Italy’s longest river, the Po, experienced its worst drought in 70 years last year. As we pause on World Water Day (22 March) to consider how we consume and manage water in our lives, it’s perhaps also worth reflecting on the wider global economic implications of droughts.
The Po crosses the northern part of Italy from the mountain Monviso in Piedmont, where Italy borders Switzerland and France in the Alps, to the Adriatic Sea in the west near Venice, the Po’s basin once covered 71,000 km². In Italy, where I am from, the river’s wide plains are known for flooding not drying up.
This crisis is heavily impacting the energy storage of its hydropower system. More than 85% of the 4,000 hydroelectric power plants in Italy are located in the northern regions. Hydro is the oldest source of renewable energy, accounting for around 35% of the total green energy production, and usually meets more than 15% of Italy's energy demand.
The consequences of droughts on the energy mix around the world
At the beginning of 2022, the stored energy value in Italian reservoirs was 22% below the average for the same period over the previous 7 years. Storage levels deteriorated further during the summer and were running more than 40% below the historical average in June. So far this winter, the stored energy value in Italian reservoirs is already 25% below the historical average.
As a result, the water shortage exacerbated the energy crisis as the drought hit the economy at a time when gas supply was being squeezed by the Russia-Ukraine war.
Of course, drought is not just a problem in Europe. Far from it.
Sichuan, a province in China that gets more than 80% of its energy from hydropower, experienced its worst drought in more than 50 years last year, for example. Restrictions on power supply were implemented due to low water levels, with some key automakers, like Toyota, reporting that they had been forced to halt production for several days at their factories in the region.
The western states of the US have also been hit by droughts. The United Nations Environment Programme (UNEP) highlighted last year that, due to more than 10 years of dry weather, the two largest hydroelectric reservoirs in the US were at their lowest levels ever. Lake Mead and Lake Powell provide water and electricity to tens of millions of people in the states of Nevada, Arizona, California, Wyoming, Colorado, New Mexico and in Mexico.
How climate change is expected to define the coming years
The impact of droughts is just one example of how climate change is an economic issue. The long-term economic impacts of unchecked climate change could be unavoidably huge. It is not simply an environmental issue.
This is why Schroders’ economics team produces 30-year return forecasts on an annual basis which incorporate the impact of climate change and what government policies to reduce global warming mean for markets.
And climate policies will be under scrutiny at COP28, the UN’s climate summit taking place in the United Arab Emirates this year, where the first Global Stocktake of the Paris Agreement will take place. This process will be the first official check-up on the Paris Agreement, evaluating if every country is making sufficient progress towards net zero pledges.
The United Nations has warned that net zero commitments must be backed by credible action and carbon pricing is seen as an effective policy lever to tackle climate change.
While governments have been slow to act, and companies have taken the lead, perhaps unsurprisingly, response to climate change is accelerating. We expect to see higher carbon pricing as the cost of emissions is still too cheap and some countries, like the EU, are set to strengthen their climate mitigation framework with innovative policy measures, such as carbon border adjustment mechanisms.
Not only that, but following COP15, the UN biodiversity summit, last year, a new biodiversity framework was finalised to address and reverse global biodiversity decline. We have to recognise that climate and biodiversity are deeply interlinked. Demands for more ambitious mitigation efforts remain and we can expect many more government interventions to come.
Such actions give me cause for optimism as I reflect on this important day for recognising the importance of water resources.