Roland Brown and Philip Daniel'

extensive damage (especially to vegetation). Develop- Introduction ment activity in either mining or petroleum entails a major industrial construction project; in mining it also Environmental protection provisions in minerals and commonly entailsthestripping, and storage or petroleum exploration and development (E & P) disposal, of large tonnages of overburden to expose con tracts substantially pre-date current fashionable mineable ore. Production operations require disposal concerns with environmental matters. Current con- (in mining) of waste, tailings and re-agents. Both cerns, however, serve to emphasis the issue and industries pose significant, but usually avoidable, perhaps to accelerate the pace of constructive thought environmental hazards: well blow-outs, failures of about it. tailings dams or leakages of toxic wastes, for example. Mineral exploration and production activity inevitably These operations are carried on in the knowledge that causes substantial disturbance to the environment and significant, and costly, environmental protection brings with it the risk of major pollution hazards. measures will nearly always be needed, and that one Mining and Petroleum Laws and mineral investment party or another will, explicitly or implicitly, assume agreements have for many years contained environ- the risk of liability for accidents or other sources of mental protection provisions and much experience has unexpected environmental trauma. been gained. Nevertheless, environmental standards Fleightenedconcernaboutenvironmentalrisks change and environmental awareness currently stands coincides with a period of rapid liberalisation in at one of its periodic peaks. One of the reasons why developing countries and former centrally-planned mining and petroleum companies are once again economies. The success of this liberalisation is, in large appraising prospects in recently neglected developing measure, predicated upon accelerated inflows of direct countries may be that the 'environmental risk' that foreign investment and the loan capital it can marshal. they perceive (in the sense of the risk that new and Countries with promising geology for discovery of more stringent environmental standards may be mineral or hydrocarbon resources are re-emphasising imposed. or that a company may be forced to accept the requirement for private foreign investment in these an unanticipated liability for environmental damage, sectors. directly or indirectly caused) is lower than itis in traditional mineral industry locations such as Canada, Environmental policy issues fall into three distinct Australia or the USA.2 categories. First, there are issues concerned with the operational management of mines, oilfields and plant Environmental problems occur at two broad levels. facilities, where the concern will be to prevent or limit There are those which involve the 'global commons' - environmental damage arising from normal operations. the ozone layer, the state of the oceans or tropical rain Second, there are issues related to the possibility that forests - and those which affect the local habitat of there will be an environmental trauma, catastrophe or humans,floraand fauna.Mostenvironmental accident. Here the problems are the degree of problems in exploration for and production of crude assumption of risk by investors and government minerals (though not necessarily in mineral processing) respectively, the circumstances in which each party occur in the second category. will be liable for damage to the environment and the Mining and petroleum operations are, by their very limits of that liability. The issues in this category give nature,asignificantdisturbanceofthelocal rise to difficult questions of law and may involve environment. Exploration activity alone can cause considering causation - the most elusive topic in English common law.3 Third, there is a special set of With acknowledgement to Alyson Warhurst for helpful discussions problems surroundingthereclamationof land and the formulation of sorne of the ideas which form the economic background to this note [Warhursi 1991]. Philip Daniel also affected by mining when operations cease, and the safe acknowledges the opportunity to consider these issues afforded by abandonment or removal of plant, equipment or his collaboration with the World Bank on an Africa Mining Policy structures that have no further use but constitute a Study. The authors atone are responsible for the views expressed. See Crowson, P., 1991, Foreign investment in natural resources: a Hart. li. L. A. and Honoré. 1985.Causation ¡n Ike Lain',2nd edition. one-way pendulons'?'.FDS Bulletin, Vol.22, t'o.2 April. Clarendon Press, Oxford. ¡OS But/eOn, 1991. sol 22 xc 4, Instituir ci Dcvrlopmrrii Studies, Susses 45 potential hazard (such as offshoreoil and gas embodied inlarge historicalcapital investment. platforms). Resources for subsequent re-investment have been scarce and so facilities now tend to be less efficient Trade-offs in Environmental Protection thanthey could from both environmental and productive efficiency viewpoints. A switchof mineral investment todeveloping The petroleum industry is probably more homogeneous countries in search of lower costs of compliance with with respect to exploration and production technology, environmental regulation or lower risk of contingent and perhaps also with respect to environmental environmental liability implies a view of mineral practices - though in E & P operations the largest production in which reduced production costs per unit companies appear to employ the more comprehensive of output tend to mean increased environmental costs. and rigorous procedures. Oil companies of all sizes In other words, the mining industry is viewed as a face the major risk of a well-publicised catastrophe 'consumer' of environmental services for which others such as the events of Piper Alpha or the Exxon Valdez. pay - the government, or those who suffer the effects of pollution. If the costs of environmental use by the In general, it is likely that the promotion of foreign minerals industry are 'internalised' (borne by the private investmentinthe mineral industries of producing company) theñ, on this view, fewer projects developing countrieswill now tend to improve are economic and the industry isless profitable environmental protection practices in addition to the overall. direct economic benefits it can bring. Whether this in fact happens depends, in part, on industry expectations An alternativeview4suggests that environmental about future environmental regulation in the region regulation in OECD countries with mineral industries and upon the kind of environmental risk-sharing (especially the USA, Canada and Australia) has provisions that evolvein mining and petroleum provided a sharp stimulus to innovation in environ- agreements. The greater is international awareness mental protection technology for the mining and about environmental protection requirements the petroleum industries. This technology then becomes more likely it is that improvements in the trade-off 'embodied' in the investment package which sub- between environmental costs and production costs stantial international mining companies bring to will be sought by innovation or acquisition of new, exploration and development in developing countries. 'best practice' technology. On thisview,itfrequently pays companies to innovate, or otherwise acquire new technology in There have been fears that governments might order to improve the trade-off between environmental compete to provide 'pollution havens' - providing damage (costs) per unit of output and production less onerous environmental obligations or regulations costs per unit of output.5 to investors than they might find elsewhere. These fears reflect the view that environmental protection This alternative view of the trade-off leads to the imposes an additional cost which must lower either proposition that production efficiency is a necessary profitability or tax receipts, or both. This is more conditionforachievement of bestpracticein likely to be the case for existing operations than for environmentalprotection.Among thedifferent new investments. The fiscal arrangements in place will categories of mineral producers it seems likely that certainly affect the incentive both to innovate and to largeinternationalminingcompaniesachieve undertake environmental protection measures. Where environmental best practice more frequently than a modern, profit-related regime is in place an investor small-scale and artisanal miners or state mineral can expect the state to meet, through tax deductibility, enterprisesindevelopingcountries.Smallscale perhaps two-thirds of the protection costina miners lack both the resources and the technical profitable mine and substantially more in the case of knowledge (and also have limited incentive) to deploy an oilfield (as a result of the generally higher marginal the best available techniques for combined productive rate of taxation on successful petroleum ventures). and environmental efficiency: hence, for example, the high-grading of surface gold deposits and excess discharge of mercury from gold recovery activity. Regulation or Incentives? State mineral enterprises (as in Zambia and Zaire) emerged from the nationalisation of privately-owned Environmental legislationin both industrial and firms, where techniques of production were already developing countries has, until recently, tended to rely on 'command and control' (CAC) policy approaches. Typically, these involve the setting of an emission or Warhurst, Alysori. April 1991, Environmental De'radation from effluent standard and requiring a specified type of Mining and Mineral Processing in Dei'eloping Couniries: Corporate technological addition to achieve the standard. For Responses and National l'olicie.r, Science Policy Research Und, University of Sussex, (processed). example, a specific type of smelter might be required Examples of this kind of innovation are available in Alyson to fit a specific type of flue-gas scrubber to achieve a Warhursi's report. prescribed ambient air quality standard. In Papua

46 New Guinea, the 0k Tedi mine was originally required - developing countries, there is no existing network to limit its deposition of incompetent waste rock into of statutory requirements confronting the operator. the river system to a specified tonnage and to construct Provisions designed to prevent or limit environmental a retention system for any excess. damage are project-specific and will have a consensual These CAC measures stand in contrast to market- dimension. Environmental issues provide one of many based instruments (MBI). CAC regulations limit the reasons why it is unreal and simplistic to aim at a freedom of the operator to determine the appropriate legal/fiscal regime for major minerals activity which is technology to achieve a given environmental outcome. fixed and has no discretionary element. MBIs are designed to remedy market failures or create Characteristically, a mining or petroleum code or markets where none exist, instead of substituting E & P agreement will have a provision requiring the government regulation, and thus might permit more preparation of a development plan when commerciality economically efficient solutions to environmental has been established and a company is seeking long problems. Much current debate concerns the relative term rights in a lease or production licence. Normally costs and effectiveness of contrasting CAC and MBI the development plan or company proposals' will approaches. require approval by government before lease or MBIs are of two types: price-based and quantity- licence is issued. based. Pollution taxes or deposit-refund systems fall What should happen if there is disagreement? Should into the price-based category, while tradable pollution government be prepared to go to arbitration or submit rights or marketable permits to emit or discharge the dispute to a binding determination by a third party would belong in the quantity-based category.6 expert? Where the issues are concerned with technical Experience with MBIs in the developing world, and questions relating to the way operations should be especially in Africa, is very limited. lt is difficult, at carried on - cut-off grades, production profiles, present, to see much scope for quantity-based MBIs infrastructure design and utilisation - governments relevant to the minerals industry in Africa. There may in most developing countries are now prepared to be more opportunity for price-based MBIs, though agree to dispute settlement provisions involving initially these are unlikely to extend much beyond a international arbitration or expert determination. generalised taxation incentive to undertake environ- This affords considerable reassurance to prospective mental protection measures of the kind inherent in a investors and is clearly an important element in a profits-based tax regime. One necessary measure to modern mining or petroleum code. make the tax incentive effectiveisto designate If the dispute preventing agreement on the Develop- environmental protection expenditure as allowable or ment Planisabout environmental management deductible expenditures in tax laws and the accounting should governments be prepared to accept arbitration procedures of E & P agreements. or expert determination? At the development plan stage companies may have spent very large amounts ofhow This, however, immediately raises the issue on exploration and feasibility studies and could stand necessary and legitimate environmental expenditures to lose these expenditures if government imposed are to be assessed. At first sight, the establishment of unreasonable or arbitrary requirements which were general standards to which all operators must comply not consistent with the economics of the project. (This is attractive if there are to be CAC measures at all. The kindofproblemismore acutewhereafter problem here is that relevant standards for mining impose new tend tobe location-specific and project-specific; development government seeksto emission and pollution standards are also changing standards or introduce new requirements. At that stage sums at stake may exceed a billion dollars and rapidly over time as public tolerance alters and as new bankers as well as investors are concerned - see preventive technologies are developed and made below.) economicallyfeasible.Despitethepotentialof project-specific CACs togiverisetoinvestor The problem for companies is very obvious, but how uncertainty or the development of corrupt practices should governments respond? Would it be right or, there seems to be little alternative but to establish indeed, feasible politically, for governments to allow transparent procedures by which the environmental foreigners to decide on issues which may involve for its standards applicable to particular projects can be set, own people balancing the advantageofincreased monitored and, where disputes arise, adjudicated. revenue from a mining project against the disadvantage of environmental damage? At the development stage of any mining or petroleum project consideration of environmental issues will Some distinctions may help in the context of that always take place. However, in many - perhaps most problem. If standards have, in a particular context, been established by government and accepted by the investor(e.g. The description of CAC and MBI at the bcginninof this section the acceptable level of suspended draws substantially on the contribution by D. O'Connor. Chapter 5, particulate matter in a river system resulting from Section 2, in Atyson Warhursi, op. cit. mining operations), there should be no real objection

47 to expert determination if there is dispute about investment is in place is alarming. A major mine may whether proposals in a development plan are adequate cost as much as a billion dollars and, however large the to ensure compliance with the established standard. players, a substantial part of the capital is likely tobe On the other hand, the situation is quite different if the borrowed and secured (inter alia) on the project. That dispute is about what standard should be established. means that banks as well as mining and oil companies In that case the issue is how much damage to local are interested in the issue. If there is drastic change in interests should be permitted for the sake of a the rules of the game after the investment is in place the profitable mining project from which the government economic assumptions on which the decision to will derive much needed revenues. That judgement is develop was taken may be falsified. That, of course, is fundamentally a national one, though obviously an old problem in terms of the fiscal regime, but one constrained by the need to attract investment and which is largely solved by the development of more develop the project in question. flexiblefiscalarrangements.Inthecontextof The distinction referred to above is embodied in the environmental controls the issue is more intractable. provisionsofthe 0k Tedi6thSupplemental Sonie companies have tried to seek a special staus for Agreement, Papua New Guinea. The Company their approved environmental plan such that their agreed to undertake an environmental study to project will be exempted from any future environ- determine the impact that the mining operations of the mental laws or regulation, or government actions, that company 'have had and are likely to have on the River would change the basis upon which the project was to System'. The Government undertook on the basis of be developed and operated from that envisaged in the that study to establish (unilaterally) 'the Acceptable approved development plan. Particulate Level'. Although the decision was the Few governments would accept such an arrangement Government's, the Government agreed to follow and companies donot,realistically,expectit. certain criteria set forth in the 6th Supplemental However, there is a genuine problem and no obvious Agreement solution. If in the event some form of arbitration or Once the 'Acceptable Particulate Level' had been expert determination is the only way home it might established by the Government the Supplemental help if: Agreement went on to deal with the possibility that a Under international auspices (such as those of the dispute might arise about whether 'facilities' proposed United Nations) there was established a new Centre by the company were or were not adequate to ensure for Settlement of Environmental Disputes between compliance with the 'Acceptable Particulate Level'. In governments and foreign investors which would try to the event of such a dispute the Government and the develop acceptable ground rules to take account of the Company agreed on reference to an Environmental inherent conflict of interest. Expert. In the agreements providing for dispute settlement The issue dealt with in the 0k Tedi Supplemental detailed criteria for arbitrators or experts were set out Agreement did not arise at the stage where the similar to the criteria in the 0k Tedi 6th Supplemental company was first seeking approval for its development Agreement. proposals. They arose later when the Company wished to modify its original proposals. How to deal with In this way, there could be an equitable evolution of 'change' whether at the instance of the Company or of general environmental standards while sufficient the Government raises difficult questions. Govern- scope is left for project-specific arrangements and for ments may wish to make changes in an environmental the revision of arrangements. The general requirement plan previously agreed because; on major investors would be for an environmental impact study as part of the feasibility study, from It may have decided over a period of time that which an environmental plan would emerge. This plan stricter standards should apply; would formthebasisofsubsequentaction: New scientific data may have become available government requirementsinrespectofitand showing the existence of dangers or deleterious variations of it initiated by either party would be consequences not previously known about; subject to agreed criteria, compliance with which Some unforeseen physical events or dimensions would be settled, in the event of dispute, by some may have become apparent in the project itself. acceptable system ofarbitrationorexpert determination. These and some othersarereasons why the Government will be unwilling to fix environmental standards irrevocably at any particular point in the life Environmental Risk-Sharing of the project. For investors the prospect of Government changing In establishing mining and petroleum policy and in the rules of the environmental game after their negotiations with companies, environmental pro- visions entail establishing the limits of risks to be 0k Tedi, Sixth Supplemental Agreement, p.19. Clause 8. assumed and how they are to be shared. In this sense,

48 the problem is analogous to that faced in structuring settlement are promptly put in place. Such claims raise financial responsibility for a project. Pollution risk the further problem, for governments, that they insurance appears to be difficult to obtain and so the increase production costs and reduce taxable profits. route of converting the cost of risk-bearing into an Once again, both governments and companies have a explicit operating charge is not readily available mutual interest in a satisfactory arrangement for (though there are still important questions about what settlement of local environmental damage claims. risks can and should be insured, and who should be The endowment of a fund for the purpose is a possible responsible for insuring against them). The issue is device. The decisions on payments from a com- then one of the degree of precautionary measures that pensationfundneedtobe made by persons have to be taken and whether company liability for independent of the claimants and the companies, or unforeseen environmental damage is limited. Most else negotiations between the parties need to be companies will wish to limit this liability, whereas supported by an arbitration procedure. governments will usually argue that it is flot in the Reclamation of exhausted minesites raises related public interest to do so. The limitation of liability issues. The first problem is the setting of reclamation frequently turns on whether the mining operation can standards. The reinstatement of mining land as it was he held to be the 'proximate cause' of environmental before mining commenced is frequently impracticable damage. and, evenif technically feasibleislikely to be In some mining and petroleum agreements, and in prohibitivelyexpensive.Thealternativeis to certain environmental codes, governments retain rehabilitate the land to a standard set by reference to powers to suspend operations that they consider feasible future use. environmentally damaging. Clearly, the existence of a Since, by definition, a project will have no cash flow unilateralpower ofthissortgreatlyincreases after exhaustion, the costs of reclamation have to be perceived risk to the investor. Nevertheless. through met either by charges on other operations of the the fiscal system, government and company in effect company concerned or by some other arrangement for share this risk and have a mutual interest in devising sharingof the burden between company and procedures (such as those outlined in the previous government. This is a problem in fiscal arrangements section) for ensuring that suspension powers do not which also arises as the 'abandonment' issue for off- have to be used. Most modern agreements also contain shore petroleum installations. provisions requiring companies to take prompt There are three possible ways to approach provision measures to deal with emergencies and defining for reclamation or abandonment costs. All of them expenditure on such emergencies as allowable for tax will require a costed and approved reclamation or purposes.Conversely,remedialexpenditureby abandonment plan. The first is to allow the company government is often made recoverable from the to make tax-deductible provisions. This route is a company, though it is difficult to see how the recovery problem for jurisdictions observing English tax law, can be made easily enforceable. since deductions cannot normally be taken until actual In the presentinternational climate, companies expenditures are made. The funds provided would in investinginthe developing world come under any case remain exclusively under the control of the considerable pressures from their shareholders, home companies. Second,areclamationfund,under country governments, lenders and public opinion in independent or joint control, could be built up, general to assume environmental responsibility and perhaps by company tax-deductible contributions in take a sophisticated level of environmental protection proportion to estimated depletion of the ore reserve or measures. This climate of opinion is probably more hydrocarbonreservoir.Third (by analogy with effective than almost any regulatory measures, but arrangements for petroleum in the Norwegian sector governments can make effective use of it by having of the North Sea), government and company could transparent procedures for preparation of environ- fundagreedreclamationandabandonment mental plans, monitoring of conformity with them expenditures in proportion to the shares of cash flow and settling disputes that may arise. they have derived from the mine or oilfield in question. Fourth, as is allowed in the USA, a carry-back of tax Environmental Compensation and losses could be introduced to allow companies to Reclamation Schemes reclaim reclamation expenditures against past tax Since much of the environmental damage from payments. The obvious difficulty with both third and exploration and production operations in minerals is fourth options is that they require governments to specific andlocal,thepopulation immediately provide,ineffect,lump sumgrantstowards affected is often identifiable and can, in turn, identify reclamation. In the present state of public finances in the cause of damage to the environment they use. As many developing countries this is probably unrealistic; has happened prominently in the Pacific region, this accordingly, the independent reclamation fund device leads to compensation claims which can be disruptive is probably worth exploring in circumstances where of mining operations unless procedures and funds for the issue is likely to be important.

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