This paper originated in an observation that there is a discrepancy between assumptions made in some areas of tax theory and the actual investment analyses conducted by the companies, in particular how tax deductions are to be treated in investment analysis.

Recently, a Norwegian government report on the cost overruns North Sea projects was presented (NOU 1999:11). It concluded that there was a 25% increase in development costs from project sanction (POD, Plan for Operation and Development) to last CCE (Capital Cost Estimate) for the 11 oil field projects investigated. Many reasons like unclear project assumptions in early phase, optimistic interpolation of previous project assumptions, optimistic estimates, and underestimation of uncertainty were given as reasons for overruns. In this paper we highlight the possibility that the cost overruns are not necessarily all due to the reasons given, but also to an error in the estimation and reporting of the capital expenditure cost (CAPEX). Usually the CAPEX is given by a single cost figure, with some indication of its probability distribution. The oil companies report, and are required to do so by government authorities, the estimated 50/50 (median) cost estimate instead of the estimated expected value cost estimate. We demonstrate how the practice of using a 50/50 (median) CAPEX estimate for the 11 projects, when the cost uncertainty distributions are asymmetric, may explain at least part of the “overruns.” Hence, we advocate changing the practice of using 50/50 cost estimates instead of expected value cost estimates for project management and decision purposes.

Many socioeconomic rates of return for climate projects have been used in analyzing the present value of the climate benefit. However, little attention has been devoted to profitability assessments based on commercial considerations. The economic valuation of climate projects, seen from the perspective of a commercial company, is the subject of this article. In particular, we examine the required rate of return for a project in which the uncertainty in the carbon dioxide CO 2 ) quota price is the main market uncertainty. We complement the existing climate literature by examining the required rate of return of a climate project in a Capital Asset Pricing Model (CAPM) setting. We find that the CO 2 quota price has a slightly more systematic risk in the period calculated than that in the oil price, and we estimate the nominal required rate of return for the value of CO 2 reduction to be 7.3 percentage points, which is similar to petroleum projects. Our findings may explain why it is difficult for oil companies to justify climate projects in their portfolios.

When evaluating new investment projects, oil companies traditionally use the discounted cashflow method. This method requires expected cashflows in the numerator and a risk-adjusted required rate of return in the denominator in order to calculate net present value. The capital expenditure (CAPEX) of a project is one of the major cashflows used to calculate net present value. Usually the CAPEX is given by a single cost figure, with some indication of its probability distribution. In the oil industry and many other industries, it is a common practice to report a CAPEX that is the estimated 50/50 (median) CAPEX instead of the estimated expected (expected value) CAPEX. In this article, we demonstrate how the practice of using a 50/50 (median) CAPEX, when the cost distributions are asymmetric, causes project valuation errors and therefore may lead to wrong investment decisions with acceptance of projects that have negative net present values. r

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