Tools and policies for understanding water risks in China

[Editor's note: This is the second in a two-part series that examines the water risks and solutions facing Chinese supply chains.]

In my last article, I summarized the enormous water challenges facing the Chinese economy and what it means for companies that source from Chinese manufacturers.

Let's now look at the brighter side -- the enlightened regulatory efforts and new tools and resources available to help companies understand and address water risk facing their Chinese suppliers.

On the policy side, the Chinese government finally appears to giving much more than lip service to calls for protecting freshwater through improved regulation and enforcement.

A significant step forward was the government's 12th five-year plan released in 2011, which set a target to improve industrial water efficiency by 30 percent by the end of 2015. It also set goals for water quality improvements, including a 15 percent reduction in heavy metals discharged and an 8 percent reduction in organic water pollution.

The Ministry of Water Resources since has released an even more aggressive long-term vision for water management in the country, called the "Three Red Lines" policy. Essentially, this policy sets absolute limits for national water use and ambient water quality, in addition to targets for efficiency through 2030. These targets are then to be subdivided to the provincial and local levels, and tied to the performance objectives for officials.

Despite these efforts, it's clear that uncertainty and poor enforcement still lie at the heart of China's water policies. For one, China's water governance system is sprawling and fragmented. At least five ministries are responsible for managing water resources in some way, creating coordination issues and redundancies that are inefficient, not to mention confusing for the operations manager who needs to engage with the government.

Amid the uncertainty, a few broad trends are still evident. Companies should expect increased regulation, stricter enforcement, more stringent water use caps and higher fees for non-compliance. Water tariffs certainly will rise, affecting operating costs and margins. Shanghai is a case in point: In October 2012, it unveiled a strict water management system that will increase monitoring of companies and will require industry to use 30 percent less water compared to a 2010 baseline.

Water prices for industry may increase substantially for two main reasons. Increasing residential prices is politically unattractive and ethically dubious from a human rights perspective. At the same time, research shows water demand decreases only after a relatively high price threshold is breached. While analyses of potential rate impacts are hard to find, some experts are warning that the textile industry should expect hikes in water tariffs of 300 to 500 percent.

High polluting sectors also will face more incentive to invest in reducing their discharges. Right now, just six sectors -- pulp and paper, food, chemicals, textiles, tanning and mining -- collectively account for nearly 90 percent of industrial chemical oxygen demand but only 30 percent of gross industrial output.

Next page: Tools and resources