Rio Tinto plc – Annual report – 31 December 2020
1 Principal accounting policies (extract)
(l) Close-down, restoration and environmental obligations (note 25)
The Group has provisions for close-down and restoration costs which include the dismantling and demolition of infrastructure, the removal of residual materials and the remediation of disturbed areas for mines and certain refineries and smelters. These provisions are based on all regulatory requirements and any other commitments made to stakeholders.
Closure provisions are not made for those operations that have no known restrictions on their lives as the closure dates cannot be reliably estimated. This applies primarily to certain Canadian smelters which have indefinite-lived water rights from local governments permitting electricity generation from hydro-power stations.
Close-down and restoration costs are a normal consequence of mining or production, and the majority of close-down and restoration expenditure is incurred in the years following closure of the mine, refinery or smelter. Although the ultimate cost to be incurred is uncertain, the Group’s businesses estimate their costs using current restoration standards and techniques.
Close-down and restoration costs are provided for in the accounting period when the obligation arising from the related disturbance occurs, based on the net present value of the estimated future costs of restoration to be incurred during the life of the operation and post closure. Where appropriate, the provision is estimated using probability weighting of the different remediation and closure scenarios. The obligation may occur during development or during the production phase of a facility.
Provisions for close-down and restoration costs do not include any additional obligations which are expected to arise from future disturbance.
The costs are estimated on the basis of a closure plan, and are reviewed at each reporting period during the life of the operation to reflect known developments. The estimates are also subject to formal review, with appropriate external support, at regular intervals.
The initial close-down and restoration provision is capitalised within “Property, plant and equipment”. Subsequent movements in the closedown and restoration provisions for ongoing operations, including those resulting from new disturbance related to expansions or other activities qualifying for capitalisation, updated cost estimates, changes to the estimated lives of operations, changes to the timing of closure activities and revisions to discount rates are also capitalised within “Property, plant and equipment”. These costs are then depreciated over the lives of the assets to which they relate.
Changes in closure provisions relating to closed operations are charged/credited to “Net operating costs” in the income statement.
Where rehabilitation is conducted systematically over the life of the operation, rather than at the time of closure, provision is made for the estimated outstanding continuous rehabilitation work at each balance sheet date and the cost is charged to the income statement.
In the context of current market volatility and uncertainty, the Group has taken a long-term view of interest rates into account in determining the appropriate discount rate for discounting of future costs for close-down, restoration and environmental obligations. The amortisation or “unwinding” of the discount applied in establishing the provisions is charged to the income statement in each accounting period. The amortisation of the discount is shown within “Finance items” in the income statement.
In some cases, Group companies make a contribution to trust funds in order to meet or reimburse future environmental and decommissioning costs. Amounts due for reimbursement from trust funds are not offset against the corresponding closure provision unless payments into the fund have the effect of passing the closure obligation to the trust.
Environmental costs result from environmental damage that was not a necessary consequence of operations, and may include remediation, compensation and penalties. Provision is made for the estimated present value of such costs at the balance sheet date. These costs are charged to “Net operating costs”, except for the unwinding of the discount which is shown within “Finance items”.
Remediation procedures may commence soon after the time the disturbance, remediation process and estimated remediation costs become known, but can continue for many years depending on the nature of the disturbance and the remediation techniques used.
Critical accounting policies and estimates (extract)
(iii) Close-down, restoration and environmental obligations (note 25)
Provision is made for close-down, restoration and environmental costs when the obligation occurs, based on the net present value of estimated future costs required to satisfy the obligation. Management uses its judgment and experience to determine the potential scope of closure rehabilitation work required to meet the Group’s legal, statutory and constructive obligations, and any other commitments made to stakeholders, and the options and techniques available to meet those obligations and estimate the associated costs and the likely timing of those costs. Significant judgment is also required to determine both the costs associated with that work and the other assumptions used to calculate the provision. External experts support the cost estimation process where appropriate but there remains significant estimation uncertainty.
The key judgment in applying this accounting policy is determining when an estimate is sufficiently reliable to make or adjust a closure provision.
Closure provisions are not made for those operations that have no known restrictions on their lives as the closure dates cannot be reliably estimated. This applies primarily to certain Canadian smelters which have indefinite-lived water rights or power agreements for renewably sourced power with local governments.
Cost estimates are updated throughout the life of the operation; generally cost estimates must comply with the Group’s Capital Project Framework once the operation is ten years from expected closure. This means, for example, that where an Order of Magnitude (OoM) study is required for closure it must be of the same standard as an OoM study for a new mine, smelter or refinery. As at 31 December 2020, there are 10 operations with remaining lives of under ten years before taking into account unapproved extensions. The largest recent closure study is at Rio Tinto Kennecott, which was completed during 2020; information available from this study at 31 December 2020 resulted in an increase to closure and environmental liabilities of US$74 million (2019: US$444 million).
Adjustments are made to provisions when the range of possible outcomes becomes sufficiently narrow to permit reliable estimation. Depending on the materiality of the change, adjustments may require review and endorsement by the Group’s Closure Steering Committee before the provision is updated.
In some cases, the closure study may indicate that monitoring and, potentially, remediation will be required indefinitely – for example ground water treatment. In these cases the underlying cash flows for the provision may be restricted to a period for which the costs can be reliably estimated, which on average is around 30 years. Where an alternative commercial arrangement to meet our obligations can be predicted with confidence, this period may be shorter.
The most significant assumptions and estimates used in calculating the provision are:
- Closure timeframes. The weighted average remaining lives of operations is shown in note 25. Some expenditure may be incurred before closure whilst the operation as a whole is in production.
- The length of any post-closure monitoring period. This will depend on the specific site requirements and the availability of alternative commercial arrangements; some expenditure can continue into perpetuity. The Rio Tinto Kennecott closure and environmental remediation provision includes an allowance for ongoing monitoring and remediation costs, including ground water treatment, of approximately US$0.6 billion.
- The probability weighting of possible closure scenarios. The most significant impact of probability weighting is at the Pilbara operations (Iron Ore) relating to infrastructure and incorporates the expectation that some infrastructure will be retained by the relevant State authorities post closure. The assignment of probabilities to this scenario reduces the closure provision by US$1.2 billion.
- Appropriate sources on which to base the calculation of the discount rate. On 30 September 2020, management reviewed the rate used for discounting provisions and reduced the discount rate by 0.5%. The discount rate by nature is subjective and therefore sensitivities are shown in note 25 for how the provision balance, which at 31 December 2020 was US$13.3 billion, would change if discounted at alternative discount rates were applied.
There is significant estimation uncertainty in the calculation of the provision and cost estimates can vary in response to many factors including:
- Changes to the relevant legal or local/national government requirements and any other commitments made to stakeholders;
- Review of remediation and relinquishment options;
- Additional remediation requirements identified during the rehabilitation;
- The emergence of new restoration techniques;
- Precipitation rates and climate change;
- Change in the expected closure date;
- Change in the discount rate; and
- The effects of inflation.
Experience gained at other mine or production sites may also change expected methods or costs of closure, although elements of the restoration and rehabilitation of each site are relatively unique to a site. Generally, there is relatively limited restoration and rehabilitation activity and historical precedent elsewhere in the Group, or in the industry as a whole, against which to benchmark cost estimates.
The expected timing of expenditure can also change for other reasons, for example because of changes to expectations around ore reserves and mineral resources, production rates, renewal of operating licences or economic conditions.
As noted in note (l) above, changes in closure and restoration provisions for ongoing operations are usually capitalised and therefore will impact assets and liabilities but have no impact on profit or loss at the time the change is made. However, these changes will impact depreciation and the unwind of discount in future years. Changes in closure estimates at the Group’s ongoing operations could result in a material adjustment to assets and liabilities in the next 12 months.
Changes to closure cost estimates for closed operations, and changes to environmental cost estimates at any operation, would impact profit or loss; however, the Group does not consider that there is significant risk of a change in estimates for these liabilities causing a material adjustment to profit or loss in the next 12 months. Any new environmental incidents may require a material provision but cannot be predicted.
Project specific risks are embedded within the cash flows which are based on a central case estimate of closure activities assuming that the obligation is fulfilled by the Group. These cash flows are then discounted using a discount rate specific to the class of obligations. The selection of appropriate sources on which to base the calculation of the discount rate requires judgment. The 1.5% real rate currently used by the Group is based on a number of inputs including observable historical yields on 30 year US Treasury Inflation Protected Securities (TIPS), and consideration of findings by independent valuation experts.
25 Provisions (including post-retirement benefits)
(a) The main assumptions used to determine the provision for pensions and post-retirement healthcare, and other information, including the expected level of future funding payments in respect of those arrangements, are given in note 42.
(b) The provision for other employee entitlements includes a provision for long service leave of US$283 million (2019: US$248 million), based on the relevant entitlements in certain Group operations and includes US$62 million (2019: US$30 million) of provision for redundancy and severance payments.
(c) The Group’s policy on close-down and restoration costs is described in note 1(l) and in paragraph (iii) under “Critical accounting policies and estimates” on page 219. Close-down and restoration costs are a normal consequence of mining, and the majority of close-down and restoration expenditure is incurred in the years following closure of the mine, refinery or smelter. Non-current provisions for close-down and restoration/environmental expenditure include amounts relating to environmental clean-up of US$468 million (2019: US$382 million) expected to take place between one and five years from the balance sheet date, and US$937 million (2019: US$883 million) expected to take place later than five years after the balance sheet date. Close-down and restoration/environmental liabilities at 31 December 2020 have not been adjusted for closure related receivables amounting to US$574 million (31 December 2019: US$166 million) due from the ERA trust fund, the co-owners of the Diavik Joint Venture and other financial assets held for the purposes of meeting closure obligations.
(d) Impact of the transition to new accounting pronouncement IFRS 16 “Leases” on 1 January 2019
Analysis of close-down and restoration/environmental clean up provisions
Remaining lives of operations and infrastructure range from one to over 50 years with an average for all sites, weighted by present closure obligation, of around 17 years (2019: 18 years). Although the ultimate cost to be incurred is uncertain, the Group’s businesses estimate their respective costs based on current restoration standards, techniques and expected climate conditions.
Provisions of US$13,335 million (2019: US$11,090 million) for close-down and restoration costs and environmental clean-up obligations are based on risk-adjusted cash flows. The Group completed a review of the discount rate used to present value the obligations on 30 September 2020 and updated it to a real-rate of 1.5%, applied prospectively from that date. Prior to 30 September 2020 and in recent years, the close-down and restoration costs and environmental clean-up obligations were discounted at a real-rate of 2.0%. To illustrate the sensitivity of the provision to discounting, if the discount rate at 31 December 2020 was decreased to 1.0% then the provision would be US$1.3 billion higher, of which approximately US$1.2 billion would be capitalised within “Property, plant and equipment” at operating sites and US$0.1 billion would be charged to the income statement for non-operating and
fully impaired sites. If the discount rate was increased to 3.0% then the provision would be US$2.6 billion lower, of which approximately US$2.4 billion would result in a decrease within “Property, plant and equipment” at operating sites and US$0.2 billion would be credited to the income statement for non-operating and fully impaired sites.
The underlying costs for closure have been estimated with varying degrees of accuracy based on a function of the age of the underlying asset and proximity to closure. For assets within ten years of closure, closure plans and cost estimates are supported by detailed studies which are refined as the closure date approaches. These closure studies consider climate change and plan for resilience to expected climate conditions with a particular focus on precipitation rates. For new developments, consideration of climate change and ultimate closure conditions are an important part of the approval process. For longer-lived assets, closure provisions are typically based on conceptual level studies that are refreshed at least every five years; these are evolving to incorporate greater consideration of forecast climate conditions at closure.
(a) A key component of earthworks rehabilitation involves re-landscaping the area disturbed by mining activities utilising the largely diesel powered heavy mobile equipment. In developing low-carbon solutions for our mobile fleet, this may include electrification of the vehicles during the mine life. The forecast cash flows for the heavy mobile equipment in the closure cost estimate are based on existing fuel sources; these could reduce if this power is sourced from renewable energy.
(b) Long-term water management relates to the post-closure treatment of water due to acid rock drainage and other environmental commitments and is an area of research and development focus for our Closure team. The cost of this water processing can continue for many years after the bulk earthworks and demolition activities have completed and are therefore exposed to long-term climate change. This could materially affect rates of precipitation and therefore change the volume of water requiring processing. It is not currently possible to forecast accurately the impact this could have on the closure provision as some of our locations could experience drier conditions whereas others could experience greater rainfall. A further consideration relates to the alternative commercial use for the processed water which could support ultimate transfer of these costs to a third party.
(c) Indirect costs, owners’ costs and contingency include adjustments to the underlying cash flows to align the closure provision with a central-case estimate. This excludes allowances for quantitative estimation uncertainties which are allocated to the underlying cost driver and presented within the respective cost categories above.
The geographic composition of the closure provision shows that our closure obligations are largely in countries with established levels of regulation in respect of mine and site closure.