Fund Solutions

Water Risks a “Substantive” Threat to Corporate Value

Financial institutions urged to mitigate risks posed by water-stranding events to portfolios and loan books.

Environmental disclosure platform CDP has identified potential value at risk of US$225 billion related to water risk exposure among listed equities. Sixty-nine percent of listed equities reporting via CDP’s platform stated they are exposed to water risks that could “generate a substantive change in their business”, said CDP’s report on how water issues are stranding assets.

“These figures are set to worsen unless we radically shift our approach to how we use, treat, and manage the world’s finite supply of water,” said the report.

Produced in collaboration with think tank Planet Tracker, CDP’s analysis indicates that “substantive corporate value” may be at risk due to worsening water insecurity. Potential scenarios include production being slowed or halted and disputes over water leading to reputational damage. Already, assets are being stranded throughout the coal, electric utilities, metals and mining, and oil and gas sectors, the report noted.

“Assets in water-stressed regions could become stranded temporarily, or permanently, if assumptions made about water availability and access prove inaccurate, regulatory responses are unanticipated, or if risk mitigation and stewardship plans are not put in place,” said the report.

Financial system exposure

The financial system is exposed to resource majors and, therefore, to water-stranding risks via a plethora of financing arrangements including equity and debt holdings as well as loan financing underwriters. CDP said it is essential that relevant financial institutions understand their exposure and take steps to mitigate the risks that water-stranding events negatively affect their financial performance.

Financial institutions should assess risks and impacts, make water-related disclosures, and manage risks across portfolios and loan books via engagement policies that take water risks into account.

CDP said the concentration of equity investments suggests that action by just a small number of shareholders, such as by exercising voting rights, could have a significant impact in driving resource majors to value water “appropriately”. Financial institutions should take immediate action to engage, identify, assess, manage, and disclose water risks across portfolios and loan books to avoid the worst consequences of the water crisis and to contribute to actively stemming it.

Worsening water security

Growing populations and increasing economic activity are resulting in increased demand for and pollution of water in both the public and private sectors, the report said. Water security is worsening in many countries around the world including India, Brazil, China, and the Middle East.

Water insecurity can affect current outputs and constrain future growth in the private sector, said CDP. “Across both developed and frontier economies, increasing numbers of companies and their investors are being confronted with growing water risks that drive home the reality that water can no longer be treated as a free, endless resource.”

The 2021 drought in California (part of a much longer-term drought in the Western US that began in 2000), caused a significant decrease in hydroelectric production, placing additional stress on the power grid and requiring power to be imported from other states. Farmers were also affected, highlighting the competing demands of agriculture and energy and the economic consequences of this.

Water risk factors and stranded assets

CDP identifies four categories of current and emerging water risk factors that could result in stranded assets, where environmentally unsustainable assets suffer from unanticipated or premature write-offs, downward revaluations or are converted to liabilities. These are physical risks, regulatory risks, reputational and market risks, and technological risks.

Physical risks include flooding, drought and declining water quality, while regulatory risks could include the implementation of more stringent water withdrawals and/or discharge permits and the mandating of water efficiency. Reputational and market risks are related to community opposition to projects, increased stakeholder concern or negative stakeholder feedback, litigation, and changing consumer behaviour. Finally, technological risks are related to data access and availability and the transition to water-efficient and low-water intensity technologies and products, where companies may be left behind if not adopting these new technologies.

The report sets out detailed case studies of the impact of asset stranding, including Adani’s Carmichael coal mine in Queensland, Australia, the Oyster Creek nuclear power station in the US, and the Pascua-Lama gold mine that straddles the Huasco River Basin in Chile and Argentina.

The case studies “illustrate that community opposition and shifts in water-related regulation are real and are having significant implications for firms, particularly at the project level”, said the report.

“With water insecurity set to grow and with it, increased community and regulatory scrutiny, it is clear that a lack of access to a stable supply of water will threaten the growth plans for these sectors if business-as-usual approaches to water management and business planning are followed.”

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