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Open thread August 13, 2013

Dan Crawford | August 13, 2013 7:32 am

Tags: open thread Comments (2) | Digg Facebook Twitter |
2 Comments
  • Jan Galkowski says:
    August 13, 2013 at 5:37 pm

    The 4th May 2013 print edition of that remarkable publication, THE ECONOMIST, features an article titled “Unburnable Fuel”. (See http://www.economist.com/news/business/21577097-either-governments-are-not-serious-about-climate-change-or-fossil-fuel-firms-are … PAYWALL.) It describes the risks to energy companies and their investors should their reserve replacement ratio drop below unity. It asks questions about whether energy company prices are therefore being properly set by the market, truly representing total risk.

    Among the arguments advanced by the report is that markets are pricing energy companies as if all their reserves will be burned, irrespective of the protests to the contrary by the energy companies that they are steadily marching towards a green future. An explanation offered is that markets see no evidence of strong government action to the contrary, that is, towards limiting fraction of reserves that will be burnt, and, so, see no constraints on these. There are reasons advanced for why securities regulators should demand more visibility of this risk as might credit rating energies. But the conclusion is that as long as public policy and markets don’t embrace risks of climate disruption, there’s little motivation for following through by regulation or credit assessments.

    Irrespective of opinion one way or another, I was intrigued by the interrelationship between market perception of risk on this point and the market’s perception of likelihood of government action. There are two cases.

    If I am an investor and I believe the energy companies to be mispriced, how will I rate likelihood of government action?

    If I am an investor and I believe the energy companies to be properly priced, how will I rate likelihood of government action?

    I may consider, for example, likelihood of government action to be independent of whether or not energy companies are properly priced. That means, my judgment of proper pricing is based upon factors other than government action.

    If, on the other hand, the likelihood of government action — or inaction — is strongly dependent upon whether or not companies are properly priced, the analysis is interesting. There are four subcases.

    One, if the companies are actually improperly priced and the government acts.

    Two, the companies are improperly priced and the government does not.

    Three, the companies are properly priced and the government acts.

    Four, the companies are properly priced and the government does not act,

    Government action when companies are improperly priced would cost me money as an investor, realizing the risk, so, rationally speaking, I would not be in favor of it. Government action when companies are properly priced would also cost me money, since reserves could not be burnt that are part of my future profits.

    If the government does not act, the only risk I have as an investor is if something else concretizes the risk of improper pricing of the companies, assuming that is the case.

    Therefore, I might simply sit tight, work against government action, since that causes me a loss, and hope that the Fates don’t make the dice roll of improper pricing come out as long as I hold the asset.

    Thoughts?

  • Jan Galkowski says:
    August 13, 2013 at 5:49 pm

    Quick follow-up to the above: If, instead of maximizing my returns as an investor for the period I intend to hold the assets of energy companies, I also see my role and responsibility as imposing fiscal discipline upon the companies I co-own, I wonder how the arguments above would change ….

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