Since the National party moved into the Beehive back in 2008, mining has been a contentious issue. The government, looking for ways to mirror Australia, as well as speed up economic growth, focused on upscaling the mining industry. We have plenty of coal in country and, possibly, major reserves of oil and gas offshore. What’s not to like about that?

Well quite a lot really. Gulf of Mexico ring any bells? Like Chernobyl and Bhopal before, major industrial accidents can have long-term, catastrophic consequences, as well as immediate costs measured in human and economic cost. Offshore drilling carries huge risk and major negative downstream effects if it goes wrong. Onshore mining, on the other hand, is supposed to be plain vanilla these days. Apparently it’s a little like rolling up a cricket wicket and re-laying it when you’ve dug out a bit of sub-soil.

It’s safe, clean and you end up with an environment, which is as good as, if not better, than before. I was told that by the Assistant Head of Global HSE at Rio Tinto back in 2000. Actually it made sense to me…if you contain all the possible polluting effects, run a safe operation and remediate to very high standards…that could work. Perhaps that culture hasn’t quite made to to NZ. Judging by the poor practices at Pike River, one would have to ask serious questions about the management of mining in NZ. This has been reinforced by the recent shutdown of the Solid Energy mine at Spring Creek.

So I’m waiting to be convinced about this new world of clean coal and safe extractive practices. However, whilst I’m waiting, I’d like to suggest another way forward. Given that we do need certain commodities to be extracted, we need to create a risk structure that allows for exploration but with a precautionary approach. In other words, extractors must pay their way and do so in a manner that reflects the worst case scenario, such as the BP Gulf of Mexico disaster. So far BP have set aside a $20b fund for settling claims, of which $7.8b has been currently allocated. It’s an extreme event but an example of how badly things can go wrong when operating in sub-optimal conditions.

It’s time to explore environmental contingency bonds, as a way of mitigating risk and ensuring that insurance is in place before the extracting activity takes place. Just as someone renting a house has to pay a bond up front, to ensure any potential damage is covered, so do extractors have to pay an upfront amount before they start work. This upfront risk adjusted payment would be used to purchase government bonds (supposedly risk free!) or similar risk free asset, for the duration of the extractive activity. If, at the end of the activity period, there are no adverse effects, over and above what may have already been applied for, then the money is returned (plus any interest) to the extractor.

There are several consequences to this approach:

- This may increase the cost of extraction (though, in reality, this is simply a financing cost, assuming no damage occurs).

- This may spur companies towards better risk management and remediation processes. If they get it wrong, they pay. The onus of responsibility falls on the extractor and not the taxpayer and/or local community.

- In some cases, the sum demanded by the rental agent (usually the government) will be too high for the extractor to bear and this may result in the proposed project not proceeding. This isn’t necessarily a bad thing, as the priced risk is considered to be too high. An example of this may be drilling for oil in the Arctic or the new trade of the day, fracking.

How will the bond be priced? Each industry will have a different risk factor, which will be based on previous data….for example, offshore oil drilling and onshore coal mining have very different risk profiles. It’s important to note that this is not an insurance payment but a full cash upfront payment. The extractor may, of course, wish to insure their own risk on having to forfeit the bond but the important point here is that the government holds the cash and can move into remediation action as soon as any damage occurs. As we have seen with numerous disasters, insurers and re-insurers are difficult to deal with and can lock up claims for many years.

Remediating and risk management plans are great but for business, paying cash up front against possible mishaps will certainly concentrate their focus on doing the job properly and without harm. The public will be happier knowing that extractors are having to pay upfront and that they will, therefore, do their utmost to ensure their activities are not polluting, harmful or dangerous. Governments will be happy knowing that they have the cash in the bank, just in case anything does happen. The extractors? Well they probably won’t be happy at the extra cost but according to them they will leave the place in a better condition than they found it. So really they have nothing to worry about at all.

 

 

 

 

 

Tags: bonds, BP, coal, drilling, ecosystem, externalities, extraction, fracking, mining, oil, pollution, trucost