Working Paper: NBER ID: w21325
Authors: Christopher Costello; Charles D. Kolstad
Abstract: Environmental concerns dominate modern-day decisions about mining. While the minerals extracted are surely valuable, mining of natural gas, deep seabed minerals, rare earth metals, and traditional ore is often fraught with environmental uncertainty. We examine how this uncertainty affects the optimal decision of if, and when, to mine. When environmental damage from mining is known, the socially optimal timing depends straightforwardly on the magnitude of the damage relative to these damages in the rest of the world. But when environmental damage is uncertain, and its magnitude is learned over time, an option value arises, which fundamentally alters the mining decision. This decision depends on the costs and benefits of mining at different times, which are innately linked for non-renewable resources by Hotelling’s rule. Using this insight, we find that any uncertainty over environmental costs can make it optimal to delay mining; this occurs even when expected environmental costs are low or even negative. We show conditions under which it is optimal to postpone the mining decision indefinitely, and conditions when it is optimal to postpone only for a finite duration. We use these insights to derive, for the first time, the equilibrium outcome of an entire industry of decentralized mine owners who all face an incentive to delay to acquire improved information. This gives rise to strikingly different price and extraction paths than are currently understood. One such outcome is that price paths flatten relative to what Hotelling theory predicts, consistent with empirical findings that have puzzled the literature.
Keywords: Hotelling's rule; option value; quasioption value; mining; environmental externalities
JEL Codes: Q31; Q32; Q38; Q52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Uncertainty regarding environmental costs (Q52) | efficient social decision to postpone mining (L72) |
| Environmental damage is known (Q53) | optimal timing of mining is directly related to the magnitude of the damage (C41) |
| Environmental damage is uncertain (Q54) | option value of delaying mining arises (L72) |
| Expected costs of environmental damage are low (Q52) | optimal to delay mining indefinitely (L72) |
| Decentralized industry of mine owners (L72) | different price and extraction paths than predicted by Hotelling's theory (D43) |
| Decentralized industry of mine owners (L72) | price paths may flatten over time (E30) |