Download Valuation of Depletion of Natural Resource Assets: Treatment of 'Time Passing' in SEEA and more Study notes Accounting in PDF only on Docsity!
āTIME PASSINGā AND THE MEASUREMENT OF DEPLETION
Peter Comisari Centre of Environment and Energy Statistics Australian Bureau of Statistics
Note prepared for the London Group meeting on Environmental and Economic Accounting. Brussels, 29 September ā 3 October 2008
Executive summary
- This note is intended as a contribution to the continuing debate within London Group on the treatment of depletion of natural resource assets within the updated SEEA. It specifically addresses treatment of ātime passingā; an element of the Net Present Valuation (NPV) method of calculating depletion of natural resource assets.
- The discussion here is a response to the reconsideration and suggestions raised by London Group member Ole GravgƄrd Pedersen in a paper circulated in advance of the 2008 London Group meeting in Brussels: Accounting for the value of time passing and the depletion of natural resources, Reconsideration and some suggestions (GravgƄrd, 2008).
- Two key points are raised in Oleās paper. The first is that the ātime passingā element should not form part of the measure of depletion; instead, it should be treated as a holding gain and accounted for in the revaluation account. Secondly, that the ātime passingā element, while not a form of production, could nevertheless be treated as income by following a Hicksian interpretation.
- This note provides some reasoning why the ātime passingā element is not a holding gain. In particular, if the price of a natural resource (or its price relativities) does not rise then there can be no holding gain. āTime passingā has long been recognised as an element of SNA consumption of fixed capital and, given the conceptual similarity of depletion and consumption of fixed capital, I suggest that the ātime passingā element be treated consistently between the SNA and SEEA systems. It is therefore suggested that the ātime passingā element be off-set against resource rent in deriving and presenting depletion in SEEA.
- A direct consequence of treating the ātime passingā element as a holding gain is that depletion equates to the full value of the resource rent. This would effectively leave extractive enterprises with a near-zero depletion-adjusted operating surplus. Oleās paper circumvents this consequence by treating this āholding gainā as a form of (Hicksian) income.
- This note suggests that altering the concept of income to encompass certain holding gains is a fundamental change of principle. As such, it needs to be supported by a compelling case, rather than simply being a convenient solution to the consequences of treating ātime passingā as a holding gain.
Resource rent, depletion and valuation of natural resource stocks
- This section sets out a basic understanding of the relationship between estimated resource rent, depletion and return on natural resource (natural capital) assets.
- The unit price of an extracted natural resource contains a resource rent reflecting the value of a marginal resource unit with respect to its future extraction (Hotelling, 1931). However, resource rents are not directly observable but instead are typically derived as the difference between total revenue generated from the extraction of natural resources less costs incurred during the extraction process including the cost of produced capital (which itself includes a return to produced capital).
- Or, as stated more simply in SEEA-2003:
"the value of capital service flows rendered by the natural resources, or their share in gross operating surplus, is the...resource rentā (para 7.167)
- Depletion is then derived as resource rent minus the opportunity costs of capital invested in the natural resource (SEEA-2003, para 10.30). Depletion represents the change in value of the natural resource stock due to extraction (SEEA-2003, para 7.168). This is consistent with the SNA definition of depletion.
- For enterprises or industries using a mixture of produced and non-produced assets as capital inputs to the production process, gross operating surplus can be decomposed into consumption of fixed capital and net operating surplus. The net operating surplus can be further decomposed into a return to produced assets, a return to non-produced assets and a measure of depletion (the latter two when added together are termed resource rent ). This decomposition of net operating surplus is typical of say a mining enterprise extracting subsoil assets, or a forestry enterprise harvesting natural forest. The relationship is depicted in diagram 1.
Capital services - produced capital
Diagram 1. Producers using produced and natural capital assets
Consumption of fixed capital Consumption of fixed capital Return to produced assets Gross operating surplus Net operating surplus Return to natural capital assets Resource depletion
Capital services ā natural capital (resource rent)
- SNA 2008 states that
the depletion of natural resources covers the reduction in the value of deposits of sub-soil assets as a result of the physical removal and using up of the assets. (SNA 2008, para 12.26).
This means that we set aside an amount that can replace the value of the natural resource as an input to production (i.e. its below ground value), not the value of outputs that the resource can generate. SNA2008ās valuation basis is entirely appropriate and applicable to SEEA.
Time passing and depletion
- Given the available techniques of extraction, the physical characteristics of the deposit and the demand for the asset, there will emerge an optimal schedule for the extraction of the natural resource asset. If we know the physical size of the resource, and our capacity for extraction within each period, it is possible to specify this schedule as the extraction of a sequence of quantities over the expected life of the asset (n). The value of the stock of the asset below ground at the start of period t (V 1 ) is determined by the present value of expected receipts, less expected extraction costs, derived from the progressive extraction and sale of the natural resource throughout the expected production schedule.
n RR^ t
V t = Ī£ āā [equation 1]
t=1 (1+r) t
Where: V = net present value, RR = resource rent, r = discount rate, n = asset life
- Depletion in any one year is the change in the value of the resource between the beginning and end of the year arising purely from the extraction of the resource. By re-arranging equation 1, depletion in the year can also be shown to be equal to the yearās resource rent minus a return on the natural resource asset (equation 2).
d = V 1 ā V 2 = RR ā rV 1 [equation 2]
Where d is depletion, V 1 and V 2 are the opening stock value at period 1 and 2, respectively, RR is the resource rent of period 1, r is the discount rate, and rV 1 is the income component of the resource rent.
- Depletion therefore consists of two inter-related components: the current value of the quantity extracted; and the increase in the present value of the quantities remaining in stock. It has been known for many years (see for example, Hotelling,
- that these two components likewise occur for produced capital in the derivation of consumption of fixed capital ā i.e. consumption of fixed capital consists of the current price value of capital services used up in the course of production less the increase in current value of services remaining to be released by the asset over its
remnant service life. Conventional international practice is to simply net-off these two effects in the derivation of consumption of fixed capital estimates.
- The central question we need to address is how to treat these two
components of resource rent: depletion; and the item denoted by rV 1 in equation 2
(the so called ātime passingā element).
- It is worth noting at the outset that the ātime passingā effect is not passive. Value does not simply accrue because we have taken one temporal step closer to future production. The value of the natural resource (and of the ātime passingā effect) are rooted in an expectation that the owner of the asset will use it according to an identified schedule of production, with expected output prices and production costs (among other assumptions). The calculation of asset values (and therefore depletion) is entirely based on an expectation of benefits arising from a defined schedule of extractive activity.
- SNA provides a comprehensive framework to understand various possible causes of asset valuation change over time. Essentially, the change in value of an asset can be accounted for in one of three ways:
(i) Stock changes due to consumption within a production process. Or due to quantities acquired or disposed of in transactions with other economic entities. These changes are recorded in the transaction accounts (e.g. depletion is recorded in the production account);
(ii) Changes due to events not related to economic transactions, for example, catastrophic losses. Recorded in the āother changes in volume of assets accountā; or
(iii) Changes may be caused by asset price changes. These holding gain/losses are recorded in the ārevaluation accountā.
- Depletion falls into the first category and is therefore restricted to the effect on the value of the asset solely caused by its use in production. Any effect deemed to be a holding gain/loss or an āother change in volumeā cannot be part of our measure of depletion.
- As a way of illustrating the characteristics of depletion and of the ātime passingā element consider the following scenarios ā apparently similar but with different implications for ātime passingā and therefore for measured depletion. Consider one natural resource for which extraction cannot commence immediately but which must instead wait one year to start. As production has yet to commence,
we see in equation 2 that the resource rent is zero, while the rV 1 (ātime passingā) item
is positive. As a result, our measure of the natural resource asset value has actually increased as it moves closer to the period in which it can be used. Under this scenario measured depletion is negative for the first period. Compare this scenario to one in which the schedule of production has had to be delayed for one year (say, due to the impact of a catastrophic natural event) and the whole production schedule moved back one year. Under this second scenario the resource rent is again zero but there has been no increase in the present value of the quantities remaining in stock (i.e. no ātime passingā effect) because they are no closer to being realised than they were at the start of the period. Under this second scenario there has been no increase in the value of the stock in the ground and measured depletion is zero. Therefore, simply knowing that a natural resource remains unused for one period does not, of itself, provide enough detail to understand and estimate depletion.
passing effects in the derivation of consumption of fixed capital. This treatment is now a relatively uncontroversial part of SNA principles and practice.
Implications of treating ātime passingā as a holding gain
- Assume, however that we were to accept that the effect of ātime passingā on natural resource asset values is a holding gain, what is the impact on SEEA aggregates?
- The most important change is that depletion would equate to the entire value of the resource rent. Therefore, in deriving depletion-adjusted measures of production and income, the full amount of the resource rent would need to be deducted from current production. That is, we would deduct not only the decline in value of the natural resource caused by its extraction, but also that part of operating surplus generated from using the natural resource. In practice, it would remove much of the operating surplus of extractive industries and, for economies with significant extractive activity it would have a significant downward impact on measures of adjusted GDP. An analyst examining these accounts would be unclear as to why anybody would engage in extractive activity.
- Integrated Economic and Environmental accounts will gain quicker and more complete acceptance if they reflect the realities of interactions between environment and economy. Based on current experience in Australia, acceptance of these accounts requires recognition that the using up of natural resources incurs a cost to the nation. Equally, though, there needs to be continuing recognition that the extraction of natural resources generates income. For example, Australia recently announced an intention to create a āBuilding Australia Fundā to finance future infrastructure development. This initiative is largely being funded by taxation receipts related to the current resources boom and is recognition that eventually natural capital will need to be replaced by other means of generating income. It is a reality that business receipts (and government revenue) are boosted by extractive activity. Treating ātime passingā as a holding gain in the accounts means that these receipts are effectively removed from SEEAās production and income accounts. Income received from extractive activity would remain more or less unaffected throughout cycles of natural resource āboomā and ābustā.
- It has been suggested however that the ātime passingā element, if treated as a holding gain, could nevertheless be reclaimed as income using Hicksian logic. In this way, resource rent would be split into depletion and (redefined, Hicksian) income components. This would effectively restore the SEEA measure of depletion to equate with resource rent less the ātime passingā element, thereby placating the concerns raised in the preceding paragraphs.
āTime passingā redefined as (Hicksian) income
- Two fundamental SNA principles are: that income derives from production; and holding gains on assets do not of themselves constitute production. So, for example, a share price increase (holding gain) is not production since no good or service has been produced. The increase in the share price is not SNA income.
- Treating the ātime passingā effect as a holding gain represents a fundamental change of concept with significant implications for key SEEA aggregates. If we propose to treat certain holding gains as income, this needs to be done because there are compelling reasons to do so. We should not recommend treating the ātime passingā effect as income simply as a way of achieving the ārightā measure of depletion.
- Itās generally agreed that SEEA and SNA both benefit from a consistency in the basic conceptual underpinnings of their economic measures. Concepts of economics are well established in the SNA through comprehensive processes of consultation and review, therefore, proposals to change these concepts need to be convincing. If the arguments are, at best, mildly appealing then why create a series of fundamental inconsistencies in the integrated environmental and economic accounts?
- The proposal creates counter-intuitive results. It would deliver different economic treatments to growth in non-renewable natural resources subject to identical natural processes. For example, tree growth in a plantation forest would be treated as a form of production leading to income, while the corresponding process in a natural forest would also generate income, but without any production occurring. Imagine there was a community decision to convert a commercial forest plantation into a natural forest. This would lead to; no change in environmentally-adjusted national income; but a fall in environmentally adjusted GDP. The approach agreed to at the December 2007 meeting of London Group would result in no change to either environmentally-adjusted national income or environmentally adjusted GDP because it applies consistent treatment of tree growth across both natural and plantation forests.
- The ātime passingā element must be calculated using NPV methodology. For those natural resources yet to commence production, the passage of time will not of itself lead to a real-world price change and therefore no holding gain is discernable from observed market prices. In this unique situation the āholding gainā is a āphantomā gain ā it cannot be observed in the real world. Estimation of the ātime passingā effect would be a unique case where we cannot use market prices but instead must use an NPV approach.
Comments on the practice of estimating depletion of natural resource assets
- It is worth making a number of observations on the practice of estimating natural resource asset values and related depletion. The following comments are drawn from the experience of the Australian Bureau of Statistics (ABS).
- In estimating natural resource asset values, resource rent and depletion, close scrutiny must be paid to results generated. Any problems in the underlying measures of gross operating surplus, consumption of fixed capital or estimates of return to produced capital will impact on our estimate of resource rent. For example, while it is possible to generate negative resource rents, we would not expect this to continue for an extended period of time. It might be necessary, for example, to reassess estimates of capital services on produced capital used in the extractive process.
- Estimation of the depletion and income components of resource rent also tends to be an iterative process. For example, negative depletion should not be
References
Comisari, P. (2007) Issues Paper: Depletion in the SEEAāNarrowing Down the Options. London Group Meeting, Johannesburg, 26-30 March 2007.
GravgĆ„rd Pedersen, O. (2008) Accounting for the value of time passing and the depletion of natural resources, Reconsideration and some suggestions. London Group meeting, Brussels, 29 September ā 3 October 2008.
Hartwick, J. and Hageman, A. (1993) Economic Depreciation of Mineral Stocks and the Contribution of El Serafy, in E. Lutz (ed.), Toward Improved Accounting for the Environment , The World Bank, Washington.
Hill, P. (1998) Accounting for depletion in the SNA. Presented at the One Day Meeting on Accounting for Environmental Depletion, Paris, 28 September 1998.
Hotelling, H. (1925) A General Mathematical Theory of Depreciation. Journal of the American Statistical Association, 20 pp 340-353.
United Nations, International Monetary Fund, Organisation for Economic Co- operation and Development, World Bank and Commission of the European Communities, System of National Accounts 1993 , Brussels/Luxembourg, New York, Paris, Washington D.C., 1993.
United Nations, European Commission, International Monetary Fund, Organisation for Economic Co-operation and Development, World Bank, Integrated Environmental and Economic Accounting 2003 , Brussels/Luxembourg, New York, Paris, Washington D.C., 2003.
