Community Development

4. Financial barriers to resource-led community development 

The failure to deliver the benefits communities desire and expect from resource development can lead to delayed projects that are less profitable for companies, reduce government revenues from resource development and damage the interests of local people.

The following interrelated aspects need to be considered by governments in allocating resources to community development and developing their natural resource base:

  • By approving a major natural resource project, the state takes on an obligation to protect its citizens from the most severe potential adverse impacts

  • By proceeding with the project, the company takes on the duty to respect the rights of affected people to participate equitably and reasonably in the benefits of development

  • The duties of the government and the company are impossible to fulfill without dedicating at least some financial resources to these tasks

Management of adverse impacts, and the maximisation of the positive impacts of development simply cannot be done without resources, but it seems very hard in many cases to put these resources together.

Three aspects of this financial problem are considered further in this section.

1. Impacts begin before revenues are available to manage them – the problem of "Revenue Lag"

2. Revenue flows are unstable and unpredictable

3. Impacts need to be managed long after the revenues end: "Legacy Costs"

Financial barriers to resource-led community development (1): Impacts Begin Before Revenues Are Available to Manage Them: The Problem of "Revenue Lag"

At the time support for community interests is most important, resources are hard to find. At the point where the community is feeling the adverse impacts of development, and the best opportunities for local development arise, the company is making no money and the government is receiving little or no tax revenue.

Development of a major resource project can create significant social, economic and environmental impacts. These impacts are often much greater in developing countries, because they lack much of the infrastructure to support development. A decision to construct a project in a rural region of a developing country may also imply the need to build roads, power lines, water supplies, ports and other necessary facilities, resulting in a bigger construction project with a bigger physical and social footprint.

From project inception, there may be years of exploration, detailed development drilling, construction of infrastructure, and construction of the well field, pipeline or mine itself; all before there is any production at all. This period can last eight or ten years and often longer.

During the initial years, the project shown in the diagram below is generating no income to the company, and very little revenue to the government. There is probably no significant income to the company until Year 13. Up to that time, the only revenue to government might well be the annual rental or permit fee typically charged for use and occupation of the permit area. But those annual charges are usually quite low.

The conclusion is disturbing. It does not appear that the revenues necessary to manage the local issues, protect people from adverse impacts, and take advantage of development opportunities are going to arrive in time. This phenomenon is called “revenue lag”.

Like government, companies are very resistant to adding any costs at the ‘front end’ of a project, before they have any revenue. Many projects are built using project finance and a significant portion of the money spent developing a project is borrowed, either via financial institutions or from shareholders.

Companies do not therefore want to spend their own money at an early stage of development. And lenders likewise will not want to lend more. Both are aware that if the project is not pursued for any reason, money spent at the early stage will never be recovered from project earnings.

For these reasons, companies developing projects are much happier providing any “community share” out of project earnings, once the project is in production and making money. But this misses the point.

This is a fundamental problem that is a major obstacle to success in resource based development. It has not yet been solved.

On one hand, it is very hard to generate money at the beginning of resource development. On the other, there are hard-to-manage impacts and opportunities that require considerable resources to avoid generating an instable environment for communities and disrupting their livelihoods. Local people, who did not ask for and may not want the development, should not be asked to subsidise it. It is not surprising that local populations are so often unhappy at this prospect.

Philanthropy, together with impact investors, can provide access to the financial capital necessary for communities to be able to hire world-class legal representation and other technical people to represent their interest at the negotiating table.

One potential solution is to promote impact investing, where individuals and institutions convert measurable social benefits into financial returns. Impact investing seeks to leverage private resources to create positive social impacts, such as environmental protection and poverty alleviation and has the potential to complement philanthropy and other sources of funding to catalyse positive change.

An impact investment fund sources capital from social investors to extend financing to communities to build and retain competent credible legal and other advisors and negotiate on a more knowledgeable, and equal basis with companies and governments. To succeed, these funds need to be based on operational structures, criteria, and processes.

The larger measure of success is whether industry recognises the cost of a social license to operate in their business model and whether they account for the value derived from good community relations.

Case study: the Oyu Tolgoi project in Mongolia

An experiment designed to enable host governments and communities to access resources at an early stage in the project lifecycle is discussed below.

One much-discussed example is the considerable expenditure made by the investor before any agreement was in place for the massive Oyu Tolgoi copper/gold porphyry project in Mongolia. From 2001 until October 2009 the investor spent nearly $US 1 billion before it signed an investment agreement with the Government of Mongolia that stabilised tax, fiscal and other requirements for the project. Since the government was to fund its share of the capital costs of the project and claimed a 34% shareholding interest in the Mongolian company, owning the licenses for the project (pursuant to a new Minerals Law that was enacted by Parliament in 2006), the government received a shareholder loan. The intention of this loan was for the government to recognise its obligation to pick up its 34% share of expended costs to the date of the investment agreement. Going forward, the investor and the government entered into a shareholders' agreement in addition to the investment agreement to address the means and manner in which the investor would loan future funds to the government to cover its 34% capital cost obligations post-investment agreement.

Civil society organisations are concerned that acceptance of loans by governments which have no way of repaying them other than mineral development is a concession that the project will always be approved, even before the performance of environmental and social studies. Companies are concerned about "front loading" the project costs with expenditures years before any income is earned. They are also concerned that there may be no recourse if the local government simply takes the money and, in violation of its promises, spends it on something other than capacity building and managing impacts.

That is another problem in need of a creative solution: companies are rightly wary of being seen as coercing local governments. But they are well aware that there is often no remedy available to them if funds they make available for development are misspent. The solution is probably a system in which the local beneficiaries would have the enforcement power.

Financial barriers to resource-led development (2): Revenue flows are unstable and unpredictable

Once revenues from a project start flowing, a community (or a country) attempting to base its development strategy on natural resources faces a second challenge: mineral prices are notoriously volatile. Volatile markets may not provide stable, predictable revenue streams to finance multi-year development programmes.

Development is an extended process. Improving an education system or achieving better public health takes careful intervention over several years. How can slow and steady progress be built on unpredictable revenue streams?

Tax structures on resource projects may mean that government receipts are even more volatile than the underlying mineral prices. A ten percent rise or fall in commodity prices might result in a much greater than ten percent change in tax revenues.

For communities deeply affected by resource projects, this volatility creates an additional problem. Higher prices and increased production may result in more economic opportunities around the project site. There may be inward migration of people seeking these opportunities.

When prices fall, this results in local unemployment and a slowdown in economic activities. Where this coincides with lower tax revenues and reduced availability of resources to the community, the situation becomes even more challenging. Just at the time when there is an increase in social needs because of the economic slowdown, there are fewer resources available to deal with them.

Local authorities dependent on volatile resource revenues face considerable challenges. If there is limited administrative capacity, the population has serious development needs, or there are political pressures, navigating these cycles can be extremely difficult.

A sudden surge in revenue, without plans in place for long-term sustainable projects, might be almost as problematic for systematic development planning as an unanticipated crash.

Agreements that cushion companies by increasing revenue volatility for governments are part of the problem. Companies like systems in which their tax payments fall to zero when mineral prices go down. But this may simply offload the risk onto those who can least afford it; and a “zero revenues” scenario may in the view of some observers be politically unsustainable.

One solution is to find mechanisms that give communities some form of cushioning from the wild rides of minerals markets. Some mechanisms do exist, such as local “rainy day funds” in which money is deposited when mineral prices are high and from which they can then withdraw funds at times of low prices.

There are several case studies presented in The World Bank's sourcebook on "Mining Foundations, Trusts and Funds", published in June 2010 and available in the topic library.

Financial barriers to resource-led development (3): Impacts need to be managed long after the revenues end: "Legacy Costs"

Mineral resources are finite, and even the largest mineral deposits will eventually be exhausted. Oil fields are also finite, and production will eventually shrink and come to an end.

Changing technologies or the discovery of new deposits may however make a project uneconomical to operate long before the reserves are exhausted. Oil sand projects in Alberta may look very promising when oil is $100 per barrel, but far less so at $40 a barrel.

Revenues, under the kinds of tax systems we have been discussing, end when production ends. But the impacts that need to be managed may continue for years after revenue stops flowing.

Case study: The Yak Tunnel mine drainage facility

In Leadville, Colorado, there is a mine drainage facility called the Yak Tunnel. Discharge from the Yak fluctuates seasonally between 17.0 and 54.4 litres per second of highly contaminated water emanating from numerous old mine workings.

The annual cost of treating the water from the Yak to protect the headwaters of the Arkansas River is close to a million dollars, not including the periodic cost of renovating the treatment plant. Treatment will be needed until some major change in conditions changes the topography. The cost to society of treating the water for what is effectively an unlimited time into the future is very substantial; the cost of not treating the water, in terms of economic costs on downstream users, and loss of the fish population would be even higher. Yet the mines that generated this cost closed over a hundred years ago, and are not yielding any tax revenues or other benefits to government or society at present.

The solution lies, at least in part, in improved closure planning. Companies are required to plan for the long-term stabilisation of mine sites, backed by a financial guarantee to ensure compliance. But closure planning is one of the most complex and difficult regulatory tasks that environmental regulators face, and government and industry both frequently lack the capacity to do this well.

In the context of developing countries, post closure social impacts may be even harder to manage. Where there has been no development of alternative livelihoods, there may be a local population of tens or even hundreds of thousands of people who are dependent on the mine. Once the project closes, they may lack either the ability to sustain themselves at the site or the ability to leave.

There needs to be planning not just for environmental aspects of closure, but for social and economic impacts as well. The Mining Minerals and Sustainable Development Project, a decade ago, recommended "integrated closure planning" that would address environmental, social and economic impacts in a single planning process. The ICMM has responded by producing an excellent "Planning for Integrated Mine Closure Toolkit".  This resource is available in the topic library.

The lesson from many bad results is that when these issues were not handled properly at the outset, the game may be lost. The Mining Minerals and Sustainable Development Project conclusion was that:

"If this issue is not explicitly raised and settled at the start of a mining project, it will become difficult to deal with later as profitability falls and the company starts to look to its next opportunity. It could also lead to pressure to avoid the consequences by keeping an unprofitable operation open.”

In this Raw Talks video Caroline Digby talks about mine closure, communities and social issues.