May 10, 2021

Water Risk Flows Across Industries and Through Value Chains

Gail Glazerman, CFA

In the first half of 2021, numerous developments have heightened the attention companies and investors focus on water risks. From scanning news headlines alone, one can observe how water stress can disrupt the supply chain of many industries; how local competition for scarce resources can directly affect a water-consuming business and its downstream customers; and how, if water supply is limited, government actions can restrict access.

Recognizing the financial implications of water usage, SASB Standards include a disclosure topic and associated metrics addressing water management in 25 of 77 industries. Corporate disclosure on water usage, exposure to operating regions classified as water-stressed, and a company’s strategy to manage risks and capitalize on opportunities can help investors better assess how effective these strategies are in improving performance and positioning.

In this article, we take a look at several ways water management can affect business performance across a range of industries.

Taiwan: Agriculture/Semiconductors

With the continued proliferation of connected devices and a pandemic-driven surge in demand for work-from-home equipment (laptops, tablets, etc.) and game consoles, semiconductors tipped into extremely tight supply/demand balance. Auto manufacturers around the world have cut production at numerous plants, citing limited supply of chips as a contributing factor. For example, Ford recently projected chip-related downtime costs of $2.5 billion (at the high end of prior estimates) and as much as 50 percent of second-quarter output could be affected. AlixPartners projects the global auto industry could see a $60.6 billion decline in revenue this year attributable to chip shortages.

As these estimates suggest, supply chain disruptions can have significant financial consequences. The current tightness in semiconductor markets is primarily a result of a traditional market imbalance, with demand outstripping supply—not necessarily a result of environmental, social, and governance (ESG) factors. However, drought conditions in the important manufacturing region of Taiwan could further exacerbate this problem.

Semiconductor production is highly water-intensive and while to date Taiwan’s chip production has not suffered material slowdowns, the government of Taiwan is taking aggressive actions in response to the ongoing drought and semiconductor manufacturers have incurred incremental costs to manage reduced water availability. At the same time, the global semiconductor industry is looking to rapidly expand capacity to meet the elevated demand and access to resources such as water could prove a limiting factor.

Taiwan is currently experiencing its worst drought in over 50 years and has been implementing a range of mitigation efforts including ordering industry to cut water usage, lowering water pressure, and shutting supply two days a week. Agricultural activity has taken a particular hit as the government reduced water for irrigation on 183,000 acres. While the government has provided some compensation to affected farmers, some fear they might permanently lose customers.

Taiwan Semiconductor Manufacturing Company (TSMC), one of the world’s largest chip manufacturers, has yet to lose production due to water. But Bloomberg reports the company has been forced to haul in water by truck, likely adding costs. The company has also been investing to improve water usage with a new reclamation facility under construction, though conservation efforts appear to be at least partially offset by rising water intensity per unit associated with technological gains. This type of analysis can be facilitated by corporate reporting on this topic (water consumption paired with the SASB activity metrics on production and share of production from owned facilities).

In response to the current market imbalance many semiconductor companies have announced ambitious expansion plans. TSMC has modestly raised its 2021 spending plan to $30 billion; this is part of a “record” $100 billion, 3-year capacity expansion program. Intel plans to spend $20 billion on two new US plants and Samsung is targeting $116 billion in spending to diversify its semiconductor production.

As these spending plans are implemented, access to water at targeted sites will be an important factor to assess. The SASB Semiconductors Standard asks management to disclose the percentage of the company’s water consumption in areas of high or extremely high water stress—engaging with management on this issue could provide useful insights.

Hydraulic Fracturing and Dairy

Advances in technology have enabled oil and gas companies to access shale deposits that previously were uneconomic or simply technologically unreachable. Water plays an essential role in this process, though not every well or shale region has the same water requirements. While essential for the extraction of shale reserves, in aggregate shale drilling water use is small relative to other industries such as irrigation.

Over the past several years a disproportionate share of hydraulic fracturing activity has occurred in the Permian Basin in the US Southwest. Much of this area is deemed as having high water stress. As such, some of this drilling activity could be at risk should drought conditions become more pervasive. The meat and dairy industry is also heavily reliant on water, and there is a significant industry presence in this region, potentially competing with oil and gas companies should water become scarce.

The oil and gas industry recognizes the potential risks associated with access to water and has been working on solutions to reduce reliance on freshwater. For example, Pioneer notes “water shortages, including physical water scarcity and demand issues in the arid West Texas region where we operate have the potential to significantly affect our operations. In 2012 we recognized the increasing demand for limited Permian Basin groundwater resources presented future water-related risks in our operations.” The company implemented a strategy to address this concern, establishing a subsidiary tasked with “providing substantial water management capabilities, improving our water sourcing operations and researching regional water resources and treatment technologies.” One tangible result is the company’s freshwater usage has declined from 82 percent in 2015 to 43 percent in 2019.

An investor in either of these industries could be well served by gaining an understanding of a company’s dependence on water, its strategy to manage this resource, and whether there are other large operations in a geography competing for tight water supplies.

Community Relations in Beverage Industries

Water is an integral ingredient to a wide range of products manufactured by the alcoholic and non-alcoholic beverage industries. If a company is unable to access or loses access to its source of water, the financial implications can be significant. Managing water resources efficiently can help reduce costs and risk.

In March 2020, voters in the Mexican city of Mexicali denied a water permit for a proposed $1.4 billion brewery project by Constellation Brands. Water was cited as a primary concern, with estimates indicating the facility’s needs could amount to 25 percent of the city’s water reserves. The company’s shares fell 10 percent on the news of the vote and eventually the brewer abandoned the project.

The impact of water use in the beer and dairy industries has caught the attention of Mexico’s president Andrés Manuel López Obrador. The Star Tribune notes López Obrador “is railing against the production of beer and milk in areas where there isn’t enough water.” And questioning “why not use the water of the south and southeast … there is so much water there is flooding?”

In another example of the beverage industry coming under scrutiny for water use—reflecting ongoing drought concerns in the State of California—the state government has taken actions to prevent Nestlé from withdrawing water it packages as its Arrowhead brand of bottled water (these assets were recently sold to BlueTriton as part of Nestlé’s disposal of its US/Canadian water business). The move to restrict the company’s water use is an escalation of an ongoing dispute with local environmental groups, with some claiming the company has been using up to 25 times as much water in the region as it is entitled to use. The current cease and desist order needs approval from the State’s Water Resources Control Board. If granted, the company could face fines of up to $1,000 a day and potentially as much as $10,000 per day should a drought be declared in the operating region.

Given the importance of water to the production of beverages, understanding the magnitude of water usage, the risks of scarcity, strategies to manage these risks, and the nature of relations with the local community could be illuminating for investors.

Reducing Water Consumption in Fashion

Apparel can be a water-intensive endeavor encompassing everything from the growing of cotton to the dyeing and finishing of garments. Many companies in the industry have worked to reduce water consumption throughout the supply chain and some find this can boost financial performance in addition to the associated environmental benefits. Using less water means not only potential savings associated with reduced purchases of water but also savings generated from processing less wastewater.

The information that apparel companies have disclosed on environmental impacts in the supply chain and materials sourcing/efficiency (both of which are SASB disclosure topics) can offer some insights into these initiatives. A few examples include:

  • Fast Company notes that Levi Strauss plans to “work with suppliers to set water use targets, based on the water situation at the local level … while using less water is good for the planet there is also a business angle: when suppliers use less water, they use less energy and they save money on both.”
  • Levi’s has designed a product called “Water<Less” jeans, creating an opportunity to boost revenue by appealing to sustainability-oriented customers. In addition to potential sales benefits, reports indicated that by saving over 1 billion gallons of water for the first 75 million garments, Levi’s generated $1.6 million in cost savings. And Levi’s is not alone. Uniqlo indicates its Bluecycle program reduces the amount of water in jeans processing by up to 99 percent, to the equivalent of about a teacup.
  • Ralph Lauren Corp introduced a new process which “seeks to drastically reduce water waste by changing the way it dyes clothes.” An initial phase aims to cut water use by 40 percent. This reduction is being facilitated by a textile treatment developed by the chemical company Dow. Ralph Lauren notes the new process also generates operational advantages allowing for shorter product lead times. This raises another angle worth considering: when companies develop products that help their customers generate environmental benefits, they can create strong business opportunities. Ralph Lauren reports Dow’s ECOFAST textile treatment enables “40 percent less water, 85 percent fewer chemicals, 90 percent less energy, and a 60 percent reduction in carbon footprint compared to a more traditional dyeing process.” (Incidentally, the SASB Chemicals Standard includes a topic focused on designing products for use-phase efficiency which would encompass chemical products designed to help reduce water consumption, like ECOFAST.)

Conclusion

As previously noted, many businesses rely heavily on access to water. While this could manifest differently across industries some potential areas of financial impact include:

  • Water scarcity could lead to production stoppages, resulting in depressed revenues. Additionally, companies operating in an increasingly water-stressed area might struggle to obtain necessary permits to grow production, potentially muting revenue growth.
  • Water scarcity might raise operating costs in terms of higher prices paid for water, or increase expenses for mitigation efforts such as hauling water by truck and incremental reclamation processing activities.
  • Capital expenditures could rise as companies deploy technologies to improve water efficiency or reclaim water.
  • R&D spending could rise as companies try to develop new production processes to reduce water consumption or redesign products with an aim of lowering reliance on water.
  • There can also be upsides—companies that develop products with lower resource-intensity could reduce their costs, cultivate competitive advantages, and see marketing/revenue benefits from selling an environmentally friendly product. Firms that develop solutions which enable others to reduce water consumption could see strong revenue growth.

While not every industry has significant reliance on water, it is quite possible multiple industries in the same water-scarce geography could be competing for the same resource. As such, a company looking to site a new facility—or an investor allocating capital—could benefit by understanding what other industries rely on that same source of water.

As these examples show, many companies, investors, and regulators increasingly recognize the risks posed by water scarcity and have begun implementing strategies to mitigate those risks. SASB Standards can be a helpful tool to provide insights on the effectiveness of these strategies in delivering performance improvements, including water withdrawals and consumption, particularly in regions of elevated water stress.

For more insights into industry-specific water risks and other financial implications related to climate change, see SASB’s Climate Risk Technical Bulletin.