For some years now, sustainable investors have been recognising the importance of water as an investment theme.
But the drought across Europe last year and the high-profile sewage leaks in the UK since 2021 have only emphasised the importance of good water management and stewardship.
To coincide with World Water Day, here’s a summary of the latest developments and what they mean for investors.
Drought and its impact on energy production
Last summer’s heatwaves led to Europe’s worst drought in 500 years.1 Along with causing wildfires and forcing the introduction of water usage restrictions, the drought had serious implications for energy production, exacerbating already high prices for electricity and gas.
Most obviously, it reduced the availability of hydropower. Low water levels in reservoirs meant monthly hydro production in the EU fell below solar power for the first time in July 2022.2
However, it was not just hydropower that was affected. EDF was forced to cut its output at nuclear power stations on the Rhône and Garonne rivers due to a lack of river water to cool the reactors,3 while German power plants warned of a coal shortage as shipping was disrupted on the Rhine.4
As investors, we not only need to monitor which issuers are most exposed to these effects, but also which are taking the steps to develop and adopt solutions. For example, the solution for nuclear is alternative cooling methods such as 1) air-cooling systems or 2) closed loop systems where the same water is circulated continuously.
UK sewage scandals and their fallout
Our discussions with various international water companies reflect that it is not just the UK that is facing issues around water leakage and pollution.
In the US, for example, many cities and water systems have ageing pipes and infrastructure. The American Society of Engineering gave the country’s drinking water infrastructure a D grade in its 2021 report card.
Equally, in many developing countries, access to clean water and sanitation is a massive challenge.
But there’s no doubt that the issue has risen in salience in the UK. In 2021, allegations emerged that some UK water companies were illegally discharging untreated sewage into rivers.
Controversy has continued with sewage being washed up on numerous beaches around the country. Within the first four days of 2023, 328 water pollution alerts had been issued around the British coastline.5
RBC has been engaging with the UK’s water companies since the allegations first emerged. We’ve taken a best-in-class approach by investing in two UK water companies that we believe to have the most progressive practices.
Both companies lead the field in innovation and environmental performance, receiving the maximum four stars in the Environment Agency’s 2021 performance metrics.
Performance as an investment theme
So more broadly, how has water as a theme been performing?
European water names have largely moved in line with the European market for corporate bonds, which suffered in 2022 due to the first-hand impact of the Russian invasion of Ukraine on energy markets, supply chains and cost inflation.
While European water companies have been partially insulated from these challenges given they purchase a significant portion of their energy through long term fixed price contracts, there has still been near-term pressure given the magnitude of the move. Energy costs have doubled on average, which is material when they typically account for around 10% of the cost base.
Outside of Europe, US and emerging market water companies have fared better given a less direct impact on energy prices. The US, for example, enjoys energy independence, with plentiful supplies of gas and a better functioning electricity market. The US Federal Reserve also acted quicker on inflation than the European Central Bank.
Overall, we see a bounce back this year. The US corporate bond market looks quite rich and there’s a much bigger opportunity in European bonds now.