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Climate risk: transforming the mining industry

Climate risk: transforming the mining industry

Introduction: the Tolstoy maxim

To paraphrase Tolstoy: successful mining companies are all alike; each mining company is facing risk in its own way. This principle is highly applicable today, as mining’s diverse geographical spread - often involving operating in remote locations, sometimes in politically instable countries - makes risk management particularly challenging for the industry. One solution doesn’t fit all.

COVID-19 has been a game-changer for the world and of course mining companies have been significantly affected, with widespread outbreaks and some government-mandated shutdowns in countries such as South Africa and Peru.

However, there is another substantive risk which the mining industry is facing, and that is climate change. It exposes the industry to potential financial, operational and market shocks and, if not managed appropriately, it can have a compounding effect¹ that changes the very nature of the mining risk landscape.

Unlike COVID-19, nations and businesses can’t just shut their borders to climate change, self-isolate and expect to ride out the wave. The climate crisis is a global issue that knows no borders and will have impacts over decades rather than infection waves; international cooperation is essential and will require collaboration on a scale we haven’t seen before. And what the pandemic is teaching us is just how interconnected, intertwined and dependent we all are on each other.

The importance of minerals
Minerals are ubiquitous, essential for society and economic development. However, the mining industry is a heavily polluting one; it’s currently responsible for between 4-7% of greenhouse gas emissions (Scope 1 and Scope 2)² globally³ and consumes up to 11% of global energy use.⁴ Regulation and legal requirements around resource management and carbon reduction are increasing; furthermore, the mining industry is a supplier to other emissions-intensive industries, which will also be subject to more downstream regulation and changing consumption patterns. At the same time, mining industry verticals are in a bit of a conundrum - renewable/low-carbon energy is heavily dependent on the mining industry to provide the metals and minerals necessary for construction and operation.

Net-zero strategy
Under the Paris Agreement, countries collectively agreed to reduce global emissions through material climate pledges. Amidst increasing activism, the willingness to act to decarbonise is gaining traction and momentum among mining industry stakeholders, including lenders, insurers, shareholders, regulators – and even consumers. Indeed, net zero-strategy is a “basic question” for every company, says former Bank of England Governor Mark Carney.⁵

Getting ahead of impending regulation by integrating climate-related risks, mitigation and adaptation measures into business and decisions, along with climate stress testing, is smart strategy. For some mining companies, it will be easier to decarbonise because the materials they mine have a lower carbon intensity and several companies are already making public pledges of emission reduction targets. For others, technology may be unproven and require great collaboration with stakeholders to get insurance, or it may not even exist yet. The fact of the matter is that change is coming, and there has never been a better time to get up to speed.

The purpose of this article is to show how climate risk is transforming the mining industry. It will provide a high-level overview of the climate risk implications for the industry, the policy and regulatory frameworks and the investor response. This is about prudent risk management for the mining industry, because choosing sustainable business practices based on the latest science is not only good strategy, it’s also the route that’s increasingly preferred by industry leaders. And don’t forget that fundamentally sustainability is about efficiency and business resilience – words that any board of directors likes to hear.

Renewable/low-carbon energy is heavily dependent on the mining industry to provide the metals and minerals necessary for construction and operation.”

What the science is telling us

In brief, the science is telling us that the earth is getting hotter. Figure 1 on the next page shows that the trend of the global surface temperature of the earth; twenty of the warmest years on record were in the past 22 years. The grey line shows the rising concentration of CO₂ levels.

The scientific body of evidence from the Intergovernmental Panel on Climate Change (IPCC) is overwhelming. The IPCC synthesises the science evidence through an objective review process and summarises it to governments to support policy and decision making; it’s then up to governments what actions to take, based on the scientific data.

The effect on the mining industry risk landscape
Companies determine their risk appetite by analysing their exposure to a variety of segments, such as market movements, geopolitical events and changes in counter-party risk. There is now a sharper focus on environmental threats that will emerge over the course of the next ten years, and mining industry leaders know it. For the first time in the history of the World Economic Forum’s Global Risk Report 2020, environmental threats dominate the issues on senior leaders’ agendas, as evidenced by the position of the green diamonds in Figure 2 overleaf – remember this is a survey asking leaders what issues are crossing their desks before the onset of the COVID-19 global pandemic.

In summary: business and finance leaders know that the likelihood and impact of environmental threats to the mining industry are high. The science is clear; high carbon intensive industries are particularly exposed to three primary risks - physical, transitional and liability - all of which have significant financial consequences for the mining industry. Let’s discuss each in turn.

Part 1: physical risk

Mining assets are often found in remote, barren and geographically diverse areas. The safety of workers and assets has always been a concern for mining risk managers. In addition, the environmental impacts of mining are well known via changes to land use, additional traffic infrastructure and the industrialisation of what are often remote areas.

As many readers will appreciate, climate change is not just about the world getting hotter - it’s also about changes to extreme weather and climate events. Mining operations are already exposed to natural catastrophes that climate change may impact these exposures further. For example, mines in South Africa face extreme heat, while copper mines in Chile are already operating in extremely water-stressed and dry locations. Can these workers, assets and infrastructure withstand an increased frequency and magnitudes of extreme weather events, not to mention the impact on vulnerable supply chains and increased bottlenecks?

In addition, increasing temperatures and potential changes to rainfall patterns pose challenges to environmental management and risk mitigation as well as putting more pressure points on community relations. The stakeholder landscape is shifting; indeed,social ‘license to operate’ is the number one rated risk in EY’s 2019-2020 survey of over 250 mining sector participants from around the world.⁶ As climate change impacts deepen, the mining industry’s social license to operate will need to include increased transparency, mutual value creation and respect to satisfy stakeholders and society.

Water: mining’s most common casualty
Mining is a thirsty business, especially for materials such as copper and iron ore, and water (or lack of it) is one of the primary ways that the mining industry may feel the effects of climate change. It’s no secret that some miners have had a major impact on water resources, sometimes depleting water supplies through high usage and, in certain instances, polluting them with discharged mine effluent and seeping from tailings or waste rock impoundments. In fact, water has been called “mining’s most common casualty”⁷ and water availability is already less predictable in several regions.

Water stress & costs
It is estimated that by 2030 up to $50bn of mining revenues are likely to be exposed to high levels of water stress risk.⁸ In other research, McKinsey’s MineSpans ran and analysed a water-stress and flooding scenario on their database on copper, gold, iron ore and zinc and found that 30-50% of production of these four commodities is concentrated in areas where water stress is already high.⁹

Figure 3 overleaf shows the identified seven water-hot spots clustered into regions in Central Asia, eastern Australia, western Australia, the Chilean coast, the Middle East, southern Africa and a large zone in western North America. In 2017, these sites accounted for approximately $150 billion in total revenues according to the McKinsey report¹⁰.

Water stress can impact a mining company’s business operation, revenue generation and expenditure requirements. In some regions, one of the most significant variables for mining projects is the availability of water. Global water demand is expected to increase between 20-30% by 2050 above the current level of water use, which will further increase stress levels as the effects of climate change intensify.¹² Mining executives are well aware of water issues and mitigation; furthermore, adaptation plans will be crucial as our climate trajectory evolves.

Hedging against this risk can include water recycling and usage of greater amounts of seawater with desalination technology; however, notwithstanding this, water scarcity will increase in many regions. The availability and management of water is therefore one of the keys to sustainable mining activity from a carbon intensity, health and environmental perspective.

The consequences of the physical risks of climate change will impact operations and workers, interrupt business and impact vulnerable supply chains and infrastructure. Furthermore, the hardening insurance market means that some assets might not be insurable in the future.

Part 2: transition risk

Transition risks occur as societies move toward a zero-carbon economy. Some mining companies are operating in host countries that have committed to carbon neutrality by 2050. The market capitalisation of the ten largest diversified mining companies is over $350 billion and they contribute, either directly or indirectly via their products, to annual carbon emissions of over 1.5 billion tonnes.¹³ A few large mining companies have set targets to achieve carbon neutrality across operations by or before 2050. Some companies, such as Rio Tinto¹⁴ and Anglo American¹⁵, are setting Scope 1 (direct) and 2 (indirect) emissions targets while others, such as BHP¹⁶, have announced that they plan to include Scope 3 emissions, which are the third-party emissions from the end use of products, in their targets.

However, a discussion paper from the Transition Pathway Initiative (TPI), a global initiative led by asset owners, supported by asset managers and designed for use by investors to scrutinise companies’ preparedness for the low carbon transition, reveals a significant carbon performance gap between the ten largest diversified miners by market capitalisation (see breakout box overleaf).

Carbon Performance Assessment in the Diversified Mining Sector Transition Pathways Initiative
Discussion Paper, May 2020

TPI released a Discussion Paper proposing a methodology to assess the carbon performance of the diversified mining sector. To accomplish this, they took the Sectoral Decarbonization Approach, which is based on estimating companies’ greenhouse gas emissions intensity, with emissions and activity – the numerator and denominator of emissions intensity respectively – defined in ways that are appropriate to the sector in question.¹⁷ By applying this methodology to the ten largest diversified miners by market capitalisation, TPI is looking to answer the question: is this company, or group of companies, aligned with the Paris Agreement goals as applied to its sector?

Because some mining products, such as coal and iron ore, generate significant downstream emissions, their methodology adds estimates of Scope 3 emissions from processing and use of sold products to companies disclosed Scope 1 and 2 emissions. Figure 4 to the right shows their results.¹⁸

Commodities are critical for low-carbon technologies

While decarbonisation is occurring across other industries, the mining industry is intricately linked to this because many commodities are critically important in the development of expected low-carbon technology out to 2050.

Indeed, mining companies play a critical role in the energy transition, as evidenced by Figure 5 overleaf. The World Bank produced a data-driven report, Minerals for Climate Action: The Mineral Intensity of the Clean Energy Transition, of how the shift to a cleaner energy system could impact mineral demand²⁰. This report is interesting because it shows how increasing demand for minerals and metals are likely to adapt under low-carbon technologies, such as renewable energy and battery technology supply chains. Global demand for minerals, such as graphite, lithium and cobalt, could increase by nearly 500% to meet the demand for clean energy technologies by 2050.²¹

Decarbonisation strategy plan
This increased demand for minerals puts pressure on creating an effective climate risk mitigation plan for the mining industry; however, it’s not impossible and there are pathways. Investors have a growing concern over the viability of high carbon business models in an increasingly carbon-constrained world. They and other stakeholders will want to see targets set and met, along with a clear decarbonisation strategy plan. While reputational risk can be hard to quantify, it can have an enormous impact on a company and the goodwill of creating and executing a transparent decarbonisation pathway will provide value for investors and consumers.

A shift in focus
However, there is not just one route for the mining industry to decarbonise. Part of this pathway is likely to be met with regulatory carbon pricing, either via emissions trading schemes or carbon taxes. The carbon intensity varies widely between commodities, so shifting the industry’s focus away from the production of commodities with the highest emissions intensity presents the most obvious decarbonisation strategy.

Electrification as part of the solution
Another decarbonisation solution could come through the electrification of the mining industry. As a large proportion of mining emissions are driven by electricity supply, the mining industry could electrify operations to decrease emissions, for example with electric fleets and/or investments in renewable energy assets to power mining operations. Furthermore, lowering emissions - through increasing technological advances of mining processes - drives more efficient energy use while the use of renewables, combined with battery storage, decreases miners’ reliance on fossil fuels. In this way, renewables can also be viewed as a possible mitigation to energy security risks for miners, and a way to build operational resilience.

These types of investment can pay off, according to BCG’s Smart Multiple analysis. This research shows that mining companies who have been early movers in addressing climate change and who are already reducing emissions have market valuations, on average, 20% greater than their peers who are not taking climate action through emissions reduction performance.²² Furthermore, companies such as BHP are supporting the growing trend of incentivising directors by linking executive remuneration with emissions reductions.²³

Part 3: litigation risk

Mining companies are already facing the physical and transition risks of climate change and now they must confront a third risk in the form of litigation liability. New litigation cases are using science to quantify and show the relationship between emissions to particular location-based companies and climate related impacts²⁴.

Global trends in climate change litigation
According to a “Global Trends in Climate Change Litigation: 2019 Snapshot” policy publication at the Grantham Research Institute on Climate Change and the Environment housed at the London School of Economics, climate change litigation is expanding across jurisdictions as a mechanism to strengthen climate action²⁵. Indeed, climate change litigation is increasingly viewed as a tool to influence policy outcomes and corporate behaviour²⁶.

Furthermore, new climate mandatory reporting rules are on the rise - including those based on the EU Taxonomy.²⁷ Financial market participants and large companies will soon face the legal obligation to report and reduce the carbon footprint of their activities; by continuing to hold carbon intensive assets, they hold direct and indirect litigation risk. In addition, this exposure to carbon intensive assets could detract from their company’s investment appeal to shareholders. Blackrock, the world’s largest fund manager with nearly $7 trillion under management, has pledged to reduce exposure to thermal coal and recognises that climate risk is investment risk.²⁸

Lending shifts away from high emissions-intensity materials
In Europe, there is now a growing pressure - from market dynamics, political forces and investors - for large financial institutions to green their lending portfolio. Several banks - and indeed insurers (see Part three of this review)- are responding to this tension and setting benchmarks that shift away from high carbon intensive materials such as coal.³⁰ This is likely to cause higher finance costs for mining companies as capital flees from coal; it’s also causing a shift of funding to Asian banks, export credit agencies and private equity firms.³¹

Central banks are taking action
Climate-related risks pose complex challenges, not just to private banks but also to central banks, regulators and supervisors. The Network for Greening the Financial System (NGFS) is a group of central banks and supervisors who are developing guidance around climate risk assessment and scenario analysis.³² This work will provide frameworks for other regulators who are also looking to evaluate climate risks – at the end of the day, what they all want to know is that companies understand their risks and are taking concrete action.

In Europe, there is now a growing pressure - from market dynamics, political forces and investors - for large financial institutions to green their lending portfolio.”

Conclusion: consequences for the mining industry

The costs of physical impacts and business disruptions arising from climate change can be considerable for the mining industry. Mining still depends heavily on fossil fuels for power generation, while water stress will continue to rise and supply chains will become more vulnerable.

Transitioning to a net zero economy will be difficult, but the global financial system and the mining industry is under pressure to make a faster shift towards the alignment of climate security and sustainable development.

Some commentators have shifted their focus to physical and transition risk, grouping the two together. However, this detracts from the significance and unique challenges of litigation risk, which encompasses risks arising out of new transition reporting regimes, but also myriad potential claims affecting all aspects of mining operations; these range from permitting to licensing to environmental protection and to the continuing efforts by NGOs and citizens to seek to attribute historic climate change to mining companies. As transition continues to change the regulatory framework, that litigation risk is likely to increase without careful and focused risk management by mining companies and their investors.

Final thoughts: prudent risk management will be critical!
Capital has to be reallocated to support the just transition to a zero-carbon economy. Such a just transition means balancing society and the economy, along with managing the transitional implications for potentially stranded assets, communities and workers.

Transitioning to a zero-carbon economy for the mining sector is extremely complex, with a number of different moving parts. At the moment, financial flows and alignment are not happening fast enough to deliver positive climate impact at scale, so fundamental systemic change is required on a global level - change is coming, whether we like it or not. It can be embraced or delayed – but not avoided, so starting now is key. The COVID-19 pandemic highlights the importance and value of collective action with coordinated support and shows that long term strategies and sustainable investment approaches are required.

To conclude: as stated at the beginning of this article, prudent risk management is at the heart of this piece. For mining companies to remain a going concern in the future, action is required: be prepared, share information and work with other relevant stakeholders and governments to find solutions for the transition to a zero-carbon economy.

Prudent risk management is at the heart of this piece- for mining companies to remain a going concern in the future, action is required.”

Margaret-Ann Splawn is a climate policy finance and investment consultant. She is a member of the Energy, Sustainability & Climate taskforce of the B20, the official G20 dialogue with business and Active Private Sector Observer for developed nations at the UN Green Climate Fund.
margaret.splawn@cmia.net

¹ https://www.willistowerswatson.com/en-GB/Insights/2020/05/the-wicked-problems-of-pandemics-and-climate-change
² Scope 1 covers direct emissions from owned or controlled sources. Scope 2 covers indirect emissions from electricity purchased and used by the organisation.
³ https://www.mckinsey.com/business-functions/sustainability/our-insights/climate-risk-and-decarbonization-what-every-mining-ceo-needs-to-know
⁴ https://www.worldbank.org/en/topic/extractiveindustries/brief/climate-smart-mining-minerals-for-climate-action
⁵ https://www.power-technology.com/features/net-zero-strategy-is-basic-question-for-every-company-mark-carney/
⁶ https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/mining-metals/mining-metals-pdfs/ey-top-10-business-risks-facing-mining-and-metals-in-2019-20_v2.pdf
⁷ https://eportfolios.macaulay.cuny.edu/est2016/2016/09/12/is-our-everyday-use-of-minerals-worth-such-widespread-water-pollution/

⁸ Digging Deep, CDP July 2017 https://www.cdp.net/en/investor/sector-research/mining-report
^9&10 https://www.mckinsey.com/business-functions/sustainability/our-insights/climate-risk-and-decarbonization-what-every-mining-ceo-needs-to-know
¹¹Water stress defined as ratio of water demand to supply.
¹² https://www.unwater.org/publications/world-water-development-report-2019/
¹³ https://www.transitionpathwayinitiative.org/tpi/publications/57.pdf?type=Publication
¹⁴ https://www.riotinto.com/en/sustainability/climate-change
¹⁵ https://www.angloamerican.com/sustainability/environment/climate-change
¹⁶ https://www.bhp.com/environment/climate-change/
¹⁷ https://sciencebasedtargets.org/wp-content/uploads/2015/05/Sectoral-Decarbonization-Approach-Report.pdf

¹⁸ https://www.transitionpathwayinitiative.org/tpi/publications/57.pdf?type=Publication
¹⁹ https://www.worldbank.org/en/topic/extractiveindustries/brief/climate-smart-mining-minerals-for-climate-action
²⁰ http://pubdocs.worldbank.org/en/961711588875536384/Minerals-for-Climate-Action-The-Mineral-Intensity-of-the-Clean-Energy-Transition.pdf
²¹ https://www.worldbank.org/en/topic/extractiveindustries/brief/climate-smart-mining-minerals-for-climate-action
²² https://www.bcg.com/en-gb/publications/2020/mining-needs-to-go-faster-on-climate.aspx
²³ https://www.pv-magazine-australia.com/2019/07/23/bhp-to-link-executive-compensation-to-reductions-in-emissions-generated-from-the-use-of-its-products/
²⁴ https://insideclimatenews.org/news/04042018/climate-change-fossil-fuel-company-lawsuits-timeline-exxon-children-california-cities-attorney-general

²⁵ http://www.lse.ac.uk/GranthamInstitute/publication/global-trends-in-climate-change-litigation-2019-snapshot/
²⁶ https://climate-laws.org/
²⁷https://ec.europa.eu/info/sites/info/files/business_economy_euro/banking_and_finance/documents/200309-sustainable-finance-teg-final-report-taxonomy_en.pdf pg 26
²⁸ https://www.abc.net.au/news/2020-01-15/worlds-largest-fund-manager-to-cut-thermal-coal-exposure/11869300
²⁹https://www.ngfs.net/sites/default/files/medias/documents/ngfs-a-sustainable-and-responsible-investment-guide.pdf
³⁰ https://www.bankingdive.com/news/citibank-pledge-stop-thermal-coal-mining-financing/576451/
³¹ https://www.bloomberg.com/news/articles/2020-03-08/death-of-coal-financing-is-exaggerated-as-china-japan-step-up
³² https://www.ngfs.net/en