MONDAY, JANUARY 24, 2011
Ian Fraser: Myopic Metrics and Blind Alleys for High Finance – and Big Oil, too (Naked Capitalism)
By Ian Fraser, a financial journalist who blogs at his web site and at qfinance.
Hitching your wagon to flawed or “dozy” metrics is never a particularly good idea. We saw this in the build up to the global financial crisis. RBS’s obsession with earnings growth, whilst paying no attention to return on capital, is just one idiosyncratic example; spurious “credit ratings” of structured products are another, and pervasive. It was financial institutions’ blind faith in flawed metrics, and their penchant for burying risk, through the use of deceptive risk models such as Value At Risk, that, as much as anything else, encouraged a generation of bank CEOs to lead their institutions over a cliff.
Equally flawed metrics are now driving risky, and indeed sometimes even desperate, behavior in the oil and gas sector. Campaigners suggest that investors’ and analysts’ obsession with certain flawed indicators is driving international oil companies such as Shell BP, Total and ENI to take environmental, political and financial risks that are likely to blow up in investors’ faces – indeed in all of our faces (they already have in the case of BP’s disastrous Deepwater Horizon spill).
According to a report by Massachusetts-based Oil Change International, Platform, and Greenpeace, “Reserves Replacement Ratio (RRR)” – the rate at which production was replaced by new oil discoveries – is the most pernicious indicator of all.
RRR measures the volume of proven reserves that company adds to its reserve base in a given year, relative to the amount of oil and gas it produces over the same period. The yardstick is widely used by analysts and investors, to the extent that an oil company is deemed to be “successful” if it consistently keeps its RRR above 100% (i.e. it is replacing more oil and gas than it is producing), but a failure if its RRR is below 100% (i.e. it is failing to replace depleted reserves and will eventually run out of oil).
RAD FULL POST HERE
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