The business case for water investments: could multinationals find the cash?

Alex Money, in Environmental Finance

Might multinationals be persuaded to invest in water infrastructure in the growth markets of the future? It might make sense for them as well as for their potential customers, suggests Alex Money.

As a factor of production water is unique: essential, irreplaceable, without substitute and in limited supply. And, while unlike oil, copper, pork bellies or other traded commodities, there is no global clearing price for water, its value – from an economic, environmental, social or political perspective – is increasingly appreciated. But underinvestment risks water supply crises – identified for the first time this year as one of the top five risks by the World Economic Forum in its annual Global Risks report.

The business of water abstraction, treatment, storage and distribution requires large capital investments. In general terms, there is a greater per capita deficit of this infrastructure in the emerging markets than in the developed world. However, it is in these emerging markets that great economic potential lies. The dramatic expansion of mass consumer markets in the South provides burgeoning opportunities for globalised businesses that can combine sophisticated supply chain management with deep marketing budgets. And if the emerging markets were attractive before, then the 2007-8 financial crisis and its aftermath, which has pushed the locus of global growth further towards the South, has only amplified this trend.

Furthermore, the demographic dynamics of the industrialising South have dramatic implications for water scarcity and food security. For instance the population of Africa, which is currently a little over one billion, is expected to double in the next 35 years. Meanwhile, statistics from the UN suggest that urbanisation has increased from 30% in the 1950s to over 50% today, and is likely to be 60% by 2030. Over nine-tenths of this growth in urbanisation will occur in emerging countries. Coupled with the population expansion, this implies a dramatic increase in the strain on their urban water and sanitation infrastructure networks, which are in many cases already buckling.

In addition, the environmental risks of climate change certainly do not need to be rehearsed here, but it is worth pointing out that the resulting changing in patterns of precipitation – and likely increases in extreme weather events – places further strain on water infrastructure, particularly in terms of storage, which is typically one of the most capital-intensive components of the network.

“The globalised companies that are best positioned to benefit from emerging market consumption are also sufficiently capitalised to make the investments required in water infrastructure”

Meanwhile, economic growth and the emergence of mass consumption in the emerging markets present attractive opportunities for globalised businesses, especially when contrasted with the anaemic outlook for the post-industrial world. However, the water infrastructure networks in these emerging markets, which typically require years of substantial capital investment, are already under strain. Population growth and migration will only increase the pressure, while climate change presents a potent additional risk.

The obvious solution would be to expand water infrastructure in emerging markets, as the expected returns from this investment should be attractive, given the outlook. Indeed, a recent report for HSBC from Frontier Economics found that, on average, a $1 investment in promoting universal access to water returned just under $5 – and $16 in Latin America.

The problem, however, is that in the post-financial crisis world, there is a funding gap. Sovereign balance sheets are insufficiently capitalised to prioritise this investment, while risk aversion and uncertainty appears to impede private sector lending at the scale required.

However, embedded in this challenge is great opportunity. The globalised companies that are best positioned to benefit from emerging market consumption are also sufficiently capitalised to make the investments required in water infrastructure. The question is, what will induce them to do so?

The answer lies in the investments themselves, which can create value beyond their pure financial return, such as improving health outcomes for citizens, raising national productivity and so on. If national authorities recognise this ‘positive externality’ that their country could benefit from – which is often actually much easier to quantify than the value of water itself – and are willing to share this value with the investing company, for example by offering them fiscal incentives, this could catalyse investments that would not otherwise take place.

Companies could moreover justify their capital expenditures to shareholders not just from the direct benefit, but also from a shared value creation perspective. After all, the citizens whose quality of life they will undoubtedly help improve will likely be the customers of the future.

What is needed are two fresh perspectives. First, governments need to revisit environmental supply-side economics from a post-crisis viewpoint. Facilitating investment in supply through incentives and liberalisation may be more effective as a policy tool than demand management through control and regulation. Second, companies need to think about their water costs less in terms of the profit and loss, and more in terms of the balance sheet. A meeting of minds is then surely possible. EF

Alex Money is a researcher in the School of Geography and the Environment at the University of Oxford, with a focus on corporate water risk. E-mail:alex.money@ouce.ox.ac.uk.

The University of Oxford will be hosting the Re¦Source 2012 event in Oxford on 12-13 July, a forum to bring together policy-makers, business people and investors to address natural resources issues. See www.resource2012.org

 

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