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The Complexity and Urgency of Water: Time for the Accountancy Profession to Step Up
by Prof. Tony Allan, Professor Emeritus, King’s College London and School of Oriental and African Studies, University of London, Dr. Tony Colman, Honorary Visiting Research Fellow, Dept. of Environmental and Geographical Science, University of Cape Town and Dr. Martin Keulertz, Researcher, Humboldt University of Berlin and Texas A&M University | April 7, 2015 |
In the run-up to its 2015 annual meeting in Davos, Switzerland, the World Economic Forum published a report on key economic risks that captured and highlighted the opinion of experts and global decision makers. Water is the number one risk threatening global stability in the coming years. Californians can already tell how this risk plays out in practice. The accounting profession can play a major role in helping to mitigate this risk by advancing global standards and reporting requirements for water use in agriculture, which withdraws 70% of freshwater worldwide while industry and households are withdrawing 20% and 10% respectively. However, due to return flows by industry and households thanks to water recycling technology, the actual water consumption rate of agriculture is at 92% compared to 3% by households and 5% by industry.
At no stage in the food supply chain do stakeholders have to account for how much water they use. Vast quantities of water flow through increasingly global supply chains without their value being passed through and captured in commodity prices. This market system mismatch between environmental costs vs. profits has very serious consequences for global water resources.
Groundwater aquifers around the world are being depleted at an accelerating pace in both developing and industrialized countries. At the same time, surface water reservoirs are increasingly under pressure as a consequence of population growth, urbanization, and increasing competition between the energy and the agricultural sectors. Examples of hotspots include the Nile River, where countries such as Egypt and Ethiopia argue over water use for energy and food security. Or the Mekong River, where there is a continual struggle to meet the demands of the local populations for the energy and agricultural uses of water.
Meanwhile, climate change further exacerbates existing trends. For example, California’s water resources face a “crunch time” thanks to a decreasing snowpack in the Sierra Nevada mountains and, thus, less run-off. Last week, the governor ordered unprecedented and mandatory water restriction regulations statewide because of the decreased snowpack.
The water systems in California can no longer provide the population and farmers with sufficient water. Although California is a naturally arid state, it is a “net-exporter” of water—its water “exports” are embedded in the food the state sells to the rest of the US and internationally. But, unfortunately, the cost of the water and the impacts of mismanaging them are not captured in the prices charged for the vast volumes of exported citrus and fresh vegetables. Californians are dangerously unaware that they are “exporting” their environment. They do not value water and Californian farmers are not yet adequately encouraged to steward the state’s scarce water.
In California and elsewhere, farmers are the main managers of water. They consume approximately 90% of all water that is needed to meet the food needs of society in a market system that does not incentivize or enable farmers to steward water effectively. On the contrary, they are being incentivized to over-use surface and groundwater in irrigation. In many world regions where farmers have irrigated, they have run out of water (see recent articles in the New York Times and Columbia University)
But there are inherent problems with irrigation. Irrigation increases crop and food production, because water can be made available when rainfall is less than needed. If the water is assumed to be free and the environmental costs of using it—such as soil salinization—are ignored, then irrigation can work financially in the short term. But the practice is not sustainable, economically or environmentally.
Over the past century, farmers have been encouraged by society and governments to irrigate. Instead of relying on water stored in the soil, accompanied by conservation farming practices that produce sustainable yields, farmers find themselves forced to produce large volumes of food—all dependent on irrigation to keep the global food system going.
Water is not an easy resource
Water is a fugitive resource. Freshwater moves around constantly. It falls as rainfall at different depths across the planet, it percolates into the soil, and is often invisible. It also changes its appearance from vapor to water and back to vapor in the water cycle. Water may evaporate at one place but precipitate at another. While wetter zones receive abundant rainfall, drylands sometimes receive marginal amounts of rain leading to decision makers facing the extreme challenges of significant flood and drought events. Transporting water is also problematic as it involves high-transportation costs. Finally, although water is strategically very important, it is assumed to be free and does not figure as valuable in the value system of food consumers. This particularly applies to the water used for food production where the cost of water as an input and the externalities of misusing it have never been internalized.
The supply chain: the arena of managing water
Food is a $5-7 trillion market. All inputs are accounted for in food supply chain management except for the environment. The market does not properly account for the natural resources of water and energy. Water is only accounted for in exceptional circumstances in food supply chains. Although stewarding water resources is assumed by society to be one of the duties of the farmer, there are no reporting or accounting rules to guide farmers or provide systems to pay them for water stewardship.
And, food production is even subsidized with roughly one billion USD a day in peak times by countries within the Organisation of Economic Co-operation and Development to keep food prices low and disposable income more effective.
The way forward: the role of the accounting profession
This is where we believe the accounting profession can help the world to become water secure. Water does not only need to capture the attention of corporate social responsibility (CSR) managers but also CFOs. The CSR side has become increasingly aware of their social and environmental responsibilities, and has begun to recognize the need for water ecosystem stewardship, as well as stewardship of biodiversity and the atmosphere. The adoption of voluntary water stewardship concepts is increasing. But the profit generating side of the food corporates has the fiduciary duty to ignore the costs of water for which there are no reporting and accounting rules.
The operationalization of stewardship deploys different methods, such as risk tools and water footprinting, to analyze water risks and disclose the water use of stakeholders. Nestle even attaches a value ranging from 1 (low risk) to 5 (high risk) Swiss Francs to reflect the current and future availability of water in their production plants.
However, these initiatives are in their infancy because of the absence of compulsory requirements. Even the most environmentally aware companies may find themselves in a prisoner’s dilemma if they attach a value to their water resources when the vast majority of the food industry still does not account for water costs and externalities. Water needs to find its way into the mindsets of CFOs so that they can recognize emerging societal values as well as the potential bottom line impacts. Those very farmers who manage, and mismanage, 90% of the water need effective economic incentives. Without incentives that protect farm livelihoods, farmers cannot practice sustainable soil and water management. The business as usual approach makes farmers the unwitting start of an uneconomic and environmentally unsustainable system of food provision.
Methodologies to account for the environment exist and have become an increasingly popular topic in the academic accounting literature. Water management accounting as a sub-discipline is, however, still in its earliest phase. Examples from the Australian wine industry show that physical water management accounting is underway and accepted by wine supply chain managers. The monetary side of water management accounting, however, is still getting used to the need for more costing and accounting information if the outcomes are to be effective. However, while margins in the wine industry are considerably higher than in, for example, cereal production, the core question will be how to develop accounting for water to change behaviors and actions of all parties in the supply chain.
This is not proving to be an easy task. It requires engagement between the leaders of the accountancy profession as well as farmers and corporate executives. It also requires the awareness of wider society. Consumers and voters need to grasp that sustainability in the twenty-first century will come at a price.
It is time for accountants to engage in this crucial debate and enable the mitigation of the world’s greatest risk of the coming decades. What is needed are appropriate global standards for accounting for water. Sustainability reporting by the Global Reporting Initiative (GRI) and the Sustainability Accounting Standards Board (SASB) provide a voluntary basis for providing disclosures, which in some jurisdictions is a requirement to disclose environmental related risks in regulatory filings. The same must be said about the Natural Capital Coalition in the United Kingdom, which seeks to develop a universal methodology valuing all externalities at risk, including water. However, the significant challenge in this process appears to be how to account for (including measurement, quantification, and pricing) of the fugitive water resource. Attaching a price to water is not an easy task and it would inevitably add a burden to welfare states across the world, which rely on cheap food to keep aging and/or young societies together. But the pricing of water and the payment to farmers for caring for water needs to be part of the accounting standards as much as labor or energy costs. Affordable food should still be possible with market competition despite the higher water costs needed for sound environmental stewardship with the continued government intervention to protect the poor.
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