Amid the energy transition, ESG related disputes are on the rise in the mining industry

This article is an extract from Lexology In-Depth: Mining law - Edition 12. Click here for the full guide.

Introduction

Environmental, social and governance (ESG) are a set of criteria used for evaluating a company's sustainable and ethical impact. Relative to the mining industry, it involves assessing how mining companies manage environmental impacts, such as land reclamation and water management, social factors like community relations and labour practices and governance issues including transparency and ethics in decision-making.

The global demand for minerals and metals continues to rise, driven by industrialisation, technological developments and the growing needs of emerging economies. This surge in demand amplifies the pressure on mining activities, intensifying existing conflicts and generating new challenges regarding ESG performance. This trend is likely to accelerate as the energy transition increases global demand for critical minerals.

The mining industry is at the crossroads of the energy transition and the ESG-based economy for two reasons. On the first hand, the industry was notoriously poor on ESG compliance: the mining industry has a complex history, often associated with environmental and human rights concerns. Revamping the industry in a sustainable fashion will prove essential to the success of the sector. On the other hand, mining is becoming essential to mitigate climate change as the race for critical minerals illustrates. This sector, once synonymous with environmental degradation, has become pivotal in providing the materials essential to meet the global aims of the energy transition.

Furthermore, the increased scrutiny for ESG compliance and the buoyant activity of the extractive sector are fuelling arbitration cases. Quantifying damages in ESG disputes is akin to calculating externalities in macroeconomics. However difficult it may be, it will be essential if disputes are to be resolved fairly.

Increased demand for (critical) minerals and specific characteristics of the mining sector

The mining sector has seen a steady rise in activity over the past 20 years: between 2002 and 2022, the revenue of the leading 40 mining companies worldwide surged from US$222 billion to US$943 billion,² a trend that is expected to accelerate in the next decade, driven by the need for critical minerals, as the energy transition marks the shift from dependence on fossil fuels to dependence on mineral resources.

The 2020 American Energy Act defines critical minerals as 'any non-fuel mineral, element, substance, or material that the Secretary of Energy determines: (i) has a high risk of supply chain disruption; and (ii) serves an essential function in one or more energy technologies, including technologies that produce, transmit, store, and conserve energy'.³ Most countries have their own list of critical minerals that is updated regularly. Schematically, people use the term 'critical minerals' to describe the minerals that are key to the energy transition, mainly to build renewal energy infrastructure or electric batteries. These minerals mainly include cobalt, copper, lithium, manganese and nickel.

Demand for these minerals is expected to boom in the next decades:

1. in 2021, the International Energy Agency estimated that an electric car requires six times more critical minerals than the conventional car and that an offshore wind plant requires 13 times more mineral resources than a similarly sized gas-fired plant;⁴ and
2. a 2020 World Bank report found that 'the production of minerals, such as graphite, lithium and cobalt, could increase by nearly 500% by 2050, to meet the growing demand for clean energy technologies. It estimates that over 3 billion tons of minerals and metals will be needed to deploy wind, solar and geothermal power, as well as energy storage, required for achieving a below 2°C future'.⁵

The mining industry will need to expand significantly and rapidly if energy transition targets are to be met. However, such a development comes with significant challenges that need to be faced as the market seeks to adapt and answer the demand.

The mining sector is first characterised by uncertainty and long timeframes. According to S&P Global, the average lead time for mining projects to enter the exploitation phase is 15.7 years.⁶ Additionally, less than one percent of exploration projects progress to becoming an exploited mine.⁷

The extractive industry is further characterised as being one of the most capital-intensive, and this trend has been accelerating. Looking at copper, for example, it has been estimated that in 2000 it cost approximately US$4,500 on average to build the infrastructure to produce a tonne of copper; this amount skyrocketed to approximately US$44,000 per tonne in 2022. This trend is explained, among others, by the degrading quality of ores (as investors initially focused on the minerals with the highest quality) and the fact that the remaining resources are located in increasingly remote and difficult to access areas.⁸

In addition, revenues and costs are at the mercy of commodities' price fluctuations, such that managing profits and losses is a challenge in itself, and valuing a mining project is a complicated endeavour. This also poses additional risks in countries where mining is an important part of the GDP. A 2019 study published in the Mineral Economics journal found that 'depending on their respective weight in the national economy of a particular country, [a metal's] price and price fluctuations can have a substantial impact on economic development of the host country'.⁹

Finally, the mining sector suffers from an imbalanced life cycle and the heavy investments required at the beginning of a project are easily changed into sunk costs when a project turns out to be less profitable than expected or does not progress through exploitation.

Mining projects are very often handled via partnerships between a state, owner of the mineral resources and one or several private investors who bring the required capital and their expertise. It is therefore necessary to reconcile the need to attract investors by creating a competitive and incentivised framework, while ensuring a fair level of remuneration to states and communities. In practice, national legislators have a hard time figuring out the optimal fiscal regimes to accommodate for the very specific features of the mining industry. This is, for example, illustrated by the Fiscal Modelling of Resource Industries (FARI) model, built by the IMF to optimise fiscal pressure according to the various stages of the mine (i.e., exploration, development, production or closure).¹⁰

It is furthermore noticeable that a number of countries have recently rewritten their mining code in an attempt to manage their sub-soil resources in a more sustainable fashion – a trend that has been growing in Africa but is not limited to this continent. France, for instance, has reformed its mining code in 2022 in line with the enactment of the Loi climat et résilience in 2021, a legislation aimed at battling climate change. This new mining code implements ESG measures such as expanding compensation and reparation for mining damages to environmental and health damages.¹¹

In practice, the combination of the sector's growth (partly driven by the energy transition) and the specific characteristics of the industry have been fuelling arbitration cases in the recent years. Out of 61 arbitrations involving mining concessions registered before ICSID between 1996 and 2023, 36 happened in the past five years.¹² Out of this general trend in mining disputes, an increasing number of arbitrations relate to ESG compliance issues, as discussed in the next subsection.

The mining industry and ESG requirements giving rise to specific disputes

The mining industry has one of the highest exposures to ESG risks. For example, a 2022 survey conducted by White & Case found that ESG was ranked as the number one risk faced by the mining and metals industry.¹³ Looking at things closely, each pillar of ESG requirements resonates with the specificities of the mining industry and with its inherent challenges. In a 2023 survey conducted by Baker McKenzie, 81 per cent of respondents expected the number of ESG disputes to either stay the same in 2024 or increase, and 73 per cent of respondents expected a form of ESG dispute to pose a risk to their organisation in 2024.¹⁴

The environmental criteria applied to the mining industry encompasses biodiversity, water management, energy, climate, noise and air. Similarly, the mining industry is often implicated in the release of toxic elements into air, water and soil, raising significant environmental concerns.

These issues impact ecosystems and draw stringent regulatory scrutiny, pushing mining companies to adopt more sustainable and less harmful practices.¹⁵

As an illustration, the recent outcome of the Gabriel Resources and Romania treaty arbitration¹⁶ highlights the importance of being environmentally compliant for setting up a mining project. Gabriel, a Canadian mining company, filed an ICSID claim in 2015 for being denied an environmental permit for a gold and silver project. The project was located on a UNESCO world heritage site and Gabriel had planned to use cyanide for gold and silver extraction, which produces toxic waste. Gabriel tried to obtain the permits for over 15 years, but the Romanian parliament eventually rejected the Canadian company's demand. Gabriel alleged that Romania had breached the bilateral investment treaty's (BIT) provisions on expropriation, fair and equitable treatment and discrimination. The tribunal, in an award dated 8 March 2024, sided with Romania and dismissed all claims brought by Gabriel.¹⁷

The social criteria in the mining industry generally refers to respecting human rights, land use, health and safety and including communities in the decisions. The risks for multifaceted ESG disasters, such as contamination or conflict, are tangible realities within the extractive industry.

Community consultation has become critical for mining projects, and it often ends up being a cause for disputes when not properly addressed. Efforts are made to regulate community consultation regarding mining projects even though there are no unique and unanimously accepted principles.

The most famous principle is the social licence to operate (SLO), which is considered a recognised and legitimate approach for companies to address community consultation. The SLO is not, however, a tangible certification but rather a set of best practices and behavioural standards that legitimise the undertakings of a mining project with respect to the local communities. Its applications are both legal and extra-legal. In reality, the SLO materialises itself, for example, in the form of companies setting up community relations programmes.¹⁸

Even if companies try to best manage their relationship with local communities, tensions can appear, especially as the lifespan of a project extends. In the event of disputes arising with illegitimate demands from local communities, international arbitration is often seen as the only mechanism for foreign companies to resolve such issues. Indeed, when mining companies do not have direct recourse against the communities, they can seek and bring a claim against the host state.¹⁹

Already cited above, the Gabriel Resources v. Romania arbitration also illustrates the intricacies of community consultation concerning mining projects. In addition to the environmental defects of the project, Romania argued that Gabriel failed to secure a social licence. More specifically, Romania considered that Gabriel did not offer financial benefits to the communities that would extend over generations and noted that the project spurred massive protests in the country.²⁰

Another arbitration example related to social challenges inherent to the mining industry is the Bear Creek Mining v. Peru arbitration²¹ that highlights the blurry contours of the social licence to operate. In 2011, Peru revoked a 2007 decree that authorised Bear Creek Mining, a Canadian company, to operate the Santa Ana mine. The Peru decision was followed by social protests where local communities rose against the mining activities. The claimant alleged that Peru violated its obligations under the free trade agreement between Canada and Peru. In the case award dated November 2017, the tribunal found that Peru's actions constituted an unlawful indirect expropriation.²²

Finally, governance tackles topics such as transparency, corruption and ethics. Mining projects have often been seen as opaque deals between states and companies, but every stakeholder is now requesting to access the ins and outs of mining projects.

Initiatives to bolster compliance and transparency are legion in the mining industry. Most notably, the Extractive Industries Transparency Initiative (EITI), initiated in 2003 in London, acts as a soft law for the mining sector and fosters the implementation of principles aiming to increase transparency in the industry. The EITI standard is now implemented in more than 50 countries.

These measures improve public confidence and accountability by fostering a more stable investment environment, which is particularly helpful as a large part of mining activities are set in countries with a certain degree of political instability and corruption in place and this is especially true for critical minerals.

Nonetheless, corruption is increasingly being seen as the background of investor-state mining arbitrations. It is invoked by both investors and host states.

For example, in 2016, Dominion Minerals, a US mining company, filed a US$268 million ICSID claim against Panama.²³ The claim related to the loss of a mining concession and alleged corruption and abuse of state resources during the previous Panamanian government, led by President Ricardo Martinelli. Dominion invested in a copper deposit known as Cerro Chorcha in 2006 through its acquisition of the Panamanian company Cuprum Resources. Dominion understood it had exclusive exploration rights for a minimum of four years, as well as exclusive rights to extraction. The Panamanian government later rejected Dominion's application to extend its exploration concession, citing Cerro Chorcha as a mineral reserve area, effectively prohibiting extraction activities. Besides accusing Panama of violating fair and equitable treatment and expropriation provisions of the US–Panama bilateral investment treaty and seeking damages for economic losses, Dominion alleged that the government demanded a majority stake in Cuprum and financial benefits through proxies, including a former Panamanian politician with close ties to Martinelli. The claim referenced allegations of corruption during Martinelli's presidency and ongoing investigations into his administration. Dominion criticised the government for inadequate compensation, prompting the arbitration filing.²⁴ In its award dated November 2020, the tribunal found that Panama had breached certain provisions of the US–Panama BIT and ordered Panama to pay Dominion US$16 million plus interest. The latter has applied to partially annul this award in 2021.²⁵ The appointed ad hoc committee granted the stay of enforcement of the award in 2022. The proceedings were then suspended by agreement of the parties.²⁶

Another example can be found in the BSGR v. Republic of Guinea arbitration,²⁷ which illustrates how a host state can retort that the investor has used corruption and that the claimant's allegations are inadmissible. BSGR filed a claim against Guinea in 2014 after the government revoked its right to operate part of the Simandou iron ore deposit. The ICSID tribunal, although admitting it lacked jurisdiction over certain claims, stated there was 'overwhelming evidence' of corrupt practices by BSGR. Despite BSGR's denial of such corruption, evidence showed substantial payments to a wife of Guinea's late dictator.²⁸

Investors, states and citizens alike now demonstrate a higher interest in ESG compliance. A survey conducted by Morgan Stanley found that 'more than half of individual investors say they plan to increase their allocations to sustainable investments in the next year, while more than 70% believe strong ESG practices can lead to higher returns'.²⁹ There is no doubt that mining companies are particularly affected by this trend, given how ESG compliance is now woven into the fabric of the extractive industry. This trend reaches out to the numerous mining disputes that are related to ESG issues, adding complexity to the valuation of damages.

Quantifying externalities generated by the extractive industry

ESG issues are often associated with the economic concept of externalities. The term externality refers to the phenomenon by which an economic agent, through its activity, creates an external effect by procuring for others, without monetary compensation (positive externality), a utility or on the contrary a nuisance or damage, without compensation (negative externality). For example, jobs created as a result of a factory opening up in a rural area (new restaurants, new shops, etc.) is a positive externality, while the additional air pollution generated by the same factory is a negative externality.

The mining industry is a very good example of an economic sector that creates a lot of externalities, both positive and negative for the local population and areas.

The positive externalities related to the mining sector are well documented. In developing countries, for example, mining projects often go hand-in-hand with the building of infrastructures by the mining companies, such as railways and roads. These infrastructures will serve many purposes in the region and remain in service long after the plant has been closed. The operation of the plant will also lead to the employment of local population, eventually improving the overall skillset of the population and stimulating local consumption via the creation of hotels and restaurants in the area, for example.

But the mining sector is also associated with many negative externalities that often resonate with ESG non-compliance. In particular, as discussed above, the extractive industry is notorious for being detrimental to the environment. Pollution of air and water, harm to biodiversity and unproper decommissioning of plants are common occurrences of negative externalities that plague the field.

Externalities, by essence, make it difficult for states to gauge exactly what they are getting out of an industry and how they should set out the regulation for said industry. By accurately evaluating these externalities, policymakers, regulators and mining companies can make informed decisions to mitigate negative impacts and promote sustainable practices within the industry.

The calculation of externalities is a widely studied topic in economics and is especially challenging when moving from theory to practice. In theory,³⁰ economists rely on models using marginal benefit (or marginal damage) and marginal cost curves.³¹ In practice, however, the economists' toolkit has a hard time capturing the asperities of reality. Indeed, marginal cost and benefit are often rough estimates. Moreover, the full extent of an externality can be subject to debate. Economists are therefore tempted to move to a qualitative approach where the level of impact on the environment is ranked (e.g., no impact, moderate impact or significant impact).

However, those qualitative methods would not be satisfactory when it comes to valuing damages in the context of disputes related to negative externalities such as ESG non-compliance (also rising as counterclaims from host states).

Borrowing from the macroeconomic literature, traditional financial valuation methods and innovative tools, quantum for damages related to externalities is a complex playground. Let us consider the hypothetical case of a mining company whose operations resulted in the pollution of a local water stream. If the host state were to file a claim against this company, how would the damage related to the pollution of the water stream be quantified? As a first step, one would estimate the costs of depolluting the water steam (i.e., bringing back the water stream in its state but for the degradation of the mining company). In addition, the damages could and should cover the costs of knock-on impacts the polluted water stream had, ranging, for example, from medical costs incurred by adversely affected population to lost profits suffered by agricultural agents operating with the water. Experts will need to adopt a methodical and systematic approach to these valuations to provide reliable evidence for the assumptions used in the calculations. A full review of the expert's reasoning should allow the tribunal to gain insight into the existence of a damage and its reasonable valuation.

Conclusion

Disputes within the mining sector are a complex interplay of economic interests, environmental concerns, social dynamics and governance imperatives. With the global demand for minerals and metals on the rise, and an increased focus on ESG considerations, an effective dispute resolution system of the industry is more important than ever.

Such an effective dispute resolution in the mining sector will require a concerted effort from all stakeholders, including governments, local communities, civil society and industry players. From the quantum perspective, experts will need to consider all externalities, positive and negative, and adopt a tailored approach to provide a reasonable assessment.