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Challenge: Linking Sustainability & Financial Value

• Companies struggle to evaluate the financial value of their sustainability initiatives. In the past, sustainability has been “the right thing to do” with implicit trust that it will bring value.

• In particular, extractives have known intuitively that sustainability investments made around their operations can bring significant value.

• This value generally takes the form of direct value creation (i.e., positive cash flow) or indirect value protection (i.e., risk mitigation).

• Nevertheless, this value perception was never rigorously quantified preventing managers from: 1) understanding the true benefits of such investments, and 2) being able to prioritize investments.

• The inability to articulate the costs and benefits has traditionally left sustainability initiatives outside the core project planning process impeding cross-functional integration and communications.

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Solution: Planning & Financial Valuation Tool

• Evaluation of site-specific sustainability portfolios applied to extractive industry

• Excel-based tool (new desktop software being developed)

• Estimates expected net present values (NPVs) of sustainability investment portfolios

• Answers two critical questions: 1. “what” is the right portfolio of sustainability investments2. “how much” financial return they will likely bring?

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Background

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Indirect value (protection) refers to the indirect risk mitigation potential of sustainability investments.

Less risk of delay, disruption, and/or expropriation

Value protected is not readily calculated- e.g., investments in social cohesion, reputation, cultural heritage, etc.

Direct value (creation) results from the direct cost-benefit of the sustainability investments.

Cost of inputs decreases or productivity rises

Value created can be readily calculated‒ e.g., workforce training enables

substitution of local hires for expensive expatriates

Objective: Assess Value Creation & Protection

• Model objective: articulate reasonable ranges for the value of sustainability investments

• Value is defined as direct value (creation) and indirect value (protection).

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Key Components of Planning & Financial Valuation Tool

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Risk Assessment & Stakeholder Engagement

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Full Flexibility to Select Investments Evaluated

Architecture : The model estimates the difference between the value impact of two user-defined scenarios which allows full flexibility to decide the scope of the investments to be evaluated:

Scenario B : user defined, most often a greater investment than scenario A e.g. proposed sustainability portfolio

Scenario A: user defined, e.g. business as usual, or base case

Estimated NPV ranges of the sustainability investments vs. base case

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Case Study – Main Project Characteristics #1 as Entered into Model

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Case Study – Main Project Characteristics #2

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Case Study – Main Project Characteristics #3

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To determine risk reduction potential, the FV Tool subtracts macro-level risks (country risks) as assessed by the Multilateral Investment Guarantee Agency (MIGA, political risk insurer part of World Bank Group) and prompts the user to consider industry specific risks using sector level data provided by Independent Project Analysis (IPA, owner of 25+ year database on extractives) to determine the potential volume of risk a sustainability investment portfolio can manage.

Quantifying Risk within Your Control

Defining Risk Reduction Potential:

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Value Creation Results from Direct Costs & Benefits

Sustainability investments evaluated Cost drivers Benefit drivers

Technical training program

Resettlement program

Biodiversity protection

Local suppliers development

Community health program

Agriculture development program

Ex. Workforce • 11 M$ (over lifetime of the project)

•Construction: 172 M$ (4 yrs)•Operations:

20 M$ (per year)

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Value Creation: Example Local Workforce

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Value Creation Example: Land Access

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Value Creation Example: Land Access cont.

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Sustainability Program Quality

Sustainability Program can reduce the level of sustainability risks by reducing their occurrence, duration and financial impact. Two key parameters used to determine the risk reduction potential of investments:

1. Importance: reflects the weight of each issue evaluated by project teams including the stakeholder engagement process.

2. Quality of Sustainability Program for Scenario A & B.

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Value Protection: How to Characterize Risks

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Generic Values to Guide Assumptions on Risks

Capital Projects Between US$15 million and US$11 billionCompleted and Ongoing Projects (Selection not limited to projects using

sustainability practices or with associated sustainability investments.)255 Mining, Minerals, and Metals (MMM) Projects; 479 Petroleum Exploration and Production (E&P) Projects

IPA Capital Project Data – 734 Observations

• Pre-defined neutral values for risks are embedded in the model to guide assumptions on risks.

• The possible ranges of neutral (base) values for event risk and magnitude are derived from IPA (Independent Project Analysis) global project database.

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Value Protection: Example of Risk Profiles

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Value Protection Ex: Cairn Farmers SMS Text Program

Partnership with Reuters Regular two-way communication through mobile phones Reach 10,000 farmer families in 2010 Developed to respond to concerns and needs of stakeholders ie:

Soil restoration requests / irrigation pipeline laying assistance Information on farming productivity, Information in case of pipeline sabotage, leaks or complaints

Farmer Benefit: Ex. Cumin seed sowed by farmer in Gujarat and sold in local market at market rate (informed by SMS). Farmer received 200 more rupees in market versus middleman. Farmer sold approx 1000 kg-- approximately $14-15k profit to farmer.Business Benefit : 5 cases of pipeline security issues reported by farmers so far In one case Cairn response avoided pipeline damage that could stop crude flow for at least one day at a cost of USD 2 million

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Intervention Effectiveness Drives Risk Reduction

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Monte Carlo Simulation Embeds Randomness

Monte Carlo is a:• Statistical technique

by which a quantity is calculated repeatedly

• Using randomly selected “what-if” scenarios.

• Results approximate the full range of possible outcomes

Value in Billions

Occ

urre

nces

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Value protection (no cash inflows means indirect value) is one side of the value coin.

Value creation (direct cash flows back to the company or cash saved) is the other side.

By adding them together we assess the overall value of the portfolio.

Value Protection & Value Creation Combined

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Output: Financial Value of Sustainability Investments

Dashboard - Total Sustainability Value Added

For $2billion CAPEX project, sustainability investments can return as much as $187 million of NPV.

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Value Protection Distribution

Initiatives Relative Share on Value Protection

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How to Use Results in Strategic Decision-making

Lessons Learned

• Tool provides the ability to answer critical business questions : “how” sustainability creates value; “what” investments are needed to capture this value; “how much” financial value may be protected/generated.

• Reinforces cross-functional integration & improves decision-making: Assists non-finance functions to articulate financial drivers; Encourages increased interaction E & S, Risk, Finance , Procurement, HR, etc; Improves capital investment decision-making process.

Pilots with Cairn and Newmont Cairn found new way to return on investment in SMS program Newmont realized huge value gains through land access program improvements

“It is clear that the model has potential if we commit the time to put the inputs in well. It takes time, but once built, will give a good indication of value.”

-- Walter Richards, Controller, Newmont Gold Ahafo

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• The tool has been developed over 2 years, tested with real extractive industry projects, and is now fully functional.• Focus is now on improving the frameworks and inputs to

facilitate its application, e.g.:The integration of MIGA macro country risk assessment

into the evaluation of sustainability-related risksThe definition of generic risk values from an expanded

fact base in order to derive better, narrower risk assumptions

The refinement of the quality assessment methodology that drives risk reduction, along with issue importance.

• Talking with O & G: IPIECA, Total, Exxon, Statoil, PAE, Cairn

Areas Being Improved

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