Some of these external water costs already are being internalized and hitting bottom lines: Just last year, the worst drought in the United States in 50 years sent commodity prices skyrocketing. Companies, especially those in the food, beverage and apparel sectors whose margins and supply chains are tightly linked to agricultural commodities, can use the true cost of water to get ahead of the trend of external costs increasingly being internalized through regulations, pricing or shortages.
Gaps in pricing and supply create opportunities
Most raw materials that businesses depend on require water. However, a gap already exists between water supply and demand, and by 2030 water demand will exceed supply by 40 percent.
Part of the problem is that water is not correctly valued, and this is creating perverse market incentives. For example, around half of China’s industrial output and 40 percent of its water-intensive agricultural products are produced in 11 of the country’s driest regions, comparable in water scarcity to those of the Middle East. Because the price of water in these regions is among the lowest in the world, the market creates an incentive for retailers and manufacturers to outsource services to this water-scarce region, despite the high risk of drought or damage to long-term water supplies.
In fact, because water assets are overexploited and undervalued in many countries, this creates an opportunity for forward-thinking businesses to use external environmental costs to inform their business strategies. For example, Yarra Valley Water recently calculated the true environmental costs of water to better understand how to allocate its own water resources. The results are highlighted in a white paper authored by Trucost, Valuing Water to Drive More Effective Decisions, which aims to spark discussion around integrating the true cost of water into the decision-making of companies and regulators.
Applying the true cost of water for business optimization
Trucost estimates the true cost of one cubic meter of water ranges between $0.10 where it is plentiful and $15 in areas of extreme scarcity (see Figure 1). Businesses can take advantage of this wide range and align water use with its availability to evaluate new infrastructure investments, procurement strategies and product portfolios.
For example, a business can include the true value of water — not just its current market price — alongside traditionally costed items in capital budgeting and adjust the net present value (NPV) of cap-ex investments. Figure 2 shows how applying economic values to projected water consumption and deducting the “environmental costs” from future cash flows can reveal which option has a lower risk. For instance, Yarra Valley Water found that each m3 of water conserved delivers $6 through avoided damages to the environment. So, selecting Project A, which uses 1 million m3 less water annually than Project B, would save it $6 million in environmental costs.
As another example, water valuations can be used to identify strategic sourcing partners and supply chain collaborations. We analysed the water intensity of fruit used in a range of juices. The valuation illustrated the risks by fruit as well as by region, and identified opportunities to shift fruit production to an orchard in a less water-scarce region.
Water valuations also can be used to map commodity flows and quantify risks across a company’s brand portfolio or business unit. Figure 3 illustrates how water valuation can highlight unsustainable water use across multiple FMCG product categories. Somewhat surprisingly, the product categories with the largest water footprints were not always the same as those with the greatest water risk intensity. In this case, water valuation and value chain hot-spotting pinpointed opportunities to invest in new technologies and strategic sourcing efforts to manage commodity risk.
Understanding the true cost of water is a growing global trend in corporate natural capital valuation. This month, 90 companies are joining a WAVES Partnership in the U.S. to explore natural capital accounting. Forward thinking companies like these that take account of their natural capital dependencies will benefit from a more complete picture of the most effective ways to allocate water and other resources that are under steadily growing pressure.
This blog has been produced exclusively for GreenBiz.