The Emergence of Water Risk: From Marginal to Systemic

Water – An Increasing Operational Risk

The 20^th century was the era of cheap, safe, reliable water supply. Although water plays a vital role in the production and availability of almost all products and services, many consumers understate its contribution to our daily lives. Indeed, in the 21^st century, water has been, most of the time, an abundant, cheap, and safe resource in developed countries.¹  

Nevertheless, in most regions of the world, especially those with large populations, both the availability and quality of freshwater are deteriorating (see Exhibit 1). Society contends with over-extraction, poor management of resources, and the continuing loss of wetlands that are directly responsible for biodiversity loss. As a result of human exploitation and mismanagement of water resources, water use limits are already being exceeded.

Exhibit 1: Forecasted Absolute Change in Water Stress - 2002 to 2030

_{*2002 to 2017 and water withdrawals based on Aquastat data, with forward demand forecasts based on IFPRI Agriculture growth, IMF country GDP forecasts, ourworldindata.org Population Growth.²}

^{Source: Aquastat, IFPRI, IMF, ourworldindata.org}

Putting Water Metrics into Practice: Water Use by Sector

Unavoidably, increasing stress will affect people and companies located in those countries. We highlight this trend and discuss ways to manage its effects. One avenue is to provide tools and metrics to better monitor water consumption and withdrawal.

As these metrics become available, investors could make more informed decisions and increase the impact on their financial eco-systems. For instance, investors may decide to divest from or engage companies that misuse water resources.

Water-related risks have material financial impacts. For example, if the company faces increased water input costs, production could become uneconomical. Moreover, heavy water-consuming companies are often perceived as taking advantage of the resource and causing economic harm to society.  Hence, companies with high water consumption and water intensity have potentially high exposure to water risk.

In Exhibit 2, water intensity and water consumption (in total cubic meters) of sectors are presented. The Utilities sector takes a clear first place for water intensity as water is necessary for many electricity-generating activities, with the Materials and Industrials sectors in second and third, respectively. For water consumption, the Materials sector is the top consumer, driven by high water demanding steel producers and mining companies, with Utilities in second and Energy in third, respectively.

Exhibit 2: Water Use by Sector

^{Source: Morningstar, Sustainalytics}

Water Intensity and Firm Characteristics

Looking at a global sample of 4,914 firms from 2020, our analysis shows that firms with high water intensity display high ESG risk, high return, high standard deviation of returns, and high downside deviation of returns (see Exhibit 3). Water intensity, however, weakly relates to risk-adjusted return.

Exhibit 3: Correlations Between Firm Water Intensity and Firm Characteristics

^{Source: Morningstar, Sustainalytics}

Sustainalytics Water Metrics

While building investment strategies, savvy investors look at water risk issues using a holistic approach by considering company and regional factors. At the company level, it is crucial to pay attention to such metrics level of water consumption, water withdrawal, and water intensity. Second, it is important to review the corporate policies and programs to reduce the company's risk exposure, which reflects the company's preparedness to manage these risks. Investors should also assess the business's location to determine if the country or region in which the company operates is exposed to other water risks. 

These indicators are measured through Sustainalytics' comprehensive ESG Risk Ratings methodology. Our findings within this framework suggest that reducing exposure to water stress correlates to ESG risk exposure. Investors can use this tool to integrate relevant data into their analyses to reduce portfolio exposure to water-related risks. 

The Emergence of Water Risk: From Marginal to Systemic

Our study shows that water stress has implications beyond the immediate use of water, as water stress affects all the aspects of the economy and well-being of society. Therefore, monitoring water usage indicators at the country and firm levels is urgently necessary for country policymakers, company executives, and shareholders alike.

You can access the full report, Water-Related Risks and Challenges: A Quantitative Research Perspective, for additional insight.

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