Water - China’s greatest challenge

Of the many factors that could block China’s development path, water scarcity, is also one of the most challenging. China’s impending water catastrophe is beginning to unnerve investors. Several large institutional investors are beginning to investigate or implement ways to manage water-related risks. In China, water scarcity directly causes economic losses of US$35 billion annually, according to Water In China: Issues for Responsible Investors, a report by Singapore-based Responsible Research. The report was commissioned by ADM Capital, an investment advisory firm specialised in managing distressed assets.

Lucy Carmody, a director of Responsible Research, says water-related issues are a direct threat to investment in China. With 20% of the world’s population living on about 7% of global freshwater supply, as the Chinese population expands, and as industrial water demand rises, the ratio may reach crisis proportions.

Already, 30% of the country’s river water is deemed unsuitable for industrial or agricultural purposes, two-thirds of 660 cities endure water shortages and 90% of Northern China’s aquifers are polluted. To intensify the predicament, China’s water efficiency is relatively poor. China takes four times as much water as its G20 peers to produce US$1 of GDP.

There is some demand-side management and an attempt to more adequately cover the costs of supply. But the coordinated, systemic responses commensurate with the size of the problem are clogged by bureaucracy. Carmody says, “We know of one draft version of a Water Pricing Proposal that has been on the drawing board for six years. This illustrates another substantial roadblock in the journey towards Chinese water sustainability — the fragmented nature of water governance, on a national and regional level, resulting in a high level of systemic inertia with respect to innovation and investment. The situation is made more complex still by the lack of sophisticated legal machinery for regulation and enforcement.”

Norges Bank Investment Management (NBIM), which manages assets of the Norwegian Government Pension Fund, is putting pressure on more than 1,000 companies in its portfolio that are in high water-related risk industries, to be more transparent with data that can help with assessing risk to earnings. The sectors include pulp and paper, food, agriculture, pharmaceuticals, water supply, power generation and other industries.

Meanwhile, HSBC has just released three key research reports examining risks to investors in India, Indonesia, Malaysia, the Philippines, Thailand and Vietnam that relate to the region’s exposure to energy insecurity, water scarcity and climate change.

The reports that were jointly produced with the World Resources Institute (WRI) found that Asian economies face rising energy and water utility costs that will impact on industrial production costs. HSBC believes that water risks also have the potential to impact on energy production, stating that whilst water scarcity risks are receiving more attention than in the past, ‘the connection to power sector development does not appear to be well understood by investors, governments, and companies in the region.’

The research states, “The confluence of increasing water demands associated with the projected growth in the power sector and other water intensive sectors such as agriculture coupled with a changing climate will create a very different operating environment in the future.” 

HSBC argues that investing in green buildings may be one way in which investors can mitigate exposure to water and energy risks in the region as buildings that are exposed and vulnerable to water scarcity and energy insecurity will experience the greatest financial risks.

There are fewer than 100 certified green buildings in the region but it is expected that this number will increase significantly as several hundred building are in the process of being evaluated. The HSBC research states that “The Indian market is the largest and is growing rapidly. The square footage of green buildings in India grew 1,500 times between 2003 and 2007 from 20,000 to 30 million square feet. While there are limited data on Malaysian and Thai green buildings, both countries’ governments have shown support for green building projects. In Vietnam, no green buildings have been certified yet; but local standards are emerging, and the government may soon introduce green building incentives.”

One of the factors that has so far prevented investment in green buildings has been the payback factor, that is the length of time that reduced energy and water utility costs can justify increased construction costs. However with green buildings typically achieving 30 to 50 percent less energy consumption and 20 to 30 percent less water consumption in comparison to conventional buildings,  it is expected that payback periods will reduce over coming years making green building a more attractive investment proposition.

“Green practices are gaining mainstream momentum, especially in India. In those countries with strong government support and strongly established green building standards, like Malaysia and India, short-term growth is likely. The markets in Indonesia, Philippines, and Vietnam will probably grow more slowly given the lack of established standards and awareness. However, as water, energy, and climate change concerns increase, it is likely that green building markets in all countries will grow significantly over the next decade.”