Primary Functions
- The use of financial risk metrics for water can improve decisions for asset allocation to reduce water risk exposure in portfolios, including stranded assets
Detailed Description
The impact of water as a constrained resource for business operations is becoming part of the investor discourse on equity water risk. A key challenge is the absence of metrics that relate physical risk to financial risk, either at the company or at the portfolio level, resulting in the lack of asset risk pricing. Our research tests the hypothesis that water risk impacts revenue and the cost of doing business and, by inference stock volatility, unless the company manages its risk appropriately. We related stock volatility metrics and water risk exposures of four electric utilities during a two-year period (2007-2008) that captured multiple drought events, commodity (coal) price fluctuations, and systemic risk in the financial markets. Using waterBeta and waterVaR metrics, the impact of water risk on stock volatility (VaR) was highly dependent on the value chain position of the firm, the capital efficiency of water, and stock elasticity. WaterVaR values range from $5M for the Southern Company to $167M for AES. The use of financial risk metrics for water can improve decisions for asset allocation to reduce water risk exposure in portfolios, including stranded assets.
