If only the people who rule us actually knew anything


Hayek pointed out that it's impossible for the centre to have enough information to be able to plan the economy. In one sense therefore, to find that our rulers are ill informed is consoling: Hayek was in fact right. In another it's not so good, for they will insist on gabbling on about things they really don't understand. Today's example is Tim Yeo:

Yeo believes fossil fuel companies must prepare themselves for a different kind of low carbon world.

“There may well be national [carbon] performance standards. There may well be caps everywhere. We now have a nuclear non-proliferation treaty, we may have then a coa-fired power station non-proliferation treaty and you can monitor these things externally.

“Or we may have a carbon price at $50 and investors think ahead so they think the world will have to be a low carbon one in the 2030s and pension funds with 25 year time horizons must take this into account. So the oil companies and the gas companies have to recognise this.”

OK. And here is the head of Shell indicating that they know this.

There’s much to do if we are to build a lower-carbon, higher-energy future. For Shell’s part, we wholeheartedly support the World Bank’s recent call for a carbon price to be applied throughout the global economy. Carbon pricing is one vital step, but there’s a long road ahead. To build the energy future we need, government, business and civil society must work together. With the right approach, one characterized by pragmatism, it can be within our reach. And, as CEO, I am determined that through our production of natural gas and our efforts to advance CCS, for example, Shell will continue to play our part.

Further, Shell has made it very clear that they already apply a carbon price in their evaluations of future investments (the only place that it's of any importance, sa projects currently producing are of course sunk costs).

So that Yeo ill informed in the specifics. But he's also ill informed in theory as well. He's getting very het up about the idea of "stranded reserves". This is the idea that the reserves that the oil companies are thinking about pumping up in 30 years' time never will be pumped up because of those climate change worries. Therefore those oil companies must recognise that risk on their balance sheets today. Write down the future value of those reserves perhaps. Which is simply an idiot thing to say.

Because we've had that whole dang report from Lord Stern discussing exactly this point. In which he goes on for several chapters pointing out that we shouldn't use market interest rates to measure the costs of something far in the future. OK, so, great, we don't when we talk about the costs of climate change. For if we did then those future costs would be, in he money of today, so small that we'd never do anything about it all. OK, make up your own minds on what you want to think about that.

But look at what that means about the values of those future reserves. We are discounting them to their present value at market interest rates. Because, obviously, we're valuing Shell's shares not at the value of those reserves in 30 years time but at the net present value discounted by market interest rates. Thus the value of those future reserves as contained in today's Shell price is piffle. Near nothing, because as Stern pointed out, discounting at 30 years and more at market rates makes something worth near nothing.

Thank goodness we don't have a planned economy, eh, given then knowledge held by those who would be doing the planning.