Valuing social factors at the project level

Clarity, certainty and transparency about how decisions are made not only improve a mining project’s productivity and efficiency, they also strengthen the social licence to operate and increase the likelihood that local communities will see sustained positive outcomes.

To take a mining project from exploration through operations and closure requires multiple decision-making systems. While the mining sector is highly systematized from a technical perspective, the approach to social outcomes is often less so. Furthermore, mining’s existing technical and business systems can have an impact on social factors, even if social factors are not always consistently acknowledged or integrated into decision- making. The processes for valuing and investing in specific mining assets (as opposed to company valuations) are one such system that has an impact on social outcomes.

Valuations are important because they influence overall investment decisions about a given project (for example, whether or not to invest; site planning) as well as specific program priorities (budgets and priorities for health and safety training; environmental programs;  community relations activities). Valuations can affect social outcomes because they influence resource allocation, risk management, and ultimately reflect how integrated an approach an organization takes. Typically, the more social factors that are integrated into decision- making, the more proactively they are managed. Project valuation practice has evolved over the years to reflect changing values, expectations (financial, regulatory, and societal), and technologies. However, the extractive industry’s commitment to social performance is not consistently and clearly reflected in project valuation practice.

Project valuations

A wide variety of stakeholders, including investors, lenders, companies, auditors and local communities, use both formal and informal processes to determine the value and investment potential of specific mining assets. While the data and information are typically confidential, stakeholders use a common approach to determine the value of a mining asset. This approach involves both a quantitative assessment (usually using a discounted cash flow (DCF) or other financial model) and a qualitative assessment. It is increasingly clear that the valuation process has an impact on social outcomes, but there are several shortcomings to the current approach and opportunities for improvement.

Quantitative assessment

The quantitative assessment is based on a model (most commonly a discounted cash flow) that makes assumptions about various inputs over a period of time to determine what an investment is worth today. This model includes ‘premiums’ or ‘discounts’ that take certain risks into account. There are various inputs into the model, some of which are known and within company control, such as capital and operating costs, reserves, annual production rates, process and recovery rates, and timeline (timeline has historically been seen as a given known cost, however, it can also be classified as ‘less known’ because of potential delays in permitting and obtaining a social licence.) Some inputs are outside of the company control or unknown (and therefore require assumptions to be made) such as commodity prices, foreign exchange rates, interest rates/cost of capital, and royalties and taxes.

At present, there are material costs of social impact management included in the DCF or other models used. These are inputs that are known and within company control, such as the costs of closure obligations, resettlement, and community revenue sharing or impact benefit agreements. These cost calculations are based on expert knowledge, assumptions, and legal requirements, and supplied by internal or external experts such as social performance practitioners and specialists.

Qualitative assessment

A more qualitative, often less formal assessment follows the valuation model. The qualitative assessment considers factors that are seen as harder to quantify, including social factors, risks and impacts. The qualitative assessment is important because it can make a project not viable, regardless of the economic value determined by the quantitative assessment. For example, a project in a highly uncertain regulatory jurisdiction or a project with a history of social conflict or protest by local communities, may be assessed as not viable because of those issues. Some organizations have more established methods for conducting these assessments, but often they are more of a ‘gut check’ to incorporate issues which are seen as important but unable to be integrated into the financial model.

Like the quantitative assessment, qualitative assessments take into consideration inputs that are both within and outside of a company’s control. For example, inputs include company management capacity and management systems, jurisdictional or country risk, the capacity of key stakeholders to fulfill their roles and responsibilities (for example, capacity of local government, regulatory bodies), and an existing social licence to operate.

Just as the ‘big ticket’ social costs are considered in the quantitative assessment, the ‘big ticket’ social risks are captured in the qualitative assessment. However, the practice for integrating social risks in this assessment is often more of a ‘gut check,’ reliant on intuition.

Social factors

The valuations process as a whole both impacts and is impacted by social factors. And while social factors are considered in both the quantitative and qualitative assessments to some extent, there is no consistent method for integrating social considerations into the project valuations process. Currently, systematic and thoughtful integration of social factors is dependent on the organization and the people involved.

The various stakeholders involved in project valuations have identified the specific challenges this represents:

• Social risks (to a company or community) are included in the qualitative assessment but rarely do they impact the financial value of a project. This continues, despite evidence that projects with high social risks and low social licence to operate can lead to cost overruns, shutdowns, long permitting timelines, and costly social impacts for local communities.
• Material social costs are included in the quantitative assessment, but only as one input. The impact of social factors on other line items such as labour or procurement is rarely considered.
• The definition of ‘material’ for social costs is not consistent. There is no commonly understood dollar range or project impact that determines if a cost is material. Furthermore, a consistent understanding about who considers which social costs to be material, is lacking. As a result, it can be difficult to decide which social costs to integrate into the valuation process.
• Neither the quantitative nor qualitative assessments value the capacity of companies, governments and other stakeholders to manage the positive and negative social impacts of mining. Proven good management for ensuring good social performance – like an understanding of context, good engagement practice, and community support/consent – does not impact a project’s valuation. However, strong management capacity does affect social licence to operate and social outcomes, particularly for exploration companies which have smaller budgets but whose activities and approach set the tone for social impact management for a project’s life cycle.

Where do we go from here?

• Investors, operators, civil society and impacted communities across the spectrum agree that there is an urgent need to improve the practice of integrating social factors into project valuations. Some of the ideas that have been suggested, and require much more discussion, include:
• Improve the process and definitions for determining material social costs and including them in the quantitative assessment;
• Include a social premium in quantitative assessments such as discounted cash flow;
• Develop a curve that measures the impact that the social context and stakeholders’ ability to manage social factors have on timeline and costs; and
• Apply more rigorous social screens in the qualitative assessment. For example, this could be based on a set of criteria predefined by the business as critical factors.

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CAROLYN BURNS is director of operations at NetPositive, a non-profit that works with diverse stakeholders to help local communities see sustained positive outcomes from mining. JANE CHURCH is a co-founder and director of collaboration with NetPositive.

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