In our conversations with investors on ESG topics in the consumer staples sector, the topic of carbon comes up regularly. Carbon pricing and company progress towards net zero are hot topics ahead of COP26 in Glasgow this November.
However, we receive far fewer questions on the topic of water, which is surprising given our analysis suggests the potential financial implications of water scarcity could be three times greater than the cost of reaching carbon neutrality. In our view, water should be the leading ESG issue for staples investors, or at a minimum viewed on par with carbon.
The CDP (Carbon Disclosure Project) estimates the consumer staples sector could face a $200bn impact from water scarcity due to its reliance on agricultural commodities, meaning elevated risks of disruption from droughts and flooding, as well as possible fines and lawsuits linked to pollution. However, if we proactively take action now, we estimate it would ‘only’ cost $11bn to address.
One of the big challenges with these big ESG topics of carbon and water is trying to put figures around the sensitivity at the individual company profit line. Addressing this difficulty has been a focus for the Barclays consumer staples research team in recent months. For carbon, the issue is complicated because reporting on scope 3 emissions is patchy, yet it’s the wider value chain (especially raw material sourcing and consumer use) where the vast majority of the sector’s carbon footprint lies.
In our research, we model two scenarios using both a €35 and €100 carbon price (per tonne) to adjust companies’ profits for the cost of purchasing carbon credits in order to reach net zero. The higher carbon price assumption is certainly not out of reach and is at a level both the Bank of England and the UN have said businesses should prepare for by 2030. Even since the pandemic, the EU carbon price has doubled to €50. Interestingly, the IMF is now arguing without an international carbon price floor, it will be very difficult for countries to limit global warming to 1.5 to 2 degrees by 2050.
In terms of consumer staples, some companies are a lot further forward in reducing carbon than others. Despite their size, Unilever, Reckitt, Danone, L’Oréal, Colgate, Estée Lauder and Diageo are not included in the list of top 10 CO2 producers and are among the most efficient in terms of carbon/profit.
We think it imperative companies map their entire value chain and put in place robust and transparent reporting on scope 3 emissions and, once done, set ambitious scope 3 carbon targets. Without more urgency here, the big changes needed can’t be made. Corporates can only do so much, but more individual consumer responsibility is needed.
Turning to water, access to clean water and sanitation for all is enshrined in the UN Sustainable Development Goals (SDG). According to the UN, 2.2 billion people lack safe drinking water, and water scarcity could displace 700 million people by 2030. The average price of water increased by 60% in the 30 largest US cities between 2010 and 2019, while the price of California water futures has jumped as much as 300% in recent years.
The average global price of water across 2,500 cities is circa $1.17/m3. However, our estimates suggest the ‘true cost’ of water (adjusted for all water risk issues) for the staples sector is likely to be three to five times this number on average. In areas of high water stress, Barclays research estimates the ‘true cost’ of water is as high as $15/m3. If we adjust our forecasts for these prices and calculate the percentage of water sourced from water-stressed regions by company, it is material for many.
In terms of sector impact, we find ingredients and agribusiness (including meat) sectors are the most exposed, as many of them own farms and have a higher direct water footprint. Applying the ‘true cost’ of water could impact sector profits by 36% and 31%, respectively. HPC has a much lower direct water withdrawal and hence, lower risk. However, if we include the consumer’s use of water, some of the big players could face a 40% to 50% profit impact, even at the lower end of our scenarios. Surprisingly, beverages see a limited comparable impact from water risk.
The outlook of our research is it’s crucial investors factor the impact on carbon and water into financials, and how it best links to valuation and funding costs. These issues are no longer just externalities, and the quicker they are priced in and discounted, the quicker real change will happen.