Water scarcity presents risk for investors, but opportunity too

Credit Suisse has highlighted the 'perfect margin squeeze' for agribusinesses and primary producers presented by water scarcity but efficiency innovation continues to present investment opportunities.

A lot has been said and written about the risk that climate change and drought poses to agriculture, especially in Australia, but a report from Credit Suisse last week laid bare the challenge in stark terms.

“The potential cost of water stress should not be underestimated, in our view,” the report said. “The World Bank has estimated that water scarcity exacerbated by climate change could cost some regions more than 6 percent of gross domestic product by 2050.”

Developed countries are not immune to this challenge. Agri Investor sat down with one of the report’s co-authors, Credit Suisse’s head of ESG research in Australia Phineas Glover, to discuss the implications for agriculture Down Under.

Glover said that the Water Scarcity: Addressing the key challenges report drew on a raft of existing reports and research, to reach its conclusions on the impact that climate change is having on water scarcity. He said the approach resulted in a clear view that water stress and climate change are “inextricably linked” with disrupted rainfall patterns, which means the “wet become wetter and the dry become drier”, even if overall global rainfall volumes do not necessarily decline.

This increased water scarcity causes what Glover calls a “perfect margin squeeze” for agribusinesses and primary producers.

“Your yields and volume both decline, and the price you can achieve for your produce declines because quality generally declines – and this is at the same time you have a huge increase in cost, through primarily water costs increasing,” he said.

Glover also said that he believes agriculture investments in Australia, and more generally in areas where climate change is having an immediate impact, are higher risk than investors perceive.

Discussing public equities where Glover primarily does his research, he said: “I think the public markets are still treating these as one-off events, with terminology like one-in-50 or one-in-20-year events [for droughts]. There’s a mindset of looking backwards at how statistically probable events are, without recognizing that this is a secular trend and thinking about risk in a completely different way.”

Glover said it is Credit Suisse’s view that water prices will continue to trend upwards in Australia, notwithstanding the current period of drought that has helped to drive up temporary water prices in the Murray-Darling Basin.

“We believe you’ll start to see more focus on the price people have to pay for water. One thing that’s been suggested is a tiered approach to pricing water, with higher charges for households that use more than the average,” he said.

He also noted that commercial enterprises like mines and farms pay less for water on a per-kiloliter basis than households currently: A$2.11 ($1.42; €1.28) per KL for households compared with the average commercial spot price of A$0.71 per KL for 2019-20 so far.

The figures show that water-intensive commercial farming and mining operations are paying less than households, even in a one-in-100-year drought, and while there may be good reasons for that, it is reasonable to question how sustainable that is in the long term, economically or politically.

Even a cursory glance at the submissions published on the Australian Competition and Consumer Commission’s website this week from its inquiry into water trading in the Murray-Darling Basin, is enough to show the strength of ill feeling among individuals when water scarcity and high pricing combine.

Despite the risks of more frequent and more severe droughts, coupled with higher water prices, Glover points out that the need to tackle water scarcity is a “big opportunity” for investors, too, especially in agriculture.

“Decarbonization of energy continues to be one of the largest investment opportunities of our generation for companies with good ideas and breakthrough technologies.

“It’s the same for water – what will be interesting is to see how that evolves, not just in terms of infrastructure projects, but in how you can improve sectors like agriculture, where large areas are still not particularly water efficient.”

Contact the author at daniel.k@peimedia.com