FT SPECIAL REPORT

Risk Managementwww.ft.com/reports | @ftreportsMonday November 10 2014

Inside

Appetite for Africa’sriches growsBut companies face risksfrom political violence toclimate changePage 2

Food producers facegrowing demandsRising incomes intensifyrisks to global suppliesPage 2

Resource-rich Amazonravaged by povertyDeforestation is on therise again despite effortsto preserve rainforestPage 3

Companies learn todiversify supply chainsSourcing goods frommore than one area canhelp when disaster hitsPage 4

F or companies and investorstrying to ensure access to basicresources, the world is lookingincreasinglychallenging.

Sectarian violence is creat-ing havoc in the Middle East – althoughoil production has not been disrupted asyet (see story below) – and the conflict inUkraine has brought military confron-tation to the borders of the EU, alongwith the threat of disruption to gas sup-plies fromRussia.

Meanwhile, extreme weather events,such as freak storms, floods anddroughts, appear to be becoming morecommon. Climate change, experts say,is posing a significant risk to food secu-rity. Meanwhile, natural disasters suchas earthquakes, volcanic eruptions andtsunamiscontinuetotaketheir toll.

Planning is key. Companies have toworry about dislocation of theirextended supply chains (see page 4), orhow to avoid litigation arising from neg-ligent business practices, for example intheextractive industries(seepage2).

In 2013, extreme weather events werebehind $37bn of the world’s $45bn dis-aster-related insured losses, accordingtoSwissRe, thereinsurancegroup.

Yet while evidence mounts of thehavoc these disasters wreak, the privatesectorremainsunderprepared.

Companies that are slow to adaptcould face increased costs. In addition to

known risks from factors such as popu-lation growth, extreme weather eventsand other natural disasters can also leadto shortages of essential resources suchas energy, water (see page 4) and rawmaterials.

These less predictable risks are often

ignored but pose particular challengestobusinesscontinuity.

When compiling its Natural HazardsRisk Atlas, Maplecroft, the risk consul-tancy, assesses the risk to business ofeverything from seismic activity andtsunamis, to cyclones, flooding,

Bonfire of the best-laid plansCompanies andinvestors have to factorin everything frompopulation growth tonatural disasters, writesSarahMurray

wildfires and drought. A single eventcan have a profound effect on access toresources. In Japan, for example, energybills were pushed up by increased reli-ance on imports after the countryturned off its nuclear reactors after the

Continuedonpage3

Saudi Arabia tapsSingapore for waterCity-state has beenusing cheaperdesalination technologyPage 4

Disaster strikes: wildfires destroyedhomes and property amid record hottemperatures in California this yearJorge Cruz/AFP/Getty Images

At a time when oil prices have just hit afour-year low, it might seem odd to beplanning for scarcity. But many inves-torsaredoing just that.

Tom Nelson, co-portfolio manager ofInvestec’s Global Energy fund, saysInvestec thinks oil supply will struggleto meet demand over the next fiveyears. “There are considerableunknowns when it comes to oil and gassupplies inthemediumtolongterm.”

Russ Koesterich, chief investmentstrategist at the asset manager Black-Rock, says the world is not “running outof oil”, but adds: “There’s a good chancethat oil supply may be tighter in futurethanexpected.”

Threats to global oil supply securityinclude production decline rates, lack ofexploration success, geopolitical haz-ards and lower capital expendituredelayingbigprojects,MrNelsonsays.

Iraq and the US have been seen as keysources of oil production, but questionmarks hang over both, leading to expec-tations of a strong rebound in prices. Inits medium-term oil market outlook,published in June, the InternationalEnergy Agency, the west’s energywatchdog, forecast a “robust” increasein global supply capacity of 9m barrels adayto105mb/dby2019.

But Iraq was expected to account for60 per cent of production growth withinOpec, the producers’ cartel, a figure thatthecountry’sconflictcalls intoquestion,although it has so far left most produc-tion intact. “This expansion looksincreasinglyatrisk,” theIEAadded.

Mr Nelson believes the IEA’s estimateis overly optimistic, and points out thatthe IEA has consistently overestimatednon-Opec production growth. He hasincreased holdings of US and Canadianexploration and production companiesin his portfolio, in anticipation of tight-eningsupply.

Other political risks in oil-producingcountries include sanctions on Russia,elections in2015 inNigeriaandsimmer-ingunrest inVenezuela.

Not all analysts in this sector share MrNelson’s expectation that supply willface strains within five years. Jon Clark,

partner in oil and gas transaction advi-sory services at EY, says: “I’ve not seenanalysis that suggests a medium-termshortfall in supply, absent a disruptionevent. There are also potential demanddisruptions, largely related to economicoutlook.”

The managers of the high performingGuinness Global Energy Fund believethe recent price lows have resulted fromSaudi Arabia, Kuwait and the UnitedArab Emirates temporarily increasingproduction by 2.9m b/d. They think theMiddle Eastern producers will cut backtoensurepricestability.

There are also question marks overwhether the US shale revolution, whichhas helped increase energy supplies anddrive down prices, will prove a lastingtransformation.

Will Riley, Guinness Global Energyco-manager, notes that current lowprices are likely to have a rapid effect oncapital expenditure in the shale oil sec-tor, since companies tend to operate“handtomouth”.

The Guinness managers see strongpotential in the US’s existing oil sites,but adds “the US has struggled to findanother large shale resource, despitethreeyearsof trying”.

The Guinness managers hold a full38 per cent of their portfolio in explora-tion and production, with a strongfocus on the US. They are also biasedtowards oil against other energy

sources, as they expect prices will rise tobetween $130 and $150 in nominaltermsby2030.

A further concern for investors is apotential lack of investment in newsources,asoilmajorscutbackoncapitalexpenditure.MrNelsonbelievesthere isalready a problem of under-investment,citing a JPMorgan survey that predicts afall in upstream spending in 2015 – onlythesecondinadecade.

“We believe this under-investmentwill compound the structural problemsalreadyfacedbythe industry,”headds.

Mr Riley said capital expenditure isbeing reduced sharply by a switchamong “super major” energy producersto “value-over-volume” strategies, atrendledbyTotalofFrance.

“They are abandoning long-term pro-duction growth targets in favour of arefocus on return on investment forindividual projects and overall returnoncapital,”saysMrRiley.

Ogan Kose, senior managing directorat the management consultancy Accen-ture, says buyers of crude oil are mean-while seeking to lock in the current lowprices as much as possible through long-termcontracts.

The managers of the Artemis GlobalEnergy Fund predict “sustained oilshortages” as a result of the spendingcuts and, like their rivals, haveincreased holdings in exploration andproductionstocks.

Mr Kose, who specialises in commod-ity trading and risk management, adds:“In the medium term there is enoughcrude, but at what price can you extractthatcrude?Themajority isgoingtostartcoming from offshore platforms andother expensive locations. There will beenough crude, but not enough at cheapprices.”

Fundmanagers divided overpredictions of oil shortagesPetroleum

Under-investment andpolitical instability putprice trends in doubt,says Judith Evans

Political risk: on guard at Zubair oilfield in Basra, Iraq— Essam Al-Sudani/ Reuters

‘In themedium term, thereis enough crude but atwhat price can you extractthat crude?’

2 ★ FINANCIAL TIMES Monday 10 November 2014

RiskManagement

I t isAfrica’sgreatparadox: theconti-nent is home to a wealth of naturalresources and most of the world’spoorestcountries.

According to the African Devel-opment Bank, the continent holdsabout 30 per cent of the world’s knownminerals and half its uncultivated ara-ble land. It is a significant producer of oiland, increasingly, gas, a position bol-steredbyrecentdiscoveries.

In one way or another, however, itsresources have all caused trouble.Access to oil and mineral revenues, landand water have given rise to friction andconflict. Hopes pinned on extractiveindustries as a basis for broader devel-opment have been largely disappointed.The continent has ample energy poten-tial, but most energy investment goes toexport projects, and only a minority ofcountries manage to supply electricitytomorethanhalf theirpopulations.

With low farm productivity, mostAfrican countries have become net foodimporters. Forest and marine resourcesare depleted by illegal and under-regu-lated logging and fishing. Water is abun-dant in large areas, but others areplagued by recurrent water and foodshortages. Drinking water supplies insub-Saharan Africa have improved rap-idly since 2000, but still reached only 64per cent of people in 2012, according toUN agencies, well below the average fordevelopingregions.

Pressures are expected to increase ontwo fronts– the population is set to dou-ble to more than 2bn by 2050, and cli-mate change threatens to extend aridand semi-arid areas, curb food produc-tionandlimit thescopeforhydropower.

Despite Africa’s growing profile as an

investment destination, foreign compa-nies operating in any of these sectorscontinue to find it a high-risk environ-ment. Oil and mining companies, espe-cially, have been hit by a wave ofchanges and uncertainties affecting taxand other key conditions in numerouscountries – including Nigeria and SouthAfrica, the biggest economies – as gov-ernments seek more revenues and eco-nomic benefits from, and control over,theseactivities.

Many risks such as political violence,expropriation, regulatory changes andcurrency upsets are covered by invest-ment guarantee and insurance schemesprovided by the World Bank and othermultilateral, public and private institu-tions. But others, such as infrastructurefailings, corruption and bureaucratichold-upsarenot.

Africa can always spring surprises.AmaraMining,agoldprospector tradedon London’s Alternative InvestmentMarket has not only faced lower worldgold prices, but two of the trio of westAfrican countries it was focusing onhavebeenhitbytheEbolaepidemic.

“You have to look at what could possi-bly go wrong, and try to amelioratethat,” says John McGloin, Amara’s exec-utive chairman. He underlines theimportance of working with local com-munities, which often means investingin facilities such as healthcare and edu-cation. “It’s a delicate area. If you don’tdo it correctly, you lose the wholeproject,” he says, adding: “The more youwork with the local community, the lessyouspendonsecurity.”

Appetite for investment in Africa andits untapped resources has growndespite the hazards. Christoph Wille, an

Africa analyst at the consultancy Con-trol Risks, suggests one factor may be aperception that armed conflicts havebecome less widespread. But he cau-tions: “The risks in Africa are diverseand remain extremely challenging insomecontexts.”

This environment tends to favoursmaller companies willing to startprojects in exchange for the prospect ofhigh returns. Companies have beenmoving intoremoteareas–TullowOil innorthern Kenya, for instance – wherethere may be little infrastructure and ascarcity of resources such as access towaterandlandsuitable foragriculture.

“In these cases, community relationsare going to be much more difficult tomanage,”MrWillesays.

Chris Bredenhann, a partner at PwC’sadvisory division in Cape Town special-ising inoil andgas, seesachange incom-panies’ attitudes to local participation.

“Co-operative approaches seem to begainingmoretraction,”hesays.

In Nigeria, Royal Dutch Shell andother oil majors have been sellingonshore and shallow-water interests,reducing their exposure to sabotage andillegal siphoningofoil in theNigerDelta.

TheInternationalEnergyAgencypre-dicts that unrest, oil theft and uncer-tainty for operators over delayed legis-lation will cause Nigeria to lose its placeas sub-Saharan Africa’s biggest oil pro-ducertoAngolainthenextfewyears.

So, are companies getting better atmanaging risk in Africa? Maria van derHoeven, IEA executive director, gives anuancedreply. “I thinkthere isarealisa-tion they have to be better at handlingrisks, and they do what they can,” shesays. But, she argues, it is up to Africangovernments to “de-risk the situation”by providing better regulatory frame-works, financial stabilityandsecurity.

Appetite foruntapped richesgrows despitemany hazardsAfrica Population growth, global warming andpolitical violence are concerns, saysDavidWhite

Remote: TullowOilhas movedinto northernKenya wherethere is littleinfrastructureEduard Gismatullin/Bloomberg

Investors’ long-term success mayincreasingly depend not just on the nar-row financial performance of the com-panies whose shares they buy, but onhow well they manage the ethical ques-tions that will ultimately shape the out-comesfor thosecompanies.

While many asset owners look onresponsible investing as an ethical obli-gation, thegrowingconsensus is that it isalsogoodbusiness.

This view casts responsibility as aquestion of risk management. If youinvest only in businesses with good

human rights practices, engagementwith local communities, clear accounta-bility through the supply chain and clar-ity about exposure to resource scarcity,you are less likely to be caught out by anunforeseen problem such as protestsover water rights or litigation followinganoil spill, suchasBP’sDeepwaterHori-zondebacle intheGulfofMexico.

Whether they have developed a clearpolicy or not, companies are beingasked to consider their ethical positionsmorethaneverbefore.

“Reducing our carbon footprint is notjust a technical scientific necessity; ithas also emerged as the human rightschallenge of our time,” said ArchbishopDesmond Tutu on the eve of the UN Cli-mateSummit in September.

Just as investors in the 1980s boy-cotted companies dealing with theapartheid regime in South Africa, todaythey should be considering their role in

averting disastrous climate change, saidthearchbishop.

Some institutional investors, led byUS universities, but including Austral-ian and Swedish pension funds andphilanthropic institutions such as the

Rockefeller Foundation, have declaredthey will divest their funds of all invest-ment infossil fuels.

This makes for good headlines, butthestory isslightlymorecomplicated.

Georgina Williams, group executivefor marketing and current affairsat Australia’s largest pension fund,

AustralianSuper, says one problem isthe lackofacleardividebetweenwhat isacarboninvestmentandwhat isnot.

If a bank, for example, has a biggercarbon footprint than an oil explorationcompany, which should an ethical fundinvest in? Or if it is defined by industryrather than direct emissions, how muchof its revenue can a company derivefrom the taboo industries before goingonthebannedlist?

As with carbon emissions, so withmostotherethical issues.What isappar-ently a clear-cut question of right orwrong can become fuzzy and compli-cated once dealing in the real world, orrather in the interface between the realworldandthefinancialmarkets.

Since a significant number of assetowners and managers have now signedup to the UN-backed Principles forResponsible Investment, which attemptto set a minimum standard of ethics for

investors, it can be assumed that manyinstitutional investors feel they have anobligationtoactresponsibly.

However, things turn out to be lessthanstraightforward.

Agriculture investment in Africa is anexample of how an apparently ethicalinvestment strategy can end up harm-ing vulnerable people and societies.This raises the question of how to bal-ance the harm against the good done – aproblem that many investors are likelyto have thought responsible investingwouldremove.

Most agricultural investments madefor financialreturnunsurprisinglyfocuson goods for export – tobacco, coffee,cocoa and biofuels – rather than food tobeconsumedlocally.

Agriculture cuts across a broad rangeof resource issues and ethical questions.Because of the rapidly growing humanpopulation (forecast to reach 9.6bn by

2050), producing more food is a prior-ity. But there are strongly competingdemands for the resources needed toproducefood.

In many areas, water is becomingscarcer than ever, as increasingly urbanpopulations consume the water thatfarmers rely on for irrigation. Land togrow food is used for biofuels, or takenfrom indigenous peoples without offi-cial title, or ravaged from rainforestareas.

Water scarcity is likely to be a leadingfactor in both business and geopoliticalarenas in decades to come. Withoutevenaddressingthequestionofwhetherit is ethical to invest in private watercompanies in developing countries, anycompany that uses water as part of itsprocesses (including all agriculture andmany industrial businesses) needs to bemanaging the inherent risk in beingdependentonavanishingresource.

An understanding of grey areas is crucial for success in businessEthical investing

Companies may aim to actresponsibly, but right versuswrong is often anything butclear-cut, writes Sophia Grene

Christine Lagarde, managing director ofthe International Monetary Fund, deliv-ered a sobering wake-up call in Febru-ary when she warned that the world was“perilously close” to reaching a climatechangetippingpoint.

As well as the direct impact of severeweather fluctuations in the form ofstorms, floods and droughts, the longerterm effect on natural resources poses asevere economic threat. This is an issuethat pension funds are being urged toaddress in their investmentportfoliosasamatterofurgency.

Given the size of assets under pensionfunds’ control, there is a growing recog-nition that failure to adapt asset alloca-tion to account for climate change riskcould leadtosignificant losses.

“There is a huge risk of running out ofvital resources, but there is also a big

opportunitytomakemoneyfromtryingto fix the problem,” says Aled Jones,head of responsible investment forEurope, the Middle East and Africa atMercer, the consultancy. “It is impor-tant to persuade pension fund trusteesto lookatbothsides.”

Credible scientific research on im-pending climate change risks hasexisted for some time, but not everyoneis convinced that pension funds are tak-ingthethreatseriouslyenough.

Louise Rouse, director of engagementat ShareAction, a charity that promotesresponsible investment, says: “Climatechange, which is going to lead to a lot ofresourceconstraints,hasnot featuredasprominently in pension fund invest-mentthinkingasonewouldexpect.”

She adds that significant climatechange comes with extreme weatherevents, which will impact on food andwater supplies. There will be a hugenumber of companies and stocks facingvolatility, she says, and that will have aneffectonpensionfundreturns.

However, Ms Rouse acknowledgesthat responsibility to adapt does not liesolely with pension fund trustees, andpoints to many “structural reasons”why schemes continue to invest heavilyin industries that are contributing to

climate change. “Pension funds areunderpressure,”shesays.

“Defined benefit schemes have defi-cits and are valued every three years,which makes them become short-term,stock-chasing funds. The big income-paying investments are fossil-fuel com-panies.”

Despite a battle with dwindling fund-ing levels and increasing liabilities,some pension funds have implementedchanges to their investmentapproachtotackleclimatechangerisk.

In Australia, the Local GovernmentSuper, one of the country’s largest pub-lic sector pension funds, announced inOctober that it was “moving away fromhigh-carbon investments” and woulddivest itsassets incoal.

Peter Lambert, chief executive of theA$8bn ($7.1bn) scheme, called climatechange “an unarguable scientific realityand one which poses a very real invest-mentrisk”.

The BT Pension Scheme, one of theUK’s largest private-sector pensionfunds, has been exploring ways to allo-cate capital to investments that couldoutperform as a result of policy movestoa low-carboneconomy.

For example, in 2011 the schemeinvested £100m in a carbon-tilted

version of the FTSE All-Share index,where carbon-intensive companies areunder-represented.

Likewise, the UK’s EnvironmentAgency Pension Fund has increased itsallocation to sustainable property,infrastructure and forestry – areas thatare seen as a hedge against both infla-tionandclimatechange.

However, not all schemes think theycan afford to take risk such as climatechange intoaccount.

Mercer’s Mr Jones says pension fundsoften face other priorities considered tobe more important to their asset alloca-tion decisions before they can considerclimatechangerisk.

“Most investors have short-term pri-orities, even pension funds that are dis-tracted by short-term issues such asfunding levels,”saysMrJones.

Amin Rajan, chief executive of CreateResearch, a fund consultancy, agreesthat implementing investment strate-gies to tackle resource risk is hard toachieve for a majority of pension fundsas its impact is“hardtomeasure”.

But he points out that it is implicit inthe types of asset classes that are nowbeing used – for example, infrastruc-ture, venture capital, private equity,commoditiesandweatherderivatives.

Climate changemoves up investment agendaPension funds

Despite pressures to boostshort-term performance,funds are recognising needto move into low-carbonholdings, says David Ricketts

‘Definedbenefitschemeshavedeficits,whichmakes themshort-term,stock-chasingfunds’

Agriculture is an inherentlyrisky business. This is whygovernments subsidisecrop insurance and futuresexchanges have existed formore than a century, writesGregory Meyer.But risks to food

supplies are changing. Agrowing world population,rising incomes, shiftingconsumption habits,biofuel mandates andglobal warming all presentfresh challenges.How farmers, traders,

processors, foodcompanies and policymakers meet them will becrucial to determining howwell the world meets a 60per cent increase in fooddemand by 2050.There is no global

shortage of calories. Infact, the world wastes athird of all food produced,or 1.3bn tonnes a year,according to the UN Foodand AgricultureOrganisation.Nevertheless, 805m

people around the worldare chronicallyundernourished, the FAOreports. This is 200m lessthan two decades ago, butstill a number that exceedsthe populations of everycountry but China andIndia.As populations and

personal incomes increase,the average household willbe better able to affordsufficient food, reducinghunger. But rising incomesalso intensify risks to thefood supply, as wealthierpeople tend to eat moremeat, fish, dairy and eggs,requiring more feed grainper pound of food.In an October speech,

David MacLennan, chiefexecutive of Cargill, thelarge, US privately held,multinational agribusiness,put it this way: “In short,the whole food systembecomes more meat-destined than grain-destined.”“Dietary expansion”

starts to happen whenincomes rise above $2,000a year, he says.Consumers also expect

more from their foodin terms of safety,healthiness andinformation on where andhow it was raised.For example, Shuanghui

International of China wasin part attracted by thesafety protocols atSmithfield Foods when itbought the US-based porkproducer for $7bn last year.Rabobank, one of the

largest lenders toagribusiness, says thetrend towards “consciousconsumerism” willcontinue.Justin Sherrard,

Rabobank’s head of foodand agri research, says: “Ifyou’re going tomeasure up tothose things,you’ve got tochange the way youmanage your supply

chain. You’ve got to startintroducing traceabilitysystems, so you candemonstrate you’remeeting consumerconcerns.”A more immediate risk is

transport. Although goodweather has resulted inbumper crops this yearacross most of thenorthern hemisphere,railways and the storagesilos alongside them areunder strain. In some cases,this makes it uneconomicalto bring surplus grain tofood importers.Bill Lapp of Advanced

Economic Solutions, a USagribusiness consultancy,says: “The inherentadvantage the US has hadfor a long time has been intransportation, both railand water.”A further complication is

that the biofuels industryhas emerged as acompeting source ofdemand for grain. In theUS, the world’s largestbiofuel producer, 130mtonnes of corn is turnedinto ethanol each year,according to a Departmentof Agriculture estimate.Biofuel policies have

helped lift grain prices.They have “recapitalised”agriculture, Mr MacLennansays, making it better ableto withstand shocks.However, government

targets, or mandates, riskexacerbating shortfallsunless they can be lifted intimes of market stress, headds.Cutting down the size of

the biofuels industry wouldcarry its own risks. Itaccounts for about 1.5 percent of world liquid fuelssupply. Taking biofuelsaway could tighten oilmarkets and drive up theprice of fuel, a key inputcost for farmers and grainshippers.Past shortfalls in

agricultural commoditieshave led to export bansand panic buying bygovernments andconsumers, driving upprices.Members of the Group of

20 nations and someothers have sought toavert this risk with thecreation three years ago ofthe Agricultural MarketInformation System, whichsheds light on opaquegrain balances andencourages members notto disrupt trade in cereals.There are signs these

efforts are working. Forexample, says AbdolrezaAbbassian, senior grainseconomist at the FAO, afterdisastrous global wheatharvests in 2012, Ukrainewas persuaded not to stopgrain exports.

Food Suppliers are adapting tomeet consumer expectations

Biofuels arecompetingfor cornsupplies

If a bank’s carbon footprintis bigger than an oilcompany’s, which should anethical fund invest in?

Monday 10 November 2014 ★ FINANCIAL TIMES 3

RiskManagement

I n the weeks leading up to Brazil’selections in October, the country’spresidential candidates battledover everything from inflation andforeign investment to day care cen-

tres and murder rates. However, onetopic was noticeably missing from thedebate: theAmazonrainforest.

Imazon, a research institute, says:“The region is superlative in terms ofnatural resourcesanditsenvironmentalimportance – it represents about one-third of the world’s tropical forests, andis home to the largest river basin on theplanet and is rich in mineral resourcesand hydroelectric potential.” It adds:“Even so, the debates passed over the[issueof] theAmazon.”

It is no wonder that politicians haveoftensteeredclearof thetopic.

While the region is Brazil’s and Latin

America’s biggest natural asset, it alsofaces many competing demands and, assuch, represents one of the continent’sbiggestchallenges.

Brazil’s ruling Workers’ party (PT), inpower since 2003, has put large areas ofrainforest under federal protection totry to prevent deforestation and reducethecountry’sgreenhousegasemissions.

In October, the government createdthe latest reserve, Alto Maues, a 6,680square km area of mostly untouchedforest.

Yet even the protected areas remainvulnerable, as it is very difficult to over-see such vast areas of the jungle andensure that rules are respected. Lastyear, deforestation of the Amazon inBrazil went up for the first time since2008,rising29percent.

Moreover, the protection of the Ama-zon rainforest does not just depend onactions taken within the region itself.Productivity gains in cleared landfurther south are also vital to allow thecountry to meet its food productiontargets without sacrificing further partsof the rainforest in the process, explainsElísio Contini, a researcher at the Brazil-ian Agricultural Research Corporation(Embrapa).

Brazil’s fight against deforestation

also has a significant social dimension.The Amazon basin not only containssome of the world’s most vulnerablespecies but also Brazil’s poorest fami-lies, presenting the government with ahugedilemma.

While Brazil, which is home to morethan 60 per cent of the Amazon, isunder intense international pressure to

protect the region, it is alsounder domestic pressure to bringdevelopment to its most remote states.

“This paradox of poverty in the mid-dle of the biggest reserves of the world’snatural riches has proven to be unsus-tainable,” writes Judson Valentim,anotherresearcheratEmbrapa.

“Asaresult, this regionhasbeenat the

centre of the debate around sustainabledevelopment, drawing the attention ofresearchers, policy makers and civilsociety on a local, national and interna-tional level,”hecontinues.

In the private sector, companies suchas Natura have made the most of theperceived risk of development to theAmazon by finding a way to make sus-tainable development profitable. Thelisted cosmetics company sources manyof its ingredients from villages deep inthe Amazon rainforest, and works withscientists, NGOs, universities and farm-ers todiscovernewones.

Beef production is a central elementin the problematic relationship betweenBrazil’s natural and agriculturalresources. It increased sixfold between1950 and 2006, turning the country intoone of the world’s top exporters of themeat. By 2019, it is expected to accountfor up to 30 per cent of the global beefmarket.

While higher beef productionbetween 1950 and 1975 was largely theresult of an increase in the country’spasture areas, growth since has beenachieved by higher productivity, saysProfContini.

In practice, this not only means rear-ing more animals per square kilometre

but also finding ways to improve thequalityandquantityof themeat.

While many of these initiatives aredependent on government investment,the private sector has been playing anincreasingly important role, says ProfContini.

Without the productivity gainsbetween 1950 and 2006, it would havebeen necessary to create an estimated525mhectaresofpastureareatoachievethe 2006 production levels of beef, ProfContini says, adding that in the decadebetween 1996 and 2006 alone, produc-tivity gains in the beef industry sparedan estimated 73m hectares of theAmazon.

The rate of deforestation in the Ama-zonis still alarming,butsuchproductiv-ity gains along with more direct effortsto stop illegal logging have played a cru-cial role in the battle at least to slow thedestruction of the region’s richestresource,analystssay.

While agriculture through pastureexpansion represents one of the biggestrisks to the Amazon, the lobby behindthe protection of the Amazon alsopotentially represents one of the biggestthreats to the expansion of the beefindustry – an industry that is vital to thecountry’seconomy.

‘Paradox of poverty’ haunts resource-rich AmazonBrazil Raising beefproduction is vital tothe economy but itmeansmore demandfor pastureland, saysSamantha Pearson

Deforestation: illegally logged timber floats down the river— Paulo Santos/Reuters

2011 earthquake and tsunami led tonuclearmeltdownatFukushima.

Globally, companies’ exposure to riskis rising as they move into new markets.Maplecroft’s latest analysis shows thatcountries facing the highest financialcosts from natural hazards includemanyemergingeconomies.

Maplecroft also points to an increas-ing concentration of global economicoutput in countries facing substantialnatural hazard risk. These includeBangladesh, IndiaandthePhilippines.

“With the economic shift from west toeast, there’s been an increase in expo-sure to these natural hazards,” saysJames Allan, head of environment andclimate change at Maplecroft. “These

countries are more inherently exposed.That’swhywe’regoingtoseeanincreasein losses inthecomingyears.”

Recent research by CDP, the environ-mental charity, which requests publiccompanies’ annual environmentalinformation on behalf of institutionalinvestors, found that S&P 500 compa-nies see climate change posing growingphysicalandfinancial risks.

In 2013, half of the physical risks thatcompanies disclosed were described asbeing from “more likely than not” to“virtually certain”, up from 34 per centin2011.

But if the risks are becoming clearerto the private sector, the question forcompanies ishowtoreact.

Michael Wilson, a partner at KPMGwho leads the consultancy’s Risk in theBoardroom programme, argues thatcompanies need to take a broaderapproach and involve a wide range of

Continued frompage1 functional leaders, rather than simplyassigning responsibility to a risk man-agementcommittee.

“The companies that do this well takea cross-section of people from opera-tions and back office, as well as from thedifferent geographies they’re involvedin, and talk through situations such as ahurricaneorextremeweather,”hesays.

Another important strategy, particu-larly for companies in sectors such asmanufacturing, is looking at the risksposed to their suppliers (See page 4).“Companies need to see how the riskcascades through the supply chain,”says Richard Hewston, Maplecroft’sprincipalenvironmentalanalyst.

But with less predictable risks such asclimate change, for example, even theinsurance sector – which is oftenregarded as being ahead of many otherindustries – appears poorly prepared toaddress therisks.

AreportproducedbyCeres,a sustain-able investor group, revealed that only afew companies in the sector had devel-oped robust climate risk management practices. Some 82 per cent of the 330US insurance companies surveyedearned a “beginning” or “minimal” pre-parednessrating.

“Most of industry is still sitting on itshands,” says Cynthia McHale, directorof the insuranceprogrammeatCeres.

The financial services industry alsohas some catching up to do, according toMr Allan. “That’s because they’reremoved from the companies they’reinvesting in,” he says. “So they’re proba-bly a couple of years behind . . . inunderstandingtheirexposures.”

Asidefromthedifficulties inassessingand managing natural disaster risk,companies must battle vested interest –admitting a risk exists could affect thevalueofanasset.

Finally, planners face the natural ten-dency to respond to immediate chal-lenges and neglect problems that seemfartheroff.

ContributorsSarah Murray,David WhiteFT contributorsJudith EvansReporter, FT MoneyDavid RickettsAssociate editor, Ignites EuropeSophia GreneReporter, FTfmGregory MeyerMarkets reporterSamantha PearsonBrazil correspondentJeremy GrantSingapore correspondentMichael DempseyFreelance journalist

Emma BoydeCommissioning editor

Steven BirdDesigner

Andy MearsPicture editor

For advertising details, contact:Peter Cammidge, +44 (0)20 7775 6321,or peter.cammidge@ft.com,or your usual FT representative.

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Theunexpectedputspaidto the best-laid plans

Firefighting: risk management planning is essential— David McNew/Getty Images

$37bnCost of globaldisaster-relatedinsured lossesin 2013

50%Proportion ofdisclosed riskscompanies saw aslikely in 2013

4 ★ FINANCIAL TIMES Monday 10 November 2014

RiskManagement

Globalisation may be unstoppable, butextended supply chains are trailing awhole new set of problems in theirwake. Assessing the risk element is adiscipline that combines establishedwisdomwithsomenewtricks.

Zurich Insurance, for example, hasharnessed computer software to helpmitigate thisrisk. It takeshistoricexam-ples of supply chain disruption and usesthem to project images of possible prob-lems on to customers’ own logisticsmaps,whichclientscanaccessonline.

Despite a background in accountingNick Wildgoose, Zurich’s customeradviser for supply chain risk, admitsthat comprehending the mass of figuresinvolved in a complex chain is nevereasy. Hence the software uses symbolssuch as dials to indicate how severe afailure at a particular point in the chaincould be. “The idea is to bring differentelements together and make them eas-ier tounderstand,”hesays.

The insurer is immersed in the com-plexities of risk at all levels and MrWildgoose maintains that its customersneed to give the supply chain moreattention. “If a large part of your reve-nue is at risk from a supply chain, youare honour-bound to analyse it andunderstand every component rightbacktothebasics.”

This approach is evident at eXceptionEMS, a UK electronics manufacturer.The company assembles sophisticatedequipment for the oil, gas and aerospacesectors.

One of eXception’s primary compo-nents is the printed circuit board (PCB)that contains the basic elements at theheart of all digital systems. These aremade across Asia, but a combination oflocal factors has forced Steve Healings,eXception’s supply chain director, tothink very hard about exactly where hepurchases them

“Our risk management policy is tohave a geographic spread of suppliers,”he explains. The idea is that any naturaldisaster will not hit the company’sentire supply. With the Japanese tsu-nami of 2011 in mind, he is splitting uphis suppliers. Mr Healings says thatwhen he allocated contracts recently, heawarded them to manufacturers in bothThailandandMalaysia.

Digital communications have shrunkthe world in some respects, but the dis-tance between eXception’s UK officeand Asia still presents problems. “Try-ing to manage supplier relationships

from 6,000 miles away is tough,” saysMr Healings, who has established asmall office in Penang, Malaysia to allowhis company to smooth out any ripplesat the Asian end before they interruptdeliveries.

Small electronic parts are not a lightcargo when shipped in bulk. Mr Heal-ings buys PCBs in volume and ship-ments of up to 200,000 eXception PCBsare usually sent by sea. This is cheaperthan air freight, but Mr Healings keepsthe air cargo option open in order torespondrapidlytoanysurge indemand.“We can save on costs by using con-tainer vessels, but we also use air freightfora flexibleresponse.”

He says his company holds somebuffer stocks in the UK in case of prob-lems with supply. But holding stock tiesupmoneyandpartscanquicklybecomeobsolete. Risk analysis dictates the scaleof thesesafetystocks.

“We have to make a decision based onourexposuretoanydelays inthechain,”saysMrHealings.

Andrew Caveney is in charge of globalsupply chain work at the consultancy

EY. He cautions against relying tooheavily on prior experience of eventswithin a given supply chain. “You needto watch things in real-time, not waituntil you see a problem in the rear-viewmirror.Bythen, it is too late.”

He encourages clients to scrutiniselocal suppliers. Any reluctance to allowvisits to a plant or permit an audit of thesite suggests a company may not be ableto deliver the goods as expected. MrCaveney recommends asking local buy-ers to ask tough questions when theymeet supplier executives. “You wantbuyers to become more savvy in spot-ting where a supply chain is comingunderstrain,”hesays.

Basic contingency plans are whatensure a stable chain. Mr Caveneyagrees that the clustering of electronicsplants in northeast Japan was shown tobe an enormous vulnerability when thetsunamistruck,but this shouldnothavecome as a surprise. “Industries dogather around one area, so their cus-tomers should have clear plans in placetobuyfromothersources.”

Ultimately, cost considerations willalways affect how a supply chain isarranged. But as the sequence of playersinvolved grows and becomes more com-plex, the risk element increases. Andthat means controls that can be exertedare weakened unless very careful atten-tion ispaidto localdetails.

Diversification remains atthe heart of reducingthemargin for errorSupply chain

Contingency plans andattention to detail helpensure smooth delivery,writes Michael Dempsey

‘We keep the air cargooption open to respondto any surge in demand’

It is hard at first glance to see what SaudiArabia and Singapore have in common.One is a vast desert nation and the othera compact island about the size ofGreaterLondon.

Yet fresh water, or the lack of it, is theissue that binds them in a way that dem-onstrates how countries are learningfrom each other how to deal withresourcescarcity.

Saudi Arabia has no permanent riversor lakes and very little rainfall, whileSingapore has high rainfall but, given itssmall size, little landforcollection.

Since the 1970s Saudi Arabia hasdrilled to tap aquifers and has devel-oped an extensive desalination indus-try, to the point where 70 per cent ofdrinking water in the kingdom’s citiescomes from seawater, according toSaudigovernmentstatistics.

Yet as the population expands and theeconomy grows, Saudi Arabia needs todevelop its desalination industry fur-ther.

This explains why government offi-cials visited Singapore last month tolearn more about how the tiny Asiancity-state has used desalination to movetowards self-sufficiency in the preciouscommodity.

“The water ministry has an ambitiousplan and Saudi Arabia is going to need alot of desalination over the next 10years,” says Olivia Lum, chief executiveof Hyflux, a Singapore company whosewater treatment expertise has helpeddrive Singapore’s rapid rise as leader intheglobalwater industry.

Ms Lum, who grew up in Malaysia ina home with no running water,

co-founded Hyflux in 1989 with aninvestment of S$20,000 ($15,700). Ithad annual revenues of $536m in thefinancialyearendedDecember2013.

The company has pioneered the useof advanced membrane technology intreating waste water and seawater tomakeitdrinkable.

The Saudi interest in Singapore, andspecifically what Hyflux has to offer,stems in part from the fact that most ofSaudi Arabia’s desalination capacityusesaso-calledthermalmethod.

This is more expensive to run thanmembrane desalination since itrequires energy to heat the water as partof theprocess.

Singapore was one of the first coun-tries to use membrane technology to

desalinate water on a large scale fordrinking and industrial use. Such amethod is one of three methods used bySingapore to build up self-sufficiency inwatersupplies.

While half its water comes fromneighbouring Malaysia – with whichrelations are currently good – Singaporehas been busy building the capacity toproduce its own water for reasons ofnationalsecurity.

The island state’s fresh water fordrinking and industrial purposes comesfrom three sources: water catchments; amassive purification programme imple-mented in 2003 called NEWater; anddesalination.

Water demand in Singapore isabout 400m gallons a day, with homes

consuming 45 per cent and the non-do-mestic sector taking the rest. By 2060,total demand could almost double,accordingtothegovernment.

The government says Singapore is “ontrack” to more than triple NEWatercapacity – and ramp up desalination,which can meet up to 25 per cent of cur-rent demand. Together, these are esti-mated to be able to meet up to 80 percentofdemandby2060.

Some of that is likely to fall to Hyfluxto build. It provided the city-state’s firstdesalination plant, which opened in2005, and has built a second whichopenedlastyear.

A third plant will be put up for tenderby the government next year, industrysourcesexpect.

Hyflux, meanwhile, has been goingglobal. Its treatment facilities are foundin more than 400 locations around theglobe, including China, India, SaudiArabiaandAlgeria.

In a few months, Hyflux is set to openwhatwillbe theworld’s largestdesalina-tion plant in the world in Oran, Algeria’ssecond-largestcity.

The increasing commercial viabilityof desalination will help both SaudiArabia and Singapore, as they increasethe proportion of their potable andindustrial-use water derived from thatprocess.

Thanks to scientific advances such asmembrane technology, it costs abouthalf as much to produce fresh waterthrough desalination as it did 15 yearsago, when it cost $5 per cubic metre toproduce.

“Today you can probably get in therange of $1-$2 [per cu m] depending ontheoilprice,”saysMsLum.

Increasing water scarcity is helpingspread the use of large-scale desalina-tiontonewmarkets, shesays. “Hyflux isin a strong position to provide clean,affordable and sustainable water solu-tions to meet worldwide demand,” sheadds.

Saudi Arabia taps Singapore for technologyDesalination

The Asian city-state hasbeen using a cheapermembrane technique,explains Jeremy Grant

Counting the costs: Saudi Arabia knows the worth of water — Fahad Shadeed/Reuters

A s São Paulo, Brazil’s biggestcity, grapples with the mostsevere drought in eight dec-ades, police escorts havebeen brought in to prevent

emergency water trucks from beinghijacked. Yet, while shortages createextreme difficulties for citizens, the cor-porate sector is also heavily dependentonwater formanyof itsoperations.

More than three-quarters of US com-panies surveyed this year by PacificInstitute, an environmental researchgroup, and communications companyVox Global said they already faced prob-lemsrelatedtowater.Andalmost60percent of respondents said water chal-lenges would affect their profitabilityandgrowthinthenext fiveyears.

This month, research by the NGOCDP (formerly the Carbon DisclosureProject), which requests annual envi-ronmental information from publiccompanies, found that 68 per cent ofrespondents believe they are exposed towater-relatedrisk.

The sources of risk emerged as scar-city(43percent), flooding(28percent),drought (18 per cent), declining quality(14percent)andregulatoryuncertainty(13percent).

Giulio Boccaletti, managing directorforwateratTheNatureConservancy,anenvironmental charity, sees three mainreasons for water risk increasing

globally: rising demand; insufficientinfrastructure (from groundwater andsoil to reservoirs); and greater variabil-ity, with rises in the frequency andintensityofdroughtsandfloods.

“Water is the ultimate risk-manage-ment problem,” says Mr Boccaletti.“And the problem is that the statisticsare changing . . . so we’re getting thedimensioning of our solutions wrongandwe’re feelingtheeffectsof that.”

Among the industries most directlyaffected are agriculture, which con-sumes some 70 per cent of the world’swater resources, according to the UN’sFood and Agriculture Organisation. Theenergy sector is also vulnerable; hydro-electric generation relies on water, ofcourse, and the recovery of shale oil andgasrequires largeamountsofwater.

Nor are the risks purely related toshortages. Tightening regulatoryrequirements can also have an impacton companies’ operations – as can a lackof regulation. “Governments have a sig-nificant role to play in the governance ofwater,” says Cate Lamb, head of CDP’swater programme. “And we’re in thissituation because of poor water govern-ancehistorically.”

Companies are responding in variousways. “There is increasing recognitionthat a business-as-usual responseisno longersufficient,”saysMsLamb.

Seeking new types of insurance is one

route some companies are taking. “Wesee more widespread use of rainfall-based protection by power producers inhydroelectric regions,” says StuartBrown, head of origination for weatherand energy at Swiss Re Corporate Solu-tions. To develop one such productSwiss Re, the reinsurer, partnered withthe World Bank on customised waterinsurance in Uruguay. This covers thestate-owned hydroelectric power com-pany if insufficient rainfall means itmust turn to thermal generation, whichcostsmoreandrequiresoilpurchases.

Working with suppliers is also critical,though sometimes the solutions are rel-atively simple. In Vietnam, for example,Nestlé is training coffee farmers to savewater by reducing the amount of irriga-tion given to their crops. Farmers nowplace plastic bottles that have been cutin half in their fields and check themeachmorningforcondensation.

If they contain dew, explains JoséLopez, head of operations at Nestlé, thesoil is wet enough not to irrigate thatday. This also improves the crop, he

adds, “because one of the problems withexcessive irrigation is that it washes outthe micro-organisms in the soil thatbringthenutrients intotheplant”.

As the Swiss Re and Nestlé examplesdemonstrate, the challenge for compa-nies is that responses to water risk varywidely in type and scale, and must beadaptedto localconditions.

This is because, unlike other environ-mental risks such as greenhouse gases,water stress is highly localised – parts ofa country might be experiencing severedrought while other regions could bedealingwithsubstantial rainfall.

Moreover, water is a resource that isused by the entire community. Compa-nies might therefore become highlywater efficient in their own operations,but still suffer shortages because of useby neighbours such as agri-businessesorpowergenerationcompanies.

This, says Mr Boccaletti, means thatcompanies need to address water riskonseveral fronts.

First, they need to increase water effi-ciencies internally. Second, they need towork with their suppliers to managerisks. Finally, they need to engage thebroader community – from local gov-ernment to citizen groups – and play arole in addressing the water problemsthataffecteveryone.

“That’s the newest territory for busi-ness,”MrBoccalettiadds.

Innovative solutions required toweather storms and droughtsWater Growing instability calls for creative new thinking frombusinesses, reports SarahMurray

‘Water is the ultimate risk-management problem,’ says Giulio Boccaletti of The Nature Conservancy, an environmental charity – Channi Anand/AP

Parts of a countrymay facesevere drought, while otherregions suffer serious rain