1
Time passing and measuring depletion
London Group Brussels, September/October 2008
Peter Comisari Australian Bureau of
Statistics
2
Overview

• Natural resources asset values depletion and
  time passing.
• Is time passing a holding gain for the owner of
  the natural resource?
• Does time passing arise from production? If
  not, could it nevertheless be considered income
  by following a Hicksian notion of income?
• Implications of proposal

3
Measuring the value of natural resource assets
and their depletion

• Where market values unavailable, natural
  resource assets can be valued using NPV.
• Asset value NPV of expected stream of benefits
  (resource rents) flowing from developing the
  natural resource.
• But resource rents are not observable and must
  instead be inferred from reported gross operating
  surplus (GOS) of the extractive industry.

4
Measuring the value of natural resource assets
and their depletion, continued

• Depletion is the decline in value of the natural
  resource as a result of its physical extraction.
• Depletion could be thought of as the amount we
  need to set aside from present operating surplus
  to allow replacement of the natural resource.
• What price should apply to the natural resource?

5
Extraction of the natural resource

• When natural resource extraction takes place,
  the below-ground resource changes into an
  above-ground resource. They are different
  products. Extractive activity causes the change.
• Extraction takes place on the assumption that the
  price above-ground will exceed that below-ground.
  
• The depletion charge seeks to replace the natural
  resource at its below-ground price.

6
Resource rent is based on above ground prices
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Extraction of the natural resource, continued...

• Typically, as we move forward one accounting
  period, operating surplus (containing the
  resource rent) is earned from production - we
  need to capture depletion
• We must estimate (and remove) the income element
  of the resource rent to derive depletion.
• But we only know opening asset value (V1) and the
  resource rent (RR)

8
Extraction of the natural resource, continued...

• So the income component of RR must be calculated
  as income RR V1 r (where r is the
  expected return on the natural resource asset)
• i.e. as production proceeds, we release one
  year of RR value from the asset stock we must
  also estimate the income component to derive
  depletion.

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Time passing

• Time passing is the unwinding of the income
  component of the natural resource asset value.
  It is the r V1 component of the equation
  depletion RR r V1
• It is an essential component of our NPV model
• But income earned from extractive activity is
  captured through our regular income sources and
  methods

10
Time passing, continued

• Time passing effect is not an issue where
  market values are available.
• It is a feature of the NPV model, but we do not
  have to explicitly articulate time passing when
  accounting for changes in asset stock values.
• In the production and income accounts,
  depletion-adjusted operating surplus needs only
  to identify the depletion variable - No need to
  also show resource rent and time passing
  elements (already included in GOS)

11
Time passing in the SNA

• Time passing effect has been known about for
  many years in the derivation of consumption of
  fixed capital.
• Where NPV is used to derive SNA consumption of
  fixed capital, conventional practice is to simply
  net-off time passing against capital services.
• SNA produced capital consumption of fixed
  capitalSEEA natural capital depletion
  (consumption of fixed capital)

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SNA treatment of consumption of fixed capital
(CFC)
Gross operating
Value V1 surplus (GOS) 6,000 Value V2
20,000 16,000
CFC 4,000

Net operating
surplus (NOS) 2,000

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SNA treatment of consumption of fixed capital
(CFC)
GOS 6,000
Value V1 CFC ??
20,000 NOS ??

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SNA treatment of consumption of fixed capital
(CFC)
GOS 6,000
Value V1 CFC 4,000
20,000 NOS 2,000

Income CFC 6000
CFC GOS r.V1
6000 - 10 20000
i.e. CFC 4000

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SNA treatment of consumption of fixed capital
(CFC)
GOS 6,000
Value V1 CFC 4,000 Value V2
20,000 NOS 2,000 16,000

Income CFC 6000
CFC GOS r.V1
6000 - 10 20000
i.e. CFC 4000

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SNA treatment of consumption of fixed capital
(CFC)..not
GOS 6,000
Value V1 less capital services 6,000 Value V2
20,000 Plus time passing 2,000 16,000

Equals NOS 2,000

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SNA possible reasons for asset value change

• Essentially, change in value of an asset is
  accounted for in one of three ways in SNA- 1.
  stock change due to consumption within productive
  process. Or acquired / disposed of in
  transactions with other economic entities- 2.
  changes due to events not related to economic
  events e.g. catastrophic events.- 3. changes due
  to asset price changes. These holding
  gains/losses recorded in revaluation account
• SNA depletion recorded in the first grouping.

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Is time passing benefit a holding gain?

• Because the time passing effect increases the
  (NPV) modeled value of the natural resource (and
  this happens even if no production occurs),
  surely this must be a holding gain?
• But this effect occurs independent of any
  observable price change. A holding gain without
  price change?
• NPV model operates on an assumed expected
  production schedule. Results are usually useful
  and intuitive - but not always!

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Time passing as a holding gain

• Assume that we decide to treat the time
  passing effect as a holding gain, what are the
  implications?
• Depletion equals entire resource rent i.e. we now
  make provision to replace not only the natural
  resource, but also the income earned from using
  the resource.
• But we only do this where NPV technique used.
  Where market values available, we calculate
  depletion as decline in asset value due to
  extraction.

20
Time passing as a holding gain, continued

• Where NPV valuation used, depletion-adjusted
  operating surplus for extractive industries would
  largely disappear.
• This ignores realities of potentially substantial
  income (and tax revenue) derived from extraction.
• Fundamental change in our basic accounting
  principles.

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Time passing as income (redefined, Hicksian)

• Problems in previous slides are placated by
  treating time passing as a redefined (Hicksian)
  income.
• i.e. that time passing does not arise from
  productive activity but nevertheless gives rise
  to income.
• Creates a major difference in the accounting
  principles applying to SNA and to SEEA.

22
Time passing as Hicksian income, continued

• would for example lead to different treatments
  in SNA and SEEA for the same natural processes
• e.g. Natural growth of forests for plantation
  (cultivated) forest is production in SNA but
  not production in SEEA. But income arises in both
  cases.
• Would require re-think of treatment of new
  discoveries and reclassifications of natural
  resources. Can these give rise to income
  directly, i.e. in absence of any productive
  activity?

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Questions

• Natural resource assets will change in value
  over time. How do we best explain time passing
  in this context?
• Is it simply an input to our (modeled) measure of
  depletion? Or is it a holding gain?
• If the latter Are we comfortable in creating
  fundamental differences in accounting principle
  between SNA and SEEA?
• If the former Do we still consider NPV approach
  appropriate for valuing natural resource assets?