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Shadow of doubt - Key messages can get lost because it is human nature to dislike uncertainty

02/01/2014

Ian Kelly

Ian Kelly

Fund Manager, Equity Value

Did you know it is possible to forecast to the nearest pound by how much the average domestic energy bill will have risen over the course of the next 17 years? Well, no, of course it isn’t – yet you might be forgiven for thinking that if you glanced at the ‘key facts’ on page four of last month’s report by the National Audit Office (NAO) into the impact of infrastructure investment on consumer bills.

£221 apparently – not £220 or £222 – is the “estimated increase in the average household energy bill between 2013 and 2030 in real terms”, according to the NAO. To be clear, that is the year 2030 and not 8.30pm on the 24-hour clock – although, frankly, The Value Perspective has little faith even that short-term a forecast could be made with much accuracy.

To be fair to the NAO here, it is to some extent a victim of human beings’ inbuilt dislike of nuance and uncertainty so that they will cling to the black-and-white certainty of a headline number – as the £221 figure has been seized on by politicians and the media in this instance – even when the high degree of uncertainty involved is actually acknowledged by those making the forecast.

A chilling example of this – and now a textbook one too, thanks to a paper by Yale professor Edward Tufte – relates to the fatal last flight of the Columbia space shuttle in February 2003. The shuttle, which earlier in its mission had lost a foam insulating panel, was destroyed while re-entering the earth’s atmosphere, killing all seven of its crew members.

Engineers at NASA had identified the potential dangers of the damaged shuttle attempting re-entry and also acknowledged the uncertainties involved in their analysis. However, the central message was compressed, simplified, corporatised and ultimately lost through layers of bureaucracy and poor communication – with tragic consequences.

Back with the NAO, we find it has based its findings on model forecasts from the Depart of Energy and Climate Change (DECC). This is despite noting “weaknesses” in the DECC’s “quality assurance of its models” – not least, “The Department has not carried out a detailed assessment of the performance of its business critical model’s forecasts against actual outcomes during the period since its development.”

In other words, neither the DECC nor the NAO has any idea how good these untested forecast models are, which is about as damning an indictment of any figure that relies upon them as one could get. Also, the DECC’s forecasts of what the gas price might be in 2030 – something that seems pretty crucial for any calculation in this context – varies from a low of 42p to a high of 105p.

Another way of thinking about energy prices 17 years from now is to consider what has happened over the preceding 17. Since 1996, for example, as the chart below shows, the price for a watt of solar-generated electricity has plummeted from a shade over $6 (£3.68) to 74 cents – and there are all sorts of smart people out there working hard on reducing the cost of solar power still further.


Source: As at December 2012

Meanwhile, scientists in the US are claiming it will soon be possible to raise the energy efficiency of solar cells from a broad level of around 15% to nearer 50%. We could go on but just think about how difficult it is to predict what inflation will be in the coming year let alone over the next 17 and, if it was not already, the pointlessness of calling a £221 rise in energy prices by 2030 should now be apparent.

Author

Ian Kelly

Ian Kelly

Fund Manager, Equity Value

I joined Schroders European equity research team in 2007 as an analyst specialising in automobiles. After two years I added the insurance sector to my coverage. In early 2010 I moved into a fund management role, and then took over management of two offshore funds investing in European and Global companies seeking to offer income and capital growth. 

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