Is the Paris Agreement credible?

In the blog last week I suggested that the credibility of the agreement reached in Paris last weekend on climate change should be judged by what happened to the share prices of oil and gas producers following the announcement of the agreement – or at least following the first indication that such an agreement would be reached. If the agreement really signalled a switch away from oil and gas based economy, we could expect to see a significant fall in these share prices. What we actually saw was a fall of only some 3.6%. See the chart below:

oil and gas index

Oil and Gas Producer’s index (NMX0530)

Under capitalism bad news tends to hit unexpectedly[1] – or at least it comes as a surprise to the Nobel Prize winning economists and bank regulators who provide capitalism’s high priesthood. Under capitalism when problems are clearly predictable, they are, however, discounted at the so called “cost of capital”. This is the long run average return investors expect to rake in and is estimated by the priesthood to be about 5% per annum before inflation. Thus a cost, or loss of profits, occurring in 20 years time would be currently valued by markets at only 38% [2]of the eventual cost in real (i.e. inflation adjusted) terms. Thus it could be argued that the observed 3.6% drop in share prices actually represents around a 10% drop in profits in 20 years time. But a fall in oil companies’ profits of only 10% by 2035 is hardly consistent with a target ceiling for global warming of 1.5 degrees centigrade and a new goal of net zero CO2 emissions by the second half of this century.

Conclusion: stock markets think capitalism is incapable of delivering the Paris Agreement. So do I. We need to replace capitalism.

Happy Christmas, everyone!

 

[1] In the past such crises tended to happen every fifteen years or twenty years, but the dot.com bubble bust in 2000 followed by the bank bust in 2007 suggests that such crises are now occurring more frequently.

[2] 1.05-20 = 0.38

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