On this idea of stranded fossil fuel assets


We were really very surprised indeed to see this assertion being made:

Fourth, in a fast-changing, post-Paris world, we need a real focus on assets. Oil companies are valued on their reserves: but as clean energy technologies such as solar and wind become cheaper and better, how many of these will ever be extracted? To hit climate change targets, an estimated 80pc of the world’s fossil fuel reserves have to stay underground.

That's from Nigel Wilson, who runs L&G, the UK's largest equity investor. And what surprises us is that it's self-evidently wrong. And yet it's also a very popular view: Mark Carney at the Bank of England has been known to sign on to it. The implication being that if the world won't use fossil fuels off into the distant future, the oil companies have reserves that won't be used in that distant future, therefore the oil companies are worth much less than the market currently says. So, of course, sell now!

But it is, as we say, self-evidently wrong. Shell's reserves look like some 6 billion barrels, BP's some 17 billion. Shell is currently valued at $130 billion odd, BP at $64 billion. We're just not seeing the connection there. With oil at $40 a barrel those valuations should be more like $250 billion and $680 billion.

And it's not even true in theory that the oil companies should be valued at the current oil price times their reserves. That is, even if we do try to value them by their reserves. Rather, they're to be valued at the value of those reserves discounted to net present value using the market interest rate.

A reasonable guess at the market interest rate is the yield on stocks, some 4-5% or so at present perhaps. So, discount something of value in 30 years time to the net present value at a 5% interest rate and......it's worth absolutely nothing today, isn't it, to any reasonable level of accuracy?

This does of course speak to the whole point of Lord Stern's Review. We humans are subject to hyperbolic discounting: we discount things in the far future too much. This is why we must use special, lower than market, interest rates to think about said far future. But if we are going to do that with one part of said future, the damages from climate change, then we really do need to use the same technique when thinking about other parts of that future, the values of reserves. Or, alternatively, we could acknowledge that that discounting at market interest rates has made the future value of those reserves spit in terms of today's corporate valuations and thus the worries over stranded reserves is simply because no one is understanding the settled economic science about climate change.

We are strongly persuaded that it's that latter. For we know that it's terribly unfashionable to do so in either political or agitating circles but we are prepared to take those economic arguments seriously in all their implications. Not to assert that they are correct you understand, but to think through what they are telling us if they are correct.

And if Lord Stern is correct about discount rates, which he is in theory as all economists agree even if there's all sorts of arguments from Nordhaus, Tol, Dasgupta, Weizman and the rest about the details of exactly what the rate should be, then there simply cannot be a problem with the value of far future reserves being incorporated into current fossil fuel company valuations. The assertion that we suffer from hyperbolic discounting means that the net present value of the far future is near nothing: and if the assumption of hyperbolic discounting is not true then climate change is something we should do absolutely nothing about at present.

It is, of course, entirely possible to believe in both: both that we must expend great effort today to deal with climate change and also that the oil companies are grossly over valued for the same reason. It's obviously possible because large numbers of otherwise sensible people do believe it. It is not however logical or reasonable to believe in both at the same time.