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TECHNICAL MEMORANDUM

Incorporating Market Volatility Into Financial Assurance Trust Fund

Initial Balance Estimates to Adequately Protect Taxpayers From the

Long-Term Operations & Maintenance Costs of

PolyMet's NorthMet Project SDEIS Wastewater Treatment Systems

Prepared By: Matthew Tyler

Professional Consulting Forester

PO BOX 511 Finland, MN, 55603.

March 12, 2014

1.0 Introduction

My name is Matthew Tyler. I am a professional Consulting Forester and a resident of Finland,

Minnesota in Lake County. I am also homeowner and taxpayer in the State of Minnesota.

Permitting decisions made in the State of Minnesota will impact the State's future financial

liabilities and the health of the state budget, and consequently effect tax rates and the quantity

and quality of services available to myself and the rest of the public.

1.1 Qualifications

I have significant training and professional experience in mathematics, statistical modeling, and

natural resources economics. I earned my bachelor's degree in Ecological Forestry with a minor

in Conservation Biology from Prescott College in 2010. My undergraduate work included

advanced courses in statistics, forest and population modeling, and natural resource

economics, and as part of my studies I presented a poster at the Ecological Society of America

scientific meeting in 2008.

I have 8 years of field forestry, consulting forestry, and forest management experience. My

duties as a consultant to private landowners include appraising timber values and conducting

financial analysis of timber management decisions.

Additionally, I have been a contract Firewise Coordinator for Lake County since June of 2011. In

that capacity, I have assisted in estimating, budgeting, and managing more than $600,000

worth of hazardous fuel reduction project grants. I was also the primary author of a major

revision to Lake County's Community Wildfire Protection Plan (CWPP). The CWPP revision

included statistical and spatial analysis of historical wildfire events and fire weather conditions

in the county, as well as creating a county-wide map of hazardous fuel conditions using the US

Forest Service's Wild Fire Decision Support System (WFDSS) and associated software tools.

Most recently, I conducted a detailed economic cost-benefit analysis on behalf of Lake County

in support of a $3,000,000 metal-roof retrofit program grant proposal to the Federal Emergency

Management Agency (FEMA).

2

2.0 Need for a Long-Term Treatment Fund

In the NorthMet Project SDEIS, PolyMet Mining Inc. proposes to meet water quality standards

post-closure by actively capturing and treating groundwater seepage from waste rock piles and

tailings basins. Water quality modeling in the SDEIS suggests that active, mechanical collection

and treatment systems are likely be needed for at least 500 years at the plant site and 200

years at mine site, although the SDEIS claims that it is uncertain how long mechanical treatment

will be required. In any rate, "it is expected to be long term." (SDEIS December 2013, p. ES-11,

ES-24, 5-7).

This raises the question of how to pay for long-term active, mechanical treatment. Commodity

metal prices are volatile, and mining companies often go bankrupt. To protect taxpayers from

bearing the cost of long term treatment, a portion of the financial assurance required by the

State of Minnesota should be set aside to create a non-refundable trust fund dedicated solely

to paying for the operations and maintenance of long term treatment. Such a trust fund is

referred to in the remainder of this document as the Long-Term Treatment Fund (LTTF), or

simply the Fund, to differentiate it from other aspects of financial assurance used to fund mine

site and plant closure or contingencies for catastrophic natural disasters or engineering failures,

or other accidents. Although we do not examine these other aspect of financial assurance here,

it is our belief that those aspects are also vitally important to properly protecting the taxpayer,

and must also be examined in depth.

The value of trust in any given year are subject to considerable variation in rates of return due

to market volatility. Similarly, the annual costs of operations and maintenance in any given year

are subject to considerable variation in annual cost inflation. In some industries, annual

inflation is considerably more volatile than the consumer price index.

While many studies have shown that investment funds can be modeled by their average rate of

return over the long-term, this modeling assumption only holds when the portfolio is subject to

a buy and hold strategy. When the portfolio must make regular pay-outs, investment strategy

usually becomes more conservative, because the fund is much more sensitive to short-term

market fluctuations.

It is the purpose of this document to calculate the initial size of the Long-Term Treatment Fund

that will be large enough to withstand market and cost variation over 500 of years. However,

we also acknowledge that this approach is based on underlying assumptions that may not be

tenable:

"Similarly, the assumption that financial assurance instruments can be developed

to ensure that funds will be available centuries from now is not logical. The State

of Minnesota has existed for 155 years. The United States of America has existed

for 237 years. The notion that a mining company and financial assurance

instruments will be available to work on a mine site 500 years from now is not

believable." (Tribal Cooperating Agencies Cumulative Effects Analysis, PolyMet

SDEIS Appendix C, pg. 152)

3

3.0 Basic Fund Model

The value of the Long-Term Treatment Fund at the end of any given year can be described as

the value of the fund from the year before plus investment returns during the year, minus

operations and maintenance (O&M) costs during the year. Furthermore, operations and

maintenance costs are equal to the O&M costs from the prior year plus the O&M costs from

the prior times the rate of cost inflation over the year.

Mathematically, this can be represented as:

F

(t)

= F

(t-l)

+ [F

(t-l)

* R

(t)

] - [C

(t-l)

+ I

(t)

*C

(t-l)

] = F

(t-l)

* (1 + R

(t)

) - C

(t-l)

* (1+ I

(t)

) (EQ 1)

Where F

(t)

is the value of the fund at the end of year t

F

(t-l)

is the value of the fund at the end of year t - 1

C

(t)

is the annual cost of PolyMet's post-closure O&M at the end of year t

C

(t-1)

is the annual cost of PolyMet's post-closure O&M at the end of year t-1

R

(t)

is the rate of return of the fund during year t expressed as a percentage (e.g. 7%)

I

(t)

is the rate of cost inflation during year t expressed as a percentage (e.g. 2%)

For example, if the initial balance of the fund (F

0

) is $100 million, the initial O&M cost (C

0

) is $5

million, cost inflation (I

1

) over the year is 2%, and fund return (R

1

) over the year is 7%, then the

value of the Fund (in millions) at the end of the first year is:

F

1

= F

(0)

* (1 + R

(1)

) - C

(0)

* (1+ I

(1)

) = $100 * (1 + 0.07) - $5 * (1 + 0.02) = $101.9

And the balance of the fund at the end of year 2, assuming stable returns and inflation rates

would be:

F

2

= F

(l)

* (1 + R

(2)

) - C

(1)

* (1+ I

(2)

) = $101.9 * (1 + 0.07) - $5.1 * (1 + 0.02) = $103.83

Note that this is a simulation representation of the Fund balance at year t. For constant

inflation and return rates, a closed-form equation for the fund balance at year t is available by

solving a corresponding differential equation. However, for real world rates of inflation and

investment return that vary randomly over time, a closed form equation is not available using

conventional calculus, but instead requires solving a difficult stochastic differential equation.

Due to this difficulty, I opted to use a simulation approach.

3.1 Fund Simulation with Variable Rates of Inflation and Return

The Variable Inflation and Return Rate Fund model was designed to simulate 500 years of waste

water capture and treatment, as that is the maximum length of time simulated in the SDEIS.

The objective of the model was to estimate the probability of the fund being solvent after 500

years for varying combinations of initial fund balances and annual O&M costs. Solvency was

defined as the fund balance being greater than that year's annual O&M cost.

4

For a given combination of initial fund balance and annual O&M cost, the fund solvency

probability was calculated by running the model 50,000 times. Each model run consisted of

starting with the initial fund balance and annual O&M cost, and then iterating Equation 1 500

times, each time with a different randomly chosen rate of return and inflation rate. The rates

were randomly chosen using normal probability distributions derived from the empirical data in

sections 4 and 5. fund balance was recorded at the end of that run, and then the simulation

was run again. The solvency probability was then calculated by dividing the number of solvent

runs by 100,000 - the total number of runs.

The simulation was conducted using the R project for statistical computing (R Core Team 2013)

using the source code in Appendix C.

4.0 Empirical Estimates of Trust Fund Rates of Return

It was assumed that the Long-Term Treatment Fund

would be managed by the Minnesota State Board of

Investment (MSBI). The MSBI handles many different

pension and trust funds for the State of Minnesota. Of

these funds, the two most similar in purpose to the

Long-Term Treatment Fund are the Permanent School

Fund and the Environmental Trust Fund. Both of these

funds are managed with the intent of making yearly

payments (MSBI 2013). However, of the two, the

Permanent School Trust Fund is more conservative and

aimed at long-term growth. The law requires that the

Permanent School Trust Fund’s principal remain

inviolate, and the fund is managed somewhat more

conservatively, with about 50% of the assets allocated

to bonds. (MSBI 2013). In this regard, the Permanent

School Fund is probably the best analogue for the Long-

Term Treatment Fund, which needs to remain solvent

for a very long time while making yearly payments.

Annual rates of return for the Permanent School

Fund between 1987 and 2013 were compiled using

public reports by the State of Minnesota that were

available online. The MSBI has published annual

reports online on the performance of all its funds

between 1998-2013 (MSBI 2013). Permanent

School Fund returns between 1987-1997 were

estimated from a graph in Nobles and Brooks

(1998).

Table 1: Minnesota Permanent School

Fund Returns 1987-2013

Year Return Year Return

1987 6.9% 2001 -2.6%

1988 7.2% 2002 -6.2%

1989 16.1% 2003 6.3%

1990 6.3% 2004 10.2%

1991 10.3% 2005 6.5%

1992 15.1% 2006 4.8%

1993 6.1% 2007 13.4%

1994 -3.1% 2008 -3.6%

1995 14% 2009 -9.3%

1996 5.5% 2010 12.3%

1997 8.2% 2011 17%

1998 17.8% 2012 6.4%

1999 14% 2013 10.8%

2000 6.1%

Mean 7.278%

Standard Deviation 7.136%

5

These rates of return can be seen in Table 1 and Figure 1, along with their mean and standard

deviation. Although the long-term arithmetic annual rate of return is 7.3%, it is also clear that

returns were quite volatile from year to year.

5.0 Empirical Estimates of Cost Inflation Rates

The most common way to model inflation for financial

analysis is derive annual inflation from the Consumer

Price Index (CPI), published by the US Bureau of Labor

Statistics. However, specific industries sometimes have

cost inflation patterns that differ from the CPI. It is

therefore more appropriate to model industry-specific

inflation using an industry-specific Producer Price Index

(PPI) series published by the US Bureau of Labor

Statistics. The PPI "measures the average change over

time in the selling prices received by domestic

producers for their output" but also includes some

services. (US BLS, 2014).

A search of the available PPI series did not reveal any

series specific to water treatment services. However, a

PPI series for "Support activities for metal mining"

(Series ID PCU213114213114) from 1985-2013 was

found. Annual percent inflation was calculated by

dividing the Annual index value by the preceding year's

annual index value. The resulting inflation rates can be

seen in Table 2 and Figure 2, along with their mean and

standard deviation.

The arithmetic average annual rate of mining

service cost inflation was 1.75%. Interestingly,

this sequence was more than twice as volatile

relative to the mean than the investment returns

in Table 1, with a standard deviation of 3.929.

The sequence is characterized by periods of

inflation near zero punctuated by periods of

rapid inflation and deflation.

6.0 Fitting Probability Distributions to Return and Inflation Rates

In financial modeling, the stock return distributions are commonly modeled using a normal (e.g.

Gaussian or bell curve) distribution. This practice dates back to at least the early 1900s, but was

widely adopted in financial analysis after the publication of seminal works by Black-Scholes

(1973) and Merton (1973). The use of the normal distribution to represent financial returns in

Table 2: Support Activities for Metal

Mining Producer Price Index Inflation

1986-2013

Year Inflation Year Inflation

1986 0.10% 2000 -9.32%

1987 0.50% 2001 7.89%

1988 1.89% 2002 -1.45%

1989 4.59% 2003 0.17%

1990 1.31% 2004 0.78%

1991 0.09% 2005 11.03%

1992 0.09% 2006 4.31%

1993 2.21% 2007 2.14%

1994 0.09% 2008 6.86%

1995 0.09% 2009 1.89%

1996 0.99% 2010 0%

1997 3.82% 2011 4.38%

1998 4.62% 2012 6.48%

1999 -1.64% 2013 -4.84%

Mean 1.753%

Standard Deviation 3.929%

6

financial analysis has since been institutionalized in derivative pricing, risk management, and

other financial fields.

A kernel density plot (e.g. smoothed

histogram) of the investment return

data was graphed and then overlaid

with a plot of the fitted normal

distribution (Figure 3). A similar plot

was made for mining service inflation

rates (Figure 4). The fits are relatively

good given the small sample size.

However, it is worth noting that the

tails (i.e. high and low extremes) of

the normal distribution are

considerably smaller than the

observed data, except for the right

tail in Figure 3. This means that an

extremely low or high rate will occur

less frequently in the simulation than

in the real world.

This is not unexpected. There is

considerable literature critiquing the

over-reliance of financial models on

normal distributions dating back to

the 1960s (Mandelbrot 1962, 1963,

1967). In the wake of the 2008

financial collapse, this literature has

regained popularity, and alternate

techniques have been rapidly

evolving (e.g. Frain 2009, Haas &

Pigorsch. 2009).

In light of these developments, we attempted to fit the data to an alternate distribution (the

alpha-stable distribution) recommended by Mandelbrot (1967) and Frain (2009). Unfortunately,

the sample sizes of the return and inflation data were too small to obtain a satisfactory fit. The

normal distribution was therefore used for modeling purposes in this document.

Consequently, this model likely tended to under-estimate the effects of volatility on the

solvency of the fund. Put another way, the real world financial markets are considerably more

risky than a well behaved computer model. Therefore, the results from this model should be

viewed as a bare minimum estimate of the required initial balance of the long-term treatment

fund. Actual requirements will likely need to be higher.

7

7.0 Long-Term Treatment Annual Operations & Maintenance Costs

Although the NorthMet SDEIS gives estimates of $3.5-$6 million annually for post-closure

operations and maintenance (O&M) (SDEIS, pg. 3-138), the source of these estimates is not

documented. The purpose of this section is to use NorthMet project specifications,

independent cost estimates, and standard scaling methods to make an independent estimate of

annual NorthMet post-closure O&M costs.

7.1 NorthMet SDEIS Waste Water Treatment Plant Capacities

PolyMet proposes to meet water quality standards post-closure by treating collected waste

water at two reverse osmosis plants: one at the plant site, and one at the mine site. Although

the main SDEIS document does not include specifications for these plants, treatment capacities

can be found in the Water Modeling Data Packages.

Mine Site

"The total capacity of the long-term closure WWTF is assumed to be 600 gpm.

The actual flow sent to the WWTF is typically half of the capacity or 300 gpm."

(PolyMet 2013i pg 168).

Plant Site

"The treatment capacity of the WWTP used in the model is 2000 gpm during the

first eight years, and 3500 gpm after that." (PolyMet 2013j, pg. 112)

While reverse osmosis is not planned to be installed at the mine site until year 40, we assume it

has been installed for the purposes of calculating long-term treatment funding. Similarly, we

assume that the full capacity of the plant site reverse osmosis plant has been installed.

Although some have questioned the accuracy of the modeling used to size these plants, it is not

the purpose of this document to raise those questions. Rather, the purpose here is to estimate

annual operations and maintenance costs assuming the specifications given in the SDEIS.

Nonetheless, the results of the financial model presented here will certainly be sensitive to the

accurate sizing of the reverse osmosis plants. Future long-term treatment fund calculations

should be based on more detailed reverse osmosis plant specifications and cost estimates.

7.2 Published Reverse Osmosis Reference Cost Estimates

Two preliminary cost estimates for reverse osmosis facilities for other projects in the region

were identified to use as reference estimates. Coincidentally, both are also on the former LTV

Steel property.

The first reference cost estimate is for a 4000 gpm plant to treat water pumped from the Area 1

Pit and discharged to Second Creek. It was developed by Barr Engineering on behalf of Mesabi

Mining in pursuit of a NPDES permit for the Mesabi Nugget Phase II project (Barr 2011). This

estimate features three fairly similar alternatives based on an ultra-filtration to reverse osmosis

8

to evaporator to crystallization system. Although the cost-estimate worksheets feature a more

detailed breakdown, the worksheets have significant mathematical errors, are based on fairly

general cost estimates, and are largely conceptual in nature.

The second reference cost estimate is for a smaller 600 gpm plant to treat water in Cell 1E of

the LTV Tailings Basin that is believed to travel through the basin and discharge into Second

Creek (Barr 2013). This estimate was developed by Barr Engineering on behalf of Cliffs Erie and

PolyMet pursuant to a 2010 consent decree between the MPCA and Cliffs Erie. Although on the

same site, this estimate is not part of the NorthMet project. This estimate features greensand

pretreatment and reverse osmosis with three post treatment alternatives: (1) evaporation and

crystallization, (2) vibratory enhanced sheer processing (VSOP), or (3) intermediate concentrate

chemical precipitation (ICCP) and secondary reverse osmosis. This estimate was based on

extensive pilot and bench testing and detailed equipment costing from manufactures. As such,

it is probably the more accurate of the two reference cost estimates.

Table 3 summarizes the capitol and annual O&M costs of the three alternatives for both

reference reverse osmosis systems. Corrections were made to the annual O&M costs from Barr

(2011). In the original tables, O&M cost totals were added incorrectly, and somehow managed

not to include the estimates for ultra-filtration and reverse osmosis. The original cost estimate

tables from Barr (2011) and Barr (2013) are in Appendices A & B.

Table 3 includes breakdowns of the reference cost estimates to facilitate cost scaling. Annual

O&M costs were broken down into fixed and variable components (AWWA 2007). Fixed costs

are those that generally vary little from month to month or with monthly treatment volume,

such as membrane and filter changes, routine equipment maintenance, and staffing. Variable

costs are those expected to vary predictably with treatment volume, such as treatment

chemicals, sludge hauling and disposal, and electricity to power pumps.

Table 3: Published Reference Cost Estimates for Two Reverse Osmosis Treatment Systems

Each with Three Alternatives.

Reference Treatment Size Total O & M Fixed O&M

Variable

O&M

Estimate Option gpm Capital Cost Cost ($) % Cap Cost ($) % Cap Cost ($)

Barr 2013

Evap +

Crystallization 600 $19,729,392 $1,492,573 7.57% $1,435,636 7.28% $56,939

Barr 2013

VSEP +

Crystallization 600 $23,969,992 $1,579,447 6.59% $1,509,698 6.30% $69,750

Barr 2013

ICCP + SRO

+Crystallization 600 $14,817,750 $1,901,833 12.83% $1,346,820 9.09% $555,014

Mean $1,657,951

Barr 2011 Alternative #1 4000 $40,462,964 $5,383,000 13.30% $4,592,000 11.35% $791,000

Barr 2011 Alternative #2 4000 $39,802,164 $4,613,000 11.59% $3,920,000 9.85% $693,000

Barr 2011 Alternative #3 4000 $40,628,164 $5,215,000 12.84% $4,466,000 10.99% $749,000

Mean $5,070,333

9

No attempt was made to evaluate whether the reference reverse osmosis systems were

adequate to remove the pollutant concentrations predicted in the NorthMet SDEIS. The

inclusion of these reference systems in this document does not constitute an endorsement of

their adequacy for the NorthMet project. Rather, the reference systems were included to

establish third-party cost baselines for financial assurance modeling.

7.3 Adjusting Reference Cost Estimates to PolyMet SDEIS Plant Specifications

The design capacity of the Barr(2011) reference estimate is just slightly larger than the design

capacity of the NorthMet tailings basin (plant site) reverse osmosis facility, while the capacity of

the Barr (2013) reference estimate is exactly the same as the design capacity of the NorthMet

mine site reverse osmosis facility. Therefore, the simplest estimate of total annual NorthMet

post-closure O&M treatment costs is the mean O&M cost from Barr (2011) plus the mean O&M

cost from Barr (2013).

Alternatively, the annual O&M cost of the NorthMet Plant Site (tailings basin) reverse osmosis

facility can be estimated by adjusting the more current and accurate Barr (2013) reference

costs using a scaling factor based on relative capacity.

Given the capital cost and capacity of a known treatment plant, AWWA (2007) state that the

capital cost of a new plant can be estimated by:

C

b

= C

a

* (S

b

/ S

a

)

0.80

(EQ 2)

Where: C

b

= capital cost of new size plant

C

a

= capital cost of known size plant

S

b

= capacity of new plant, in gpm

S

a

= capacity of known plant in gpm

The exponent reflects economies of scale where per unit costs decrease as plant capacity

grows.

Total O&M costs for the new plant can then be estimated using:

T

o

= C

b

* R

f

+ (S

b

/ S

a

) * C

vo

(EQ 3)

Where T

o

= total O&M cost of new plant

R

f

= ratio of fixed O&M costs to capital costs for known plant

C

vo

= variable O&M costs of known plant.

and C

b

, S

b,

, S

a

are as above

This is formula assumes that fixed O&M costs increase at roughly the same rate as capital costs,

which is a common practice for estimating building maintenance costs (i.e. keeping

depreciation at bay). In contrast, the formula assumes that variable O&M costs increase at the

same rate as plant capacity. In other words, there is little economy of scale effect for

10

consumables; a 1000 gpm plant should use about twice as much treatment chemical and

electricity as a 500 gpm plant.

Using these formulas, we developed alternative capacity adjusted cost estimates for the 3,500

gpm NorthMet Plant Site (tailings basin) reverse osmosis facility based on the Barr (2013)

reference costs. The results can be seen in Table 4. Although the Table 4 estimates are

considerably higher than the reference costs in Barr (2011), they likely reflect Barr's

advancements in process research and cost escalation since 2011.

Table 4: Capacity Adjusted Cost Estimates Based on Barr (2013) for Three Alternative

Systems for the 3500 gpm NorthMet Tailings Basin (Plant Site) Reverse Osmosis Facility

Alternative Capital Cost

Fixed

O&M Cost

Variable

O&M Cost

Total

O&M Cost

Evap + Crystalization $80,881,116 $5,885,422.21 $332,142 $6,217,565

VSEP + Crystallization $98,265,558 $6,189,042.39 $406,876 $6,595,919

ICCP+SRO+Crystalization $60,745,722 $5,521,318.89 $3,237,583 $8,758,902

7.4 Lowest, Highest, and Mean Estimates for Post-Closure Total Annual O&M Costs

Combining all available estimates from Tables 3 and 4, the lowest, highest, and mean post-

closure annual O&M costs were calculated and are shown in Table 5. These estimates are

considerably higher than those found in the PolyMet SDEIS. Note that the lowest total annual

O&M cost in table 5 is higher than the highest cost estimate in the SDEIS.

Table 5: High, Mean, and Low Estimates for NorthMet Post-Closure Total Annual O&M Costs

Mine Site RO Facility Plant Site RO Facility

Reference

Cost Alternative Cost

Reference

Cost Alternative Cost

Total O&M

Cost

Low Barr 2013 Evap+Crystal $1,492,573 Barr2011 Altern. #2 $4,613,000 $6,105,573

Mean -- --

1

$1,657,951 -- --

2

$6,130,564 $7,788,515

High Barr 2013 ICCP+SRO $1,901,833 Table 4 ICCP+SRO $8,758,902 $10,660,735

1

Mean of three cost estimates from Barr (2013).

2

Mean of three cost estimates from Barr (2011) and three cost estimates in Table 4.

7.5 Third Party Adjustment of O&M Cost Estimates

According to Tribal Natural Resources Agencies and the EPA, financial assurances are typically

adjusted to reflect the cost of the government hiring a third party contractor should the mining

company go bankrupt. Generally, it costs about twice as much for the government to hire a

contractor for cleanup than it does for the mining company to conduct cleanup. (Margaret

Watkins, Grand Portage Natural Resources Dept., pers. Communication).

However, these cost estimates already contain considerable contingencies (30-40%) for cost

overruns. We therefore applied a more conservative third-party multiplier of 1.75 to the total

O&M cost estimates. The third-party adjusted values can be seen in Table 6.

11

8.0 Long Term Treatment Fund Simulation Results

Having obtained reasonable high and low estimates for post-closure NorthMet O&M annual

costs and statistical distributions for trust fund returns and mining service inflation, we

conducted the simulations outlined in Section 3. The input parameters and simulation results

are displayed in Table 6. Figures 5 displays the probability of fund solvency after 500 years as a

function of initial fund balance for each estimate of annual O&M costs in Table 6.

Table 6: Evaluation of Minimum Initial Balance Requirements for Solvency of

NorthMet Long Term Treatment Fund After 500 Years Using Stochastic

Investment Returns & Inflation Rates for Various Annual Costs

O&M Cost Third-Party Simulation Minimum LTTF Set Aside

Type Estimate O&M Length p > 0.95* p > 0.99*

Low $6,105,573 $10,684,753 500 $333,000,000 $404,000,000

Mean $7,788,515 $13,629,901 500 $423,000,000 $513,000,000

High $10,660,735 $18,656,286 500 $579,000,000 $694,000,000

* Probability of fund solvency is greater than p-value, (e.g. 95% or 99%)

12

9.0 Conclusions

The annual long-term operating and maintenance post-closure cost estimates in the PolyMet

SDEIS are significantly lower than the lowest estimates calculated from published estimates for

similar reverse osmosis plants on the LTV property. This is a significant problem. Independent

estimates of long-term annual O&M post-closure costs range from $6.1 to $10.6 million.

Lacking specific, detailed treatment water treatment plant plans specific to the NorthMet

Project, there is still considerable uncertainty about annual long-term treatment costs.

Stochastic simulation of volatile investment returns and inflation rates show that the minimum

beginning balance for the Long Term Treatment Fund required to ensure water treatment for

500 years after closure is $333 million, and quite possibly $500 million or more.

The Long Term Treatment Fund set aside is above and beyond the estimated $50-$200 million

mine closure and reclamation cost estimates in the SDEIS (SDEIS, pg. 3-138). The SDEIS also fails

to include an estimate of a financial assurance funds for accidents, natural disasters, and other

unforeseen events.

Not including additional contingency funds, the total financial assurance package should be at

least $383-$700 million.

10.0 Recommendations

• The annual post-closure operations and maintenance costs presented in the SDEIS

should be rejected, as they are inconsistent with independent estimates of reverse

osmosis operating and maintenance costs.

• Because the accuracy of long-term treatment trust fund requirements depends

considerably on the accuracy of annual post-closure costs, the NorthMet FEIS must

include detailed specifications and cost estimates for the post-closure treatment

operations and maintenance.

• The NorthMet FEIS and permit applications should include financial assurance trust

funds requirements for long-term treatment based on probabilistic analysis of

investment return and inflation volatility similar to that presented here.

• Deterministic estimates of long-term treatment trust fund requirements are typically

40-60% lower than those presented here, and should not be used in the FEIS or permits

because the fund is much more likely to go bankrupt over time.

• Future probabilistic financial analyses should ideally use alpha-stable or other non-

normal distributions.

• Future probabilistic financial analyses should use longer investment return and inflation

rate time series to improve the fit of statistical distributions.

13

References

American Water Works Association (AWWA), 2007. Reverse Osmosis and Nanofiltration, 2nd

ed., Manual of Water Supply Practices M46.

Barr Engineering Co. 2011. Area 1 Pit Water Treatment Evaluation in Support of the

Nondegradation Analysis. Mesabi Nugget Phase II Project. Prepared for Steel Dynamics, Inc.,

Mesabi Mining, LLC. June 2011.

Barr Engineering Co. 2013. Reverse Osmosis Pilot Test Report. SD026 Active Treatment

Evaluation. Prepared for Cliffs Erie LLC, and PolyMet Mining Inc. June 2013.

Black, Fischer and Myron Scholes. 1973. The Pricing of Options and Corporate Liabilities. The

Journal of Political Economy. 81(3):637-654.

Frain, John C. 2009. Studies on the Application of the a-stable Distribution in Economics. Ph.D.

Thesis. University of Dublin: Ireland.

Haas, Markus, and Christian Pigorsch. 2009. Financial Economics, Fat-Tailed Distributions.

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Mandelbrot, B. B. 1963. The Variation of Certain Speculative Prices, Chapter 15, Cootner

(1964b), pp. 307–332. M.I.T. Press.

Mandelbrot, B. B. 1967. The variation of the prices of cotton, wheat, and railroad stocks, and of

some financial rates. The Journal of Business 40, 393–413.

Merton, Robert C. 1973. Theory of rational option pricing. The Bell Journal of Economics and

Management Science. 4(1):141-183.

Minnesota State Board of Investment (MSBI). 2013. Annual Report 2013. Minnesota State

Board of Investment. St. Paul, MN. http://www.sbi.state.mn.us

Nobles, James and Roger Brooks. 1998. School Trust Land: A Program Evaluation Report.

Minnesota Office of the Legislative Auditor. Report #98-05. St. Paul, MN.

PolyMet Mining (PolyMet). 2013i. NorthMet Project Water Modeling Data Package, Volume 1 -

Mine Site, Version 12. March 8, 2013.

PolyMet Mining (PolyMet). 2013j. NorthMet Project Water Modeling Data Package, Volume 2 -

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14

Appendix A: Reprints of Tables 23-25 from Barr (2013)

15

16

17

Appendix B: Reprints of Tables 3.1-3.3 from Barr (2011)

18

19

20

Appendix C: R Source Code for Probabilistic Long-Term Treatment

Trust Fund Model

library(MASS)

# Initiate Variables

reps <- 50000 # Number of Model Runs

lowfa <- 100 # Low Bound of Initial Trust Fund Balance

highfa <- 800 # High Bound of Initial Trust Fund Balance

startannualcost <- 18.656286 # Annual O&M Cost in 2013 dollars

# Initiate normal distribution parameters

# Inflation

infl.mu <- 1.753

infl.sd <- 3.929

# Returns

return.mu <- 7.278

return.sd <- 7.136

# Initiate model parameters

AssureVals <- seq(from=lowfa, to=highfa, by=1)

pvals <- rep(0,length(AssureVals))

# Main loop

for(fa in AssureVals ) {

AnnualCost <- rep(startannualcost,reps)

Fund <- rep(fa,reps)

for(yr in c(1:500)) {

# Begin loop code

Fund <- Fund - AnnualCost

ann.inflat <- (1 + 0.01 * rnorm(reps, mean = infl.mu, sd = infl.sd))

# Fail safe for out of bounds probability densities

ann.inflat[ ann.inflat <=0] <- 1

AnnualCost <- AnnualCost * ann.inflat

ann.return <- (1 + 0.01 * rnorm(reps, mean = return.mu, sd = return.sd))

ann.return [ ann.return <= 0] <- 1

Fund <- Fund * ann.return

}

pvals[ AssureVals == fa ] <- (sum(Fund > 0) / reps)

}

# Graph the Results

dev.new(width=6.5, height=6.5)

par(mgp=c(2, 0.75, 0))

plot(pvals ~ AssureVals, col="white",

xlab= "Financial Assurance Value (in $ Millions)",

ylab="Probability Fund > Cost at yr. 500" , ylim=c(0,1.1),

main="Figure 6: Probability of Long Term Treatment Fund\nSolvency at Year 500",

cex.main=1, cex.lab = 1, cex.axis = 1)

abline(h=c(0.95), lwd = 2, col="gray")

lines(pvals ~ AssureVals, lwd = 4, lty="dashed" )

title(sub = "Gray horizontal line is at 95% probability level", line = 3.5, cex.sub

=0.75)

# Find the minimum amount of money needed for a given probability of solvency

min(AssureVals[pvals>0.95])

min(AssureVals[pvals>0.99])

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