Improving illiquidity: Reducing your water footprint

Natalie Stafford, ESG Director at S-RM and Markus Korhonen, Senior Associate, Strategic Intelligence, at S-RM, discuss how businesses can navigate the water crisis.

The UN’s first global Water Conference in almost 50 years underscored how global access to essential freshwater resources is growing worryingly scarce and precarious due to rainfall changes.

Southern Europe was recently gripped by a heatwave, suffering from even worse droughts and wildfires than the record dry summer of 2022. Meanwhile, the increasing prevalence of wildfires in unexpected areas like southern England, the ongoing Thames Water troubles, the ever-receding shorelines of the United States’ largest reservoirs, and the way water shortage is obstructing Biden’s green hydrogen plan, all highlight that water security must be a top ESG priority for governments and businesses.

The variability of water (in)security – with high- and low-latitude regions becoming wetter as arid mid-latitude regions dry up – is playing a part in exposing an estimated two-thirds of businesses’ direct operations and value chain to serious water risks, which are being insufficiently managed.

Water demand is set to rise exponentially, exceeding supply by two-fifths (40%), or over half (56%) according to other predictions. Meanwhile, the UN anticipates availability becoming more “erratic and uncertain”. Global policymakers have already been implementing various disclosure rules for financial institutions around their adverse impacts on water.

Yet, macroeconomic volatility, inflation, geopolitical conflict, and cyber security have been dominating most companies’ risk registers so far in 2023, and their ESG priorities are still focused on other issues like greenhouse gas emissions.

This is reflected by the composition of environmental impact disclosures and materiality assessments, where water security has typically been underrepresented in favour of more regulated, ‘popular’ issues such as decarbonisation. By failing to adapt their water management processes, companies are putting US$301 billion worth of business value at risk, instead of taking action for less than a fifth (US$55 billion) of this cost.

However, the issue is rising up the agenda; investors are increasingly insisting companies report on water security, with the number of companies receiving such requests up by over half (51%) in 2022.

Businesses seeking long-term sustainability and growth should prioritise tackling the pressures brought on by dwindling water supplies and swelling demand. Effectively evaluating and mitigating the risk entails more than simply measuring and reporting on direct water usage; each business needs to quantitively assess water consumption, withdrawal and intensity, as well as how water security could disrupt its supply chain, drive competition for resources, and affect government water policies.

The business impacts of water shortages

Water scarcity has far-reaching implications for businesses beyond regulatory requirements. Businesses have to grapple with higher water prices, supply chain disruptions along the full value chain, and the impacts of water shortages on power production, all of which contribute to their bottom line. Increased transportation costs compound these losses when falling water levels disrupt shipping routes.

Businesses can begin to manage their exposure to water insecurity risks through increased capital expenditure, infrastructure investment, Research and Development for mitigation measures, pollution abatement, and compliance with regulatory requirements.

Water security management will affect every industry differently, bringing up a unique set of challenges for businesses in each sector. For example, these are more complex in manufacturing than professional services and most heightened in the agribusiness and energy sectors, where 140 litres of water goes into producing a single cup of coffee.

Businesses will also have to manage indirect consequences of water security challenges, including reputational issues stemming from tainted consumer perception over unsustainable water use, or community relations management around water resource competition.

Adapting to water security risks

Water resource management is highly complex and, due to their limited reach, individual organisations can only realistically mitigate some aspects of growing water scarcity, while the real legwork falls to governments and international bodies.

This does not absolve businesses of their individual responsibility. While businesses may have some idea of their direct operational footprint, most are unaware of their full water footprint across the supply chain and many will be surprised to learn that it is up to hundred times bigger. Having a thorough grasp of a business’s water footprint is a prerequisite for accurately calculating its exposure and resilience to risk, and accordingly, for being able to devise the most effective mitigation strategies.

The first task for businesses is to quantify the materiality of water scarcity risks to all aspects of their operations and supply chains, as well as their customers’ vulnerability to price shocks. Aside from investigating local and national governments’ regulatory plans and competing stakeholder interests, to scope out the knock-on effects for operations and investment, companies need to strengthen their understanding of different products’ water footprint. Even AI technology like ChatGPT, which businesses increasingly rely upon, consumes a bottle’s worth of fresh water for every 20-50 questions it answers.

Once they’ve comprehensively mapped out their full water footprint and exposure, companies will be able to gauge their tolerance towards various water risks so that they can ultimately incorporate appropriate mitigation strategies into their wider risk management framework. Many businesses are already accustomed to examining a myriad of different risks using the 4 Ts of risk management – Tolerate, Treat, Transfer, and Terminate – and this is also a valuable way to evaluate their water security outlook.

Through the first T, Tolerate, a business can identify where costs outweigh benefits, and determine the degree to which less exposed areas of the business can “carry” its more exposed elements. Companies can then work out what steps they need to take to ‘treat’ the risk and bring their water consumption down to an acceptable level, through water stewardship measures such as saving and recycling. It is also worthwhile exploring how risk can be converted into an opportunity to target ‘green’ consumers and investors, as in the case of popular “waterless” jeans in the fashion industry. ‘Transferring’ will involve taking out insurance against the risk components where possible, as insurers are increasingly recognising that diminishing water security has implications beyond agriculture. Where certain elements of water risk exposure are deemed too high risk to mitigate, terminating the activity may be the most sensible, cost-effective, and low-impact course.

Yet companies’ risk mitigation processes cannot remain static; water security concerns are ever accelerating while legislation and regulation are constantly evolving. As investor, public and consumer scrutiny grows, businesses should incorporate water security into their ESG programmes and disclosures while regularly monitoring the regulatory and environmental landscapes. By analysing existing intelligence feeds through the lens of water security, companies can ensure their operational and strategic decision-making is more well-considered.

Water scarcity is creating challenges for many businesses and these cannot be dealt with in isolation. By acquiring a comprehensive understanding of their risk exposure and preparing themselves accordingly, through water impact assessment tools and mitigation strategies, companies will be adequately forearmed and ultimately more resilient to the evolving risks.

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