Episode 25: The future of water resilience in the US featuring J.P. Morgan

The transcript highlights below have been edited for clarity.

Water insights from COP16

Mark Lee

Today we will be discussing water in the context of a new report from J.P. Morgan and ERM which is entitled “The Future of Water Resilience in the US”. We chose to publish the new report during the COP16 biodiversity conference in Cali. Vamsi, Prad, I just wonder if you have some observations or conclusions on what you saw of COP16.

Vamsi Alla

There are three broad points that I want to make. I think first, COP16 reinforced the importance of connecting with clients and communities to better understand what solutions they need. Then second, I think it's important to understand the client demand for products that embed nature and biodiversity, and we should be able to use a lot of the framework that has been built around sustainable finance, that's been funding the green transition, to leverage that for nature and biodiversity. And then the third point I'd note is, there's a lot of focus on how to increase the bankability of the projects in the space. So we need to get the financial sector and the project developers thinking on leveraging these frameworks to improve that so that we can have more capital and finance flowing into the sector.

Matt Haddon

Can I just add as well to your point Vamsi about seeing the signs of building on previous momentum. One of my takeaways from Cali was that lots of conversations I was in, all the way through to some very senior ones, lots of people were saying, isn't this a single agenda? Isn't climate connected to water, connected to biodiversity, connected to desertification, which is the other often forgotten COP? So, I think there's a growing realization that it's all connected together.

Mark Lee

Prad, any COP16 perspectives about interconnections or otherwise?

Pradipta Parhi

It's a little disappointing that we didn't get much talk about water, although we highlighted in the paper that green water, which is the main source for nature and biodiversity is already crossing some of our planetary boundaries, so that's disappointing. Apparently in a drought region, there were elephants who were trying to dig in and break water pipes to get water. And that actually created issues for insurers and bankers for funding water infrastructure. But if I could just highlight another conference I attended just last month, WEFTECH, that's a water technology conference with more than 20,000 participants and thousands of companies, it was very encouraging to see innovations across the whole ecosystem of water. We had a chance to talk to a lot of founders and corporate venture arms. This was in the US but was a very global event. There are some conferences where water is actually getting a lot of attention, which is encouraging.

Company water resilience issues in the US

Mark Lee

Vamsi, why release the report now? What was so important for JPM and ERM to get into the topic of water scarcity and how water resilience is reshaping in the US at this point in 2024?

Vamsi Alla

I feel like water is one of those topics that’s been in a lot of people's minds for a long time, but never cracked the boundary of what's really important for you to act now to address some of the issues. With that backdrop, I feel like we are seeing from a financial banking perspective, three broad themes that are bringing this issue to the forefront. First in our work on Carbon Compass and climate change, we've seen that lead to a variability in the water supply and that's creating challenges for our corporate clients to properly plan for their water needs.

And the second issue is we are seeing a huge onshoring effort into the US where the manufacturing investment is going up and typically those industries are heavy water consumers. And third with the advent of AI and the data center growth which need water for the cooling use cases, the expected growth in that area is also bringing a lot of focus on the water usage for those companies. Once we combine these three points and look at the variability in supply and the increase in demand, it's becoming abundantly clear that companies and investors are going to focus on it. As primary intermediaries between companies and investors, we felt like we should develop a voice and having done a lot of work with ERM previously, wanted to partner with ERM to develop that voice and talk to different stakeholders.

Mark Lee

Matt, why now? Why did we dig in in this way on resilience at this time?

Matt Haddon

Part of the reason for us was that we were seeing a convergence between climate change, the impact of climate change and water availability, and our clients. The world of water has been a potential stress point in the world for a long time. And I think now we're moving to the point where businesses are starting to take it much more seriously. We've been working with a number of organizations in the States where their ongoing operations, whether those are in energy, technology, agriculture, are starting to feel real stress. And it leapt from being a technical issue to being an executive issue very quickly about 18 months ago.

So we found ourselves working with very senior clients who are saying, we have some real issues that we need to think about with real financial impact. And then when we got into the conversation with the J.P. Morgan team, it became clear that they were seeing some similar things from a different angle. We know that once a sustainability topic crosses the membrane between the environmental world and the finance world, things start to get very real. We saw that with carbon. The whole world is on a decarb journey. I see something similar happening with water. We're crossing that bridge to the worlds of finance, the worlds of business decision making really starting to take it forward. When I think about the past around water, it's very much a technical thing, environmental thing, local politics thing. And I think it's primed for much more significance.

Mark Lee

Tess, in the context Vamsi and Matt just outlined of scarcity, onshoring, manufacturing, climate impact, what else did we learn at the next level down?

Tess Jarriel

I think one interesting thing that we saw in the US specifically is the growth of those really water intensive industries that are occurring in areas that are already considered to be regions of high water stress. For instance, six of the 11 semiconductor manufacturing plants and about half of the 50 or so proposed hydrogen gas facilities, which are all really water intensive industries, are located in regions that are classified as high or extremely high future water stress. So I think that led us to ask the question, why are these water intensive industries not seeming to take account of long-term water availability in their decision making? What steps can companies take to avoid situations like this?

Answering that, there are a lot of practical steps that we can take with organizational structures and data collection and we can touch on some of those details later. But I think conceptually a big picture answer is that there's a shift in mindset that's also required to convince those with decision making power higher up in companies, that water scarcity is a real problem and something to focus on. People are saying, we want to implement these strategies, we want to adjust our framework, but there is this historic precedent of water being this infinite and cheap resource, there's decades and decades of water that’s always been there, it's always been available, we've never had problems. So there are no structures in place to facilitate these changes that need to be made because it's so ingrained in the company policies. But doing this paper and looking at all these instances, you can really start adding them up.

You see communities running out of water supply and industry being blamed or groundwater table decline is another hot topic of resources becoming limited, curtailments that happen in the face of unprecedented severe drought events or we're seeing more regulatory policies pop up, like disincentive fees or limitations on the amount of water that you can be permitted for certain uses. So I think that we were seeing that the more that those kind of events are occurring, the first step is to convince companies that this is a problem that needs to be addressed, and it should be at the top of your priority list. And then once you convince them of that, making the business case for it and tying back into the financial side of things seems to be an avenue that could potentially work to address some issues.

Mark Lee

Prad, which report findings would you highlight?

Pradipta Parhi

The most interesting question was that we are recognizing that it's critical, but then why is there no action? We highlighted that water infrastructure is such a long duration asset that most of these assets were put up 50 to 100 years ago. And suddenly what has been going on for the last two decades at least, is that most of these assets, we realized are almost reaching their lifespan. So that brings one aspect of the risk to the forefront and on top of it the climate volatility is making it even worse.

But then the second challenge is, now we recognize that water is critical, and why don't we do the required investments? So that's what we try to highlight. Where are those pockets of investment need and who can provide the funding. People are recognizing the problem, and you see recent government support for infrastructure public finance, but the magnitude of the need for financing is so great that we propose that the public financing is not enough and we need the private sector. There is research already suggesting that when you bring PPP (public private partnership) the projects are more efficient and more cost effective. We have highlighted in the magnitude of 90 to 100 billion per year of investment required just to maintain the service quality. And then that will grow to 150 billion, so if you're considering over the next couple of decades, we're talking about more than a trillion dollars of CapEx. So these are interesting times and we of course go into how we see private equity, infra funds, public markets are responding to different parts of the supply chain.

Mark Lee

The US economy has been a marvel in recent years compared to most of the rest of the world and it's continuing to enjoy really significant growth. Some of that growth is happening in water scarce areas. Some of it is high water demand. Those industries are also changing incredibly quickly right now. I'm sure that folks in the data center world who are listening to this would say, well our evaporative cooling technology was highly water dependent, but look at what we're bringing online in terms of air and especially liquid cooling technologies and where they'll move us, but we need a whole bunch of that kind of innovation over time to move forward.

Vamsi, what would you add about how JPM and clients might be able to apply some of the learnings from the report?

Vamsi Alla

From a client engagement perspective, the first one is the big investment gap that Prad spoke about. Infrastructure as an investing class is growing tremendously, even outside water, it's a huge focus area for different banks more broadly. And we see the ability to deploy capital for these large infrastructure funds into the water space as an emerging opportunity and I think more awareness on this topic will help the cause there.

Number two is companies in water intensive sectors, if you roll back the clock five years, the point I was making on how companies in carbon intensive sectors have had to elevate their discussion on carbon or decarbonization strategy up to the C-Suite and the conversations that happened since then, we would see that pattern following the same trend in companies in water intensive sectors. So it's no longer a technical issue and companies would need to strategize at a higher level.

In the paper we lay out certain best practices on how companies should think about it. We're already seeing companies talk about water risk much more in their disclosure, we're seeing companies set water efficiency targets following the trend of carbon intensity and carbon reduction targets. So, we are seeing movement there. But I think again as we see the confluence of all the factors we discussed, we expect the focus to increase more.

And then on the opportunity side, Prad mentioned the WEFTECH conference and the big water tech companies, in the paper we make the observation that among sustainability funds, water is a very interesting theme. A lot of these water tech companies attract significant interest from that pocket of funds and there is a lot of opportunity for them to deploy more capital in enhancing the solutions that could be made available for the water intensive companies to address their issues. So I think there are a lot of practical, tangible takeaways for our clients that we hope to engage further and dig deep as we go forward.

Managing water risks and opportunities

Mark Lee

Tess, connecting to that, I'm wondering what you can tell us about the degree to which the research and the report found that corporations have got good water management strategies in place.

Tess Jarriel

We see quite a range of the development of water risk management strategies, at least in our clients at ERM. There are some companies who are really ahead of the game. They've already set reduction goals, they’re implementing water management strategies, getting their assets in line with the Alliance for Water Stewardship (AWS) standard and they sometimes just want our help to implement a strategy that they already have. But a lot of our clients are in the early stages of developing water strategy and are looking for help to set those frameworks.

Some of the companies, we're seeing them opt for an all in approach from the beginning where they're asking for help rewriting their water standards from the top down, creating robust frameworks for water management across their entire portfolios and really diving in and investing fully in this because they've already been convinced and made their own internal business case for why this action is good. Others are still a little bit nervous about fully diving in and investing in something that is so new and changing that historic mindset of ‘water has always been available, why are we going to invest millions of dollars in this?’ And those people or companies that are a little bit more tentative are asking for us to pilot individual site assessments, so they can just dip their toe in before committing to more extensive adjustments.

To answer your question about the maturity and whether or not those frameworks are prepared for potential challenges of water scarcity, there's a range. There are some companies that are using really great robust methods to track their water use and create risk frameworks. But just to touch on the errors that we do see in the standard way that people are looking at risk. There are two key ones that I've seen talking to clients. One is only focusing on single basin wide global water balance data sets. A lot of companies will look at tools like WRI Aqueduct or the WWF risk filter, enter their location and say all right, here's my risk there and I'm going to treat that as truth. And it's really convenient and that data is useful and helpful and wonderful as a screening tool. But there have been case studies that show that misses a lot of key information, when you only focus on the basin scale of water risk. So you could completely miss all these different elements of risk.

The second kind of issue that we see is not focusing on all the nuances of water risk. People are really focused on the quantity element of water, the present quantity, how much water is here for us right now today without considering all these other nuances like what's the quality of that water? What are regulatory restrictions that might prevent us from accessing it? What are the potential reputational impacts on our company of selecting this water source? What does community local supply look like? That sort of question.

And then beyond that, there's another third layer of a temporal aspect to all of those. You can't just focus on your present day. You also need to make sure that you can get enough water and are managing it sustainably into the future. So what do population growth rates look like throughout the entire lifespan of your project? Is industrial water use in your region static or is it growing linearly or exponentially? How might changing drought reduce future availability? I think some companies miss that aspect of all these secondary and tertiary layers of water risk by not fully elaborating on those risks in their own existing frameworks.

Mark Lee

Prad, I wonder if you see these issues of risk and strategies similarly or a little bit differently from where you sit?

Pradipta Parhi

Tess already alluded that the quality aspect is not fully recognized and the risk is not fully priced in. I think the main hot debate there is the new regulations around something called forever chemicals. We have highlighted in our paper the liability can be big numbers and these were all regulated parts of how you treat before dumping the water as part of your industrial processes. But the regulations are catching up to the health-related impact research, which is every day discovering new kinds of risk. So far out of 10,000 to 15,000 chemicals as part of this PFAS umbrella, only two or three are starting to get regulated. So, we see a big driver for corporate action in terms of how you treat, otherwise you hold this liability.

The other surprising finding was the water and carbon nexus we have. We've been talking about them differently, but I think one issue came up which is if you just look at the water sector, how much does it emit and one of the experts highlighted that it can be 8% to 12%, global average or a particular state. So we are starting to now think about water, not only the impact on the water sector but how this nexus works and how do you apply decarbonization strategies into the water sector.

Matt Haddon

I wonder whether we can expect to see water, strategic approaches to it, practical implementation around it, as a real source of competitive advantage between companies going forward. I mean, if you go back 5-6 years, the early conversations about carbon, decarbonization, companies would say things like ‘there'll be no differentiation on the basis of carbon intensity’, and now there is absolutely differentiation between energy producers, between energy consumers on the basis of carbon intensity.

I think we'll see the same for water. I think we’re starting to see it already. Some of the big tech players are very advanced in how they think about water, both about where do they put facilities, which technologies do they use. So we know clients in the data center space are looking at non-water based cooling because of water challenges. They're taking the whole local license to operate piece incredibly seriously because they recognize if they can put their facilities in a place that a competitor can't, maybe they can access the market differently. So I think we're going to see some really rapidly shifting approaches where there will be winners and losers.

Water at COP29

Mark Lee

COP29, the next climate COP in Baku is right upon us. Matt and Vamsi, we do see lots of evidence of the nature and climate agendas coming together, but how much do you expect related to nature and water in Baku and what's the hope for what's next on that front in terms of how these agendas come together and accelerate?

Matt Haddon

Whilst there is a water day at COP 29 in Baku, I'm not sure I'm expecting a great deal on the overall policy front. I think it's more a recognition that water is part of the climate conversation, so I think it's a start. I think the real interest, the real activity is going to be in the corporate world, I think that's where businesses are feeling the pinch and seeing both the pinch increasing and the possibility, the opportunity that our colleagues from J.P. Morgan outlined so well on this podcast about spaces to finance new activity. So I think the corporate world will be where we see the real action as it gets to grip with actual climate change.

Vamsi Alla

I agree with what Matt was saying about COP29 itself, I don't expect there to be a lot of discussion on water, but I don't think that's a reason to have any despair in my opinion, if I look at the history of the past COPs, I would see that over the last three to four climate COPs is where we've started seeing significant engagement from the corporate sector and investors. I think that has, in my opinion, meaningfully increased the quality of dialogue between public and private sectors on how to find solutions in this area now.

And, at the biodiversity COP, this is the year where we are starting to see the inflexion of increased participation from the corporate and the investor sector. So I think we should let that play out for a few more years and I think things will catch up, that's the hope. I think even in our paper we highlight this trend where the water topic is lagging the carbon topic by three to four years. There's a lot of interesting differences, but the key one is a lot of investment that happens in water tends to benefit the local areas immediately. You go build more infrastructure in a particular area to improve the quality of water or increase supply, you will see the benefits immediately. As an optimist, I see all the science pointing to increased interest from corporates, increasing interest from investors in the space and that water will get the right share of interest and focus going forward.

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