Concerns about water availability are increasing around the world. Water scarcity threatens the ability of companies and communities to operate as they have in the past. Business value may be at risk if they do not have insight into these natural capital considerations and adjust their operations accordingly.

Understanding the true value of water and pinpointing limits to growth is a growing global trend. Companies that quantify their natural capital dependencies will benefit from a more complete picture of the most effective ways to allocate water and other resources.

Current market pricing disconnected from risks

In many regions, the market price of water is inversely proportional to how much is available. For example, water-scarce regions of China can have a low price for water which does not reflect its relative availability. Forbes India magazine has an informative world map showing local water prices based on data from Global Water Intelligence.

The market also does not consider the risk to business value of water availability, nor the benefits that water provides communities and ecosystems. As water demand rises around the world resulting in shortages and increased operating costs, it will be difficult to conduct business in the same way as before. Without measuring the hidden risks to business value of insufficient water, a company cannot perceive the potential losses or respond to them.

The full value of water should be measured by incorporating its broader social and environmental significance within the market price. By using this value, companies can identify hidden water risks and make more informed decisions, such as locating facilities based on water availability and selecting water-efficient technologies to use in production processes.

Facing water scarcity

Trucost’s research for GreenBiz’s State of Green Business 2014 report found that the average US business uses over 49,000 cubic meters of water per million dollars of revenue. In a world faced by increasing water shortages, we must identify and implement ways of decoupling commercial growth from natural capital dependency, so that economic success does not overwhelm natural resource capacity.

This year’s drought in California reflects the impact of resource scarcity on quality of life, economic activities and public services. As of September 2, 2014, a total of 58 emergency proclamations for water conservation have been issued by municipalities, counties, tribal governments and special districts. The State Water Board is providing technical and funding assistance to communities facing drinking water shortages. The state also has responded to 25 percent more wildfires than during an average year, which have burned 15 percent more acreage, equating to increased costs for firefighting and natural resource damage.

Focusing on the true value of water

Water is not valued properly according to the gaps between supply and demand. For instance, the low market price of water in dry regions is a perverse incentive to grow water-intensive agricultural products despite the high risk of drought or damage to long-term water supplies.

Since market water prices do not capture the full costs of extracting water, these costs are borne by society and the environment — so-called ‘externalities.’ These externalities are becoming more visible as water shortages threaten local communities, ecosystems and economies, droughts shrink crop yields and increase food prices, and desertification takes over farm land.

Applying the true value of water for business growth

How do we monetize water risk so it can be factored into investment decisions and considered alongside other business metrics? Trucost estimates that the true value of one cubic meter of water ranges between $0.10 where it is plentiful and $15 in areas of extreme scarcity. Forward-thinking businesses should apply this true value of water to inform their operating strategies, such as aligning water use with its availability and evaluating new infrastructure investments, procurement strategies and product portfolios. Companies can focus on the true value of water to prepare for having to absorb costs that were once off the books, but are now being internalized due to new regulations, higher water prices or water shortages.

One example of this approach is work by Yorkshire Water in the U.K., which applied natural capital valuations to inform its 25-year corporate strategy so that it could meet the needs of one million new households. The company created an environmental profit and loss account so that it could allocate resources and manage commodity costs for the long term. In the EP&L, negative environmental impacts are shown as losses, such as water extraction, waste disposal and pollution, while environmental benefits are identified as profit, such as the company’s water recharge and energy recovery facilities. Applying monetary values helped the company communicate its water efficiency strategy to stakeholders, including suppliers, customers and regulators, in a way that is easy to understand.

Another example is the use of shadow water pricing by Nestlé, so that the company includes the full value of water in its operational decision making. A recent article in The Financial Times outlines how the food company applies an internal water value to spur more efficient use in its factories. Under this policy, water is priced at approximately $1 per cubic meter for facilities located where water is readily available and $5 in more arid regions. Nestlé applies this value when considering purchasing new equipment, making tangible the impact of water availability within capital expenditure decisions. Shadow pricing has also been applied to greenhouse gas emissions by Microsoft, Disney, and at least 27 other US companies, to factor climate impacts into their business decisions.

Monetary valuation for improved decision making

Monetary valuation enables a business to include the true value of water — not just its current market price—alongside traditionally priced items such as labor in capital budgeting, as well as adjusting the net present value of capital and operational expenditure. Applying monetary values to projected water consumption and deducting the environmental costs from future cash flows can reveal which option has a lower risk. By expressing all of its environmental impacts in the single metric of monetary value, a company can easily identify and manage its most significant environmental risks and opportunities. Water valuations also can be used to map commodity flows and quantify risks across a company’s brand portfolio or business unit.

As a result of understanding the true value of water, a company can make more informed decisions which maintain business value by avoiding or minimizing the risks associated with water scarcity and other natural capital constraints.

Top image by Wollertz via Shutterstock.