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Measuring the cost of conflict with local communities

In today’s challenged financing and commodities price environment extractive companies must be more careful than ever when allocating budgets and resources. The process for doing so is fairly straightforward for expenditures in capital assets (bar forecasting prices) but how about for estimating the cost of non-technical risks, such as company- community conflict?

The Harvard Kennedy School and the University of Queensland Centre for Social Responsibility in Mining teamed up to do some interesting research led by Rachel Davis and Daniel Franks to quantify the cost of conflict with communities. Their initial work, based largely on interviews with key industry staff, was shared at the First Social Responsibility forum in mining in Santiago Chile in October 2011. The release of further research is expected soon.

Extractive sector projects have significant impacts on nearby communities most often located in remote areas with few if any other industrial activities. The company’s presence brings with it major economic, social, and environmental change. Different stakeholders experience change differently. This creates the potential for conflicts when costs and benefits are evenly distributed or when developments are not compatible with important interests and values.

The Davis/Franks study informed that conflicts most frequently arose over pollution, access to and competition for resources, community health and safety, resettlement, distribution of benefits, dissatisfaction over consultation and communication. Conflict was measured along a spectrum starting with procedure‐based actions, such as submissions (to government or to the company), and administrative proceedings, then moving towards litigation, and publicity campaigns, and finally physical protests such as demonstrations and blockades. A not insignificant number of cases involved violence to property or persons.

When conflicts develop these often amount to significant costs to companies, which sometimes have to shelve projects altogether after significant investments have been made. A 2008 study of 190 major international oil company projects showed that the time taken for projects to come on‐line nearly doubled in the last decade, causing significant increase in costs (Goldman Sachs, 2008). Follow‐up research on a subset of those projects found that non‐technical risks accounted for nearly half of the total risks, and stakeholder‐related risks constituted the single largest category (Ruggie, 2010).

Lost production was found to be the most frequent cost identified in the Davis and Franks research, while the greatest costs were lost opportunity costs arising from the inability to pursue future projects, expansion, or sale opportunities, as a result of company-community conflict. The interviews indicated that a world‐class mining project with capital expenditure of between US$ 3–5 billion would incur roughly US$ 20 million per week of delayed production losses in Net Present Value (NPV) terms. In the case of an advanced exploration project, around US$ 10 000 will be lost every day of delay in terms of wages, idle machinery etc. An example that immediately comes to my mind is Newmont-Yanacocha’s Minas Congas project in northern Peru; a $4 billion gold project that has been unable to move forward for years despite major efforts at mediation and resolution.

The most overlooked costs were the result of the additional staff time required to manage conflicts. The working assumption for one company was that 5% of an asset manager’s time should be spent managing social risk yet in conflict situations this becomes much higher. Yet for one of its African subsidiaries it is in fact 10–15%, and in one Asia‐Pacific country it is as high as 35–50%. In other cases, senior management estimated assets worth 10% or less of the company’s income were demanding more than 80% of senior management time.

Now that the cost of conflict is better quantified, how can companies drive performance in this area? One way is through the right performance incentives. Most operational staff have bonuses that are driven by production or drilling targets often on a quarterly basis. These motivate individuals for short-term gain but can punish the company in the longer term. For instance if a company pushes forward with activities on land whose ownership is under dispute, or where other stakeholder concerns have not been effectively addressed. Companies that are trying to introduce social performance indicators are still in a minority but some are now looking at social indicators such as zero or no incidents similar to more developed occupational safety performance measures already in place.

This important research for understanding the costs of conflict bodes well for the improved social performance of extractive sector companies. The bottom line remains the bottom line; therefore the more companies understand the impact social risk poses to the bottom line, the more ingrained it is likely to become in business management systems. Stay tuned for my next post on “How should companies allocate resources to social management?”

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