Wednesday, July 28, 2010

A difficult valuation

Author:- Anurag Behar

The Deepwater Horizon is off the headlines, even though it continues to spew huge amounts of oil into the sea every day. Estimates of this amount have only been rising. One such estimate is that Deepwater is leaking the equivalent of the infamous Exxon Valdez oil spill every four days. The Exxon Valdez incident occurred off the coast of Alaska in 1989, and Exxon spent over $3 billion to manage and compensate for it.

It’s not surprising that the market valuation of the company that operates Deepwater has plummeted and then risen on the hope of a resolution. That company apparently distributed 10% of all dividend income in the UK last year. The UK government is said to be considering options in case the company goes bust, driven by the Deepwater liabilities.

This brings us to the issue of the “valuation” of this company (or the issue of “valuing” the effects of this accident). In the current situation, I wonder how people must be going about doing this valuation, when we don’t even have an accurate estimate of how much oil is spewing out from the collapsed rig.

To be sure, no fix to the spill has been found yet. But that’s not for want of attention or money — US President Barack Obama himself has been on the job. It’s imprudent to assume that we know how much money it will take to really fix this mess.

Then we get into the really deep waters of trying to estimate what damage the oil will cause, and how that can be mitigated. We also get to the issue of how all those hurt must be compensated. And then to the cost of restoring (if that’s possible at all) the surrounding ecosystem.

There are really smart people working on these issues, and given the stakes involved, I am sure everything is being thrown at them. It is absolutely clear to all stakeholders of that company (and many others) that some reasonable estimate of the financial effect of the incident be understood. However, it seems equally clear to me that valuing the cost and effect of the spill is very difficult, if not impossible, at present.

This difficulty is not unique to the Deepwater spill. It’s present in any exercise that tries to factor unknown (sometimes unknowable) facts, uncertain effects and consequences, and differential understanding of “value”. This is true for normal business situations, and even more so for significantly more complex ecological and social situations or systems. But the fact is that we need to understand these “valuations”.

If we are aware of the perils of such “valuation”, we cannot but admire the efforts of Robert Costanza, Ralph d’Arge and 11 of their colleagues who published a remarkable paper in the journal Nature in May 1997. This paper, titled “The value of the world’s ecosystem services and natural capital”, took on the onerous task of doing what it says.

Let me quote verbatim from the paper: “The services of ecological systems and the natural capital stocks that produce them are critical to the functioning of the Earth’s life-support system. They contribute to human welfare, both directly and indirectly, and therefore represent part of the total economic value of the planet… For the entire biosphere, the value (most of which is outside the market) is estimated to be in the range of US$16-54 trillion per year, with an average of US$33 trillion per year. Because of the nature of the uncertainties, this must be considered a minimum estimate. Global gross national product total is around US$18 trillion per year.” This was in 1997.

This dry scientific paper speaks more eloquently than anything else I have read about why we should be deeply bothered about ecology, and why we must act right away. This is simply because the value of the world’s ecology is far greater than the global gross domestic product (GDP). To a world obsessed with economies and GDP growth, the paper makes this point immediately apparent. And it should matter hugely — perhaps more than anything else.

The key issue in my view is that Costanza, d’Arge and the others have tried to “value” what we must but we don’t. Such attempts at proactive assessment of “value” are always signs of “good management” — if I can call it that in the context of managing the ecology and the earth. This approach (and this article deliberately) does not even attempt to consider issues of ethics and equity, which are inextricably a key part of all ecological issues.

That is because even the language of money, which is what we seem to understand best, voices in this paper a key concern: that we must act now, and that we must fundamentally change our approach to ecology. After all (at least), “it’s the economy, stupid”.

(This piece was published as a part of Anurag’s fortnightly column,"Other Sphere", in Mint on July 14, 2010.)