofAML, as above.
6) Source; the UN, http://www.un.org/sustainabledevelopment/water-and-sanitation/
7) Source; the UN, http://www.unwater.org/statistics/statistics-detail/en/c/211793/
8) CDP = the Carbon Disclosure Project, an organisation based in the United Kingdom which works with shareholders and corporations to disclose the greenhouse gas (GHG) emissions of major corporations. Its programmes also include Water, Supply Chains, Forests, and Cities. https://www.cdp.net/en

 
The stock examples here are intended for illustrative purposes only and are not indicative of the historical or future performance, or the chances of success, of any particular strategy. Henderson Global Investors, one of its affiliated advisors, or its employees, may have a position in the securities mentioned in this article. References made to these securities should not constitute or form part of any offer of solicitation to issue, sell, subscribe or purchase the security.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

Past performance is not a guide to future performance. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

The information in this article does not qualify as an investment recommendation.

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