Why do we use 10% discount rate in upstream oil & gas, and 8% for copper mining projects, and 5% for gold mining projects?
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It’s mainly because of the “risk” that is present in each industry. Also the risk to reward ratio or expectations that you get in each of those industries. For example, O&G is very risky or a highly volatile market, also can be highly cyclical, therefore the discount rate is higher at 10%. Now copper mining isn’t as volatile or risky as O&G so therefore is would be moderately volatile/risky and its discount rate would be lower because of that at 8%. Now gold which is considered a very safe investment which is not volatile at all what so ever and which is also considered like the safehaven of investments because of its stability and gains during crisis, it’s going to have an even lower discount rate of 5%. Can you see a pattern here! All these industries discount rates are correlated with the risk/volatility that they present and also the risk/reward expectations. So when risk is higher discount rate is higher, when risk is lower, discount rate is lower in this scenario (directly proportional). So overall I’d say that the discount rate is mainly impacted by risk and reward expectations but also other things impact it like regulation/regulatory impacts on each industry.
I am aligned to your thought process but why precisely 10% for O&G, why not 12% or 9% ..
Simple round number and at this point is industry standard. It's all gut feeling anyway
Equity cost of capital can't be calculated using CAPM or DDM because it's a finite resource instead of an infinite going concern. Also, it's generally very difficult to value reserves so it's back of the envelope calc.
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