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Kathryn Hoffman and Scott Strand, MCEA Alan Thometz, CFA Financial Assurance for the PolyMet Project March 11, 2014

In the case of PolyMet, the criteria for achieving financial assurance and the instruments available are limited. We believe only one option, U.S. government Treasury securities held within a trust fund under the complete control of the MDNR, meets the objectives outlined in Minnesota’s Rules. Minnesota Rules (Chapter 6132) require that financial assurance provided to the MDNR must meet the following five criteria: 1. 2. 3. 4. 5. sufficient funds to meet PolyMet’s estimated closure and reclamation costs, available to DNR whenever needed, valid, binding, and enforceable under both federal and Minnesota state law, not dischargeable through bankruptcy, and approved by MDNR Commissioner.

Additionally, there are five types of financial instruments that individually or in combination are recommended for projects such as PolyMet: 1. 2. 3. 4. 5. trust funds surety bonds letters of credit certificate of deposits insurance policies

Financial assurance or security Financial assurance or security is illusive. Throughout human history a great deal of time, thought, and effort has been expended trying to assure financial security. Amounts and investments that seem sufficient and risk-free at one time are not necessarily sufficient or risk-free in the future. The longer the time horizon, the greater these risks become. The financial community defines a “risk-free” security as a one issued by the U.S. government. Actually U.S. government securities contain risk, as we have recently seen: e.g., will the Congress approve an increase in the debt limit ceiling? Similarly, how large can the total U.S. national debt become before we default as a nation? Governments default as we have recently seen with the financial crisis in Greece. Despite this, U.S. bonds carry less risk than any other security issued because the full faith and credit of the government stands behind these securities and, hence, the full taxing power of the U.S. No other security issued in the U.S. can make this same claim. No security issued by any bank or insurance company has the taxing authority of the U.S. government supporting its repayment. 1

The financial crisis of 2008 is another case in point: major banks would have failed without the emergency Troubled Asset Relief Program (TARP) funding. AIG, one of the world’s largest insurance companies, would also have failed without U.S. government emergency support. No credit rating agency is capable of performing a credit analysis of a bank or insurance company 200 years into the future. In fact, very few of the current major U.S. banks and insurance companies existed 200 years ago. Banks and insurance companies do not meet the definition of risk-free investments. If the intent of Minnesota Rules (Chapter 6132) is to provide sufficient funds with minimal investment risk to meet PolyMet’s estimated closure and reclamation costs up to 200 years into the future, only U.S. government bonds will meet the definition of a risk-free investment. No other issuer will protect Minnesota taxpayers from PolyMet’s environmental risk. Financial Instruments Of the five types of instruments suggested to meet the financial assurance requirement, four involve substituting the credit of one institution for another, specifically banks and insurance companies. Letters of credit and certificates of deposit are substituting PolyMet risk for bank risk. Surety bonds and insurance policies are substituting PolyMet risk for insurance company risk. Beyond the risk issue, banks and insurance companies are uneconomic alternatives. If a sum of money is placed today in a trust and invested in U.S. government bonds, it can grow into the future sum needed at mine closure in an estimated 20 years. PolyMet’s high end of the range estimates a $200 million closure cost and $6 million annual water treatment cost for 200 years. We have no way of knowing if these amounts will be sufficient but we do know that the higher the investment rate of return, the smaller the sum that PolyMet must provide today. Restated, a small present value grows into a larger future value given higher rates of return. These differences are profound over the time horizon being considered. Small changes in rates make big differences in present value or future value amounts. Banks and insurance companies expect to be compensated for the services they offer. Bank fees for letters of credit or insurance companies’ premiums for insurance policies would be a deduction to earnings. By financial market standards, the amount of money needed by PolyMet to meet its financial assurance requirements is high and the 200 year time frame is unprecedented. Banks and insurance companies cannot evaluate these risks, and would likely require cash collateral. This is equivalent to telling a borrower you will lend them money if they post cash in an equal amount. “I’ll lend you a dollar if you deposit a dollar and it will cost you a nickel.” This unnecessary cost of involving a thirdparty is economically inefficient. If PolyMet offers a sum to a bank or insurance company as collateral for the letter of credit or insurance policy, it is highly inefficient. Any investment income earned on the collateral will be reduced to pay a bank letter of credit fee or premium for the insurance policy. This reduces the net investment return, requiring PolyMet to post a larger amount at the inception of the project. Any third party that requires fees puts a larger funding requirement on PolyMet at the inception of the project.

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Banks and insurance companies do not meet the definition of risk-free and are inefficient from an economic perspective. The only remaining financial instrument option is a bankruptcy-proof trust dedicated to MDNR. It alone achieves four of the five criteria of the Minnesota Rules: 1. 2. 3. 4. available to DNR whenever needed, valid, binding, and enforceable under both federal and Minnesota state law, not dischargeable through bankruptcy, and approved by MDNR Commissioner.

The unsatisfied criteria is the amount sufficient to meet PolyMet’s estimated closure and reclamation costs. More independent technical analysis and confirmation of PolyMet’s assumptions must be done to determine this amount. Given PolyMet’s current estimate, satisfying financial assurance will require hundreds of millions of dollars. Several alternatives for meeting the requirements of financial assurance are outlined in Minnesota Rules. In this case, only U.S. government Treasury securities held within a bankruptcy-proof trust fund under the complete control of the MDNR meets the objectives outlined in Minnesota’s Rules and protects the Minnesota taxpayer. Only U.S. Treasury securities are risk-free and introducing unnecessary third-parties entails fees which makes the economics of the net investment rate of return inefficient and impractical.

Alan Thometz March 11, 2014

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