If only people could be bothered to understand their own arguments, eh? Carbon Tracker tells us that the fossil fuel companies are horribly overvalued. Because we’re all going to stop using fossil fuels at some point and that means that at some point the remnant fossil fuels – and the infrastructure to extract, refine and use them – is going to be valueless. Or, perhaps, great big piles of scrap steel which does have a value but rather less than that of a pipeline being used to shift crude oil.
OK, they’re right about the basic scenario. We will stop using fossil fuels at some point, the infrastructure and companies used to produce it for us will become valueless. We’re fine so far.
Then they tell us that of course this is going to happen at some future date. OK, that’s true too. So, the correct valuation of those assets depends upon which future date and also the discount rate that we apply to valuations over time. This is all also entirely correct. Money in the future is worth less than money now – that’s why interest rates exist – and how much less depends upon what that interest/discount rate is.
We’re all entirely copacetic about this analysis so far. At which point Carbon Tracker’s analysis turns to shit. this:
If we take 2% as our starting point (based on
the petrostate approach) and then add 2%
for decline and 2% for risk, the new discount
rate would be 6%. This is 4 percentage
points higher than the aspirational petrostate
approach and two percentage points higher
than the World Bank number.
If we combine a 6% discount rate …
OK, cool, the discount rate should be 6%. That means that money next year is worth 6% less than money this, 12% (and a bit, it’s compound) in two years, 18% in three and so on and on. Something that happens in 20 years is worth spit right now. That’s just what the net present value of future money decades is today, spit, at a discount rate of 6%.
This again is fine, entirely so. A high discount rate does mean that future events have no current value. OK.
They then go on to insist that since the discount rate should be this high, 6%, that means that the fossil fuel industry should be worth near nothing now. Which is where they step in the ca-ca.
So, what did the Stern Review say was the basic economic problem about climate change? That the discount rate that we apply to future events is inappropriately high. Market interest rates are great out to, oooh, 15 to 20 years. But for things that happen further out than that we’ve got to use lower interest/discount rates. Because market interest rates make those future events worth spit right now and that’s not really true.
At a 6% discount rate – just to use an example, – the cost of all of humanity boiling to death 50 years out is pretty much nothing. And while I’m not going to last that long there’s a good chance the grandkiddies will and I’d not really think that boiling my grandkiddies has no current cost.
So, we must use lower than market interest rates in order to measure that far future.
And now to the important part. What are those market interest rates that are too high to use as a discount rate about the far future? 7 to 8% from memory.
At which point d’ye see the problem? Sense the bull pucky that Carbon Tracker have dropped themselves in? They’re saying that fossil fuel assets should be discounted at 6% and that this makes them worth less – or should – than the market values them at today. Thus the worries about a sudden collapse in those valuations. And yet financial markets already value those fossil fuel assets in the future using a discount rate higher than the one that Carbon Tracker recommends. Meaning that the net present value of those assets today is already lower than the one that Carbon Tracker thinks they should be.
That is, there is going to be no collapse of fossil fuel asset values because they’re already valued lower than the future collapse of the industry means they should be.
And d’ye know the joy of this argument? We’ve been able to reach this conclusion purely by taking that accepted science of climate change seriously. With just the one refinement. We understand it, something not vouchsafed to all too many chuntering about it. Like, you know, Carbon Tracker.