How does the drought affect investors?

Current issues related to economics, (responsible) investment, pensions and income: every week an APG expert gives a clear answer to the question of the week. This time: Climate Data Specialist Lucas Wouters talks about the impact of prolonged drought on investments.

Extreme drought in Italy’s Po Valley, forest fires throughout the Mediterranean and historically low water levels in the Rhine. All of Europe is suffering from a precipitation deficit this summer. And the drought is not incidental. “It’s not a question of if the drought will get worse than it is now, in the long- term; it’s a given that it will,” says Wouters. “About 20% of the carbon we are emitting now will still be in the air in a thousand years. So our current emissions will still have a long-lasting effect on future temperature increases, with all the consequences that will entail. Droughts will last longer and be more severe.” 

Agriculture

Climate change will lead to increasing droughts in certain parts of the world, which will affect water supplies, among other things, Wouters argues. “And that in turn has consequences for agricultural production, as well as for industries that depend on a stable water supply to produce consumer goods and materials, for example, and for the energy sector, which uses a lot of water to cool power plants or to generate energy with steam turbines or hydropower. Such impacts will in turn affect the entire economy, making the increasing drought a potential risk for investors.” According to a study done by the World Bank, drought could lead to a loss of 6 percent of gross domestic product in certain countries by 2050. That would involve water shortages and the consequences of that, such as crop failures. A long-term investor like APG therefore looks at the potential impact of climate factors, including drought, in all its investments, and analyzes the potential risks and returns.

A tangible example is investments in agriculture and forestry, grouped together at APG under the heading Private Natural Capital. “In agriculture, the presence of reliable water sources is a key indicator of a good harvest,” Wouters says. “That’s why, for potential investments, we assess whether there is enough capacity in the surrounding area to secure sufficient water for the intended operations. In addition, innovation with respect to irrigation is an important aspect in protecting the harvest. In Romania, we are investing in a project that involves working with local parties to repair, improve and expand irrigation networks, which often also save water and energy.

APG also urges managers of land that is invested in to cover any climate risks. “In agriculture, for example, this involves leaving land fallow as little as possible, thus preventing evaporation. This improves the quality of the soil, so that it can absorb more water. The crops to be grown are also determined by the water that is available in the longer term. In forestry we expect the managers to have fire extinguishing facilities in place, in case persistent drought leads to forest fires. We also want fire prevention to be taken into account in the management and layout of forests. We use climate scenarios to assess potential investments. We won’t take on investments in which the impact of climate change is too great.

Adaptation

To counteract the negative effects of drought on investments, APG encourages companies to do more to adapt. This can be done, for example, by creating on-site water reservoirs around properties and farms. APG also works with external data sources to monitor climate change and the consequences thereof. Wouters: “Our real estate team, for example, has developed a method that measures physical climate risks for our investments. In this way, we want to make the real estate we invest in more climate-resistant.” For its pension fund clients, APG invests in the American company Xylem. This company offers solutions that promote efficient water use and so prevent water scarcity. Examples include the transport, purification and reuse of water. Closer to home, APG invests in a number of green bonds issued by the Nederlandse Waterschapbank (Netherlands Water Boards Bank), which include water bonds. This sustainable water bank uses the proceeds to better prepare the Netherlands for the consequences of climate change by financing projects and companies that focus on flood risk, water management, water quality and biodiversity.

Water

Due to increasing drought, it is becoming increasingly important to conserve water. This offers interesting opportunities for investments in, for example, water technology companies and water treatment plants, Wouters explains. “In the Netherlands, we have high quality drinking water; in many other countries there is a shortage. Of all the water on earth, 97 percent is salty and most of the remaining water is frozen, as in glaciers. Technologies already exist to desalinate seawater, but the technology is still very expensive and the process still uses a lot of energy. If a company succeeded in converting part of that 97 percent salt water into drinking water more efficiently, it will have struck gold.”

There are also opportunities to invest in techniques that make water use in buildings more efficient. “APG invests in The Student Hotel, on behalf of our fund client ABP. The showers there have meters so that hotel guests can see exactly how much water they are using. This encourages guests to take shorter showers and thus use less water. That is a small contribution to the solution, of course, but it does indicate that there are opportunities to contribute to combating drought through our investments.”