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From Site Selection magazine, January 2013

The Mispriced Resource

Local challenges and local solutions are key to
assessing and managing global water risk.


y 2025, water withdrawals are expected to increase by 50 percent in developing countries and 18 percent in developed countries. Overall, this is expected to lead to an average gap of 40 percent between current water supply and water demand in 2030 to meet economic and social growth aspirations across the world.

While proactive governments such as those in Mexico, California, South Africa and Jordan have been taking preliminary steps towards better water resource management at the country and basin levels, private-sector companies have mainly focused on improving the water-use efficiency of their production footprint and looking at pilots for water efficiency in different parts of their value chain, often as part of the corporate sustainability agenda. This picture is rapidly changing: Many private-sector companies, particularly in the food and beverage, mining and oil & gas sectors, are rapidly moving the issue of water scarcity from the sustainability agenda to a key business risk consideration.

Many of the growth markets for private-sector companies (such as the Middle East, China, India and parts of Africa) are already seeing severe water scarcities that are only expected to get worse. In these regions, water is a sensitive social and political issue with farmers, who are often the largest water users. Some of these regions also have chronic challenges in sustainable and efficient water use due to weak institutions, lack of funding and low capability levels.

Companies have often underestimated the importance of assessing water as a key business risk as they set up operations across the world and seek to capture the opportunity from growth in these water-stressed regions. Competition for limited resources has limited the ability for growth and even put at risk current operations in many regions. Local water supply has been a challenge for beverage companies in some regions. In others we see herders' interests compete with mining interests, and in some countries there are limits to potash mining.

Value at Stake

Water risk can roughly be categorized as physical, regulatory and reputation risks. While these risks manifest themselves differently, understanding their nature and inter-relation is important in managing and mitigating them.

Physical risks manifest themselves as water interruptions, permanent reductions in water availability and deterioration in water quality. Temporary interruptions are quite common in many countries with significant


waterstress and variability, and in places with poor municipal infrastructure and capability. For example, U.S. electricity companies can suffer significant revenue losses when they can't operate some of their plants during droughts. Climate change and over-extraction of groundwater are making permanent reductions in current supplies a reality in many parts of the world, including California and India. These lead to significant cost of investments in water storage and developing alternate water sources.

In addition, drops in water quality due to falling groundwater levels, salt-water intrusion and pollution have increased the costs of production because more investments in water treatment facilities are required. Moreover, physical risks lead to significant opportunity costs from limits on the ability to grow and real transportation costs that are particularly challenging in fast-growing markets. A textile producer has had to revise its profit forecast by over 20 percent as a result of drought. A paper producer lost several million U.S. dollars after production stoppage in the midst of a drought. And Australian winemakers have seen production losses of over 25 percent because of water scarcity.

Companies also face significant regulatory and pricing risk from their water use — a fact that is not often well appreciated or understood. The common misconception that water has to be a free resource has been around for a long time, and water is usually mispriced. Water generally also makes up only a small portion of production costs, and companies often underestimate their exposure to the future costs of water.

Governments and municipalities across the world are laden with heavy debt levels and are not in a position to afford the water and wastewater investments that they will need to make over the next 20-30 years. They are increasingly choosing to raise water tariffs (particularly industrial ones) to fund their capital programs and improve the financial health of municipalities. For example, Chinese cities have seen tariff increases exceeding 60 percent and further rise is expected. Moreover, in areas with established water trading regimes such as California, reducing water allocations could result in increases in market-based pricing of tradable water rights.

Reputation risk often works in conjunction with regulatory risk to impact the company's brand, influence sales in local and global markets, and put at risk the company's right to operate. There are examples of beverage producers around the world that closed down plants or production as a result of protests or reputational damage, and some mining companies resorted to expensive alternative supply options like desalination in response to public concern or saw their stock prices plummet.

Understanding and Managing Water Risk

Most companies currently do not have a comprehensive global process to assess water risk, and resort to reactive assessments based on local situations. But there are companies who tackle the issue head-on — especially in the food and beverage, mining and oil & gas sectors — and carry out water risk assessments. These assessments are usually on a global level and based on high-level water scarcity projections. As a result, specific local situations that are key to identifying and mitigating the risks might be overlooked, such as the likelihood of water stress for the facility, and the value at stake.

Other site-specific factors include growth in local users, the influence mechanisms and political capital of other users such as farmers and residents, and the local influence of the facility as a contributor to the local economy. These factors are relevant as there are often trade-offs, and other water users might have political clout to influence water pricing and allocation decisions — all of which have an impact on a company's value at stake. Site-specific assessments are therefore very useful, and can be part of regional and global assessments that give a company a good view of its full risk exposure while accounting for local factors.

Seek the Right Level

Once water risk is well understood, it can be managed and mitigated by operating at three levels:

The most direct actions are at the site level. Most proactive and leading companies understand these measures well and are working to address them through site (and company-level) operational water footprint targets. This usually involves technical measures such as water audits, leakage detection, moving to low-water processes such as compressed/chemical washing and dry cooling, and a significant increase in water recycling. While some companies are proactively taking steps to engage stakeholders at the local and regional levels, many companies have not fully become aware of the importance and the potential of stakeholder engagement. It can often be combined with investments and capability building of external stakeholders, e.g. investing in local agricultural efficiency measures, building deeper wells for local communities, training the local utility or government in lean operations or water strategy development. These are often measures that are more cost-effective and long lasting than site-level measures.

Finally, companies need reliable company assessments of their water risk exposure, and mitigation measures across the company portfolio. This includes growth and investment decisions, and large-scale global investments. Companies can also benefit from engaging with global entities such as the Water Resources Group (visit

Some companies may wish to take water management to a more advanced level: Differentiating water by quality level and cascading uses is a next step, as is optimizing not only water use, but also the value — energy, product and chemicals — water carries through a plant. Also, outside a company's four walls there may be options for arbitrage through the use of ecosystem services: The idea is to use nature's services systematically and to pay to protect and maintain these services. For example, water purification is an ecosystem service. Protecting the ecosystem that delivers the clean water may be cheaper than the alternative of building a water treatment plant.

Organizationally, water risk management needs to evolve from being part of the corporate responsibility/sustainability agenda to becoming a core part of business and decision-making processes. It should also inform and drive operational risk assessment, local and global government and community relations, technical and process improvement and supply chain management. Only then will companies be truly well-placed in proactively understanding and managing water as an important business risk.

Sudeep Maitra is an associate principal at McKinsey & Co. Martin Stuchtey is the director of McKinsey & Co.'s sustainability and resource productivity practice.

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