Antoine Heuty and Linda Pappagallo
At the “Shared Value Leadership Summit: Investing in Prosperity” this week in New York, leading thinkers and practitioners from around the world meet to explore approaches in sustainably reconciling business goals and social impact. Creating shared value, a concept that posits that companies cannot succeed in societies that fail, is particularly well suited for adoption as management philosophy in the extractive industries: the sector represents 5 percent of the global GDP and operates profitably only with a secure a long horizon for operations, yet has historically struggled to reduce negative impact on communities affected by operations. The resulting high operational risks are an important incentive for business leaders seeking to put their operations on secure long-term footing.
The need for a paradigm shift in corporate behavior and risk management strategies in oil, gas and mining are clearly outlined in a new study published in the Proceedings of the National Academy of Science. In the paper, Daniel Franks and his colleagues find that extractive industry companies tend to not factor the full scale of costs arising from strive with affected communities. This is despite existing and detailed internal reviews that clearly show that economic costs of social and environmental risk can be considerable. The paper quotes one company, which calculates that “more than US$ 6 billion was attributed to non-technical risks over a two-year period, representing a double-digit percentage of the company’s annual operating profits.”
Failing to properly account for economic costs arising from community conflict translates into a failure to design appropriate risk mitigation and resolution strategies – which is exemplified by the high number of extractive projects that are in trouble due to falling out with affected communities. Most risk accumulates early on in the project cycle during the feasibility and construction phase, when community mobilization and project vulnerability is greatest.
There are three key costs of community conflict for extractive sector companies that the Franks at al paper identifies: lost productivity due to delays, opportunity costs for lost business development, and increased staff costs to deal with escalating conflicts:
1. Productivity losses due to delays are the most visible costs of community conflict. Major mining projects with a capital expenditure of between US$ 3 to 5 billion lose US$ 20 million on average per week of delayed production in net present value should community conflict shut down production through strikes, blockades and other activities. Particularly prone to such costs are the early phases of extractive project cycles. Data supplied by companies shows that in initial mineral exploration every day costs about US$ 10,000 in wages and other exploration camp costs. This figure rises up to US$ 50,000 per day in advanced exploration involving drilling and geophysical delineation. With no revenues coming in early stages, even a few days of delay due to community-company conflict can rack up enough costs to cripple exploration.
2. The second most frequent cost the paper identifies is related to the opportunity cost of falling business development prospects in expansion, sale or pursuit of additional projects. These can lead to asset write-downs and steep drops in share prices. In the example of one Australian company, Credit Suisse applied a 2.9% discount on its corporate valuation of AGL Energy to account for the risks of regulatory approval delays following local community opposition to hydraulic fracturing.
3. More hidden yet severe for companies are costs that result from additional staff time needed when conflicts arise. The authors estimate that dealing with the management of stakeholder-related risks increases the overall staff time budgeted for community relations up to ten times. Often in these cases senior management has to be brought in, resulting in an additional amplification of staff costs dealing with community disruptions.
While social and environmental risk do not always turn to conflict, Franks and his co-authors find that perceived risk is the most frequent factor that translates to conflict. When perceived risk is not addressed – for example the failure of responding to expressed concerns about risk, dismissing particular community perceptions as unfounded, or the failure of government to mediate the perceptions of risk – conflict with affected communities is often inevitable for companies.
Extractive sector companies are in agreement that the problem of non-technical risk is real, but have yet to find a compelling answer. Traditional approaches along the lines of corporate social responsibility or corporate philanthropy have shown clear limitations in successfully defusing negative social and environmental impacts before they accumulate and escalate. Discussing shared value as a broader management philosophy in extractive industries offers critical insights into ways in which community concerns can be addressed to reduce conflict while unlocking sustainable economic potentials for companies.
This is the first part of a series of three blogs that discuss the concept of shared value in the extractive industries. The next blog will highlight three case studies that exemplify risks associated with failed community engagement, while the third and final part will discuss some of the outcomes of this week’s Shared Value Leadership Summit in New York.
Antoine Heuty
Antoine Heuty is the founder of Ulula. He is an experienced development practitioner with a long track-record designing and delivering policy reforms and working for social good with business, civil society and government in over twenty countries.
Linda Papagallo
Linda Papagallo is a monitoring and evaluation specialist. She is designing Ulula’s methodology for collecting, organizing and analyzing data. She is an expert in field based project management of randomized control trials, socio-economic and environmental analysis.