Accounting for the value of time passing and the depletion of natural resources

Reconsideration and some suggestions

Ole Gravgård Pedersen

Statistics DenmarkSejrøgade 11

DK 2100 Ø+45 3917 3488

ogp@dst.dk

Main questions ?

What should the standard asset accounts for exhaustible natural resources look like?

- How do we explain the accounting items of the depletion adjusted flow accounts and interprete the results, especially if we partition the stock value according to economic ownership ?

- Adapted form or generic asset account ? - How do we value the effect on the stock value of extracting a natural resource ?

Outline of presentation• Background

• The asset accounts and the measurement of depletion - The agreed approach, some properties and problems - An alternative measurement

• The depletion adjusted accounts and split ownership– Agreed approach and some questions– An alternative approach

• Some conclusions

• Some questions

Background

SEEA 2003 asset accounts -several options

Decisions taken at the London Group meetings in Johannesburg and Rome 2007 (agreed approach)

Suggestion on the recording ofsplit ownership betweenGovernment and extractor

Decision on the measurement of the value of depletion

- Strange results when the principles are actual implemented

-Two measures of the ”effect on the stock value of the extraction”-How do we use the generic asset account of the SEEA/SNA

But some outstanding issues:?

The generic SEEA 2003/SNA asset accounts for natural resources

Opening stock value (?)

…

- Depletion = "the reduction in the value as a result of the physical removal and using up of the asset“ (?)

…

+ Revaluation (?) …

= Closing stock value (?)

Often all items are non-observable

Using the NPV method when no market values can be observed gives the following:

- RR = resource rent = the surplus resulting from extraction of the natural resource assets

= the output of the extraction industry minus all costs involved in the extraction, including the costs of using fixed capital

= immediate decline in resource rents due to extraction now

V1 = opening stock = NPV of all future ressource rents, beginning of period 1

+ rV1 = time passing element = effect of the discounting = future ressource rents come closer

V2 = closing stock = NPV of all future ressource rents, beginning of period 2

How do we combine the items from the NPV method with the generic asset account items ?

Opening stock = NPV of future ressource rents beginning period 1

Closing stock = NPV of future ressource rents beginning period 2

- Depletion (?)

+ Revaluations (?)

-RR, ressource rent/immediate decline in income

+ rV1, value of time passing (discount element)

??

OK

OKAsset account NPV

The links for the change items are undetermined and requires assumptions/decisions

Correspondance in SEEA 2003: The NPV method used on oil and gas assets

698.8-58.328.916.6

44-21709

SEEA 2003 Table 7.14 (bold added)

Discoveries and reappraisalsChanges in extraction pathChanges in the unit resource rent (nominal holding gains/losses)

Closing stock

Opening stock Extractions (resource rent)Return to natural capital (revaluation due to time passing)

Table 1. SEEA 2003 Monetary asset account for oil and gas

The value of extractions = RRRR represents here the decline in the value of the natural resource due to the extraction

The time passing element = revaluations/holding gains ???

This is an ”adapted” account which do not follow the terminology and form of the generic SEEA 2003/SNA asset account !

But: The SEEA 2003 example and country practices (?) seems to indicate the following link:

Opening stock = NPV of future ressource rents, beginning period 1

Closing stock = NPV of future ressource rents, beginning period 2

- Depletion* = - RR

+ Revaluations = + rV1

-RR, ressource rent-/immediate decline in income due to -the extraction

+ rV1, value of time passing (discount element)

* In SEEA 2003 this item is called extraction instead of depletion in relation to the asset accounts

In contrast, SEEA 2003 and the agreed approach does at the same time define depletion = RR-rV1, which gives the

link:

Opening stock = NPV of future ressource rents, beginning period 1

Closing stock = NPV of future ressource rents, beginning period 2

- Depletion = -RR + rV1

+ Revaluations = 0

-RR, ressource rent/immediate decline in income

+ rV1, value of time passing (discount element)

This accounting approach is, however, not shown in SEEA 2003!

Therefore, for the revised SEEA, we need to improve the clarity of the asset accounts for natural assets:

• The format, accounting items and terminology of the generic asset accounts should be used

- depletion in stead of extraction, avoid ”return to natural capital”

• In relation to the asset accounts there should only be one value for the depletion, i.e. "the reduction in the value as a result of the physical removal and using up of the asset“

How do we measure the reduction in the asset value as a result of the physical removal and using up of the asset“ ?

1) Agreed approach: d = V1-V2= RR - rV, i.e. the ressource rent minus the time passing element

2) Alternative: d = RR i.e. the ressource rent

The value corresponds to the ressource rent which immediately disappears because of the extraction

Depletion is the total change in the stock value, including the effect on stock value due to the fact that future ressource rents come closer and the time preference.

or

Agreed approach: Depletion = RR-rV1

Background/rationale:

- The role of a natural ressource is the same as that of fixed capital, and depletion is therefore defined in parallel to the definition of fixed capital (change in NPV) leading to the formula RR- rV1

- Instrumental for the adjusted income accounts

Agreed approach: Depletion = RR-rV1

• Depletion is determined by factors which are unrelated to the current extraction ( future extraction, extraction profile, and discoveries).

Therefore an increase in the natural capital stock reduces the depletion.

• Depletion is negative if RR<rV1 i.e. the result of the physical removal and using up of the asset is that the stock value increases !

• The calculation of d = V1-V2 (= RR-rV1) must always be based on constant price calculations of V1 and V2.

• Although in principle measured the same way as fixed capital (NPV), this does seldom hold in practice

Some properties:

Alternative approach: depletion = RR (ressource rent)

• Rationale:

• RR measures the immediate effect on stock value of the extraction if we didn’t extract, the ressource value would be RR higher • Under optimal extraction: RR = NPV of loss of future extraction

(i.e. RR is a cost of extraction measure)

• We would probably have to spend RR if we were going to ”replace” the extracted oil

• The time passing element can be seen as a revaluation of the resource, and has as such nothing to do with the current extraction

Alternative approach depletion = RR (ressource rent)

Some properties:

• Depletion is independent of the total stock value (i.e.of future extraction, extraction profile, and discoveries, etc.).

• Depletion is never negative i.e. the result of the physical removal and using up of the asset is always a decrease in the stock value“

• The asset accounts can be calculated in current prices, without calculating the constant prices accounts first.

• No assumption on a correspondence between natural capital and fixed capital is made

-5

0

5

10

15

20 Bill. DKK (constant prices)

Ressource rent (RR) d=RR-0,04*V1

Example: What does the agreed and the alternative measure look like:

Denmark’ oil and gas: Ressource rents (RR) and depletion (RR - 0.04*V1)

Negative depletion

Discoveries

Can the time passing element (rV) be seen as a revaluation?

• No: Since the price on oil (and thus the ressource rent) is not

changing, the price on the asset must also be the same.

• Yes: If the same quantity increases in value, a revaluation has

taken place.

A unit below ground and a unit above ground are different commodities, and have different prices.

Depletion adjusted income accounts – agreed approach

Gross operating surplus 104.1

Less consumption of fixed capital 24.9

Equals net operating surplus 79.2

Less extraction of natural resources -58.3

Plus returns to natural resources 28.9

Equals operating surplus adjusted for the depletion of natural resources 49.8

Based on SEEA 2003 Para. 10.38 and Table 10.4

Table 3. Agreed depletion adjusted generation of income accounts

Time passing elementDepletion

Net operating surplus-depletion ( RR-rV )= Depletion adjusted NOS ( NOS – RR+rV )

Since depletion has been ”decreased” by rV this amount is per definition left as return to capital and included in the adjusted NOS

return (rV1) > RR: ???

Depletion adjusted income accounts – split ownership

SNA 2008: The asset is attributed to the legal ownerSEEA: Split ownership between government and extractor

Table 4. Agreed approach: Asset and adjusted income accounts with split ownership and return to natural capital attributed to the extractor

  Total resource

Owner Extractor

(Government)

Asset account      

Opening stock 698.8 400 298.8

- depletion -29.4 0 -29.4

= value of extraction -58.3 0 -58.3

- return to income 28.9 0 28.9

Closing stock 669.4 400 269.4

       

Adjusted income account      

Net operating surplus 79.2 0 79.2

less extraction of natural re sources -58.3 0 -58.3

Plus returns to natural resources 28.9 0 28.9

equals operating surplus adjusted for the depletion of natural resources

49.8 0 49.8

       

Rate of return to natural capital (per cent) 4 0 9.7

Depletionand return to natural resources

???

???

Asset account

Income account

Agreed approach under legal owner or split ownership situation:

Charging the full depletion to the extractor and giving him the full return to natural capital seems to lead to ”strange” results:

The owner’s stock value is undetermined and the return to capital is attributed in proportions we would not expect.

Some solutions

1) The extractor gets it all (owner = extractor)

2) The owner gets it all and an annual capital transfer, equal to the depletion, from owner to extractor is recorded. (However, this does also lead to strange rates of returns to natural capital at the sectoral level).

3) Alternative approach: the depletion (=RR) is charged against the extractor, and the return to capital is taken from the holding gains and allocated in relation to the stock values

Owner(Government)

Asset accountOpening stock 698.8 400 298.8 - depletion (=resource rent) -58.3 0 -58.3 + Holding gains (due to time passing) 28.9 16.5 12.4Closing stock 669.4 416.5 252.9

Adjusted income accountNet operating surplus 79.2 0 79.2 less depletion -58.3 0 -58.3 Plus returns to natural resources (=holding gains from time passing)

28.9 16.5 12.4

equals operating surplus adjusted for the depletion of natural resources

49.8 16.5 33.3

Rate of return to natural capital (per cent) 4 4 4

Total economy

Extractor

Table 5. Alternative asset and adjusted income accounts with split ownership and return to natural capital attributed according to ownership shares

Depletion

Split returns to natural capital = holding gains

Alternative approach: split ownership and split return to capital

The alternative approach

• Requires a new interpretation of the adjusted income accounts:

– The income does not come from production, but from the holding gains, (Hicksian income concept)

– We include gains as income because it increases our wealth and consumption possibilities

– It opens for inclusion of other ”gains”, such as discoveries and natural growth of uncultivated assets, without including them as production

Some overall conclusions• The ”agreed” definition of depletion (RR-rV) leads to

inconsistent and strange results, when NPV is used in practice

• There is a need to streamline the definition and presentation of the depletion and the asset accounts in SEEA

• There seems to be some unresolved issues with regard to the proposed split-ownership recording

Some overall conclusions, (contd)

• An alternative definition of depletion (=RR) and accounting approach would remove the strange results

• Such an alternative approach requires a new approach to the adjusted income accounts based on Hicks’ income

• The alternative approach removes the parallel approach to accounting for fixed capital and natural capital

• The alternative approach is more flexible and does not require changes in the production boundary of the SNA

Questions for the London group• Q.1 Do you agree that the “reduction in the value of a sub-soil asset as

a result of the physical removal and using up of the asset” should be unambiguously defined?

• Q.2 Do you agree that the generic asset accounting format (Table 2) should be used instead of the adapted form (Table 1) when accounting for natural resources?

• Q.3 Should the value of the “reduction in the value of a sub-soil asset

as a result of the physical removal and using up of the asset” be valued as

• a) RR resource rent, (and the time passing element as holding gains) or • b) Equal to the resource rent minus the time passing element, RR-

rV ?

• Q.4 What is your view on allocating the time passing element/return to capital in proportion to the the owners’ share of the natural resource stock value (Table 5) instead of allocating it to the extractor (Table 4)?

• Q.5 The alternative approach argues that the time passing as a holding gain can be regarded as income because it increases the wealth (Hicks’ income). Similarly, discoveries and the growth of an uncultivated natural resource can be seen as income because it increases our wealth and consumption possibilities.

What is your view on the alternative approach?