An index for drought induced financial risk in the mining industry

Water scarcity has emerged as a potential risk for mining operations. High capital spending for desalination and water conflicts leading to asset stranding have recently occurred. Investors in mining companies are interested in the exposure to such risks across portfolios of mining assets (whether the practical at-site consequences are foregone production, higher OPEX and CAPEX and ensuing lost revenues, or asset-stranding). In this paper, an index of the potential financial exposure of a portfolio is developed and its application is illustrated. Since the likely loss at each mine is hard to estimate a priori, one needs a proxy for potential loss. The index considers drought duration, severity and frequency (defined by a return-level in years) at each mining asset, and provides a measure of financial exposure through weighing of production or Net Asset Value. Changes in human needs are not considered, but are relevant, and could be incorporated if global data on mine and other water use were available at the appropriate resolution. Potential for contemporaneous drought incidence across sites in a portfolio is considered specifically. Through an appropriate choice of drought thresholds, an analyst can customize a scenario to assess potential losses in production value or profits, or whether conflicts could emerge that would lead to stranded assets or capital expenditure to secure alternate water supplies. Global climate data sets that allow a customized development of such an index are identified, and selected mining company portfolios are scored as to the risk associated with one publicly available drought index.