- Water conflicts are on the rise, according to Pacific Institute data. The World Economic Forum ranks water crises as higher in impact than infectious diseases. As part of our ESG Evaluation, we assess a company's preparedness to face emerging and strategic risks--and water crises are an important consideration.
- As countries respond to water crises, geopolitical and social risks can emerge. For example, India and China are currently in a dispute over the planned construction of the Diamer-Bhasha dam in Pakistan-administered Kashmir. Egypt, Ethiopia, and Sudan are seeking intervention from the United Nations (UN) into a dispute over a dam in Ethiopia.
- The Taskforce for Climate-Related Financial Disclosures (TCFD) asks that business leaders disclose to investors how climate change might affect their businesses. Yet physical risks can indirectly affect businesses via the impact of water scarcity on communities and geopolitics, which can lead to under-reporting of climate risks in financial disclosures.
- Water crises stand to worsen as the climate changes, leading to more disputes and possible conflicts particularly when two sovereign entities compete for water from the same geological basin. That said, not all transboundary water disputes result in violent conflict, and some can be resolved via financial agreements.
As climate change warms the planet, it is reducing the capacity of glaciers to store fresh water in winter for release in spring and summer. This is also increasing volatility in water volumes, which can cause extreme floods. The flood-drought cycle has begun to play out more noticeably in recent years, leading to an increase in cross-border water disputes and conflicts.
In our ESG Evaluations, we assess an entity's board and management teams' preparedness to face emerging and strategic ESG risks such as water conflicts. We also look at a company's ability to understand and manage its water risks throughout its network of suppliers, customers, and other key stakeholders, known as value chain analysis.
Water conflicts seem to be headlining more than ever in 2020. China and India are in dispute over a dam in Pakistan, while Egypt, Sudan, and Ethiopia are seeking the UN's involvement to resolve concerns stemming from the construction of a dam in Ethiopia.
The Grand Renaissance Ethiopian dam will store 74 cubic kilometers of water from the Blue Nile and boast hydroelectric capacity of 6,000 MW, roughly doubling Ethiopia's electricity supply and allowing the nation to export energy to other countries. Egypt, a water scarce country, gets 80% of its water from the Nile and is concerned that the dam puts Ethiopia in control of this resource. Sudan is also located downstream of the dam and relies on the Nile for water.
The recent India-China dispute is over the planned construction of the Diamer-Bhasha dam on the Indus River in Pakistan-administered Kashmir (over which India claims territorial sovereignty). The Indus flows primarily through Pakistan, which has been suffering a water crisis in recent years. Indeed, water use stands at just above the UN's definition of water scarcity: 1,000 cubic meters (m3) per capita per year. At independence, Pakistan had 5,000 m3 per capita. The dam will store 10 cubic kilometers of water, about 50 m3 per capita, so is unlikely to solve Pakistan's water crisis. However, it will serve as a hydropower generator with 4,500 MW capacity bringing low-carbon energy to a nation primarily dependent on coal and natural gas. It is being funded by Power China and built by Pakistan Water and Power Development Authority, in a region that has a long history of conflict.
More broadly, the glacial meltwater and springs that start in the Himalayas are of strategic importance to many Asian countries. Hundreds of millions of lives and livelihoods depend on the mountains' waters, which start small but flow into some of the planet's largest rivers: the Indus, the Ganges, the Yellow, the Mekong, and the Yangtze. Nations relying on glacial waters face new infrastructure needs to better manage water scarcity, especially given that rivers like the Indus are so heavily tapped for economic use--an estimated 95% of the Indus' flow is extracted before it reaches the delta.
According to the OECD, $1.7 trillion of investment is needed to meet the UN's 2030 Sustainable Development Goal of achieving safe drinking water for all--about three times the current level of investment. Debate continues about whether large-scale dams will help meet demands for water in scarce regions.
Water conflicts can lead to heightened social and geopolitical risk
Water scarcity can directly affect businesses such as water utilities, and can also do so indirectly through its impact on geopolitics. We have already highlighted the importance of climate change risk to U.S. water utilities in the municipal bond market (see "Space, The Next Frontier: Spatial Finance and Environmental Sustainability," published Jan. 22, 2020). The India-China and Egypt-Sudan-Ethiopia disputes are another manifestation of water scarcity risk. Disputed political boundaries can transform a water crisis from being purely environmental into the geopolitical and social realm. Conflicts can arise when two political entities share boundaries and compete for water from the same geological basin (such as a river system) and over the coming decades we could see more such conflicts play out on the global stage.
The TCFD asks that business leaders disclose to investors how climate change might affect their businesses. It asks that they consider all physical risks, both acute and chronic. Yet physical risks can indirectly affect businesses via the impact of water scarcity on communities and geopolitics, which could lead to under-reporting of climate risks in financial disclosures. The TCFD may require companies to disclose how these risks could affect their business either directly, or through their customer or supplier networks, under their TCFD commitments.
As part of our ESG Evaluation, we consider the climate scenario analysis companies are asked to do as part of their TCFD disclosures. We view this to be an important way of understanding how companies assess emerging and strategic risks caused by climate change. Climate scenario analysis is still nascent and, by the latest TCFD status report, only 33% of disclosures incorporate physical risk into scenario analysis.
Recorded water conflicts and deaths are on the rise
The Pacific Institute collects information on water-related conflicts around the world, showing how conflicts over water--or attacks on water infrastructure as part of a conflict--can spill into social risk. Some are directly related to disputes over water, such as the 2018 protests in Khorramshahr in Iran. Sometimes it involves largescale damage to infrastructure such that whole communities can be without a water supply. The World Economic Forum's Global Risk Report ranks water crises as higher in impact than infectious diseases.
Conflicts and deaths are increasing according to the Pacific Institute's dataset (see chart 1). This growing trend could be partially explained by it now being easier to track such events using web-based media. The majority of recorded water-related conflicts since 2010 have been in the Middle East and sub-Saharan Africa (see chart 2). These figures exclude deaths in Yemen where an estimated 4,000 people die each year from water-related conflicts and where more than one million have died from cholera outbreaks after critical water infrastructure was destroyed. In some conflicts water is not the cause but is used as a weapon to constrain an enemy's ability to supply troops, as well as to kill or displace civilians.
Violent water conflicts can displace huge populations. In 2018, over one million people fled violence stemming from disputes over water resources and pasture lands in Gedeo and West Guji in Ethiopia. In the Democratic Republic of the Congo, wide-scale domestic and cross-border population displacement and the resulting poor access to fresh water are making the fight against ebola and cholera extremely difficult. While not all water conflicts stem from climate change effects, the warming of the planet could make them more frequent or they could occur in other geographies.
We note that not all transboundary water disputes result in violent conflict--indeed they can result in financial consequences. Rand Water in South Africa is able to extract 2.2 km3 of water from the Lesotho highlands. Under an agreement between the two nations, Rand Water pays South African rand 150 million annually to Lesotho whether or not it uses the water allocation. Water scarcity in South Africa remains a concern.
Could climate scenarios include water conflicts in the future? We could not find any TCFD disclosures on the potential financial impact of geopolitical and social risks stemming from water crises. Sumitomo Mitsui Financial Group conducted a forward-looking scenario analysis on water-related physical climate risks as part of its TCFD disclosures. The group concluded that by 2050 credit costs associated with flooding in Japan could increase by about JPY30 billion-JPY40 billion. At S&P Global Ratings we have done our own flood risk scenario analysis on U.K. residential mortgage-backed securities (RMBS). From our analysis of 101 rated RMBS transactions we found that the residential loans in U.K. RMBS transactions are primarily concentrated in regions that are not exposed to high precipitation. We should see more of these kinds of disclosures as the market starts to integrate water crises into investment analysis.
Potentially high-impact risks such as water conflicts are important in our ESG Evaluations
The current situations in Kashmir and North Africa could spell the start of a wider conflict and crisis, or they could find resolutions with financial consequences. Whatever the outcome, an awareness of potentially high-impact risks is an important consideration in our overall ESG Evaluation of companies. Our Country Risk Atlas also helps us factor into an ESG Evaluation any outsized natural disaster risks, especially for companies headquartered--or with significant operations--in regions where natural disasters are more likely to occur.
Our ESG Evaluation analysis shines a light on whether boards and companies are integrating a full range of emerging and strategic risks into what we assess as an entity's preparedness. We score an entity on its board's awareness, how it assesses the effects of these risks on its business, what action plans the board and management has in place, and how they are embedding these capabilities throughout the organization. Our evaluations seek to understand how the most exposed companies and countries are not just looking at water scarcity today, but how boards will continue to evolve their thinking as the risk becomes more severe. It requires much thoughtful discussion because it exists at the intersection of finance, geopolitics, and science. It is our view that ESG analysis requires forward-looking assessments of uncertain and evolving risks including water scarcity and its impact on all stakeholders.
How do we consider conflicts in our credit ratings?
Conflict and civil unrest are also important considerations in our credit analysis, although small scale clashes might not necessarily weigh on a rating. This is particularly so in sub-Saharan Africa where generally low sovereign credit ratings already factor in fragile domestic and international institutional frameworks, high social and infrastructure needs, and external security risks. Conflicts or external security risks concerning neighboring countries can also weigh on higher rated sovereigns like Saudi Arabia, South Korea, and Israel.
- Future Flooding Represents A Low Risk For U.K. RMBS Ratings, March 19, 2020
- Space, The Next Frontier: Spatial Finance and Environmental Sustainability, Jan. 22, 2020
- Every Drop Counts: Is Water The Most Valuable Liquid Asset? Feb. 28, 2012
This report does not constitute a rating action.
|Primary Credit Analyst:||Beth Burks, London (44) 20-7176-9829;|
|Secondary Contacts:||Michael Wilkins, London (44) 20-7176-3528;|
|Patrice Cochelin, Paris (33) 1-4420-7325;|
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