By Timothy P. Dunn, CFA, Founder, Managing Member and Chief Investment Officer of Terra Alpha Investments, LLC
Adapting to a Water-Stressed Future
Water is a resource needed by everyone on the planet, but few fully appreciate the accelerating risk that a lack of water might mean to a company or an investor.
In this blog, we outline the challenges facing companies and investors as water becomes a scarcer resource. We offer a number of suggestions about how to address the investment and operational risks in a water-stressed future, and we provide further analysis in our white paper, Navigating Rough Waters.
At a higher level, though, this blog is about environmental productivity, an emerging idea in investment analysis.
Environmental productivity focuses on the efficiency with which companies use and impact natural resources. In our view, the more efficient a company is in using resources such as water, the greater the likelihood of higher risk-adjusted returns for investors. Environmental productivity is a game-changer for investors thinking about how to deploy capital.
This new investment approach is possible because of the growing availability of quality data about corporate carbon and water usage, as well the other environmental impacts, such as waste output. The good news today is that we now have an expanding body of actual data to gauge the usage of precious environmental resources. In the days and years ahead, more environmental impacts will be factored into investment analysis.
In 2015, the World Economic Forum called the global water crises “the biggest threat facing the planet over the next decade.” The demand for water is rising faster than the world’s population. Between 2007 and 2025, water use is predicted to increase 50% in developing countries and 18% in developed countries. By 2030, experts project a 40% gap between global supplies of and demand for freshwater.
At the same time, the global supply of water is becoming more variable and unreliable. Only 2.5% of Earth’s water is fresh water. By 2025, 67% of the world’s population is expected to be living in water-scarce regions, compared to about 20% in 2015. Rising global temperatures can cause faster glacial melting, more evaporation, and less snowfall, all of which raise the risk of drought. The severity and frequency of extreme droughts and floods are increasing.
Exacerbating the problem is that water infrastructure worldwide is dated and inefficient. In the U.S. alone, our existing infrastructure loses about 2.1 trillion gallons of water each year, or 1.7% of annual water usage. From a business perspective, water constraints are having a bottom line impact. In 2015, 405 global companies reported detrimental water challenges that totaled more than $2.5 billion.
The point is clear: Ignoring water-associated risks is a significant peril to companies, investors and of course humans.
What Investors Should Do
So what is an investor to do?
In our view, it’s essential to incorporate environmental factors, including corporate water usage and water stress exposure, into investment analysis and portfolio creation. As important, investors need to request that companies measure and report their water usage and impact information on a routine basis.
Among the water-related issues that should be consider in portfolio construction:
- Identify material amounts of potentially stranded assets due to water risks. Has the company provided locations of their largest assets and are any exposed to negative changes in weather patterns or sea level rise?
- Identify operational risks due to availability of water or changing weather patterns that could disrupt production facilities and supply chains.
- Identify operational opportunities of a company versus its peers, and/or in terms of improvements in operations, to lower costs related to water.
- Incorporate efficiency factors into earnings forecasts.
- Incorporate balance sheet and operational risks into the valuation process.
In fact, some institutional investors have already begun factoring water risk into the investment analysis. Norges Bank Investment Management and CalPERS have publicly stated they consider the water risks of their portfolio holdings. Private equity firms Carlyle Group and KKR, among others, expect their portfolio companies to assess and manage their water risks and seek to improve water-related efficiencies. This is what we do at Terra Alpha Investments.
What Companies Should Do
For their part, companies need to do their own risk assessment. All potential physical (quantity and quality), reputational, and regulatory risks must be acknowledged and assessed. The risks will vary depending on where the company operates.
To properly size those risks, it’s critical for firms to evaluate their total water usage. A full water risk analysis includes measuring direct water usage, waste, value chain footprint, and assessing local conditions in areas of both current and future operation.
Additionally, a company’s water footprint must be regularly monitored and operate under the assumption that water-related events can suddenly appear and can have severe ramifications. A water footprint is not static.
Once measured, it is critical for companies to publicly disclose water risk data. Water is a material factor that aids investors in their investment analysis. Full disclosure also gives companies the ability to optimize water efficiency and minimize water risk. Investors should expect transparency of material information.
More and more companies are recognizing the importance of water disclosure. In 2013, which is the latest data available, 1,025 companies publicly shared their water metrics. As disclosure rates continue to rise, a company can more accurately benchmark performance against that of their peers.
The Bottom Line
As world population grows, water demand will only grow. Every company, as well as every investor, would be well-served to make sure they understand water-related risks.
Timothy P. Dunn, CFA, is Founder, Managing Member and Chief Investment Officer of Terra Alpha Investments, LLC, an advocacy investment firm.
*The information presented by Mr. Dunn is not an endorsement of Terra Alpha Investments by Veris Wealth Partners