Analysis & Reviews

China Water Risk 5 Trends for Year of the Goat (2015)

China Water Risk’s 5 Trends for 2015

Reform is always difficult. Medicine is always bitter. Winners and losers across corporates, investors and governments are to be expected in China’s long march towards an “ecological civilisation”. Yet many are still harbouring doubts or in disbelief over China’s efforts to go green.

We warned in last year’s Trends for 2014 that “The true cost of water is not X dollars to the business because no water = no power = no food. Water’s worth runs much deeper, it is the foundation on which our economy & society is built.” We thus predicted that for 2014, that Beijing would lay the groundwork for environmental reform in order to avoid this.

A water supply crisis seems an unlikely but in Brazil, São Paulo residents could face water rationing for five consecutive days a week

A water supply crisis seems an unlikely scenario but as Brazil is finding out, both São Paulo and Rio de Janerio are facing water and power shortages. Nearly 80% of Brazil’s energy is generated by hydropower plants and most of the reservoir levels are at record lows. São Paulo’s state water utility SABESP warned last month that the worse-case scenario for residents is a water supply cut for five consecutive days a week. Jerson Kelman, SABESP’s new head in 2015 warns “there is a significant part of the population that is not yet aware of the seriousness of the situation and refuses to change habits”.

No surprises why a water supply is now the #1 Global Risk by impact according to the World Economic Forum’s 2015 Global Risks Report.

Incidentally, we discussed the very topic of water and power in development with Dr Kelman in last year’s “The Power of Water Seminar” during the World Water Week. Both China and Brazil are developing nations but China has over 10x less water resources per capita than Brazil. Besides, increasingly frequent extreme droughts and floods brought on by climate change only serve to exacerbate already fragile watersheds. In short, a water supply crisis may more likely to happen than you think.

In China, the situation is dire, 54% of coal reserves lie in water scarce regions & energy bases overlap with its agricultural heartland as well as 36 ecological protection zones … delicate watersheds could be damaged

In China, the situation is dire, 34% of ‘sown area’ is located in water scarce provinces as is 54% of its ensured coal reserves. Many of China’s energy bases overlap with China’s agricultural heartland, the North China Plain and are reliant on groundwater of which >70% is severely polluted. Worse still, China’s energy bases overlap with 36 ecological protection zones where pollution and overuse could damage delicate ecosystems and watersheds. As if this is not bad enough, the air quality is poor; almost 20% of China’s farmland is polluted; and close to 44% of GDP is now generated in water scarce provinces.

Too alarmist? Unfortunately not, these are all the most up-to-date Chinese government statistics released last year; some were even previously considered state secrets.

The good news is that Beijing is not sweeping this under the carpet and hoping that it will somehow disappear. Last year we hoped that… 马到成功 or “horse arriving signals success” taking us along to the path to ‘Economy & Environment’ and not ‘Economy vs Environment. Our bet on success paid off: amendments to the Environmental Protection Law passed in 2014, now enshrines environmental protection as the nation’s basic policy. Future economic & social development must be coordinated with environmental protection. This is a fundamental shift in planning China’s future growth.

The bad news is that corporates and investors are still in denial or borrowing from Dr Kelman, “still not yet aware of the seriousness of the situation and refuses to change habits”. For the year of the horse, we made 5 predictions – only those pertaining to government action were right on the money, whilst corporate and investor/stock exchange action continue to lag.

Policy & regulatory groundwork laid in 2014 sets the path for 2015… it is time to tread with caution rules of the game has changed

Nevertheless, policy & regulatory groundwork were laid in 2014 and the path for 2015 is set. Shanghai’s recent removal of GDP as a target indicator is sign of things to come in the Year of the Goat. There will be winners and losers in the reshuffle from ‘economy at the expense of the environment’ to ‘growing the economy whilst protecting the environment’. On the surface, it might appear like nothing has changed yet, but multiple game-changing policies were introduced/expanded in 2014. As the new law is now into effect since 1 January 2015, it is time to tread with caution.

亡羊补牢  or “mend the fence after a sheep/ goat is lost”

It is never too late to pay to clean up/invest in the environment … better to be the surefooted goat than the sacrificial lamb

We believe that the rules of the game has changed in 2015. For the year of the goat, be nimble and pay attention to the shepherd. There is a saying … 亡羊补牢literally “mend the fence after a sheep/goat is lost”. In other words, it is never too late to make amends. Reform is always difficult and mending fences can be time consuming and costly, but it could be better to swallow ‘the medicine’ and pay to clean up/invest in the environment.

After all, as Beijing shepherds us through this path in the Year of the Goat, it is much better to be the surefooted goat than the sacrificial lamb.

Here are our top 5 game-changing trends for 2015:

1. Shepherd plans surefooted path towards water security

Water risk is now the norm in China; three years ago, it was still on the fringe. For this year, we expect water to firmly be tied to the economy. Water should seep into and influence decision making across different sectors – not just at a boardroom level but more importantly at a policy level: should we allocate water to X or Y?

It’s a resource allocation game. Should we allocate water to X or Y?

Yes, it’s a resource allocation game. Wrong allocation and mismanagement of water means food, energy, industry, employment, population and the economy could all be affected.

Beijing will try shepherd the nation to stay within the Three Red Lines: (“Red Lines”) towards water security:

  1. to not use more water than the national/provincial caps;
  2. to improve water use efficiencies; and
  3. to prevent, control and reduce water pollution.

8 Game Changing Policy PathsStaying within the Three Red Lines means rough terrain ahead. Tough choices need to be made to grow the economy with limited water. There will be trade-offs amongst industries, agriculture & energy, fuel mix, crop mix and water use & carbon emissions.

To balance the economy & the environment to ensure long term prosperity, government has no choice but to herd China’s key sectors towards a circular economy. This train leaves the station in 2015 and the policies set in the last few years  paves the way ahead (see “8 Game-changing Policy Paths”).

2. Water & fresh pasture comes first then power

Water is a key input across all industries but some industries are more important than others. Policies made to ensure water, food & energy security will affect multiple industries but current management systems (whether government, corporate or financial) are still siloed.

Policies made to ensure water, food & energy security will affect multiple industries

Last year, we said there will be signs of un-siloing with more “collaborative” policy making across ministries to push stakeholders to adopt “business unusual”. Indeed there has been numerous forums/dialogues with academia, think tanks and various government ministries on the water-energy nexus and water-food-energy nexus: in 2014, water, food & energy security, previously ‘taboo’ subjects are now openly discussed.

Some experts say that China will have to ensure agricultural water savings in order to “free up” water for China’s energy bases

In this regard, we are always of the opinion that water comes first then agriculture followed by power. Last year, it was great to see an official echo this view. The recently issued 2015 No.1 Document focused on agriculture reaffirms this. It states that “rural reform and development are confronted with a more complicated environment and an increasing number of difficulties and challenges, as the country is going through a period of transformation“.

The document reiterates food security as top priority designating permanent farmland for basic needs, pushing to accelerate agricultural modernisation, soil fertility conservation and increasing small, medium and large scale irrigation to facilitate water savings.

Will Energy Bases Drain the Yelllow RiverSo does this mean energy takes a back seat? Some China experts argue that it is equally important and China will have to ensure agricultural water savings in order to “free up” water for China’s energy bases. This is particularly pertinent in the upper and middle reaches of the Yellow River where coal bases and farmland lie next to each other.

Will China’s Energy Bases Drain the Yellow River? See what the Deputy Director of Center for Water Resources Research at Chinese Academy of Sciences, has to say here.

3. Rod & staff guidance to pen in pollution

Last year we said the “Race to Clean-up Starts with SEI#1”.  China delivered: declaring an official war on pollution and President Xi made a 2030 carbon emissions promise. We also expected “big stick to match big carrot” and “comprehensive tariff reform”. In 2014, State Council moved to ensure an environment in which they can now be implemented: by passing amendments to the Environmental Protection Law and putting in place EIA reforms along with harsher punitive measures. Tariffs were also raised throughout the year with the latest being a rise in wastewater tariffs by NDRC last month. Policies were also put in place to encourage the development of a third party environmental service industry.

As the amendments to the law as well as several new industrial discharge standards come into full effect in 2015, we expect the MEP to tighten the fences with stricter enforcement of more stringent standards, more fines, centralised treatment, discharge permits and blacklists. Since the shepherd is still redefining the pen, corporates, brands and investors should beware.

Beijing’s priority is to tackle illegal discharge through collective/ centralised treatment but will violating treatment plants be fined?

We believe Beijing’s priority is to tackle illegal discharge – in 2011, only 45% of the papermaking & stationery, 40% of chemicals and 31% of textile, apparel & footwear sectors (the top 3 most polluting industries in China) are monitored.

Policies will therefore first push factories to indirectly discharge through collective/centralised wastewater treatment facilities. In general, across industries concentrations of pollutants allowed in the indirect discharge to a treatment facility is ‘less stringent’ than direct discharge from a factory into a body of water.

IPE - Risks Shifting Beyond the WallHowever, as IPE warns, many of these wastewater treatment facilities themselves are not meeting the standard themselves; their pollution map show that from 2008 to June 2013, the 3,622 wastewater treatment facilities had 4,961 violations in total. See what IPE’s Ma Yingying has to say on this matter in Risks Shifting Beyond the Wall”.

And it is not just domestic plant operators; their recently published report cited that subsidiaries and affiliates of Singapore’s Hyflux NewSpring (“a leading provider of integrated water management and environmental solutions” according to its website) had as many as 33 violation records for the same period.

Investors beware, even subsidiaries & affiliates of Hyflux NewSpring had as many as 33 violation records in the last 5 years

The new policies clearly push risks beyond the factory wall. Also, wastewater treatment facilities could face fines for violations.

Investors rushing into wastewater treatment must be cautious as the mismatch in industrial discharge standards & water quality standards could be addressed in the hotly anticipated ‘Water Pollution Prevention and Control Action Plan’, expected to be announced at/ahead of the National People’s Congress in early March.

MEP 16 Heavy Polluting IndustriesIn 2015, we expect to see a herding mentality/flocking behavior within industries to mitigate such risks; some industry associations and brands/MNCs may take the lead to protect the industry.

Meanwhile investors should also start to take notice as significant punitive fines are meted out.

This is just the start; there is still a long way to go in penning in pollution. Be prepared if you have exposure to one of the 16 Most Polluting Industries in China (see box).

 

 

4. Market-orientated pilots may bring about sacrificial lambs and new industries

We said to saddle up with corporate water strategies and prepare to rein in water risks & rope in opportunities in 2014. Reining in water risks has been disappointing: although recognition of water as a risk to business operations has risen in 2014, not enough action is being taken to match the risk. The 2014 CDP Global Water Report said 68% of the Global 500 respondents reported exposure to water related risk that could generate change in their business, operations or revenue, yet 58% still do not have not publically demonstrated a commitment to water (more on the inaction here).

Meanwhile, the water sector in China is heating up with varying opportunities roped in during last year. But it is not just the traditional water markets that were hot…

New Market Tools to Enforce Red LinesChina is experimenting with innovative market mechanisms to stay within the Red Lines. One such area is the trading of Water Use Permits & Water Discharge Permits.

No company requiring water in their operations can operate without these. China has been experimenting with the trading of the Water Discharge Permit in eleven provinces since 2007. Last year, State Council announced it wants to establish pollution discharge permits trading markets in these pilot provinces by 2017.

Discharge permit fees & trading market is worth RMB4 bn & auctioned on Taobao

Too far-fetched? Think again, the discharge permit fees & trading market is now worth RMB4billion and permits are now auctioned on Taobao or used as collateral in securing loans.

More on how this works in  New Trading Markets to Enforce Red Lines

These permits can be used to limit total discharge from or total water use of a particular industry. They encourage water efficiency and help weed out lower quality players. In addition to the more stringent industrial standards, all industries & factories must therefore pay attention to the development of these new market mechanisms to avoid being the sacrificial lamb. Ultimately, Beijing hopes that these new trading markets will reflect the true price of water and those who can afford to pay to clean up will stay in business.

These permits limit total water use and discharge in a particular industry. Market trading means only those who can afford to pay to clean up in business – there will be sacrificial lambs

For these pilots to be successful, we expect to see continued and deeper collaboration between different ministries. However, change needs funding and we see the government setting aside funds and loosening investment criteria to encourage private sector participation to help kick start the clean-up industry. Indeed, many of the policies announced late last year and early this year pertain to this – hopefully a ‘spoonful of money incentives’ makes the medicine go down.

Despite clear risks ahead, stock exchanges have yet to react to increase disclosure of companies exposed o such risks. Maybe when sacrificial lambs are a plenty as a result of fallout from stricter standards and new water permit trading markets, will financial regulators start to take notice.

The government is looking for ‘new ways of doing old things’ … any innovation to take China towards a circular economy will be welcomed. Perhaps monitoring and enforcement of polluting industries might be even be privatized. There are no precedents of these new market mechanisms globally. The risk of being blindsided by these is therefore high.

5. Work to avoid head-butting over Asia’s waters in solving energy & climate issues

China’s international freshwaters are shared with more than 20 riparian countries (North Korea, Russia, Mongolia, Kazakhstan, Kyrgyzstan, Tajikistan, Bhutan, Myanmar, Laos, Nepal, Pakistan (Kashmir), Afghanistan, India and Vietnam to name a few). In 2014, we said China could take advantage of this unique opportunity to lead and play a central role in enhancing transboundary cooperation.

China to focus more on the water-energy-climate nexus

In May 2014, China took a positive step towards this and held its first-ever officially sanctioned International Water Law Symposium, hosted by Xiamen University. Also, in June 2014, China and India signed a new MOU to detail the sharing of hydrological data on the Brahmaputra River.

More coal could accelerate glacial melt & more hydro could lead to water wars

In 2015, we expect to see China continue to play a key role with more focus on the water-energy-climate nexus. China’s energy choices not only impact global climate change but affect water availability for Asia: more coal could accelerate glacial melt in Asia’s watershed, the Third Pole, and more hydro could lead to water wars given the region’s transboundary water resources.

No Need to Sacrifice Rivers for PowerPresident’s Xi’s low carbon emissions promise is a good start. But let’s be clear – coal is still the vanguard. It is time to steer focus to (1) cleaner coal with less water; (2) whether we need to sacrifice Asia’s rivers for power; and (3) how to avoid a ‘water war’ if China did add more dams to the transboundary rivers.

However, it is not just China but India also needs to add significant power with limited water resources.

Asia’s choices to generate power to meet rapid development with the cheaper fuel options of coal and hydro matter. China’s actions in this global nexus could lead Asia towards water & energy security whilst keeping climate change in check and side-stepping transboundary conflict. In addition, China pilot solutions for sharing of water between provinces along the Yellow and Yangtze Rivers, if successful, could be applied regionally.

The situation is sobering and critical …

… glaciers equivalent to the land area of 8 Hong Kongs are ‘lost’ in the last 30 years

Glaciers have already shrunk 15% from 53,000km2 to 45,000km2 over the last three decades (Chinese Academy of Science). This means that the Qinghai-Tibetan Plateau has ‘lost’ 8,000km2 of glaciers. This is equivalent to the land area of 8 Hong Kongs.

The situation is sobering and critical.  It’s all interlinked and it comes down to water. Regionally, we must avoid head-butting over Asia’s waters and start dialogues to find solutions for our water-energy-climate nexus.

It’s time to seriously tend to these matters in 2015.


Past Trends

  • 5 Trends for 2014: The Year of the Horse With environmental risk cited as one of the top risks most likely to derail economic growth along with the banking crisis and housing bubble, check out our top 5 trends in water for the year of the Green Horse
  • 5 Trends for 2013: The Year of the Snake Not sure what happened in 2012? Read our review and find out what our top 5 water trends are for the Year of the Snake. Will we be bogged down or will we slide ahead?
  • 5 Trends for 2012: The Year of the Dragon Find out what’s happened in the water space in the Year of the Rabbit and check out the five trends we see continuing into 2012, the Year of the Water Dragon

 

Debra Tan

About Debra Tan

Debra heads the China Water Risk team and spearheaded the development and build out of the China Water Risk brand and website in 2011. Since then, she has written extensively about the water-energy-food nexus as well as reports analyzing the impact of water risks on certain sectors for financial institutions and corporates. She has also given numerous keynotes, moderated and participated in panel discussions and conferences around water issues to investors and corporates. Debra started her career in finance, spending over a decade as a chartered accountant and investment banker specializing in mergers & acquisitions and strategic advisory. She has lived and worked in Beijing, HK, KL, London, New York and Singapore. Debra left banking to explore her creative side pursuing her interest in photography resulting in her first solo exhibition within a year. She also ran and organized hands-on philanthropic and luxury holidays for a small but global private members travel network and applied her auditing, financing and photography skills in the field for various charitable organizations and foundations.

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