• Uncertainty can be good or bad
  • Net zero is the bad sort
  • The price of net zero isn’t showing up in the stock market

No doubt you’ve gotten mighty sick of hearing it after the Brexit referendum. Business leaders complaining about “uncertainty” would’ve seemed like a mantra, or even a political slogan…

Today, we dig deeper to examine the nature of uncertainty and how you are ultimately paying its price. Then we’ll apply our newfound knowledge to the greatest source of uncertainty today, perhaps ever, in net zero.

The idea behind uncertainty is that it defines the range of possible outcomes, or their relative probabilities. This needn’t be bad. Uncertainty can be on the upside too.

Explorers for resources, for example, risk finding nothing or something. The upside is almost unlimited, the downside is limited to not finding anything.

Given this, it’s not obvious that uncertainty is inherently a bad thing. Brexit uncertainty could’ve been about the extent to which we improve business conditions in Britain… could’ve.

In fact, given that all investments face uncertainty, with even cash facing the uncertain risk of inflation, investors are really looking for uncertainty when they decide how to allocate their money.

However, in their endeavours to develop a potential resource, mining explorers nevertheless attempt to reduce uncertainty. A key task dedicated to this is infill drilling – drilling between previously successful exploration holes. The idea is to confirm that the previous results weren’t just a lucky strike. For investors to be willing to fund a mine, they need to know with a high degree of certainty that the ore really is there.

Why do this? Why not persist in the dream of a firm possibility of a definite maybe that you’ve struck the motherload based on a single drill hole?

Because uncertainty reduces the value of an investment. Most investments, anyway. Some actually profit from greater uncertainty, such as options, but this is a purely financially speculative asset, not an economic one.

The reason why uncertainty reduces value is that people are risk-averse. We fear the downside more than the upside. We fear losing money more than gains. It is, after all, our hard-earned money… or someone else’s… that’s at stake.

And so, when uncertainty goes up overall, we tend to focus on the risk of a loss, not of a gain. Indeed, most people see the word “risk” as having only negative connotations. However, in financial markets, it is considered to be almost synonymous with reward. The presumption being that the risks are reflected in the price, making more risky investments cheaper and thereby more lucrative if they pay off.

All that said, just as uncertainty can be focused to the upside, the sorts of uncertainty we face can also be focused on the downside. For example, there’s political risk. It’s not exactly likely to work out in an investor’s favour…

This was best explained by Allison Pearson in the Telegraph:

Steven, a Telegraph reader who has worked as a geologist around the North Sea for a quarter of a century, says that new investment has been scared off by the EPL (Energy Profits Levy, the additional 35 per cent on oil and gas profits imposed by Chancellor Jeremy Hunt).

“Before the EPL, my company ranked the UK below Pakistan on the above-ground (political) risk,” says Steven, “Not any more. Our economic models play out over 20 years. You simply cannot change taxes halfway through the game.” Steven says the UK is now “completely uninvestable”.

Ah, yes, uninvestable.

The trouble with the sorts of investments that Steven is referring to is that they actually create wealth rather than just shuffling it around. Most people buy stocks and bonds from someone else on the market. But when companies raise money and invest in a new project, it creates value… or the company goes bust. Assuming the project’s developers did their numbers right, the money that goes into the project will be less than the value created by it. That’s why profit is a good thing – it signals that what the company is doing is creating something worth more than the cost of what went into it.

Without such wealth-creating projects, we run out of wealth, jobs, and whatever is being produced.

Of course, it’s difficult to predict the future. Over the course of long projects like mining or oil wells, a lot can happen. Which is why companies apply a margin of error to their calculations before deciding to go ahead with a project and funding it.

If a project doesn’t meet the expected required returns, it is never attempted.

What do you think an increase in uncertainty does to this margin of error? What is the effect on marginal projects that may or may not be worth funding?

You might not have to wonder because even the green dream’s investors are discovering it the hard way. Unrealistically low prices at the UK’s recent energy auction mean that no bids were submitted by offshore wind developers. The Telegraph has more:

Offshore wind farm developers are delaying non-essential work on UK projects after a government renewables auction flopped, with industry sources warning they may be forced to wait until after the next election to get schemes moving again.

“Uncertainty” even got a mention:

The cloud of uncertainty has spooked developers, who warned there was now little chance the UK will reach its target of 50 gigawatts of offshore wind capacity by 2030.

One executive said: “The target is a joke now. Ministers just haven’t got it. They don’t realise how fundamentally serious the situation is.”

All of this is, of course, precisely what you’d expect from a government auction. Especially after renewables advocates have been telling us how cheap wind energy is. But it’s still going to be a pain in the neck for future power prices and thereby all of us.

It’s also worth remembering that companies tend to have capital and a range of choices on how to invest it. It’s a relative and comparative game. Raising uncertainty in one country relative to others means investment will be done elsewhere instead.

Which brings me to the real point of discussing uncertainty in such detail. You see, a good chunk of the world is embarking on the drive towards net zero. This has created rather a lot of uncertainty for a long list of reasons… not the good sort.

Because the energy transition seems to require vast amounts of government intervention, despite claims that it’ll be economically beneficial, net zero creates the wrong sorts of risks for many companies. Risks that only have downsides.

We’re talking taxes, rules, mandates, price controls, bans and all sorts of other reasons not to invest in future projects across the economy. Take for example housing. It’s a risk to build houses today that may not comply with future requirements. So why do it?

As I discussed on Monday, governments and their thinkers have been busy coming up with a long list of ways to make your life more miserable. They want to impose all sorts of “choices” on you. Your stove, your car, what you can eat and drink, your ability to travel and so on and so forth are all on the chopping block in the name of net zero.

This creates rather a lot of negative uncertainty.

The good news is that this is then priced into financial markets. If combustion engine car bans are going to be imposed, that will show up in the stock market prices of car makers. If flights were going to be rationed, or worse, that’d show up in the share prices of airlines. Investments become cheaper for us to buy.

However as I considered in Friday’s Southbank Insider, a publication that all subscribers to one of our paid newsletters get, it seems that financial markets are simply not buying into net zero ever materialising… literally.

If net zero had any chance of getting off the ground, the resources that would be in short supply would be soaring, for example. Wind farm producer’s stocks would be flying, but the opposite has happened instead. The point being that markets are pricing in a future where net zero was nothing more than a political promise.

The uncertainty, however, remains. Who knows what hare-brained schemes the government will come up with next?

What does all this mean for you? It’s time to insulate yourself as much as possible from the rather long list of uncertainties we all face.

Until next time,

Nick Hubble
Editor, Fortune & Freedom