(October 16, 2012) A new report by Hong Kong and Shanghai Banking Corporation Limited (HSBC) warns that water shortages in China could undermine power production by water-intensive thermal generators and hydro dams, putting economic growth at risk, especially in the metals and mining, utilities, and manufacturing sectors.  Allocating water resources by decree in China’s planned economy is unlikely to work, predicts HSBC’s strategist Wai-Shin Chan. Investors should beware and attempt to estimate the effect of looming shortages on the life of their assets: without water security, investors could be left stranded.

Probe International notes: This HSBC report does not make concrete suggestions for China to protect and allocate its scarce water resources. There are, however, many institutional and market reforms described by Probe International on this website — for example, the enforcement of existing laws and regulations, the introduction of full-cost water pricing to reduce demand and promote efficiency investments, and the creation of tradable water rights and water markets — that will solve China’s water crisis. But each one of these reforms depends on constant progress in the direction of greater government transparency and public oversight, market discipline, and the rule of law.

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Does China have enough water to keep building three power stations a week?

By Wai-Shin Chan, published by China Dialogue on October 5, 2012

Cities like Beijing and farming heartlands are at risk of water shortages from China’s surging demand for power, says HSBC. China builds an average of three new power stations a week; by 2030 it plans to add more power capacity than exists in the US, the UK and Australia today. This will require huge amounts of water for cooling and driving steam turbine generators. The country’s water resources are already stretched and climate change is making conditions even tougher.

So what does this mean for investors and companies?

We believe that water and power risks must be a top priority when planning capital expenditure. It is vital that the availability of water and the potential effect on supply chains is taken into account for the life of the investment.

Forty percent of China’s total agricultural output is produced in water-scarce regions. We believe five provinces – Hebei, Shanxi, Shandong, Henan and Jiangsu – and three municipalities, Beijing, Shanghai and Tianjin, are most at risk of water shortages. The industrial sector is doubly exposed because it consumes well over 80% of all electricity.

Given the investment implications, it’s important to look at how China is attempting to deal with the twin challenges of generating sufficient power to drive its giant economy and protecting its precious water supplies.

In 2010, thermal power represented 74% of China’s total installed capacity and hydropower 22%. This means that almost all power generation relies on water. The nation’s industrialisation, urbanisation and rising affluence will increase demand for electric power and with that comes the further depletion of limited water resources.

China’s annual renewable-water resource per capita averaged slightly over 2,000 cubic metres in 2003-2010, just above the water stress level of 1,700 cubic metres. On closer examination, this water is not evenly distributed throughout the country’s 31 provinces and municipalities. Eleven provinces are already water scarce (meaning they have less than 1,000 cubic metres per capita per year) and climate change, caused mostly by carbon-dioxide emissions from burning fossil fuels, exacerbates existing water stresses. The Chinese government recognises this and has responded by setting tough new water quotas as well as pollution reduction targets.

Coal and hydro expansion

We estimate China’s power sector uses approximately 10% of the nation’s water, relatively low compared to the UK’s 34% and 49% in the US. However, China plans to add 1,212 gigawatts of water-reliant power capacity by 2030, equivalent to almost six times India’s current installed generation capacity. Coal-fired power will continue to dominate: in the decade to 2020, China plans to add 453 gigawatts of coal-fired power capacity, equivalent to double Russia’s entire 2009 power generation capacity.

China’s coal-fired power capacity expansion will also involve an increase in coal mining, which consumes an abundance of water for extraction and processing. We estimate that 47% of coal reserves are located in water-scarce regions. Water scarcity could also lead to a greater reliance on coal imports; for example, 30% of China’s ensured coal reserves are in Shanxi, a province suffering from extreme water scarcity.

Changes in water availability also threaten hydropower. Although hydro-capacity is usually built in water-rich areas, the effects of shortages can be felt more quickly in the event of drought. Some hydropower stations have operated at below capacity in recent summers due to droughts in southern China.

The government plans to expand hydropower from 216 gigawatts in 2010 to 568 gigawatts by 2030. Unfortunately, the damming of rivers upstream has the potential to generate tensions with countries further downstream, so hydropower in China comes with geopolitical risk.

We believe the expansion of China’s installed thermal and hydro capacity will further stress water resources. Even with a change in fuel mix, we expect that 87% of power capacity will still require water. That means efficiency needs to be greatly improved.

The full article on China Dialogue is available here.

This article is drawn from HSBC’s report “No water, no power: is there enough water to fuel China’s power expansion?”