Poisoned wells

Another water risk

“I have repeatedly said that green mountains and clear water are as good as mountains of gold and silver.” So insisted Xi Jinping in his opening address to the G20 summit in Hangzhou this month.

The evening before, China and the US had jointly announced their intention to ratify the Paris climate change agreement in a move which may allow the deal to come into force later this year. As WiC has written many times before, China is the world’s largest greenhouse gas emitter and much of that is down to its use of coal for 70% of its power generation.

Xi has pledged to cut coal capacity by one billion tonnes over the next three to five years and analysts believe government measures may, finally, be starting to take effect. Earlier this year, working days at mines were reduced from 330 to a 276 day cap per year and production fell 14% in the second quarter year-on-year as a consequence.

China’s coal policy has a huge impact too on the country’s limited water resources since the pollution it discharges seeps into the water tables. It is just as environmentally damaging, albeit less visibly so, to the degradation of the country’s air by burning coal. On top of that, almost one fifth of the country’s freshwater is consumed by the coal mining sector. As a new report by China Water Risk outlines, the country’s largest coal miners are often based too in the most water-stressed areas (for example, in the Ordos-Datong-Batou region straddling Inner Mongolia and Shanxi).

In its report, the Hong Kong-based group tells fund managers they need to pay more attention to water-related risks when making their stock picks. The group canvassed 70 fund managers of whom half came from Asia and the rest largely from Europe. Of the total, 23% ran funds mandated to make socially-responsible investments, and the rest were conventional funds. What emerged was a growing awareness and concern about water risks within the energy sector (90% of respondents flagged it) – but also a lack of understanding about how to measure them.

China Water Risk analysed five of the biggest listed coal producers (Shenhua, China Coal, Yanzhou, Datong and Yitai), plus five of the biggest power generating companies (Huaneng, Datang, Huadian, Guodian and China Power International Development). It concluded that water risk could impact earnings margins far more than fund managers think (reducing them by between 1% and 13% for the five coal producers and 3% and 24% for the power generators). The recommendation: that analysts model water risk scenarios into their discounted cash flow models.

One major issue is disclosure since individual companies do not release information about water usage at individual facilities. However, China Water Risk puts forward a ‘shadow’ water pricing model, which tries to give a better understanding of the real cost of water in the event of a physical shortage.

The most exposed of the 10 firms is Datong (at a cost of $12.1 per cubic metre) followed by Yanzhou Coal on $12. These levels are more than 100 times their existing costs – though some fund managers argued that the shadow model is still imperfect because companies can desalinate water all year round at a cost of $5 per cubic metre.

What clearly emerges from the report is fund managers’ belief in the strong likelihood of greater regulatory and compliance costs as China seeks to meet its climate change targets. For example, the government wants mining companies to recycle between 75% and 95% of their mine water by 2020 (the biggest player, Shenhua, is currently at 60%).

There is also a big push to improve water quality with a goal of getting 70% of river water to meet the government’s grade III quality target by 2020. At the moment, a quarter of the coal sourced by the big five comes from the Hai River Basin, where only 39% of the river water is compliant.

China Water Risk believes the fund management industry is at a tipping point in terms of environmental action. More socially responsible funds are being set up, and even within conventional funds there seems to be a greater desire to take environmental considerations into account.

“Makes me bullish on renewables,” one fund manager concluded in the China Water Risk survey. n

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