The shape of water scarcity

If you live in the UK, you could be forgiven for thinking of water as an infinite and cheap resource. It falls on our heads in plentiful volume rather more regularly than most of us would like and comes out of the tap, clean and clear, on demand.

Shamefully, most of us in the UK flush our toilets with perfectly potable water. However, of all the things that water is, infinitely available it is not, particularly the clean and fresh variety. Inconveniently, only 0.3% of the stuff that makes ‘the blue planet’ blue is available to us in its fresh, liquid form. As the climate changes, so does the availability of water, and we waste a staggering amount. In the UK alone, we waste 3 billion litres of water every dayⁱ. Since a human adult can survive on c.2L of water per day, and the entire population of Africa is c.1.3 billion, every day the UK wastes enough drinking water to hydrate the population of Africa. As investors, increasing populations and increasing consumption of things have generally been viewed in favourable terms. From the perspective of water scarcity, these factors are anything but positive.

According to the World Resources Institute (WRI)ⁱⁱ, 25% of the world’s population currently live in countries facing extremely high water stress. Demand is projected to grow by 30% by 2050, and demand is expected to exceed current supply by 40% in less than a decade. From the WHOⁱⁱⁱ, 55 million people experience drought every year and 700 million people are at risk of being displaced by drought by 2030. And from the CDP 2020 Global Water Report4, almost 300,000 children under age 5 die of diarrhoea linked to dirty water and poor sanitation annually. In 2017, Rome was forced to reduce water pressure and the Vatican turned off its c.100 fountains, because rainfall was down 70% on previous years. Closer to home, London and the South-East of the UK are ranked as ‘high’ in terms of baseline water stress. For context, ‘high’ means we are one prolonged dry spell away from our taps running dry. It is goal number 3 in the UK government Environmental Improvement Plan 2023 to improve supply of ‘clean and plentiful water’.

It is clear then that we as responsible investors should ask ourselves what we can do. The combined effects of agriculture and industry are responsible for approximately 90% of direct water withdrawals. The CDP estimate that inaction at this point has potential financial impacts for companies which are five times the cost of addressing the issue. In 2020 the total potential financial impact of reported water risks was more than $300bn, or the entire GDP of Pakistan. However, the money required to mitigate those risks was $55bn. Put another way, 1% of global GDP could provide safe and secure water for all by 2030. Failure to implement change could result in a loss of regional GDP of 2% - 10%, depending on location, by 2050^iv. However, the problem is fixable, and many companies are both recognising the issue and taking action. Around 2/3 of CDP responding companies have committed to maintaining or reducing their water withdrawals, and in 2020 there was a 20% increase in corporate disclosure.

From an Evenlode perspective, it is important for us to understand and incorporate water stewardship into our ESG framework to help inform our investment decisions. Not all companies and sectors are created equal in terms of water usage, and we must identify which of our investment candidates are water intensive and could have a material impact on the situation, and which are taking appropriate action. Utilising this knowledge and awareness helps us identify and invest in high quality, socially responsible companies who have future vision and thus the potential for long term growth and sustainable returns for our clients. Understanding the way in which both existing Evenlode universe companies and potential new entrants manage water usage is the first step. Then, engagement, discussion and voting help us to ensure transparency, accountability, and ultimately positive outcomes from our investments.

According to Thomas Insights^v, the top 5 industries for water usage are, in order from highest to lowest: Fruit and Vegetable Farming, Textiles, Meat Production, the Beverage Industry and Automotive Manufacturing. At Evenlode, our core investing philosophy is built on quality, asset-light, cash generative businesses. This inherently excludes direct exposure to many of the relatively asset-heavy industries on that list. We do, however, have direct exposure to some of the world’s largest beverage producers, and so it is here where we can focus on what we and the industry are trying to do to mitigate the problem. For context, from a recent BBC article^vi, including associated agriculture it takes 75 litres of water to make a glass of beer, 120 litres of water to make a glass of wine, 140 litres of water to make a cup of coffee and 170 litres of water to make a glass of orange juice.

Based on revenue, of the top 10 Statista-listed leading beverage companies worldwide in 2021, five are either in or have recently been in our combined portfolios. These include Anheuser- Busch Inbev (1st place on the Statista list), Nestlé (2nd), PepsiCo (4th), Heineken (6th) and Diageo (7th)^vii. Focussing on the top two by revenue, until recently AB Inbev resided in our Evenlode Income and Global Income portfolios, and is now excluded from all but the reserve list (we call it the bench) for the Global Income fund. On the other hand, Nestlé forms part of both our Global Income and Global Equity portfolios. From their latest annual reports, AB Inbev have achieved a c.14% improvement in water efficiency since 2017 and are targeting 100% of their communities in high stress areas to have measurably improved water availability and quality by 2025. Nestlé have achieved c.32% reduction in direct water withdrawal per tonne of product since 2010 in manufacturing operations, monitor 100% of discharged water for quality, and aim to have zero environmental impact by 2030, including water sustainability and efficiency across all operations. Of course, it is useful that companies publish their ESG facts, figures and targets in their reports, but for us this is the first step. We must then analyse and assess them as part of an all-inclusive approach to see if we feel that the companies in our universe are doing enough to justify their place.

In the case of AB Inbev, in 2021 we downgraded their ESG score for various reasons, one of which was based on their reporting around water stewardship. Whilst we were generally happy with their water stewardship performance to date, their lack of long-term planning for the future informed part of our decision-making process. A downgrade of this nature raises a flag and presents our ESG team with an opportunity to engage with companies, which we did with AB Inbev in both 2021 and 2022. Ultimately, the downgrade and engagement outcomes fed into a wider investment decision leading to a full exit of our combined holding in AB Inbev across 2021/22. For Nestlé, we engaged with them twice in 2021, and three times in 2022. All occasions gave us the opportunity to drill down into their plans around climate change and water stewardship, helping inform our investment decisions. At the other end of the scale, considering new ideas, the investment team recently analysed and swiftly excluded a large US beer producer from our investable universe. One of the major reasons was because their ESG reporting was practically non-existent and so presented a huge weakness as we built an investment case when comparing them to their peers in the industry.

At Evenlode, we will continue to deepen our ESG analysis and escalate our engagement efforts on behalf of our clients to ensure that our investee companies are responsible. Company decisions and action around disclosure, engagement and measurable action on their water stewardship policies will contribute to our holistic ESG decision making. In turn, that forms a large part of our broader investment view and ultimately helps evaluate our decisions on whether we introduce, increase, decrease, or eliminate positions within our portfolios and wider investment universe.

To summarise, Nigel Topping, a UK High Level Climate Action Champion put things perfectly:

“In the Race to Zero, we cannot afford to neglect water security. Water must be at the front and centre of corporate climate strategies. Decarbonising water use and treatment will significantly contribute to reducing emissions, and wastewater is a huge untapped source of renewable energy. Meanwhile wetlands are a huge carbon sink, storing more carbon than most terrestrial ecosystems. The private sector has a vital role to play in the transition to a water-secure, net-zero world.”^viii

Ben Armitage, Investment Analyst
2022

Please note, these views represent the opinions of the Evenlode Team as of 2022 and do not constitute investment advice. Where opinions are expressed, they are based on current market conditions, they may differ from those of other investment professionals and are subject to change without notice. This document is not intended as a recommendation to invest in any particular asset class, security or strategy. The information provided is for illustrative purposes only and should not be relied upon as a recommendation to buy or sell securities. Every effort is taken to ensure the accuracy of the data in this document, but no warranties are given.