While it is widely recognised that agriculture is the largest global user of water, supply of and demand for water by basin and crop vary considerably.
Companies that rely on a variety of raw material inputs from agricultural commodities such as cotton, wheat and sugar are subject to different water risks depending on local context and crop production practices. Basin water risk is not only linked to how a producer could affect others downstream (impacts) but how reliant they are on others upstream (dependencies).
Water risk comes in several forms. A company can be exposed to physical, regulatory and reputational water risks through its agricultural operations and supply chains, which can manifest in financial impact.
Physical water risks in agricultural supply chains occur when there is insufficient water for growing crops or the quality of the water is too poor for irrigation. Overabundance (including flooding and inundation) can also cause crop failure in some regions. Water scarcity risks can derive from arid conditions (generally or during periods of drought) or supply and demand imbalances.
Regulatory risk can create restrictions (prioritising water for one user over another), unanticipated or arbitrary changes to water allocations or effluent discharge limits. For example, a regulatory decision to develop new irrigation schemes upstream could divert water away or negatively affect the water quality of existing supply chain sourcing areas. Poorly implemented regulation over pollution and poor water quality can generate unforeseen costs and create additional physical and reputational risks. Effective policy and regulatory frameworks are essential for addressing water risks from river basin conditions. In basins where water is managed well, unexpected changes are less likely, as flows and quality are more consistent, predictable and, therefore, less risky.
Reputational water risks and reputational damage occur when companies, including their supply chains, are associated with negative impacts of poor water management on communities or ecosystems. Conversely, companies can gain positive reputational benefits from proactive measures to reduce impacts or contribute to improved local water security. Reputational damage can impact brand value and product sales. It can also result in political pressure and lobbying, which can lead to regulatory risks. For some companies, reputational damage is limited to local communities and political processes. However, reputational damage can extend across countries and create a global backlash for multinational companies with strong brand identities or those operating in contentious sectors.
Defining water risk
Agricultural exposure to water risk can be assessed through different lenses. Investors often refer to water risk in the context of water stress or scarcity only. Before analysing agricultural exposure to water risk, it is important to understand the following terms:
Water risk: The possibility of an entity experiencing a water-related challenge (e.g. water scarcity, water stress, flooding, infrastructure decay, drought). The extent of risk is a function of the likelihood of a specific challenge occurring and the severity of the impact created. The severity of impact depends on the intensity of the challenge, as well as the vulnerability of the actor.
Water scarcity: The volumetric abundance, or lack thereof, of freshwater resources. Scarcity is a function of the volume of human water consumption relative to the volume of water resources in a given area.
Water stress: The ability, or lack thereof, to meet human and ecological demand for freshwater. Water stress is a more inclusive and broader concept than water scarcity. It considers several physical aspects related to water resources including availability, quality and accessibility (i.e. whether people are able to make use of available water supplies), which is often dependent on infrastructure and the affordability of water, among other factors.
Water risk exposure in agriculture
Agriculture withdraws 70% of the world’s freshwater. Research by the PRI, WWF and PwC in 2014 found that the food, beverage and apparel sectors are reliant on agricultural commodity raw materials from regions facing high levels of water stress. Agricultural products, food retail, packaged foods and meats, and soft drink companies were found to be the highest users of water-scarce regions. This prompted investors to be concerned about water dependency and the risks impacting company supply chains. For example, Heineken NV disclosed that 90% of the water used to make its product stems from its agricultural supply chain. This is a significant physical risk for companies that are dependent on raw commodities from specific regions.
|Crop||Low risk||Medium risk||High risk|
|Mangoes, mangosteens and guavas||9%||53%||38%|
|Cucumbers and gherkins||8%||69%||23%|
|Tangerines, mandarins, clementines and satsumas||12%||66%||22%|
|Green chillies and peppers||8%||72%||20%|
|Peaches and nectarines||9%||71%||20%|
|Cabbages and other brassicas||15%||65%||20%|
|Country||% cropland at high water risk|
Both irrigated and rainfed agriculture are exposed to water risk. With water stress levels expected to rise globally, pressure will increase on companies that rely on agricultural inputs. As of 2012, irrigated land accounted for 20% of arable land and 40% of all food production. The other 80% of rainfed cropland that produces 60% of the world fs food could experience rainfall variability - timing, locational shifts and temperature changes. Crop yields may be affected by water stress, flooding or pollution, which could exacerbate non-physical water risks (e.g. increased regulatory water risk). Figure 1 shows how overall water risk for crops varies globally.
The countries with the most cropland at high water risk are presented in Table 1. The analysis overlays the agricultural risk score within the Water Risk Filter with global cropland extent15. It identifies the proportion of total cropland area that is at high water risk by country. The overall risk score is a combination of weighted physical, regulatory and reputational risk factors to reflect the specific risk in the agriculture sector. On a scale of one to five, low risk is defined as ≤2.33, medium risk is >2.33 and < 3.66 and high risk is ≤3.66.
Only countries that cumulatively account for 95% of total global production of crops (in tonnes, source: FAOSTAT) were included in the analysis; countries with almost 0% cropland at high water risk were excluded. The water risk data represents the long-term condition in catchments, with some influence from recent droughts, so does not reflect the extent or severity of current droughts. As it is calculated at a country level, countries with some high water risk areas, but which only account for a near-zero proportion of total cropland, are not represented in the table (e.g. Brazil and Australia).
A comprehensive assessment of a company’s agricultural supply chain water risk requires understanding a company’s:
- Water dependence: Operational and financial risk exposure from company reliance on water resources, including through crop varieties, water use intensity of the crop and the type of water delivery (irrigated versus rainfed).
- Geographic water security: Where it is grown (i.e., its context . whether it is located in a high water risk basin); and the physical, regulatory and reputational risks that may affect current and future water use.
- Management response: What mitigation actions have been taken at the farm and basin levels; and what actions have been taken at the corporate level to support supply chain awareness and resilience/capacity building.
Some of the most significant global crops (such as wheat, rice and cotton) with high economic trade value or production volumes are grown in countries exposed to high water risk (see Table 2). The global average of the world’s cropland estimated to be at high water risk is 7%. Therefore, crops with over 7% of production in high water risk areas are disproportionately exposed to water risks. A crop’s water footprint consists of the quantity of water required for producing the commodity and the amount of water required to dilute the pollution produced - but the broader context of water availability and quality in the basin in which it is grown must also be considered. It is important to note that the water footprint and water intensity for the same crop will differ depending on where and how it is grown, as will yields.
It is difficult to obtain an accurate and robust dataset on which companies are most exposed through their supply chains and are reliant on crops that are the most waterintensive and grown in high water risk basins. Many companies do not have full traceability of their own supply chains and water risk exposure is difficult to gauge for companies with multiple tiers and multiple raw materials to consider, as this level of granular data is not available. Data on how a site responds to water risk is also not readily available. Best practice involves first determining which commodities are most material to a company and then assessing water risk and water stewardship response using a geographically weighted average of production. Enhanced input data means that companies can generate better water risk assessments.
Company water risk is not only connected to water dependency and geographic water security; understanding how companies respond and manage their basin water dependency and water-related impacts is critical. Investors need to determine whether companies are investing in solutions such as increasing operational efficiency and taking a catchment-based approach to help mitigate basin risks. Those companies that are exposed to basin risk, but are more resilient, are more likely to outperform their peers.
Water risk hedging versus risk mitigation: Should companies simply diversify their supply?
Investors should pay closer attention to companies that do not have robust water stewardship approaches. Some water risks might be managed through procurement strategies; for example, where supply chains are disrupted by weather events or water allocation problems, water risk can be diversified by sourcing the same crops from multiple areas. However, this strategy does not apply to reputational risks where even sourcing a small quantity or proportion of overall volume from areas with environmental or social issues can impact a company’s reputation. Where sourcing areas are relatively constrained (by climate, soils, infrastructure etc.) and in high water risk areas, investors should encourage businesses to engage at the supplier, catchment and governance levels to help mitigate those risks.
As well as diversification of commodity procurement, many companies have opted to implement supplier codes of conduct, employed sustainability standards or implemented certification standards. The key issue for businesses to consider in this context is whether the certification standards for commodities are addressing the relevant water risks for that crop’s context.
How material is agricultural water risk to companies?
For a company sourcing agricultural commodities, water risk can materialise as impacts to financial statements through operations and supply chain disruptions, negative impacts on capital assets and increased commodity prices (see Figure 2). Examples of companies disclosing detrimental financial water impacts are cited below. The financial implications are caused by physical, regulatory and reputational water risks, which can affect a company’s supply chain security and potential business growth. Supply chain disruption was one of the top five risks highlighted by companies in their CDP responses in 2017.
Examples of financial water impacts
- In 2016, Illovo Sugar reported a 36.5% drop in profits partly due to the drought across southern Africa causing a delay in sugar production.
- Associated British Foods experienced a financial impact of almost US$25 million due to two consecutive years of below-average rainfall in the Pongola-Umzimkulu river basin. The sugarcane quality and yield were negatively affected: the 2015/16 sugarcane crop closed at 4 million tonnes - approximately one million tonnes less than the 10-year average - and the cane contained a lower percentage of sugar.
Linking water risk to shareholder value and business strategy
Figure 2 shows the link between contextual status, water risk, risk mitigation response (stewardship) and impacts on value (financial or otherwise) and the connection to business strategy.
When engaging with a company on agricultural supply chain water risks, investors seek to understand what the associated water risks for a company are (including where in the supply chain these risks occur), how much value is potentially at risk and how they are managing those risks today and in the future. It is important to consider the company’s future business strategy (e.g. expansion into new markets or products) and potential water risks that could affect future production and revenue. For example, a company’s main agricultural sourcing regions may experience changes in water availability, quality, regulation, climate and demand or competition for water in the future. Any of these changes may not only impact the company’s water use, but also impact the company’s ability to generate expected shareholder returns or service loans.
While good corporate governance can be indicative of a transparent and accountable company that recognises and manages water risk, it is not a proxy for how the company is managing its supply chain water risk. Investors expect there to be oversight of water risks for direct operations and supply chains at the board and senior management levels. However, companies should integrate water risk into their business strategies and not view water stewardship as an exercise in improving efficiency and brand management.
Why should investors engage on water risk?
Water is a material risk to companies and reasons for why investors should care are articulated in the PRI’s investor guidance on water risks in agricultural supply chains. The topic is material to all investors with holdings in companies in the food, beverage, apparel and retail sectors due to their heavy reliance on water through direct and indirect operations. Investors holding these companies directly (for example, through public and private equity or bonds) are exposed to water risk.
However, investors with long-term and diversified portfolios are also exposed as universal owners. This means their portfolios are exposed to the wider environmental externalities caused by other companies in the same or different sectors. Through this broader market exposure, investors may be concerned about a company operating in a specific basin with poor water management practices. This may have an impact on other businesses operating in the region, which are directly or indirectly linked to investor portfolios.
Recent academic research based on collaborative engagements coordinated by the PRI shows that successful engagement improves company profitability and that unsuccessful engagements experience no change in return on assets or in shareholding. Structured engagements with companies can help reduce risks and create opportunities for those directly held by investors through encouragement to improve corporate water management and disclosure of long-term water risk in agricultural supply chains. Engagement can also reduce risks at the basin level, a positive outcome for universal owners exposed to that region.
PRI-coordinated collaboration engagement
The PRI-coordinated collaborative engagement on water risks in agricultural supply chains was launched in 2014, with 41 global investors representing US$5.7 trillion in AUM. The investors engaged with 32 companies in the food, beverage and apparel sectors on their water risk management and disclosure of agricultural supply chains. This included three agricultural product companies, 21 food and beverage companies, four apparel and luxury goods companies, and four retailers.
A public disclosure benchmark was conducted in 2015 and 2017 using 25 indicators developed by the PRI Water Risk Advisory Committee. The indicators reflected a company fs awareness and acknowledgement of water risk in agricultural supply chains, assessment of impact, policies and strategies, and disclosure. The results showed that:
- 84% of the 32 companies benchmarked improved their disclosure of water risks in agricultural supply chains in 2017;
- the company that made the most progress boosted its disclosure score by 44%; and
- Retailers were the biggest laggards in terms of disclosure, with one company seeing its score drop by 71%.
Other relevant investor initiatives and resources
- CDP Global Water Report is an annual analysis of the CDP water response data from large publiclylisted companies. It presents key trends and company actions to address water security.
- Ceres Investor Water Toolkit is a resource to evaluate and act on water risks in investment portfolios. It includes links to resources, databases, case studies and other tools for all investors to use, from pension funds to endowments and asset managers.
- Ceres: Feeding Ourselves Thirsty is a report that benchmarks over 40 companies in the packaged food, beverage, agricultural products and meat sectors on how they are responding to water risks. The first benchmark was conducted in 2015 and progress was assessed again in 2017. Four categories of water management were used to assess the companies. This report has also been used by a Ceres-WWF led initiative called the AgWater Challenge that has sought to recognise agricultural supply chain water commitments.
- Ceres Aqua Gauge is a tool for investors to score a company’s water management activities against leading practice for direct operations and supply chains. It allows investors to interpret and evaluate the information provided by companies across different sectors on their management of water issues.
- Interfaith Center on Corporate Responsibility (ICCR) is a faith and values-driven investor membership organisation. It has a water engagement program with high-impact sectors including food and agri-business, energy production, automotive, mining, apparel and chemical companies.
- GES Water Stewardship Engagement: Benchmarking Report is an investor engagement and associated research report covering the food, beverage, mining and apparel sectors. The benchmark indicators cover direct operations and supply chain.
Download the full report
Investor guide on water risks in agricultural supply chains
Growing water risk resilience: an investor guide on agricultural supply chains
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What is agricultural supply chain water risk?