Mining with Environmental Risk

Christopher Costello and Charles Kolstad

No 21325, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Environmental concerns dominate modern-day decisions about mining. While the minerals extracted are surely valuable, mining of natural gas, deep seabed minerals, rare earth metals, and traditional ore is often fraught with environmental uncertainty. We examine how this uncertainty affects the optimal decision of if, and when, to mine. When environmental damage from mining is known, the socially optimal timing depends straightforwardly on the magnitude of the damage relative to these damages in the rest of the world. But when environmental damage is uncertain, and its magnitude is learned over time, an option value arises, which fundamentally alters the mining decision. This decision depends on the costs and benefits of mining at different times, which are innately linked for non-renewable resources by Hotelling’s rule. Using this insight, we find that any uncertainty over environmental costs can make it optimal to delay mining; this occurs even when expected environmental costs are low or even negative. We show conditions under which it is optimal to postpone the mining decision indefinitely, and conditions when it is optimal to postpone only for a finite duration. We use these insights to derive, for the first time, the equilibrium outcome of an entire industry of decentralized mine owners who all face an incentive to delay to acquire improved information. This gives rise to strikingly different price and extraction paths than are currently understood. One such outcome is that price paths flatten relative to what Hotelling theory predicts, consistent with empirical findings that have puzzled the literature.

JEL-codes: Q31 Q32 Q38 Q52 (search for similar items in EconPapers)
Date: 2015-07
New Economics Papers: this item is included in nep-ene, nep-env and nep-res
Note: EEE
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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