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3 Accounting for Subsoil Mineral Resources Introduction Subsoil minerals—particularly petroleum, natural gas, and coal—have played a key role in the American economy over the last century. They are important industries in themselves, but they also are crucial inputs into every sector of the economy, from the family automobile to military jets. In recent years, the energy sector has been an important contributor to many environmental problems, and the use of fossil fuels is high on the list of concerns about greenhouse warming. The National Income and Product Accounts (NIPA) currently contain estimates of the production of mineral products and their flows through the economy. But the values of and changes in the stocks of subsoil assets are currently omitted from the NIPA. The current treatment of these resources leads to major anomalies and inaccuracies in the accounts. For example, both exploration and research and development generate new subsoil mineral assets just as investment creates new produced capital assets. Similarly, the extraction of mineral deposits results in the depletion of subsoil assets just as use and time cause produced capital assets to depreciate. The NIPA include the accumulation and depreciation of capital assets, but they do not consider the generation and depletion of subsoil assets. The omission is troubling. Mineral resources, like labor, capital, and intermediate goods, are basic inputs in the production of many goods and services. The production of mineral resources is no different from the production of consumer goods and capital goods. Therefore, economic
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accounts that fail to include mineral assets may seriously misrepresent trends in national income and wealth over time. Omission of minerals is just one of the issues addressed in the construction of environmental accounts. Still, extending the NIPA to include minerals is a natural starting point for the project of environmental accounting. These assets—which include notably petroleum, natural gas, coal, and nonfuel minerals—are already part of the market economy and have important links to environmental policy. Indeed, production from these assets is already included in the nation's gross domestic product (GDP). Mining is a significant segment of the nation's output; gross output originating in mining totaled $90 billion, or 1.3 percent of GDP, in 1994. This figure masks the importance of production of subsoil minerals in certain respects, however, for they are intimately linked to many serious environmental problems. Much air pollution and the preponderance of emissions of greenhouse gases are derived directly or indirectly from the combustion of fossil fuels—a linkage that is explored further in the next chapter. Moreover, while the value of mineral assets may be a small fraction of the nation's total assets, subsoil assets account for a large proportion of the assets of certain regions of the country. Current treatment of subsoil assets in the U.S. national economic accounts has three major limitations. First, there is no entry for additions to the stock of subsoil assets in the production or asset accounts. This omission is anomalous because businesses expend significant amounts of resources on discovering or proving reserves for future use. Second, there is no entry for the using up of the stock of subsoil assets in the production or asset accounts. When the stock of a valuable resource declines over time through intensive exploitation, this trend should be recognized in the economic accounts: if it is becoming increasingly expensive to extract the subsoil minerals necessary for economic production, the nation's sustainable production will be lowered. Third, there is no entry for the contribution of subsoil assets to current production in the production accounts. The contribution of subsoil assets is currently recorded as a return to other assets, primarily as a return to capital. There is a well-developed literature in economics and accounting with regard to the appropriate treatment of mineral resources. The major difficulty for the national accounts has been the lack of adequate data on the quantities and transaction prices of mineral resources. Unlike new capital goods such as houses or computers, additions to mineral reserves are not generally reflected in market transactions, but are determined from internal and often proprietary data on mineral resources. Moreover, there are insufficient data on the transactions of mineral resources, and because these resources are quite heterogenous, extrapolating from existing transactions to the universe of reserves or resources is questionable.
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Notwithstanding the difficulties that arise in constructing mineral accounts, the Bureau of Economic Analysis (BEA) decided this was the best place to begin development of its Integrated Environmental and Economic Satellite Accounts (IEESA). BEA in the United States and comparable agencies in other countries have in recent years developed satellite accounts that explicitly identify mineral assets, along with the changes in these assets over time. This chapter analyzes general issues involved in minerals accounting and assesses the approach taken by BEA (as described in Bureau of Economic Analysis [1994b]). The first section provides an overview of the nature of subsoil mineral resources and describes the basic techniques for valuing subsoil assets. The second section describes BEA's approach to valuation, including the five different methods it uses to value subsoil mineral assets. The third section highlights the specific strengths and weaknesses of BEA's approach, while the fourth considers other possible approaches. The chapter ends with conclusions and recommendations regarding future efforts to incorporate subsoil mineral assets into the national economic accounts. General Issues in Accounting for Mineral Resources Basics of Minerals Economics A mineral resource is "a concentration of naturally occurring solid, liquid, or gaseous material, in or on the earth's crust, in such form and amount that economic extraction of a commodity from the concentration is currently or potentially feasible" (Craig et al., 1988:20). The size and nature of many mineral resources are well known, whereas others are undiscovered and totally unknown. Figure 3-1 shows a spectrum of resources that differ in their degree of certainty, commonly described as measured, indicated, inferred, hypothetical, and speculative. Another important dimension is the economic feasibility or cost of extracting and using the resources. Some resources are currently profitable to exploit; others may be economical in the future, but currently are not. Along this dimension, mineral resources are conventionally described as economic (profitable today), marginally economic, subeconomic, and other. Resources that are both currently profitable to exploit (economic) and known with considerable certainty (measured or indicated) are called reserves (or ores when referring to metal deposits). This means reserves are always resources, though not all resources are reserves.1 1 Two additional categories of mineral endowment are worth noting since they are commonly encountered. The reserve base encompasses the categories of reserves and marginal reserves, as well as part of the category of demonstrated subeconomic resources shown in Figure 3-1. While reserves and the reserve base are typically a small subset of resources,
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Figure 3-1 Classification of Mineral Resources. Source: Mineral Commodities Summaries, U.S. Geological Survey (1992:203).
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Over time, reserves may increase. Exploration may result in the discovery of previously unknown deposits or demonstrate that a known deposit is larger than formerly indicated. Research and development may produce new techniques that allow previously known but uneconomic resources to be profitably extracted. A rise in a mineral commodity's price may also increase reserves by making previously unprofitable resources economic. The exploration required to convert resources into reserves entails a cost. As a result, companies have an incentive to invest in the generation of new reserves only up to the point at which reserves are adequate for current production plans. For many mineral commodities, therefore, reserves as a multiple of current extraction tend to remain fairly stable over time. While by definition all reserves can be exploited profitably, the costs of extraction, processing, and marketing, even for reserves of the same mineral commodity, may vary greatly as a result of the reserves' heterogenous nature. Deposit depth, presence of valuable byproducts or costly impurities, mineralogical characteristics, and access to markets and infrastructure (such as deepwater ports) are some of the more important factors that give rise to cost differences among reserves. Figure 3-2 reflects the heterogenous nature of mineral resources by separating the reserves and other known resources for a particular mineral commodity according to their exploitation costs.2 The lowest-cost reserves are in class A; their quantity is indicated in the figure as 0A and their exploitation costs as 0C1. The next least costly reserves are found in class B, with a quantity of AB and a cost of 0C2. The most expensive reserves are found in class M. These reserves are marginally profitable. The market price 0P just covers the extraction cost of class M (0Cm) plus the opportunity cost (CmP) of using these reserves now rather than saving them for future use. This opportunity cost, which economists refer to as Hotelling rent (or sometimes scarcity rent or user cost) is the present value of the additional profit that would be earned by exploiting these reserves at the most profitable time in the future rather than now.3 resources in turn are a small subset of the resource base. The resource base, not illustrated in Figure 3-1, encompasses all of a mineral commodity found in the earth's crust. 2 Similar comparative cost curves are used to illustrate the relative costs of mineral production for major producing countries or companies. See, for example, Bureau of Mines (1987) and Torries (1988, 1995). 3 Where the relevant market for a mineral commodity is global and transportation costs are negligible, Figure 3-2 reflects cost classes for reserves and other known resources throughout the world. Where a mineral commodity is sold in regional markets, a separate figure would be required for each regional market, and the cost classes shown in any particular figure are only for the reserves and other known resources in the regional market portrayed.
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Figure 3-2 Mineral Reserves and Other Known Resources by Cost Class. Known resources in Figure 3-2 with costs above those of class M, such as those in classes N, O, and P, are by convention not reserves. In this case, mineral producers, like other competitive firms, will have an incentive to produce up to the point where the current production costs of the next unit of output, inclusive of rents, just equals the market price. When Hotelling rents exist, they are the same for all classes of reserves for a particular mineral commodity market. Thus, the total Hotelling rent shown in Figure 3-2 is simply the Hotelling rent earned on marginal reserves (CmP) times total reserves (0M). Those reserves whose marginal extraction costs are below those of the marginal reserves in class M are called inframarginal reserves. As a result of their relatively low costs, they yield additional profits when they are exploited. Mineral economists refer to these additional profits as Ricardian rents. In Figure 3-2, the Ricardian rents per unit of output equal C1Cm for reserves in class A, C2Cm for reserves in class B, and so on. Unless technical or other considerations intervene, mineral producers will generally exploit first those reserves that have relatively low production costs and thus high Ricardian rents (like classes A and B). This implies that the reserves currently being extracted have lower costs than the average of all reserves and that their Ricardian rents are likely to be above average.
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Since reserves by definition are known and profitable to exploit, they are assets in the sense that they have value in the marketplace. Although mineral resources other than those classified as reserves might have incompletely defined characteristics (in terms of costs and quantities) or be currently unprofitable to exploit, they still may command a positive price in the marketplace. Petroleum companies, for example, pay millions of dollars for offshore leases to explore for oil deposits that are not yet proved reserves. Mining companies pay for and retain subeconomic deposits. The option of developing such deposits in the future has a positive value because the price may rise, or some other developments may make the deposits economic. Thus, a full accounting of subsoil assets should consider not only reserves, but also other mineral resources with positive market value. In the case of reserves, market value may reflect Hotelling rent, Ricardian rent, and option value.4 In the case of mineral resources other than reserves, a positive market value is due solely to their option value. Key Definitions in Mineral Accounting Changes in the value of the mineral stock come about through additions, depletions, and revaluations of reserves. Additions are the increases in the value of reserves over time due to reserve augmentations. They are calculated as the sum of the price of new reserves times the quantity of new reserves for each reserve class. Depletions are the decreases in the value of reserves over time due to extraction. They are similar to capital consumption (depreciation) and parallel the concept of additions. Revaluations are changes in the value of reserves due to price changes. They measure the residual change in the value of reserves after correcting for additions and depletions. Techniques for Valuing Mineral Assets As noted in the last section, the major challenge in extending the national accounts to include subsoil minerals is to broaden the treatment of mineral assets to include additions and depletions and to incorporate depletion in the production accounts. This task involves estimating the value of the subsoil assets. A specific subsoil asset consists of a quantity 4 The total value of reserves is V = ΣiviRi, where vi is the unit value of reserves in class i (i = A, B,..., M), and Ri is the quantity of reserves of class i.
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Figure 3-3 The Two Components of Subsoil Assets. of a mineral resource and the invested capital associated with finding and developing that resource. Invested capital includes physical structures such as roads and shafts, as well as capitalized exploration and drilling expenses. The total value of the subsoil assets equals the sum of the value of the mineral and the value of the associated capital (see Figure 3-3). Currently, U.S. national economic accounts include the value of the associated capital, but exclude the value of the mineral resource. One of the goals of natural-resource accounting is to estimate the total value of subsoil assets and to separate this estimate into the value of the mineral and the value of the associated capital. An additional goal is to track over time changes in the value of the stock that result from additions, depletions, and revaluations. Three alternative methodologies are used in valuing mineral resources: (1) transaction prices, (2) replacement value, and (3) net present value. In developing its mineral accounts, BEA used one version of the first method and four versions of the third. This section explains the basic elements of each approach. Transaction Prices The most straightforward approach to valuing mineral resources relies on market transaction prices. This is the standard approach used across the national economic accounts for capital assets. When resources of petroleum, copper, gold, and other minerals are sold, the value of the transaction provides a basis for calculating the market value of the mineral component of the asset.
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A close look at the transaction-prices approach reveals, however, a number of difficulties that need to be resolved. The major difficulty is that a market transaction usually encompasses a number of assets and liabilities, such as the associated capital (e.g., surface roads, shafts, and refining operations), taxes, royalty obligations, and environmental liabilities. Because the transaction usually includes not only the mineral resources, but also associated capital, the value of the capital must be subtracted to obtain the mineral value. In addition, the property is usually encumbered with royalty obligations to prior owners or to owners of the land. Many mineral properties also have associated environmental problems, such as contaminated soils and water, and they may even be involved in complicated legal disputes, such as connection to a Superfund site with joint and several liability. Some of these associated assets and liabilities (such as mining structures) are true social costs or assets, while others (such as royalty obligations) are factor payments. Another difficulty with using transaction prices is the sporadic nature of the transactions. The infrequency of the transactions, coupled with the heterogeneity of the grade of the resource, makes it difficult to apply the transaction price for one grade or location of the resource to other grades in other locations. Because of the complex assortment of assets and liabilities associated with transactions of mineral resources, the price must be adjusted to obtain the value of a resource. As noted above, the working capital and the associated capital must be subtracted from the transaction price, while any extrinsic environmental liabilities should be added, as should any factor payments, such as royalties or taxes, to obtain the value of the underlying resource. Box 3-1 provides an example of how to adjust the transaction price to obtain the market value of a mineral resource for a hypothetical sale involving the purchase of 500,000 barrels of oil. In this example, the buyer pays $2 million for a property containing 500,000 barrels of oil, and this is recorded as the transaction value. Attached to those reserves is a long-term debt of $1.0 million; this liability must be added to the purchase price. If the acquired reserves also include associated working capital of $0.2 million, this amount must be deducted from the purchase price. Correcting for these two items creates an effective purchase price or market value of the asset of $2.8 million. An additional issue arises because of payments such as future taxes and royalties. In acquiring the above property, the new owner must, for example, pay a 10 percent overriding royalty to the landowner. Such payments should be included in the value of the resource even though they do not accrue to the seller of the property. In the example shown in
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Box 3-1 Transaction Price Method a Recorded Dollar Transaction (500,000 barrels) $2.0 million Adjustments Add: assumed liabilities $1.0 million Subtract: working capital $0.2 million Effective Purchase Price of Asset $2.8 million Add: present value of taxes, royalty transfers $0.6 million Value of Assets $3.4 million Subtract: value of associated capital $0.8 million Value of Petroleum Reserve $2.6 million a This methodology is not followed in the conventional accounts. For instance, in valuing the stock of cars, we do not subtract tax credits, nor do we add in future liabilities such as property taxes. Similarly, to the extent that royalties are regarded as a sharing of profits (like dividends), they should not affect the value of an asset; to the extent that royalties are actually a deferred part of the purchase price, they can be capitalized to increase the value of an asset. Box 3-1, future royalties and taxes are assumed to have a present value of $0.6 million. These payments introduce a major new complication because taxes and royalties depend on future production. Not only are they uncertain, but they also cannot be easily estimated from market or transaction data. One approach is to adjust the transaction price by marking up the value of the transaction by a certain amount. Adelman and Watkins (1996:4), for example, suggest that 27 percent be added to the ''effective purchase price" to account for transfers. After adjusting for royalties, this yields a social asset value for the above property of $3.4 million. The final adjustment is for associated capital, which is assumed to have a value of $0.8 million. After this amount is subtracted, the estimated social value of the underlying petroleum reserve is calculated to be $2.6 million. Replacement Value A second approach uses the costs of replacing mineral assets to determine their value. Under this approach, it is assumed that firms have an
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incentive to undertake investments to find new resources up to the point where the additional cost of finding one more unit just equals the price at which firms can buy that unit—that is, up to the market value. Therefore, the additional or marginal cost of finding a mineral resource should be close to its market price. Associated with this approach, however, are many of the same issues discussed above under transaction prices. For example, a particular replacement cost is relevant only for valuing deposits of comparable quality and cannot be used to value resources of another grade. This point can be illustrated using Figure 3-2. Assume that exploration is resulting in the discovery of resources of class M. The market value of this class would be a function of the difference between 0P and production cost 0CM. It would be profitable for firms to continue exploring for such deposits until the finding costs (that is, the replacement costs) just reached the value of this class of resource. However, the replacement cost of class M cannot be used to value other classes, such as class A, which have a lower extraction cost and therefore a higher value. Because of cost differences, using class M to value classes A through L would yield an underestimate of the value of these reserves. Net Present Value A third valuation technique, the net present value or NPV method, entails forecasting the stream of future net revenues a mineral resource would generate if exploited optimally, and then discounting this revenue stream using an appropriate cost of capital.5 Under certain conditions—such as no taxes—the sum of the discounted revenue values from each time period will equal the market value of the resource. For example, assume that a 100 million-ounce gold asset generates a stream of net revenues (after accounting for all extraction and processing costs) that, when discounted at a rate of 10 percent per year, has a present value of $1.5 billion. According to this approach, the value of the asset is taken to be $1.5 billion. If the value of the plant, equipment, and other invested capital ultimately associated with the asset is estimated to be $500 million, the current value of the gold reserves is $1 billion, and their unit value is $10 per ounce. Again, as with the previous two methods, each class of resource should be separately valued, since the stream of revenues from a higher class of resource will be greater than that from a lower class. A special case of the NPV approach, known as the Hotelling valua- 5 The appropriate discount rate for energy and environmental resources is debatable. See Lind (1990, 1997), Schelling (1995), and Portney and Weyant (1999).
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determine the implications of its findings for trends in mineral scarcity. If scarcity indicators are desired, deflated per unit prices for each type of mineral reserve should be presented. Data Availability Issues Although BEA's valuation methods require limited data, all may suffer from potentially significant measurement error. For example, while the replacement cost method of valuing oil and gas reserves is conceptually appropriate, it requires an estimate of the value of associated capital that cannot be measured directly and must be estimated through current exploration and development expenditures. There is no indication that this estimate, as proposed by BEA, has any empirical validity. The transaction price method is also conceptually correct, but one must make adjustments to the transactions, as listed in Box 3-2, to obtain the reserve value. The necessary data may not be available for each transaction, causing the method to lose its appeal. The current rent methods, once correctly formulated to take production constraints into account, will require average cost data that are not always observable in markets. Other Issues Whenever asset valuation requires discounting of future cash flows, as is the case in the valuation of mineral stocks, questions arise as to the appropriate discount rate. Finance theory offers some theoretical guidelines, but practical implementation is difficult. The popularity of the formula based on the Hotelling valuation principle derives in part from the fact that it does not require a discount rate, but this advantage comes at the cost of an implausible assumption about the increase in net mineral rents. In constructing present value estimates, it is difficult to justify the extremely low real discount rate of 3 percent per year used by BEA if the purpose of the estimates is to determine the market value of the reserves. All NPV techniques, which include both current rent methods and the replacement cost method, omit asset value that is created by managerial flexibility (see Davis, 1996). With mineral assets, the ability to alter extraction as prices move up or down can create significant option value, especially for marginal deposits. Of the valuation techniques used by BEA, only the transaction approach includes these option values, since they will be included in the observed asset price. BEA's results show clearly the potential margin for error among the various techniques, for they yield widely different estimates. In some cases, the net change in the value of reserves (additions minus depletions) even has a different sign under different valuation techniques. All of this
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suggests that correctly accounting for mineral stocks and flows in a set of satellite accounts will be just as intensive an accounting exercise as current accounting for the stocks and flows of produced capital in the NIPA. Other Approaches and Methodologies Efforts in Other Countries Mineral accounts are currently constructed by many countries. The current rent and discounted present value valuation approaches used by BEA to calculate resource stock and flow values are similar to those employed in other countries, with current rent method I being used most widely. The shortcomings of this approach were discussed earlier. Other countries assume that the current rent, after a return to capital is deducted, represents the current unit price of all reserves; they then calculate the present value by discounting the projected rent using an arbitrary discount rate. Again, as noted above, this is an unrealistic method of pricing reserve stocks or flows. Although BEA estimates only a set of monetary accounts, most other countries compute both physical and monetary accounts for reserves. In Europe the most important minerals are oil and gas under the North Sea. Indeed, the discovery of these resources and the economic-policy problems they created led Norway to pioneer the development of resource accounting in the 1970s. Most other minerals appear to have a market value barely in excess of production costs, and hence the valuations applied to subsoil assets result in a very small value for the stocks and depletion. In Canada and Australia, however, other minerals have a significant economic value. Coverage The types of minerals covered in studies for other countries are similar to those covered in the IEESA. Most countries tend toward a slightly broader definition of reserves: instead of the "proven" reserves included by BEA (those that are currently known to be commercially exploitable at today's prices and technology), other countries often include "probable" reserves (defined as those having a better than 50 percent chance of being commercially exploitable in the future). Canada and Norway distinguish between "developed" or "established" and undeveloped reserves. This distinction is useful for assessing options for the future schedule of extraction. The distinction is also necessary when applying current rent method II, under which the value of associated fixed capital is deducted from the value of the reserve, and which therefore applies properly only
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to those reserves for which all fixed capital needed to extract the reserves is already in place. The minerals covered by studies for other countries include oil and gas, coal, and a selection of metal ores, depending on what appears important in a given country. Hence Canada includes about 8 basic metals, while Australia values nearly 30 minerals, including precious metals and gold. In Europe, however, most minerals other than North Sea oil and gas appear to have a very small value, and efforts have not focused on them. Valuation The valuation methods used by other countries are generally the same as those reviewed earlier. As in the BEA work, total resource values are a small fraction of national wealth. The starting point is physical data on the stock and annual use of the minerals. As noted early in this chapter, the simplest valuation techniques are current rent methods I and II, which derive a resource rent for the current period as the difference between the extraction costs and the wellhead or surface price of the mineral. Often this margin is relatively small and can be highly volatile when the selling price of the mineral fluctuates while extraction costs undergo little change. In some cases, such as coal extraction in many parts of Europe, the mine-mouth price of coal is consistently less than extraction costs, and extraction continues only because of subsidies. A negative asset value in this case may actually be realistic. Most countries assume that the Hotelling hypothesis is inadequate and instead use the present discounted value of the expected future income stream from extracting mineral reserves. The future schedule of extraction is often assumed to be constant, or it may actually be determined by contracts with purchasers of the mineral. In the absence of other knowledge, prices are assumed to rise with expected future inflation. The discount rate used tends to be the historical average interest rate on government bonds (typically around 6 percent), which is taken to represent the opportunity cost of funds. Normal rates of return for industry generally, or the mining industry specifically, have also been tested. Because these returns include a risk premium, they are higher than government interest rates. An interesting and quite different valuation method adopted in The Netherlands is described in the next section. Practice in Selected Countries Australia. The Australian Bureau of Statistics publishes values of reserves and changes in reserves for nearly 30 minerals, including oil and gas, uranium, and gold. The valuation method used is essentially BEA's cur-
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rent rent method I. Even in resource-rich Australia, the reported value of subsoil assets is only one-tenth the value of the fixed capital in structures and equipment. The Australian Bureau of Statistics notes that economically exploitable reserves are only a very small proportion of the total resource. It also points out that its valuation techniques can give a misleading impression both of the value of reserves and of year-to-year changes in reserves because mineral prices fluctuate considerably. Canada. Statistics Canada has estimated the value of reserves of oil, gas, coal, and eight metals using both current rent methods I and II, although its preferred valuation technique is the latter. Current rent method I sometimes produces negative values for mineral reserves. Because Canada is concerned with regional depletion issues, it produces monetary and physical accounts for each province. The Netherlands. Statistics Netherlands estimates the value of gas under the North Sea, the country's principal natural resource, by an unusual method. In all North Sea operations, governments (United Kingdom, Norway, The Netherlands) attempt to appropriate most of the resource rent through royalties and taxes. Instead of estimating the resource rent indirectly by the methods employed elsewhere, the Dutch estimate the resource rent directly from known government receipts. Tests by other countries have shown this method performs reasonably well for the North Sea fields, where governments take 80 percent or more of the resource rent. Norway. The first work on resource valuation was done in Norway in the 1970s, when North Sea oil suddenly appeared as a major influence on the Norwegian economy. The Norwegians were pioneers in natural-resource accounting, beginning with oil, but later extending to other assets, such as forests. Their studies have had a considerable effect on subsequent work in other countries. The 1970s was, however, a period of massive changes in world oil prices that produced huge swings in the apparent value of this resource; as a result, many Norwegians concluded that their estimates had serious shortcomings. A number of Norwegian analysts concluded that physical data on resources were more useful. Norway recently resumed valuing natural resources to complete the balance sheets of national wealth for SNA national accounts. Sweden. For its national accounts balance sheets, Statistics Sweden has calculated reserves and depletion of subsoil assets, in particular metal ores. The reserves covered are proven reserves, which are valued by BEA's current rent method I. Because prices of metals are volatile, the
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calculated resource rents occasionally turn negative, a problem reduced but not removed by adopting a moving average of prices. As a result of a fall in world copper prices, a proportion of the country's mineral stock has ceased to be economically exploitable and therefore may disappear from proven reserves. United Kingdom. Estimates of the depletion of U.K. oil and gas in the North Sea were published in 1996 for several successively broader categories of resources—proven, probable, possible, and undiscovered but inferred from geological evidence. Several valuation techniques were tested, including current rent methods similar to those of BEA and the present value of the future income stream. Significant differences were observed in the estimates derived with the various techniques. Other countries. Valuation studies by developing nations including Brazil, China, and Zimbabwe have produced other important findings (see Smil and Yshi, 1998; Young and Seroa da Motta, 1995; and Crowards, 1996). Alternative Methodologies One quite different methodology has not been employed by BEA—that of relying on financial information for individual firms. At the level of the firm, the value of mineral reserves can be imputed from data on financial balance sheets. Figure 3-6 indicates the calculations required. This method calculates a nation's mineral wealth by aggregating the values of the domestic mineral resources held by all resident mineral firms. This is a laborious process that requires assessing the balance sheets of both listed and unlisted companies. It also provides only private reserve values, since the owners of the reserve implicitly deduct the value of any taxes, royalties, and other payments on the mineral assets when attaching a value to equity capital. Finally, as with any calculation of the value of the reserve stock, it is difficult to apportion changes in total values of the mineral reserves among additions, depletions, and revaluations. A much simpler approach entails empirically based modifications to current rent method II. Cairns and Davis (1998a, 1998b) have found that multiplying the total asset value as calculated using current rent method II by a fixed fraction can eliminate the upward bias in total reserve value and produce estimates that are closely aligned with the observed market values of mineral assets. The fraction used, which lies between zero and one, varies by commodity. Cairns and Davis' work suggests a fraction of 0.7 for gold reserves. Work by Adelman suggests a fraction of 0.5 for oil and gas reserves. For other mineral reserves, the appropriate fractions have yet to be determined, but are likely in most instances to be around
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Figure 3-6 Imputing the Market Value of Mineral Resources from Balance Sheet Data. 0.6 according to Cairns and Davis (1998b). To estimate the value of the mineral reserves, the value of associated capital must still be deducted from the total asset value. This can be done in the same manner as in current rent method II. The mathematical formulation of this modified reserve valuation approach is shown in Box 3-9.
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Box 3-9 Modified Formulas for the Calculation of Reserve Stocks, Additions, and Depletions total mineral reserve valuet = Vt = [βpt - βat - Kt/Rt] × Rt additionst = [βpt - βat - Zt/At] × At depletionst = [pt - at - rKt/qt - Dt/qt - rVt/qt] × qt where β is an empirically estimated adjustment coefficient with a value between zero and one, and all other variables are as defined in Boxes 3-3 and 3-6. Additions are simply the value of new reserves, which can be calculated with the same formula used for valuing total reserves, except that exploration and development expenditures, rather than existing associated capital, are deducted. The formula for valuing additions is given in Box 3-9. Depletion calculations have been studied by Cairns (1997) and Davis (1997), who suggest a modification to the BEA depletion calculations (see Box 3-9). Cairns and Davis take the depletion calculation of current rent method I and deduct an additional term that reflects a return to the mineral. This modification lowers the depletion calculation of current rent method I. The discussion thus far has been aimed at estimating the value of the reserve stock and the value of depletions from and additions to that reserve stock. The discussion is guided by the notion that produced capital and natural capital are currently treated asymmetrically in national accounting and that this discrepancy should be corrected. There are yet other approaches that take a ''sustainability" perspective. El Serafy (1989) has devised an alternative approach to adjusting NDP to account for mineral depletion. As currently measured, NDP is temporarily augmented during mineral extraction. El Serafy would convert the temporary revenue stream from mineral extraction into the equivalent infinite income stream, likening this latter stream to permanent income from the mineral asset. He thus advocates deducting an amount from the conventionally measured NDP during the extraction period to create an adjusted sustainable NDP.14 It may be noted that the production of satellite ac- 14 The deduction proposed by El Serafy is R/(1 + r)n+1, where R is the current depletion, r is an appropriate discount rate, and n is the number of years of mineral reserves remaining assuming a constant extraction path. See also Hartwick and Hageman (1993) and Bartelmus (1998)
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counts is intended to address just this type of concern, since those who prefer El Serafy's concept of sustainability to other accounting conventions can make their own adjustments to national output using the information contained in satellite accounts. Conclusions and Recommendations on Accounting for Subsoil Mineral Resources Appraisal of BEA Efforts 3.1 BEA should be commended for its initial efforts to value mineral subsoil assets in the United States. At very limited cost, BEA has produced useful and well-documented estimates of the value of mineral reserves. These efforts reflect a serious and professional attempt to value subsoil mineral assets and assess their contribution to the U.S. economy. The methods employed by BEA are widely accepted and used by other countries that are extending their national income accounts. 3.2 The panel recommends that work on developing and improving estimates of subsoil mineral accounts resume immediately. As a result of the 1994 congressional mandate, BEA was forced to curtail its work on subsoil assets. Its estimates of subsoil mineral assets are objective, represent state-of-the-art methodology, and will be useful for policy makers and analysts in the private sector. 3.3 Because of the preliminary nature of the BEA estimates, as well as the potential volatility introduced by the inclusion of mineral accounts, the panel recommends that BEA continue to present subsoil mineral accounts in the form of satellite accounts for the near term. Once the accounting procedures used for the mineral accounts have been sufficiently studied and found to be comparable in quality to those used for the rest of the accounts, it would be best to consider including the mineral accounts in the core GDP accounts. It is appropriate that assessments of changes in subsoil assets be presented on an annual basis, as BEA has done in its initial efforts. 3.4 The panel does not recommend that a single approach to mineral accounting be selected at this time. No single valuation method has been shown to be free of problems. Thus BEA should continue to employ a variety of valuation methods, modifying them as warranted by new developments in the field.
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3.5 The panel has identified a number of shortcomings in current valuation approaches, and it recommends that BEA consider modifying or eliminating some of its procedures in light of these findings. The panel has identified problems involving appropriate adjustment of asset values for associated capital and other assets and liabilities, as well as potential overestimation of the value of assets, additions, and depletions by use of the Hotelling valuation technique. BEA should consider such findings in refining its techniques. Empirically based modifications to the Hotelling valuation technique along the lines suggested above should be examined. 3.6 The derivation of accurate and parsimonious valuation is an area of intensive current research, and BEA should follow new developments in this area. The panel has identified a number of promising research efforts that may reduce the uncertainties among various approaches to valuing mineral resources. Most of the shortcomings of BEA's approaches identified in this chapter reflect data limitations and inherent problems that arise in estimating quantities and values that are not reflected in market transactions. Given the uncertainties involved, as well as the small share of total wealth represented by subsoil assets in the United States, a major commitment to data generation for these assets does not appear to be justified at this time. BEA should therefore emphasize valuation methods that rely on readily available data. 3.7 The most important open issues for further study are (1) the value of mineral resources that are not reserves, (2) the impact of ore-reserve heterogeneity on valuation calculations, (3) the distortions resulting from the constraints imposed on mineral production by associated capital and other factors, (4) the volatility in the value of mineral assets introduced by short-run price fluctuations, and (5) the differences between the market and social values of subsoil mineral assets. One of BEA's most important contributions has been to stimulate discussion and research on resource-valuation methodologies. BEA's actual findings regarding the value of reserves—stocks, depletions, and additions—should be considered preliminary and tentative until there is a better understanding of the magnitude of the distortions introduced by the various techniques. It is recommended that close attention be paid to these five important open issues.
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Implications for Measuring Sustainable Economic Growth 3.8 The initial estimates of the subsoil mineral accounts have important implications for understanding sustainable economic growth. In one sense, the major results of the initial estimates are negative. Perhaps the most important finding is that subsoil assets constitute a relatively small portion of the total U.S. wealth and that mineral wealth has remained roughly constant over time. According to the IEESA results, the value of mineral resources is between 3 and 7 percent of the tangible capital stock of the country. If other assets, particularly human capital, were considered, mineral value would be an even smaller fraction of the country's wealth. This is an important and interesting result that was not well established before BEA developed its subsoil mineral accounts. 3.9 Alternative measures, along with measures of sustainability from a broader set of natural-resource and environmental assets, will be necessary to obtain useful measures of the impact of natural and environmental resources on long-term economic growth. The mineral accounts as currently constructed are of limited value in determining the threat to sustainable economic growth posed by mineral depletion. The value of subsoil mineral assets in the United States could fall because much cheaper sources of supply are available abroad. Conversely, the value could rise because serious depletion problems are driving mineral prices up. The real prices of individual mineral commodities provide a more direct and appropriate measure of recent trends in resource scarcity than is offered by the total values of specific minerals in the mineral accounts. 3.10 The panel recommends that BEA maintain a significant effort in the area of accounting for domestic mineral assets. While subsoil assets currently account for only a small share of total wealth in the United States and do not appear to pose a threat to sustainable economic growth at present, this situation could change in the future. A good system of accounts could address the widespread concern that the United States is depleting its mineral wealth and shortchanging future generations. By properly monitoring trends in resource values, volumes, and unit prices, the national accounts could identify the state of important natural resources, not only at the national level, but also at the regional and state levels. Better measures would also allow policy makers to determine whether additions to reserves and capital formation in other areas are offsetting depletion of valuable minerals. Development of
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reserve prices and unit values would help in assessing trends in resource scarcity. Comprehensive mineral accounts would provide the information needed for sound public policies addressing public concerns related to mineral resources. 3.11 Efforts to develop better mineral accounting procedures domestically and with other countries would have substantial economic benefit for the United States. Other countries and international organizations are continuing to develop accounts that include subsoil assets and other natural and environmental resources. The United States has historically played a leading role in developing sound accounting techniques, exploring different methodologies, and introducing new approaches. A significant investment in this area would help improve such accounts in the broader world economy. Unfortunately, the United States has lagged behind other countries in developing environmental and natural-resource accounts, particularly since the 1994 congressional mandate suspending those efforts. 3.12 To the extent that the United States depends heavily on imports of fuels and minerals from other countries, it would benefit from better mineral accounts abroad because the reliability and cost of imports can be forecast more accurately when data from other countries are accurate and well designed. International development of sound natural-resource accounts would be particularly useful for those sectors in which international trade is important. Indeed, as has been learned from cataclysmic events in financial markets such as the Mexican peso crisis of 1994-1995 or the financial crises of East Asian countries in 1997-1998, the United States suffers when foreign accounting standards are poor and is a direct beneficiary of better accounting and reporting abroad. Better international mineral accounts would help the nation understand the extent of resources abroad and the likelihood of major increases in prices of oil and other minerals such as those of the 1970s. Improved accounts both at home and abroad would help government and the private sector better predict and cope with the important transitions in energy and materials use that are likely to occur in the decades ahead.
Representative terms from entire chapter: