Egregiously egregious

Second, most extractive companies are valued not on their current profits but on the reserves that they hold.

No, they’re not. Can’t recall which way around this works to be honest, did the checking of it a long time ago. But between BP and Shell one has more reserves than the other. And it ain’t the one worth more either.

And as my old friend and fellow Green New Dealer, Jeremey Leggett, has long suggested, most of their known reserves are going to have to stay in the ground if the world is not to fry.

So, third, we face both a massive energy crisis and a financial one too as the enormous valuation placed on those reserves in the world’s financial markets collapses, as surely it will.

It’s Ritchie who keeps insisting we mustn’t discount to net present value, isn’t it? Which is a pity, for that’s what the stock market does, discounts the future income from a stock at the market interest rate. Note, not the gilts rate, the one applied as the discount rate to future stock market incomes – 7% is a reasonable guess here. And the NPV of income 20 years out at 7% discount rate is, well, it’s spit, isn’t it?

21 comments on “Egregiously egregious

  1. The answer you get is also rather dependent on the oil price you use, which tends to fluctuate considerably. At best, all you would ever get from this exercise is a wide range of numbers and that is before you get into the problem of guessing the capex required to reach those reserves in 15 years’ time. It’s an interesting modelling exercise but almost certainly useless

  2. WACC for oil companies is c.10% for the big ones, and a bit more for the smaller ones – factor in political risk, oil price volatility and technical risk and yes, reserves that are way out there are discounted down to very little

  3. Don’t know about bilbaoboy, but we fry most things in olive oil. So if we’re putting mundo frito on future menus, petroleum can indeed stay in the ground.

  4. What are the chances that these soothsayers are aware that petroleum has other uses than being burned in automobile engines? I am fairly sure that Mark Carnage does not know that

  5. But they want to ban plastics, fertilisers… but…. not vaseline…for some inexplicable reason

  6. Point of information: NPV over 20 years at 7% is around ¼ (doubling period at x% is ~72/x – as long as x is reasonably small). So, not much, but > spit.

  7. Chris Miller said:
    Point of information: NPV over 20 years at 7% is around ¼

    True. But it drops rapidly as the discount rate rises. At 10% (which Flatcap Army said above is a typical cost of capital for oil companies), PV of revenues 20 years in the future is only 1/8th. At 12% (adding on a bit for risk), it’s only 1/12th.

  8. The left used to say that the oil was about to run out. Now they are saying we have too much. Of course, Leggett’s role as CEO of a solar company gives him an unbiased perspective on this.

  9. @Sam Jones – I was once collared by one of Leggett’s employees/cult members at a drinks party when I worked in the oil industry, and he literally jabbed me in the chest and flecked my face with spittle as he demanded that my profitable and highly-taxed industry be taxed even more to subsidise his loss-making one

    And as people have said, petrochemicals are so mindbogglingly useful that our grandchildren will look at us disbelievingly and say “What do you mean, you burnt it all?”

  10. The *value* of the reserves is the estimated value of sales minus the estimated cost of production less taxes on the difference, discounted back to the present day at a discount rate reflecting the risk. Not quite the linear model that Tim ridicules.
    7%? YMBJ. 15% is a minimum.

  11. “we face […] a massive energy crisis”

    The world is absolutely awash in fucking oil and there’s enough coal to last 2000 years. So fuck off Spud.

  12. So, third, we face both a massive energy crisis and a financial one too as the enormous valuation placed on those reserves in the world’s financial markets collapses, as surely it will.

    You can actually hear the plaintive “please, please happen!!” from him as he bashed that out with his fists.

  13. It’s not really hard.

    If a thing is giving you a revenue stream, then you value it based on the stream.

    If it’s not, then you value it based on what you think you can get the next sucker to pay.

  14. @ Diogenes
    Actual out-turn ROI ranges from -100% to + quite a lot. It used to be that the majority of projects had a ROI of -100% because a dry well is a dead loss and many projects are written off when the analysis concludes that they are not economically viable. The top rates are when a cheap well finds a significant oilfield with subsequent appraisal wells being reuseable for production e.g, Kuwait or when the oil price jumps between spudding the discovery well and bringing the field into production – e.g. the Forties field.
    BP’s original well in Kuwait pre-WWII was still producing until Saddam invaded so its ROI must have been in the millions % and its IRR must have run into thousands %.
    That doesn’t give you much *useful* information

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