Stock market valuations being another thing he doesn’t understand

Despite this whole rafts of the stock market are valued not on what extractive industries companies actually do but on what their reserves are.

It’s not in fact true that they are valued on their reserves. Just isn’t.

But there’s a more important point which such a campaigner as the Spud should grasp. The central problem as revealed by Nick Stern is the discount rate. At what interest rate do we discount future events? As Nickyboy pointed out, if we use market interest rates than things which happen decades out have near to no net present value. The damages from a 70 metre sea level rise as Antarctica melts in 2,500 AD have a value of about tuppence today. and that really cannot be quite right thus we should use a lower discount rate to value far into the future events.

But note that when we do value reserves of extraction companies we do not use the lower and Stern approved social discount rate. We use the market interest rate. No, that’s not the yield on gilts either. It’s the stock market rate – something much more akin to 5 or 7%. And if we discount, say, oil reserves at 7% out to 50 years we get a net present value of spit.

That is, anyone who actually understood the climate change argument could not possibly argue that fossil fuel companies face an imminent collapse in valuation because future reserves will be stranded.

But Spud does so argue.

10 comments on “Stock market valuations being another thing he doesn’t understand

  1. Also worth pointing out, despite my receiving one ever couple weeks, there’s no such thing as a “stock market valuation” worth spit in the sense he’s talking about. They’re just a snapshot of confidence in a market. You could wipe 25% off the index tomorrow & it’d make bugger all difference to anything apart from in those quoted companies who invest in shares of other companies. Investment trusts, insurance whatever. Certainly have zero influence on the resource dependent sector. RTZ would be exactly the same company at 2758 as they are at 3638

  2. Bis nails it. Demand for iron ore drives activity in RTZ. So if the index tanks but demand for iron ore holds up, investors pile into RTZ and drive the price to some multiple of expected earnings in some short term time frame

  3. Exactly, Diogenes. The market’s valuing RTZ & its resources against the prospects of Anne Summers’ new line in anal vibrators. The market doesn’t care what companies do for a living.

  4. The value of a share is essentially the discounted value of expected dividend payments – which is why for large oil and gas companies like BP and Shell maintaining the dividend is so crucial that they’ve been borrowing for the last few years to maintain payouts.

    Speaking as someone who spent quite a few years writing economic models of oil fields and associated taxation, I’d say that the discount rate used will be the market rate plus a risk premium – 10% is not uncommon to value Proved reserves, then for Probable and Possible reserves you can either multiply the income stream by a risk factor OR apply a premium to the discount rate to achieve a value. Different companies use different methods to assess the value of a cashflow, which is why being at the centre of a bidding battle on an asset and watching the variability of prices becomes so fascinating

  5. The other thing the LHTD doesn’t factor into his badly written article is petrochemicals – yes, we almost certainly are at or about peak demand for fossil fuels for transport and power (as PV becomes cheaper and commoditised we’ll suddenly find that we’re paying for transportation and storage of the power) but we don’t have *any* suitable alternative to plastics right now. We may get one, who knows, all it takes is some little sod beavering away at the interface of chemistry and materials science to come up with a breakthrough and BAM. But for now, not a hope. So the companies will keep producing, and refineries will see the value of their various product streams flex dramatically as we become oversupplied with fuels that have no application.

  6. Flatcap, that is one of the many things that make me roar with laughter at the people who talk learnedly about stranded assets, while sitting on a vinyl chair, surrounded by a myriad of plastic products.

  7. No doubt your work’s very interesting to those determined to invest in the oil sector, Mr Capp. As a comparator for companies in the sector.
    But one can’t get round that actual share values are the result of market forces operating on all shares trading in that market. As in: Is the oil sector a better prospect than the home entertainment sector?

  8. M’Lud, I bet that our friend Rocco is planning how to employ them in his next opus, which is set to include both Diane and Polly…:(

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