Transcript Structuring the natural resources conundrum

Prodipto Ghosh, Ph.D
Distinguished Fellow
The Energy & Resources institute
September 2011
The classical texts on economics in referring to
the “factors of production” speak of ‘land’,
‘labour’ and ‘capital’. However, in discussing
‘land’ they refer to the various ‘services’ and
‘qualities’ of land, rather than its simple spatial
extent.
 The third factor of production is thus,
conceptually, from the very beginning, ‘natural
resources’, rather than a more narrow
(dictionary) notion of ‘land’.

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A classification of attributes of natural
resources
Natural Resources
Depletable
Renewable
Non-Depletable
Non-Renewable
This classification is largely relevant in the context of
depletion paths (sustainability), which I do not address in
this presentation
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Some insights from natural
resource economics
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Typically, where a market valuation exists for a given natural
resource, there is a positive difference between the (long-run
average) cost of its extraction and delivery to the market,
and the market valuation.
This is the “resource rent” (also referred to in the economics
literature as “royalty”)
The extractor/user and the agent who has property rights
over the resource typically compete over this resource rent.
This competition has resulted in colonialism, and explains in
large part the continuing civil wars in Africa, and tension in
the Middle East. It is also the source of much domestic
political controversy. (2-G, Naxalism, Bhatta Parsaul), etc.
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Resource rent arises from two attributes of a
resource:
(i) Any property of a resource that gives value to
humans: (e.g. soil fertility for agricultural land, location
of urban land, carrier of electromagnetic radiation,
timber yields for forests, source of energy for wind
power locations, etc.). These sources of value arise
from markets, technology change, etc. and may vary
over time
(ii) Scarcity of the resource: No scarcity, no resource
rent (e.g. sea-water).

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In a competitive market (many potential holders
(sellers) and users (buyers), no “sunk costs”, no
externalities) if the holders resort to competitive
bidding to allocate the resource to potential users,
the holders extract the entire resource rent (as well
as maximize their return and realize economic
efficiency).
 The market output in this case is at the maximum,
and price at the minimum, among all cases.

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i.
ii.

Very often, however, the users side is cartelized (few users,
numerous holders). (This is typically the case with many
internationally traded minerals)
If (all) the holders resort to auction in such cases, there are two
cases:
“One-off auction”: The holder(s) extract the entire rent
between the LRAC of extraction and the (cartelized) market
price
“Repeated auction”: The users may collude, and reduce the
rent realized by the holders to (their perception of) the
minimum expected return of the holders.
The market outcome in these cases is lower output, and higher
price than the competitive case (e.g. global carbon market).
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If the holders side of the resource market is cartelized
(few holders, numerous users – e.g. petroleum ), no
collusion by the bidders is possible, but the holders
may collude, and the entire rent may be realized by
the holders. (In practice, OPEC pursues several
objectives, which somewhat dilute its own yield of the
resource rent)
The market outcome in this case is a resource price
that is higher than in case of a competitive market, but
the level of supply is smaller.
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Uncertainty in future demand for the resource (market
conditions, technological substitutes, etc), would result
in incentives to both sides to maximize near-term yields
of the resource rent
 Typically, users would bid less than the case with price
certainty (in each alternative market structure), and
holders would seek to set higher minimum levels of
resource rents for acceptance of any bid.
 A typical resolution to the problem is risk sharing – by
means of setting shares of the resource extracted,
rather than a specified monetary value of the rent (e.g.
NELP).

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Issues in allocating
extraction/user rights to natural
resources
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We consider the implications for sharing of resource rents
(R)between relevant agents of different policies for
allocations of natural resources to candidate users, the
price (P) of the resource (or equivalently, the good (e.g.
steel) or service (e.g.mobile telephone) which it enables),
and the quantity (Q) of resource extracted (or good/service
produced).
 The set of agents (A) comprise the resource owners (W),
(which may be several, for a given resource); the decision
makers (D) who actually make the allocation decisions
(distinct from the “owners”), (the owners and decision
makers referred to collectively as “holders” (H)); candidate
users (C); and the actual users (U) (who are allocated the
resource).
 For tractability, we do not consider uncertainty (inc. market
price, quantum of resource, extraction cost), etc. We also do
not consider the regulator of the regulated price (where
applicable, see below).

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The set of policy variables comprise:
discretionary and non-discretionary (e.g.
auctions, “first come first served”) modes of
decision-making; unrestricted market pricing or
market pricing with a ceiling of regulated tariff.
 The candidate users may be numerous or few (or
one); and similarly, the actual users may be
numerous or few (or one).
 Finally, the allocated right to extract/use the
resource may be tradeable or refundable; or
extinguished without compensation if not used.

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We also adopt the following terminology:
Resource rent under competitive conditions, no
uncertainty, R*
Resource (or dependant good/service) Price under
competitive conditions no uncertainty, P* = Long-run
marginal cost (LRMC), (which must equal or exceed
the long-run marginal average cost)
Regulated price or tariff of the resource (or
good/service) (where applicable) = T
Regulated resource rent (in Case 2) = Rr
Quantity of resource extracted (or good/service
produced) under competitive conditions = Q*
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
The effect of specifying whether or not the allocated
right to use the resource is (i) tradeable or may be
refunded with compensation; or (ii) extinguished if
not used without compensation; is simply that it
affects the basis of computation of LRMC (and
LRAC), and thereby the competitive price, P*. In the
former, the resource rent paid to the holder (i.e.
resource owner(s) and decision-maker(s) is part of
the LRMC or LRAC. In the latter, it counts as a sunk
cost, and is excluded from the computation of
LRMC or LRAC (and P*).
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
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The different policy options considered are: nondiscretionary (auctions) and discretionary modes of
allocation; and market situations where candidate
users are many or few; and where actual users are
many or few (Note: Where candidate users are few,
actual users cannot be many); and price is solely
market determined or market determined with a
regulated tariff ceiling). (Where there is no
regulated tariff, the tariff can be taken as unlimited.
The outcomes are in respect of respective shares
of the resource rent (R)to holders (H) and actual
users (U), and the resulting price (P) of the
resource (or derived good or service).
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Table 1: Outcomes in Case 1:
Market
structure
Allocation policy options,
with/without market pricing with
ceiling of regulated tariff
Nondiscretionary
(inc. auction)
Discretionary)
C=many
RU = 0
RU = 0
U=many
RH = R* if P = P*,
else R < R*
RH ≥ R*
P = P*, st P* < T,
else P = T
P ≥ P*, st P*<T,
else P=T
Q ≤ Q*
Q = Q* if P = P*,
else Q > Q*
C=many
RU = 0
RU = 0
U=few
RH = R* if P = P*,
else R < R*
RH ≥ R*
P = P*, st P* < T,
else P = T
P ≥ P*, st P*<T,
else P=T
Q ≤ Q*
Q= Q* if P = P*,
Note: Quantity Q always follows the market demand curve for the resource or
good/service, i.e. Q = F(P)
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
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
We consider that the “holders” are now segregated into
“owners” (which may be one (e.g. central government) or
several (e.g. central, state, and local/(forest) panchayat); that
there may be separate decision makers corresponding to each
“owner”, and that each decision maker has veto power over the
allocation decision.
The policy options/market situations are the same as in Case
1, plus auctioned and regulated (Rr) resource rent, with and
without specified shares for each owner.
The outcomes considered are shares of resource rent to each
owner/decision-maker, and resulting price and quantity of the
resource (or good/service).
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Market Situations
Allocation Options
Non-discretionary allocation
Single
Resource
Owner
Single
Decision
Maker
Discretionary allocation
Auction
Regulated
resource
rent
Discretionary
resource rent
Regulated
resource
rent
C=
many, U
= many
RW = R*
RD = 0
RU = 0
P = P*, st P
< T else P =
T
Q = Q*,
unless P = T
when Q =
Q(T)
RW = Rr
RD = 0
RU = (R* Rr)
P = P*, st
P*
< T, else
P=T
Q = Q*,
unless P =
T
when Q =
Q(T)
RW = 0
RD > R*
RU = 0
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
RW = Rr
[RD > 0
RU = 0
st (RD+Rr) >
R*]
P > P* st P*
<
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
C=
many, U
= few
Rw = R*
RD = 0
RU > R*
P > P* st
P*<T else P
=T
Q < Q*
unless P = T
when Q =
Q(T)
RW = Rr
[RD > 0
RU > 0
st
(RD+Rr+
RU
) > R*]
P > P* st
P* <
T, else
P=T
Q < Q*,
unless P =
T
when Q =
Q(T)
RW = 0
[RD > 0
RU > 0
st (RD+ RU
) > R*]
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
RW = Rr
[RD > 0
RU > 0 st
(RD+
RU+Rr) >
R*]
P > P* st P*
<
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
C= few,
U= few
[RW < R*
RD = 0
RU > 0 st (RW
+ RU) > R*]
P > P* st P*
< T, else
P=T
Q < Q*,
unless P = T
when Q =
Q(T)
RW = Rr
RD > 0
RU > 0
P > P* st
P* <
T, else
P=T
Q < Q*,
unless P =
T
when Q =
Q(T)
Rw = 0
[RD > 0
RU > 0 st
(RD+ RU
) > R*]
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
RW = Rr
[RD > 0
RU > 0 st
(RD+
RU+Rr) >
R*]
P > P* st P*
<
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
Market Situations
Allocation Options
Non-discretionary allocation
Multiple
Resource
Owners
Multiple
Decision
Makers
Discretionary allocation
Auction
Regulated
resource rent
Discretionary
resource rent
Regulated
resource rent
C=
many, U
= many
Sum RW = R*.
If pre-agreed
shares, each
RW in
respective
share, else
each RW > 0,
but
indeterminate
RD = 0
RU = 0
P = P* st P <
T else P = T
Q = Q*,
unless P = T
when Q =
Q(T)
Sum RW = Rr
If pre-agreed
shares, each
RW in
respective
share else
each RW > 0,
but
indeterminate
RD = 0
RU = (R*- Rr).
P = P* st P <
T else P = T
Q = Q*,
unless P = T
when Q =
Q(T)
Sum RW = 0
RD > R*
RU = 0
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
RW = Rr
RD > 0
RU = 0 st RD+
Rr) > R*
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
C=many,
U = few
Sum RW = R*.
If pre-agreed
shares, each
RW in
respective
share, else
each RW > 0,
but
indeterminate
RD = 0
RU = 0
P = P* st P <
T else P = T
Q = Q*,
unless P = T
when Q =
Q(T)
Sum RW = Rr
If pre-agreed
shares, each
RW in
respective
share, else
each RW > 0,
but
indeterminate
RD = 0
RU > (R* - Rr)
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
Sum RW = 0
RD > 0
RU > 0 st
(RD+ RU) > R*
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q =
Q(T)
Sum RW = Rr.
If pre-agreed
shares, each
RW in
respective
share, else
each RW > 0,
but
indeterminate
[RD > 0
RU > 0, st
(RD+ RU) > (R*
- Rr)
P > P* st P* <
T, else P=T
Q < Q*,
unless P = T
when Q = Q(P)

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
The intuition behind these complex tables is actually
quite simple:
Whenever there is discretionary decision making, there
is rent accrued to the decision maker(s)
Whenever there are few candidate users, there will be
collusion among them
Whenever there are few actual users, there will be
cartelized markets
Whenever there are multiple owners of the same
resource, there is smooth rent sharing if there are preagreed shares, otherwise the result may be
indeterminate.
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Issues for Policy Making
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What are the (legitimate) objectives of
policy making? Examples:
Revenue maximization?
Mass affordability of a good/service?
Process of allocation must be “fair”?
Facilitation/promotion of an “infant” sector?
In the ultimate analysis, these questions
must be resolved politically, with
Parliamentary accountability!
How the policy analyst can help?

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Identifying policy options that are most likely to
realize the chosen objectives – requires
specialized knowledge in the field!
Identifying possible perverse outcomes (e.g.
giving scope for rent-seeking) of candidate
policy options (e.g. discretionary resource
allocations)
Identifying policy options that may avoid
deadlock during implementation (e.g. prior
agreement on respective shares of resource
rent for multiple resource owners)
However, it is not within the mandate of the
analyst to choose the policy objectives!
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Prodipto Ghosh, Ph.D
Distinguished Fellow
The Energy & Resources institute
Email: [email protected]
Phone: 011-24682100
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