Business Water Risk: Limiting Impact Through Analytics

Equarius Risk Analytics is using comprehensive analytics to determine the potential impact of water risk on investments. Given the size of this impact, they offer a lifeline to CFOs who need to protect value in their portfolios.

Every year, sudden water shortages and quality scares result in commercial operations grinding to a halt - from Coca-Cola factories in India to Zambian copper mines. The economic impact of water is not trivial. The affected Glencore copper mine produces 26% of Zambia’s copper output worth $2.1bn annually. The availability and quality of water underpin the health of thousands of companies. Just as managers need to better anticipate these risks to ensure business continuity, asset managers and insurers need to measure company exposure to water issues in order to make the right investment decisions.

Water risks can “strand” assets just as easily as other commodity prices

We have heard a lot about the risk of “stranded assets” in the oil and gas market. As the price of coal, for example, goes down, new mining operations become impossible to justify. The mines themselves that were previously considered an asset to the company, are now essentially worthless - they have become “stranded” by the rising tide of falling demand for coal.

Exactly the same thing can happen with water. Insufficient long term availability or impaired quality may make business operations uneconomical. Just in the last year, droughts have impacted the cut back of beer brewing in the Czech Republic because of dismal hop harvests. Over the last few months, power plants have had to shut down in India because of water shortages. Apparel companies such as Nike and Levi Strauss were directly impacted by droughts in 2011, resulting in reduced cotton harvests and increasing commodity prices, prompting extensive water risk management strategies.  

Risks are spreading across sectors and asset classes

Even high tech isn’t immune: the semiconductor industry is highly water-intensive, both in direct process operations and in energy needs. Given that most fabrication facilities are located in China and the Southwestern US, supply interruptions can be devastating. A shutdown of a Texas Instruments or Intel facility is estimated at $100-200M per quarter. Food companies are feeling the water woes as well. For example, Kraft was forced to raise product prices because floods and droughts impacted commodity prices.

The cost of debt for companies can also be affected. Bonds of major mining companies have been downgraded by Moody’s because of long term water availability concerns. This may leave up to 10% of the global value of gold reserves in the ground. Electric power plants in the South East and South West US routinely produce less power output than they are designed for ('de-rating events') resulting in revenue losses of up to $5M per plant and per month during the Summer.

Bringing transparency to water risk in investment analysis

Analytics that translate actual business water risk into company or portfolio valuation are key to financial risk management. They allow managers to do something about water risks just as they would do with “normal” risks. These risks matter to portfolio management.

Equarius Risk Analytics offers that analytics solution: a set of proprietary algorithms that quantifies the contributions of business water risk to the volatility of the company’s stock price. Essentially, the company provides the tools to help managers understand their exposure to water risk.

Following feedback from asset managers and analysts, Equarius decided to focus on capital markets data and models such as Value-at-Risk (essentially, how much value in the company is at risk from water issues) and waterBeta (a risk sensitivity metric). Expressing business water risk in the language of capital markets tools will help analysts and portfolio managers manage these risks according to their severity, rather than excluding them completely.

Managing the downside

As water issues continue to impact valuations and asset prices, Equarius Risk Analytics can help firms to manage their water risks appropriately, helping CFOs to be better at their jobs. It could be short-term financial strategies such as hedging and risk transfer, or long-term capital allocation strategies. Firms need to start managing water risk in the same way as any other business risk. If they don’t they’re likely to be in for costly surprises in terms of revenue, market share, and value of their stock on the markets.