The Role of Royalties in Resource Extraction Contracts

36 Pages Posted: 3 Oct 2015

See all articles by Robert F. Conrad

Robert F. Conrad

Duke University - Sanford School of Public Policy; Duke University - Department of Economics

Bryce Hool

Singapore Management University - School of Economics

Denis Nekipelov

University of Virginia

Date Written: September 30, 2015

Abstract

The manner in which governments charge mineral resource producers has been the subject of considerable debate. In particular, there is a continuing debate about whether royalties should be reduced or eliminated, the preferred alternative then being some variant of an income-based charge such as a resource rent tax, a policy adopted in Norway, the United Kingdom and Australia. The argument for avoiding royalties is based on analyses demonstrating that royalties and other quantity-based charges distort production decisions and lead to outcomes such as high-grading and premature mine closure. We argue that it is inappropriate to infer that royalties are inefficient from the perspective of the resource owner (typically a government on behalf of society). Rather, the royalty serves a key pricing purpose and should be interpreted as the capital loss on the resource owner's balance sheet from extracting marginal reserves. We demonstrate this result under various conditions of uncertainty and informational asymmetry, using an incentive-based framework which enables us to highlight the separation of asset ownership from asset use. The principal-agent framework is consistent with the contracting problem encountered by governments who as resource owners contract with private sector firms for extraction rights.

Keywords: Natural resource taxation; optimal mining royalty; asymmetric information

JEL Classification: H21, H25, Q38

Suggested Citation

Conrad, Robert F. and Hool, Bryce and Nekipelov, Denis, The Role of Royalties in Resource Extraction Contracts (September 30, 2015). Economic Research Initiatives at Duke (ERID) Working Paper No. 195. Available at SSRN: https://ssrn.com/abstract=2668253 or http://dx.doi.org/10.2139/ssrn.2668253

Robert F. Conrad (Contact Author)

Duke University - Sanford School of Public Policy ( email )

201 Science Drive
Box 90312
Durham, NC 27708-0239
United States
919-613-7355 (Phone)

Duke University - Department of Economics

213 Social Sciences Building
Box 90097
Durham, NC 27708-0204
United States

Bryce Hool

Singapore Management University - School of Economics ( email )

90 Stamford Road
178903
Singapore

Denis Nekipelov

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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