Why don't environmental bonds fully cover reclamation costs?

Abstract

Governments often require that extractive industry firms post environmental bonds as financial assurance to cover eventual reclamation liabilities. Such bond requirements frequently do not fully cover the reclamation cost. We show that a revenue-maximizing government may reasonably require a bond amount smaller than the full reclamation cost. This is because large bonds may discourage the extractive activities, diminishing fiscal income from project rents that could more than offset the decreased reclamation liability falling on the government. The selected bonding rate largely depends on the regulator's estimation of the elasticity of exit in response to bonding. Western Australia's recent refund of mining reclamation bonds to strong balance sheet firms, the US Bureau of Land Management's (BLM) historical concern over exit of oil and gas operators on onshore federal lands in response to bonding requirements and willingness to accept for its own account reclamation risks associated with incomplete bonding, and Texas's requirement for full-cost onshore oil and gas reclamation bonding are shown to all be consistent with this calculus.