Leaving your tailings behind: Environmental bonds, bankruptcy and waste cleanup

This paper studies the impacts of an environmental bond, which fully covers waste cleanup costs, on a mining firm's optimal actions over the full life cycle of a mine, when bankruptcy may shift cleanup costs to the government. A firm's stochastic optimal control problem is described by an HJB equation with the resource price modelled as an Ito process. A theoretical result shows that under certain assumptions, an environmental bond can ensure that the option to declare bankruptcy has no impact on the firm's optimal actions. A numerical solution is implemented for a hypothetical copper mine using two different models of bankruptcy risk. Numerical results show that when bankruptcy is an option and no bond is required, the firm produces too much waste relative to a benchmark case, resulting in an efficiency loss and a cleanup liability imposed on government. In the presence of bankruptcy risk, a bond ensures that the firm acts optimally and no efficiency loss is imposed on society.