Why Companies And Investors Need to Address Water Risks As Part Of Their ESG Considerations

This article was first published on UOBAM. 

In June last year, Taiwan experienced its worst drought in 56 years. The typhoons that typically occur in Taiwan during the summer and autumn months failed to arrive. As a result, reservoir levels fell to below 20 percent of their normal capacity, forcing the authorities to impose water rationing in several counties and municipalities.

Taiwan’s water woes are far from the exception. Although more than 96 percent of Earth’s surface is covered in water, less than three percent of this is from freshwater sources and therefore consumable by humans. As global warming continues to give rise to more severe and extreme weather conditions, water supplies are frequently contaminated or destroyed, exacerbating clean water scarcity.

At the same time, the global demand for water is projected to increase by 55 percent by 2050. As with energy and food, population growth increases water demand. Most of this growth will take place in developing countries within the African and Asian continents where water scarcity is already a pressing issue.

Water Scarcity Is A Global And Asian Challenge

As a result of this increasing demand and decreasing supply, water stress has become one of the most prominent consequences of climate change. The World Resources Institute estimates that 17 countries – home to a quarter of the world’s population – face “extremely high” levels of baseline water stress. This level is reached when on average every year, more than 80 percent of a country’s available supply is withdrawn due to irrigated agriculture, industries and municipalities.

National Rankings: Extremely High Baseline Water Stress

Source: wri.org/aqueduct 2019

Part of the problem is that much of the wastewater in these countries are not re-used. In the MENA (Middle East and North Africa) region, this is the case for over 80 percent of wastewater but some initiatives are taking shape. Oman, for example, treats all of its collected wastewater and re-uses 78 percent of it.

In Asia, while only two countries – India and Pakistan – feature in the list of 17 extremely water-stressed countries, India alone has more than three times the population of the other 16 countries combined. India’s water resources from its rivers, lakes and streams are severely overdrawn, but so are its groundwater resources, largely to provide water for irrigation. Overall, it is estimated that 300 million people in Asia Pacific have no access to potable clean water or basic water infrastructure services, and 1.2 billion lack adequate sanitation.

Water Risks Can Affect Companies

Water scarcity, flooding and pollution risks are an increasingly pertinent ESG issue that can affect a company’s bottom line. According to CDP, a charity specialising in environmental disclosures, the total potential financial impact of water risk to businesses in 2020 was up to US$301 billion. The food, manufacturing, energy, chemicals, pharmaceuticals, apparel, and mining sectors account for 70 percent of the world’s water use and therefore are at the forefront of these risks.

This is because companies that use large amounts of water in their business operations, and/or have facilities in water stressed regions, are facing mounting costs. These typically relate to increased operating expenses, capital expenditures, insurance payments, litigation and compliance costs, and disruption to production. To mitigate against these costs, companies are investing in new modes of operation totaling US$55 billion in 2020, according to CDP estimates.

• Within the food industry, companies are adopting water saving and water re-use measures. Some are also promoting sustainable agricultural practices.
• Within manufacturing and materials, the focus is on adopting water saving and re-use measures and developing flood emergency plans.
• With apparels, textile manufacturing and raw material production is particularly water intensive. Expenditure is dominated by investment in technology to address regulatory risks associated with pollution.
• Within power generation, there is significant capital expenditure on diversification into renewable energy sources and lowering the temperature of discharged cooling water.

These measures are starting to take effect. For the first time since CDP started their freshwater withdrawal surveys, the trend of companies reporting increased withdrawals fell in 2020. This was likely the result of companies setting withdrawal reduction targets two years previously, largely based on water savings and re-use. However, improving the supply chain and supplier performance is still a relatively untapped opportunity in dealing with water risks, so there is room for further improvement.

Companies Reporting Increased Withdrawals Fell In 2020

Source: CDP Water Report 2020

Case Study: Taiwan’s Semiconductor Industry

The financial risks and implication arising from water risks need to be taken into account and may not be fully priced in by investors.

For example, Taiwan’s semiconductor industry relies heavily on water use in its chipmaking operations. The chip-fabrication process relies on large volumes of pure and high quality water supply in order clean the wafers and chip surfaces from particles and chemicals. The industry was thrust into the limelight when the country’s Baoshan No.2 Reservoir – one of the primary sources of water for Taiwan’s semiconductor industry – fell to seven percent of its normal water level.

Some of the world’s largest semiconductor foundries operate the bulk of their water-intensive chip fabrication businesses in Taiwan. Their water intensity increased by 20 percent from 2015 to 2019, and each company can use more than 150,000 tons of water daily. As these companies continue to expand their advanced semiconductor fabrication, it is likely that they will become even more reliant on freshwater sources unless steps are taken to enhance their water management plans. This includes increasing their water recycling rate and installing reclaimed water plants to reduce their water dependency.

However, more extreme weather events are anticipated in Taiwan making the freshwater supply more volatile. Investors will need to factor in this water risk when valuing Taiwan’s semi-conductor earnings.

Evaluating Water Risks Is Increasingly Important

Water risk is an ESG issue that is becoming increasingly relevant to companies and investors. The potential financial implications should not be ignored.

Companies that are more resilient to water risk, water stress and climate-related risks may face less earnings impact, are potentially better positioned for sustainable transition and can become potential leaders in their industries. On the other hand, affected companies that fail to actively invest in water management stand to be penalised by the market.