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Mitigating corporate water risk: Financial market tools and supply management strategies

Wendy M. Larson
LimnoTech, Ann Arbor, MI, US; wlarson@limno.com
Paul L. Freedman
LimnoTech, Ann Arbor, MI, US; pfreedman@limno.com
Viktor Passinsky
Erb Institute for Global Sustainable Enterprise Programme; Ross School of Business; School of Natural Resources and Environment, The University of Michigan at Ann Arbor, MI, US; viktorp@umich.edu
Edward Grubb
Ross School of Business, The University of Michigan at Ann Arbor, MI, US; rubbe@umich.edu
Peter Adriaens
Zell-Lurie Institute for Entrepreneurial Studies; Ross School of Business; Civil and Environmental Engineering; School of Natural Resources and Environment, The University of Michigan at Ann Arbor, MI, US; adriaens@umich.edu

ABSTRACT: A decision framework for business water-risk response is proposed that considers financial instruments and supply management strategies. Based on available and emergent programmes, companies in the agricultural, commodities, and energy sectors may choose to hedge against financial risks by purchasing futures contracts or insurance products. These strategies address financial impacts such as revenue protection due to scarcity and disruption of direct operations or in the supply chain, but they do not directly serve to maintain available supplies to continue production. In contrast, companies can undertake actions in the watershed to enhance supply reliability and/or they can reduce demand to mitigate risk. Intermediate strategies such as purchasing of water rights or water trading involving financial transactions change the allocation of water but do not reduce overall watershed demand or increase water supply. The financial services industry is playing an increasingly important role, by considering how water risks impact decision making on corporate growth and market valuation, corporate creditworthiness, and bond rating. Risk assessment informed by Conditional Value-at-Risk (CVaR) measures is described, and the role of the financial services industry is characterised. A corporate decision framework is discussed in the context of water resources management strategies under complex uncertainties.

KEYWORDS: Water-risk management, water scarcity, decision framework, water trading, water derivatives