Water Risk Valuation Tool - Case Study
Water is a critical natural capital factor that underpins many industrial processes. Water scarcity is therefore emerging as a potentially material risk for business, particularly for companies that operate in water-stressed regions and water-intensive industries such as mining.
Along with growing recognition of the potential material impacts of water scarcity, the increasing availability of geospatial data makes it feasible to model out possible effects of water risk on revenues and/or costs. The Water Risk Valuation Tool (WRVT) was developed to address the often missing link between corporate environmental risk and financial value. The WRVT is the product of a collaboration between Bloomberg LP and the Natural Capital Finance, with support from Bloomberg Philanthropies and the GIZ (Deutsche Gesellschaft für Internationale Zusammenarbeit). The WRVT is a practical, high-level demonstration tool that illustrates how water risk can be incorporated into company valuation in the mining sector using familiar financial modelling techniques.
APPLICATIONS AND EXAMPLES
This section outlines some case studies to illustrate how analytics and insights from applying the WRVT can be used to assess investment risk and inform corporate engagement. We present four use cases that illustrate in broad strokes how different outputs of the tool can be utilized by analysts.
Case Study 1: Identify macro-level company exposure to water risk
The tool provides a unique macro-level view of water stress exposure (based on WRI data) by aggregating asset-level data on water stress severity and the proportion of total company output located in areas of water stress. This can inform assessments of how resilient a company’s overall operations are in the face of current and future water constraints, as demonstrated in Figure 3 below.
For instance, the tool shows that 80% of Capstone’s copper production is located at the water-stressed Pinto Valley mine in the United States and Cozamin mine in Mexico. By 2020:
- 61% of the company’s production may experience an increase in water stress by 1.4 times baseline
- 37% of total production output will hold steady at 2010 levels of water stress
Figure 1. Capstone: Change in % of production exposure to water stress between 2010 and 2020
Case Study 2: Model potential unanticipated cash flow fluctuations
A mining analyst could use the WRVT to model potential unanticipated cash flow fluctuations from potential production loss and/or increased costs to maintain production under conditions of water stress.
Figure 2. The WRVT enables users to easily model and observe the impacts of water stress on mining equity valuations
For instance, using the default settings on the WRVT demonstrates that a water supply gap could theoretically have an impact on Antofagasta (Figure 4):
- The model shows a 40% difference in free cash flow between the DCF outputs that incorporate and exclude water risk considerations (model estimate of $3,817 million (considering water risk) vs. $6,352 million (business as usual) in 2021).
- This in turn would impact Antofagasta’s total equity value and result in a lower projected share price. It is important to note that these figures are not to be interpreted in absolute terms as price targets, but rather a demonstration exercise to observe the relative differences between model results for business as usual (“Model” in Figure 4) and water risk considered (“w/Stranding” in Figure 4).
Case Study 3: Pricing risk using a customizable framework and shadow prices
For the investor already factoring in ESG issues, the tool can complement existing assessments of water use by mining/extractives companies. The tool could be a potentially useful identifier of companies in a portfolio with the most or least water risk and help pinpoint underlying factors to more accurately price water risk. For example, the analyst can, in partnership with the client and the credit team, customize the dynamic framework to price risk and account for mitigation efforts:
- Combine shadow prices with water use, production and reserves data, to identify stress points and evaluate potential limits to expanding ore extraction at specific mines
- Use data provided by the company itself to override estimated information or assumptions in the model to take into account actual water-related expenditure and risk management
- Incorporate forecasted expenditure on water rights, water supplies, and water treatment and recovery activities to adjust potential future capex and opex costs. This can provide a more refined, quantitative overview of the risk, which, if significant, can also inform credit conditions.
For instance, integrating shadow water prices for 2020 into the model (see Figure 5) results in a potential 10% or higher fall in the share prices of several companies analyzed. The WRVT results can be used to guide further qualitative research into how these risks might play out for the companies and sites that are most exposed, by evaluating management responses and policy environments at production sites most exposed to water stress. If an asset manager believes water governance and infrastructure will address water scarcity at a specific location for the lifetime of the mine, the analyst may lower estimates of production losses modelled in the WRVT.
Figure 3. TEV costs for a company from 2010-2021
Case Study 4: Active ownership practices — ESG commitments, engagement and proxy voting
The WRVT can help investors meet commitments to integrate ESG factors into investment analysis and decision-making, and report on progress to the UN-supported Principles for Responsible Investment (PRI).
Asset owners could request that internal or external asset managers:
- For actively managed portfolios of listed equities, use a tool such as the WRVT to assess the variations in exposure to water scarcity across the assets of mining companies with implications for the share price of individual listed mining companies or the aggregated effect on an index. This information could be relevant during considerations to underweight or overweight a particular stock, or tilt an index based on material ESG risks.
- Use tools like the WRVT for active ownership practices including engagement and proxy voting. This can be done individually or collaboratively (e.g., through the Clearing House of the PRI). The outputs of the WRVT can inform engagement with companies by providing an evidence base upon which to encourage discussion of the company’s water management and risk mitigation.
The tool can be used to engage companies on water use as a fundamental risk management issue. For example, using a standard enterprise value/earnings model, the WRVT shows a potential 18% fall in total equity value for Barrick Gold Corp due to exposure to water stress (Figure 6). In the specific context of mitigating risks in mining, the WRVT can be used to explore whether capital expenditure for new mines in regions with existing or expected water stress is viable.
Figure 4. Water-related capex can be modelled and included in EV/EBITDA models