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Real liquidity: Why investors care about water

Investors should understand the water risks in their portfolios, even if the companies don't

Apr 19, 2015 @ 12:01 am

By Julie Fox Gorte

One of the great teaching tools in undergraduate economics is the Diamond-Water Paradox, which challenges us to think through why water, a necessity of life, is almost free, while diamonds, which pretty much everyone can live without, are expensive. The deus ex machina here is scarcity: Diamonds are scarce, and water isn't. Rewind the tape: it wasn't.

That's changing, and fast.

Most people understand that it takes water to make food. Morgan Stanley recently analyzed water risks in food production and came to the sobering conclusion that at least one-third of global production of three major food commodities — wheat, corn and soybeans — occurs in areas where water scarcity is high or extremely high. If drought affects enough of the range, food prices could suffer, along with the fortunes of agriculture companies.

For instance, both ADM and Bunge suffered from lethargic earnings during the Midwest's drought in 2012.

Today's drought epicenter is California, which grows 90% of the U.S.'s tomatoes. Last year, tomato growers used their increasingly precious water for tomatoes, producing a bumper crop but at a premium price.

Campbell Soup Co. paid the highest price ever for tomatoes last year. The drought also dealt a blow to Campbell's carrot business, which contributed to a 28% drop in its profitability last quarter.

COMPUTERS NEED WATER TOO

It is not so well known what increasing water scarcity could do in other sectors. One of the driest things in the office is the computer. Surely that can weather a drought? Well, no.

Semiconductors, indispensable for computers and other electronic equipment, take a boatload of water to make. One semiconductor fab can use as much water as a small city; a large one can use nearly 5 million gallons per day. Semiconductor production recently was identified as one of the six industries most imperiled by California's drought.

Even turning the computer on can be endangered by drought. The thirstiest industry on the planet is electric power. According to the Carbon Disclosure Project, about one-sixth of all water used worldwide goes into the production of energy, from fuel mining to electricity generation.

The water it takes to power up the computer is real, if invisible to users. And imperiled: A recent article in Forbes noted that Brazil and California (the world's seventh and eighth largest economies by GDP) both rely on hydropower, and both are seeing electricity production impacts from drought.

California is coping, with only about 10% of its electricity coming from hydropower. But three-quarters of Brazil's electricity comes from hydropower, so while California considers rationing water, Brazil is rationing both water and electricity. Even with rationing, there have been rolling blackouts. Of the electricity generation companies responding to CDP's 2014 water risk survey, 38% reported detrimental impacts to business operations as a result of deteriorating water security.

Three years ago, before the California drought was in the headlines on a daily basis, Standard & Poor's produced a report on how water shortages could increase costs for utilities in the UK, where there was a drought in 2012.

Investors are beginning to understand these risks better. The Principles for Responsible Investment Initiative is running a multi-investor dialogue on water risks, and the United Nations Environment Programme Finance Initiative has a water work stream focused on investment challenges and opportunities related to water.

Water is the stuff of life, and increasingly the stuff of investment. Few economies can withstand increasing water scarcity without damage, and companies that figure out how to make use of it more efficiently are better positioned for long-run prosperity.

The water we have on earth has been here for billions of years, and we aren't getting more. The Curiosity rover found water on Mars, but at the moment, that's not an investable idea, and it won't help the Brazilian utilities or California vegetable growers.

All investors should understand the water risks in their portfolios, even if the companies don't. Investor pressure is a great way to convey the message that investors need to understand water risks to portfolio companies, and they need it: 70% of the global utilities that CDP requested water risk information from in 2014 chose not to respond. That's not acceptable.

Julie Fox Gorte is senior vice president of sustainable investing at Pax World.

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