Investors have limited choices when it comes to tackling investment constraints like carbon and water risks, highlighting the need for government and regulators to urgently take action, a new report by WWF South Africa (WWF-SA) and WWF-UK has shown.

The report, ‘Navigating Muddy Waters: Securing Investment Returns under Carbon and Water Constraints’, was undertaken in collaboration with Carbon Tracker, Trucost and SinCo, as well as the Government Employee Pension Fund.

Researchers found that climate change and water scarcity would impact on companies’ operations, revenues and costs and that investors in these companies would also be affected.

This is particularly pertinent in water-stressed South Africa, which is especially vulnerable to the impacts of climate change.

WWF-SA sustainable business programme manager and co-author of the report Malango Mughogho told Engineering News Online that South Africa’s energy sector represented the largest opportunity for mitigation, as it accounted for about 86% of the country’s greenhouse gas (GHG) emissions.

However, regulations dictating that power generated from renewable sources had to be sold to power utility Eskom were constraining investment in low-carbon technology and projects.

“The government has regulatory mechanisms that control how we generate our electricity and that is the block. For example, the Integrated Resources Plan for energy sets a limit in terms of what we consider to be low carbon. The quantity of renewable energy has a specific limit, the same with the quantity of hydro energy and the quantity of coal-based energy,” Mughogho pointed out.

She suggested that the government consider restructuring the electricity sector in terms of who generated electricity and how it was distributed.

Further warding off investment in the clean-energy sector was the higher cost of electricity generated from renewable sources, compared with conventional coal-generated electricity.

“This is where the government comes in, Eskom needs to be supported so that it can buy more expensive electricity from renewables to lower its carbon emissions. The energy sector in general has high emissions, but electricity makes up most of this. So, this is where change should be made to make a significant impact,” Mughogho stated.

WWF-SA CEO Morné du Plesiss told Engineering News Online that the country’s policy and regulation environment could face a “lemmings’ cliff” scenario if changes were not made.

He welcomed the imposition of a carbon tax, but indicated that the WWF-SA was not calling for a “reckless imposition that is going to have all sorts of unintended consequences”. “It must be well constructed. The same goes for the water sector.”

Meanwhile, the report revealed that institutional investors were failing to systematically factor in climate change and freshwater risks when making investment decisions.

This created the risk that the listed bonds and equities of companies in high carbon sectors could be mispriced, which could lead to financial instability when the market recognised the realities of water scarcity and GHG emission limits and repriced these securities accordingly.

“Making risk-adjusted returns is at the heart of the investment industry,” Mughogho said.

Constraints on returns from investments in South Africa’s bond and equities markets as a result of climate policies and water scarcity included a potential limit on revenues earned by the sale of coal owing to regulated limits on GHG emissions.

Carbon Tracker’s research showed that listed coal reserves for domestic use on the JSE exceeded a carbon budget for coal-related sectors by 7.2 Gt of carbon dioxide equivalent.

Increased costs as a result of the planned carbon tax, especially for investors in the carbon- and energy-intensive basic resources and energy sectors, was also a concern. Trucost’s research indicated that carbon liabilities could cut Eskom’s interest coverage by 22% and that carbon costs could be material to many companies on the All Share Index.

Companies would also be forced to internalise the full environmental cost of water. Reflecting levels of scarcity in South Africa, Trucost’s calculations revealed that the external value of water used by operations and first-tier suppliers of JSE top 100 companies could total more than R56-billion each year.

An International Energy Agency report released last week showed that two-thirds of proven fossil fuel reserves could be used if the world was to limit global warming to 2 °C. The report also highlighted freshwater risks facing the energy sector.

Meanwhile, South Africa’s Second National Communication under the United Nations Framework Convention on Climate Change anticipates that the degree of warming in the country will be higher than the global average.

Without wide-scale international mitigation efforts, South Africa’s interior faced average increases of between 2 °C and 3 °C by mid-century and between 6 °C and 7 °C after 2050.