The Free-entry Mineral Allocation System in Canada's North: Economics, Sustainability, and Alternatives

by Malcolm Taggart 

The Free-entry Mineral Allocation
System in the Canadian North

The free-entry system of mineral allocation used in the Canadian North grants exclusive rights to the minerals in a given area of public land.' Certain rules must be followed (the staking and registration process) and the claimant must perform a certain amount of work on the area claimed (known as assessment work). The claimant incurs costs, which can be considerable when staking is done on a large scale. The government, as owner of the resource, receives little or no direct benefit from granting these rights. Underlying free entry is the assumption (often unstated) that mining is the highest and best possible use of the land.

The free-entry system consists of three inter-linked rights: the right of entry onto lands containing minerals; the right to acquire a claim on those lands; and the right to lease the land and extract the minerals. Under the free-entry system, the state has only one very crude discretionary power in making allocation decisions: the power to withdraw lands from staking. Nonfree-entry systems (e.g., a leasing or concession system) offer the state far more discretionary power in the process of determining who will develop mineral resources and where.

Is the free-entry system the most economically efficient means of allocating mineral resources? Does free entry help or hinder the achievement of economic rent for minerals and so help or hinder meeting the criterion of sustainability? What are the possible reforms of, or alternatives to, free entry?

Free Entry, Economic Rent, and Sustainability

Over the past several decades, there has been increasing pressure to reform or replace the free-entry system. Competing land uses have increased in economic and political importance; there has been a rise in environmental awareness among the general public; and governments have largely adopted principles of sustainability including the component sustainable development. The federal Department of Indian Affairs and Northern Development, for example, has adopted sustainable development (defined as meeting the needs of today without compromising the ability of future generations to meet their needs) as a guiding principle for the management of the North's resources.

For non-renewable resources such as minerals, applying the criterion of sustainability emphasizes the need to collect economic rent for the resource and to invest it in substitutes or in renewable forms of economic activity. For minerals, economic rent can be defined as the surplus above the return required to motivate production; thus the rent of a mineral deposit is the difference between unit extraction costs (including a normal profit and a risk premium related to the risky nature of mining investments) and the final selling price of the product. In Canada's North, mineral resources are publicly owned but privately extracted. In return for the right to extract the resource, companies pay to the federal government the economic rent of the resource. Because of the wide variation in extraction costs from deposit to deposit and in the final selling price of minerals over time, the economic rent available for collection will also vary widely.

The Economic Importance of
Mining in the Canadian North

The importance of mining in the measured economies (i.e., excluding non-market and subsistence activities) of Yukon and the N.W.T. is summarized in the following table.

Table 1

The Importance of Mining in the North
Annual Averages 1991-1996 (dollars expressed in millions)

Note: GDP and employment figures are arrived at using Statistics Canada input-output multipliers. Exploration figures are drawn from Natural Resources Canada data. Average annual salary and tax percentage are based on Yukon Government's rule of thumb.

Fees, Mining Royalties, and
Administrative Costs in the North

The average annual totals for fees and royalties collected from the mining industry in the North are shown in table 2. The current budgets for the federal and the two territorial governments' costs to administer and promote the mineral sector in the North are also shown.

Table 2

Fees, Royalties, and Administration Costs
Annual Averages 1992-1997 (millions of dollars)

Note: Federal costs are likely understated, as true costs-spread between sections of DIAND and other federal agencies-are difficult to ascertain.

It is clear that the fees and royalties contributed by the mineral industry in the North do not cover the costs of administering, subsidizing, and promoting the industry. Of course, governments also reap direct and indirect tax benefits, including corporate income tax, income tax from those employed in the industry, and taxes from firms and individuals working as suppliers to the industry. The territorial governments are net beneficiaries (see table 1); however, the federal government and the country as a whole do not benefit greatly. While it is impossible to predict the exact proportion, some (and perhaps most) of the capital and labour involved in northern mining would be employed producing similar benefits elsewhere in the country if they were not in the North.

Costs of Free Entry

Some of the costs associated specifically with free entry (exclusive of costs endemic to mining or mineral exploration generally) are direct and easily measured; other, indirect costs are more difficult to measure accurately and have been conservatively estimated for the purposes of this analysis. Environrnental costs, although real, have not been included because of difficulties in estimating them and in determining to what extent they are linked to free entry rather than to mineral exploration in general. All of the costs shown in table 3 could be wholly or partly eliminated by replacing or reforming the free-entry system.

Table 3

Annual Estimated Costs of Free Entry 

The process of staking claims in the field is both expensive and inefficient. The field-staking estimates in table 3 are based on the amount of land staked and the average cost of staking in each jurisdiction. Government subsidization of mineral prospecting is a direct cost of the free-entry system as it is currently practiced in the North.

The indirect costs of the free-entry system include government administrative and inspection costs and the costs to industry and government to resolve disputes over staking and mineral title. Extrapolating from Newfoundland's experience in switching from field to map staking, we can conservatively estimate savings in government field inspection costs in the order of $100,000 per year by eliminating two inspectors' positions.

Disputes over boundaries of staked claims, fractions, and whether or not procedures have been followed are commonplace in the North. Although most are settled outside the formal hearing structures of the mining recorders and the courts, there is a cost. Negotiations between companies, calls on government inspectors to adjudicate, delays, and ill will all impose costs estimated at $100,000 per year.

Environmental Costs 

The historical right conferred on miners by the free-entry system to enter onto lands and to do largely as they pleased on their claims appears to have imposed higher environmental costs than those strictly necessary to locate and delineate mineral deposits. Of course, the process of mineral exploration must inevitably lead to some environmental disturbance, and this cost must be accepted as part of the mining equation no matter what form of allocation system is used.

The free-entry system has encouraged poorly financed, speculative exploration efforts that have sometimes resulted in exploration camps and sites being abandoned, with their associated garbage and contaminants. In Yukon, DIANDhas approximately 133 abandoned mineral exploration sites on its files; it has cleaned up 79 of them to date. The average cost of clean-up is given at approximately $10,000 per site, making the total direct cost $1.33 million for Yukon alone. These are the direct costs only. If the costs of identifying the sites and those environmental costs caused by contaminants were to be included, the totals would be much higher.

The Benefits of Free Entry

Proponents of the free-entry system claim two general benefits. The first is that it gives the mineral industry the necessary level of confidence to operate in the North. The second is that it maintains diversity in the industry, encouraging the independent prospector and the small junior companies. Neither benefit is easily quantified.

Representatives of the mining industry often assert that industry confidence is a delicate flower in need of careful nurturing. Security of tenure is usually cited as the most important concern (behind promising geology) in choosing where to invest exploration dollars, and any suggestion of modifying the allocation system quickly raises concerns about tenure. Yet mining companies operate around the world under extremely unstable political conditions and, for senior companies especially, it appears that the free-entry system is not a particularly important requirement. It is, therefore, debatable that a somewhat altered mineral allocation system that continues to grant security of tenure would drive the industry out of the North.

Given that free entry allows and encourages the participation of independent prospectors and small junior exploration companies, the question becomes whether or not this is an economically desirable state of affairs. It has already been argued that small, poorly financed exploration companies can impose unnecessary environmental costs. It has also been suggested that free entry allows every prospector to explore and stake as soon as he or she perceives the value of the claim to equal the outlay. The process is often repeated several times, sometimes over decades, before a deposit is developed. This dissipates the economic rent of the resource, as all of the expenditures plus the interest on them must (in theory at least) be paid out of the producing deposit.

Historically, the prospector and the smaller juniors have played a strong role in the exploration industry, discovering many deposits and generally adding value before deposits went into production. Is this still the case? And will it continue to be the case? It is generally accepted in the industry that the most efficient exploration teams tend to be those in the mid-range between the too small and underfunded and the too large and rigid. This, coupled with the declining discovery rate of mineral occurrences and the increasing cost of exploration, points to a shrinking role for the smallest operators regardless of the mineral allocation system used.

Potential Reforms of the Free-entry System

There are two areas in the current free-entry system where reform can increase economic efficiency and the available mineral rents without fundamentally altering the nature of the system: replacing field staking with paper (map) staking and altering the assessment work process.

Moving from field to paper staking is an easy and obvious means of improving the efficiency of the mineral allocation process. The industry would save millions of dollars in staking costs over the years and that money would be available for more productive uses. Costs related to conflicts over claim boundaries and disputes over staking procedure would also be eliminated. Governments would reduce their costs because staking inspections would no longer be needed. Costs identified in table 3 for field staking, administration, and dispute settlement suggest paper staking in the early 1 990s would have reduced rent dissipation by approximately $8.8 million annually.

Of course, a change to paper staking would not result in universal joy. Staking dollars currently end up in the pockets of local staking contractors and their employees, local helicopter pilots, and various other suppliers. Field staking can be viewed as a tradeoff that governments make between future resource rents and current regional economic stimulation.

Those wishing to hold a claim must do a certain amount of exploration-related work on their claims or pay the equivalent sum. This discourages holding large tracts of land for speculative purposes, encourages the development of mineral deposits into producing mines, and, as a side benefit, creates some employment and economic activity. All of these goals could be better served by expanding the list of eligible "explorationrelated" work to include environmental baseline studies, impact assessments, and perhaps marketing studies, and by raising the required value of that work, which has remained unchanged since the early 1 920s.

Conclusions

The free-entry system as it is currently practiced in the Canadian North is far from ideal from the perspective of long-term sustainability. It is rife with economic inefficiencies, and it hinders the collection of mineral rents. If the commitment by governments to the principles of sustainability is serious, these inefficiencies should be corrected, and far more of the mineral rents must be collected. Even simply moving from field to paper staking would result in a considerable gain in efficiency. And if free entry is to be replaced, the system of mineral allocation used in Greenland offers a possible alternative to the current system in Canada's North.

The Greenland system has a three-stage process for acquiring mineral title: the prospecting licence, the exploration licence, and the exploitation licence. Neither the prospecting nor the exploration licence automatically grants rights to any minerals found, although holders of the exploration licence are entitled to an exploitation licence if they meet all the requirements. Corporations are required to supply information on their technical and financial capabilities (including annual reports) on the licence application, and the government reserves the right to refuse any applicant at either of the first two stages. An exploration licence grants the exclusive right to explore for minerals in the area selected by the applicant for as long as ten years. Exploration licences have work obligations (assessment work), which, at the onset of the ten-year term, are about ten times that required in Canada's North. The scale of work obligations then increases sharply towards the end of the licence period to encourage companies to accelerate their exploration on smaller areas relatively rapidly and free up areas in which new companies may be able to apply fresh geological theories. Work obligations may be met in part with environmental or feasibility studies. All work obligations and licence fees are indexed to allow for inflation. An exploitation licence must be issued before mineral production can commence, and the applicant is required to have an ore body delineated, a "bankable" feasibility study, an environmental assessment report, and a closure plan before the licence will be granted.

Mineral exploration is driven by expected value. In the short term, exploration expenditures vary wildly in response to new discoveries, metal prices, investor confidence, changes to the tax structure, and other factors. The North has seen great surges-and deep slumps-in mineral exploration over the decades. Furthermore, while the discovery rate of new mineral occurrences (any confirmed incidence of a mineral regardless of size or grade) has been in steep decline since the mid- 1 970s, the delineation rate of significant deposits (a deposit with a defined tonnage and grade) in the North has remained remarkably constant at approximately three per year over the past fifty years. The constant delineation rate, together with a high expected value of base metal exploration, suggests mineral exploration in the North will continue at a high level regardless of the precise means of mineral allocation used. 

Malcolm Taggart is completing his Masters degree in Environmental Studies at the University of Victoria.

Notes

1. The full version of this paper is available from CARC's Yellowknife office: "The Free Entry Mineral Allocation System in Canada's North: Economics and Alternatives." ISBN: 0-919996-81-7.

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