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GreenBiz 101

Will water pricing be the next carbon pricing?

Water prices are artificially low and businesses are adding in shadow prices to get ready for a drought future.

Dollar sign made out of water

Is internal water pricing becoming the norm for companies as droughts increase? Image by Julia Vann/GreenBiz.

The price of water — essential for human life, nature, communities and businesses — is often subsidized, reflecting a commonly held belief that everyone should have abundant access to clean water. But in many locations, those prices don’t reflect the true cost of addressing issues such as water quality or scarcity. That makes it difficult for companies to fully evaluate and account for the business risk of supplies drying up as a result of climate change.

"Water pricing typically bears no relation to how scarce water is or the realities on the ground," said Alexis Morgan, global water stewardship lead for the World Wildlife Fund. "Industry often pays a hugely subsidized cost for water."

Water-stressed regions around the globe are grappling with the realities of climate change’s effects on water availability. In the Western United States, cutbacks to one of the Southwest's most important watersheds, the Colorado River, are imminent and possibly economically crushing to farmers who will have to fallow land, ranchers who will have trouble providing water to cattle, cities that will have to find new sources of drinking water and electricity that comes from hydropower at dams such as Lake Powell. California agriculture lands are straining to access groundwater that used to be plentiful.

The World Economic Forum predicts a 40 percent gap between the global water supply and demand by 2030, and climate change is likely to increase water shortages and competition. Indeed, Barclays analysts estimate that 19-27 percent of industrial withdrawals are from areas with high or extremely high water risk. 

Some companies that want to stay one step ahead of the pressing water crisis are adopting strategies that set higher internal prices on water than what they actually pay to their local utility or municipality. It’s a strategy similar to the policy of setting internal carbon pricing to account for the "cost" of carbon emissions as part of a product or service. Most internal water prices are never actually collected as money but instead used in discussions to evaluate water efficiency investments and decisions — and to help companies achieve their water goals.

According to Morgan, food and beverage companies are the most likely to use internal water prices, because they view water as a crucial ingredient in their products and are sometimes externally charged by water utilities to extract water for production. Other industries such as mining, agriculture and manufacturing  all use water in their operations, but some may not actually pay a utility for that resource. Miners and farmers, for example, can often tap water sources on their property, including groundwater, rivers or lakes. Internal pricing for water would hopefully force these companies to begin considering those costs, potentially changing their behavior or inspiring them to take action to restore those resources. 

"In the same way carbon pricing will put a different thought process around the cost of emitting, that same lens is meant to be applied on the water front," Simon Fischweicher, head of corporations and supply chains at CDP North America, said of water pricing strategies. 

A seldom used approach

Water pricing, however, is a practice that is much less common among corporations than carbon pricing. Will Sarni, founder and CEO of the advisory firm Water Foundry, estimates that adoption of water pricing is about five years behind carbon pricing. A few companies doing it include Nestle, Colgate-Palmolive and Anheuser-Busch InBev; however, all declined to be interviewed for this story. In 2017, CDP reported that Nestle assigned a hypothetical price on water between $1 and $5 per square meter, depending on a few risk factors and found that Colgate evaluates its true cost of water at 2.5 times more than the purchase cost. 

Where Fischweicher anticipates the biggest room for growth in adoption of water pricing is in the investment and financial sectors. According to him, the banking sector has been thorough in outlining the billions or trillions of dollars in oil and gas investments that are at potential risk amid a clean energy transition. The sector has focused far less on the water security side. 

"It’s equally important for the financial sector to be thinking about that water price as they evaluate the companies that are investing in and the projects that they finance. I always try to bring it back to the capital," he said.

Setting an internal water price could encourage companies to reduce freshwater consumption and withdrawals, address wastewater discharge policies and increase investment in water recycling infrastructures, such as Salesforce’s blackwater treatment facility and Bush Beans' local water recycling equipment, according to the experts interviewed for this story.

"[A water price] allows you to more accurately reflect costs," Fischweicher said. "If you understand that with more accuracy, it helps build out the incentivization and backing for investing in more efficiency to prepare for future prices." The idea is to create a monetary incentive to increase water investments to future-proof operations against a water-scarce future. 

How to set an internal water price

According to Fischweicher, the companies embracing internal water pricing as a planning tool are usually using a "shadow" price, where a price is added during discussions and evaluations of water-related business decisions, but no actual money is collected or fee charged internally. Sarni noted that because the water pricing world is so new, there isn’t really a standard approach for setting a price and unlike carbon, there is no credits market to base a price on.

"This will sound bizarre," Sarni said. "But carbon is easy from an accounting perspective. That's not to suggest climate change is easy. But if you're just looking at a ton of carbon, it's pretty straightforward in the scheme of things, and that’s not the case with water." 

Carbon is fungible because a market for carbon avoidance or removal credits has been created, giving internal carbon prices a benchmark to work off, something that hasn’t really happened with water. There isn’t a water credit system or a market for water conservation, quality and efficiency as there is for carbon.

Water is inherently a local issue, and the risk and scarcity are related to local factors. So prices vary more widely, unlike a ton of carbon released into the global atmosphere that creates the same risk no matter where it is released. 

Sarni’s company, Water Foundry, outlined in a presentation about shadow pricing a few ways an internal and local water price can be determined. One way is to find the minimum cost of producing water from alternative sources such as desalination, which often costs 4x the water price in the region. Other methods are more qualitative including determining the current and future water stress for a region or implementing a water risk score to come up with the "true" cost of water for a given location. 

A Barclay’s report suggested equalizing water costs across emerging and developing areas while factoring in the cost of droughts, floods or other extreme water events, reputational damage and impacts of water shortages. Its model suggests the true cost of water is three to five times more than reported by companies.  

Several organizations have developed tools to help companies create an internal water price. WWF’s Water and Value Tool (WAVE) is a model that looks to calculate a business’s operational risk related to water shortages by using a scenario model based on data from frameworks, databases and other research documents. The Smart Water Navigator, created by Ecolab, a company that specializes in water treatment, purification, efficiency, cleaning and hygiene for businesses, is a free public platform where you can look up the water risk of certain areas based on local conditions. The algorithm considers biodiversity, environmental issues, ecosystem services, health impacts and recreational services to calculate a premium for the local water price that accurately reflects the actual cost of using the water.

This will sound bizarre. But carbon is easy from an accounting perspective. If you're just looking at a ton of carbon, that’s not the case with water. it's pretty straightforward.

Ecolab Chief Sustainability Officer Emilio Tenuta said that the tool has been very popular with ESG investors, who use it when evaluating a company’s proposed new facility location or development. For example, for a site in Bangalore, the current water bill price is just 21 cents per cubic meter. But according to the Smart Water Navigator’s risk calculations, the price should be $2.62. 

Another tool from Ecolab, the water risk monetizer, looks at the other side, helping companies uncover the gap between what they are paying for water and its true value to their options. 

What does a water price do?

Just like an internal carbon price, water pricing helps executives who usually think in dollars account for a more subjective and qualitative risk. It is a metric for translation. It helps put in money terms protecting a watershed or river and having better water stewardship practices. But it can also encourage investment in new technologies that can use water more efficiently. According to Fischweicher, right now most of the focus on water is about compliance and regulation, a.k.a. not polluting. 

"When you look at how cheap water generally is, as a business there is less incentive to invest in technology that is going to reduce water use or increase the water recycling rate," Fischweicher said. "[Water pricing] can be a tool for companies to demonstrate the return on investment translated into dollars."

The other way to use water pricing is as a risk analysis when a company is investing in a new project, building a new facility or creating a new product. According to Fischweicher, the price helps companies understand the increasing expense of doing that work or industrial activity in that region in the future. 

Where water pricing falls short

While an internal water price can help companies more accurately account for some costs in the future, there are still ways this framework fails. Adding a higher price to water does not encapsulate the actual issues that come with water availability and quality in a climate change-stressed environment. It isn’t just that water will be more expensive — it might not be available at all or there might be too much of it, Morgan noted. Droughts could cause production to be cut or cause farmers to fallow land. Floods could shut down factories completely for a few weeks, keeping products from reaching the market.

According to an CDP white paper published in 2019, one of the world’s largest mining companies, Anglo American, experienced a 28 percent drop in production due to the 2019 drought in Chile; Unilever had higher costs and a slowdown in production of the soy oil used in Hellmann’s products due to water quality issues in the Mississippi River Basin; and in China in 2017, several manufacturers had to reduce capacity because of water pollution. According to Morgan, there’s nothing a shadow price on water can do to future-proof against that type of loss. 

Another issue Morgan has with water pricing: Is a water price really just a different sort of carbon price? "Because if you run out of water, the question is, where are you going to get water from, right?" he said. "Where are you going to get water from is somewhere far away. Somewhere far away means you're going to have to use a lot of energy to get it to wherever you need it."

Transporting water, desalinating it, digging new groundwater wells or creating longer piping, purifying rainfall — all of these processes could be energy infrastructure costs covered by a carbon price born out of a water scarcity issue, Morgan said.

But Ecolab’s Tenuta doesn’t think a carbon price alone fully reflects the human health, environment and biodiversity issues associated with water scarcity and quality issues along with the future energy treatment costs, which is why he advocates for a more nuanced water pricing structure. Either way, it's time for companies to dive more deeply into how water relates to their broader environmental, social and governance mandates.

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