Energy Transition in Oil-Dependent Economies: Public Discount Rates for Investment Project Evaluation

Fatih Karanfil and Axel Pierru

The Energy Journal, 2024, vol. 45, issue 1_suppl, 63-88

Abstract: Selecting welfare-enhancing projects necessitates determining the present value of cash flows from a public policy perspective. For an oil-exporting economy, the domestic energy transition often implies displacing oil from domestic consumption. Economic dependence on oil affects the public discount rate for oil price-related cash flows in two opposite ways: On the one hand, it renders the economy more volatile, which lowers the risk-free discount rate; on the other hand, it increases the correlation between consumption and the oil price, which results in a higher risk premium. To study these opposite forces, we first derive the public discount rate for an oil price-related investment project. Our framework considers economic uncertainty, an oil price-related risk premium, and allows for valuing oil at its opportunity cost. We illustrate our methodology using data from a panel of 26 oil-exporting countries. The results indicate that a risk-free discount rate of 3.1% is appropriate for our panel. However, to discount oil price-related cash flows, a risk premium of 1.4% needs to be added to the risk-free rate, which yields a risk-adjusted real discount rate of 4.5%. We find significant disparities between country-specific public discount rates. Additionally, for each country, we assess the present value of reducing domestic oil consumption by a barrel per day from 2023 to 2040, breaking down the different effects. Oil-exporting countries can use our estimates for making investment or policy decisions.

Keywords: Public economics; Risk premium; Opportunity cost; Public discount rate; Oil-exporting countries; Cost-benefit analysis (search for similar items in EconPapers)
Date: 2024
References: Add references at CitEc
Citations:

Downloads: (external link)
https://journals.sagepub.com/doi/10.5547/01956574.45.SI1.fkar (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:sae:enejou:v:45:y:2024:i:1_suppl:p:63-88

DOI: 10.5547/01956574.45.SI1.fkar

Access Statistics for this article

More articles in The Energy Journal
Bibliographic data for series maintained by SAGE Publications ().