When reaching a conclusion on damages, tribunals often have to make assumptions about the likely outcome of future events. Expectations about future financial performance, for example, determine the value of an expropriated business or a breached contract. In turn, those expectations may depend upon expectations about several further factors.
In the case of an early-stage oil field, for instance, they might depend on the cost and likelihood of discovering oil, the potential size of any oil discovery, the costs of extracting the oil and the prices at which the oil might be sold. For example, one might assume that 10m barrels of oil will discovered in 18 months’ time following capital expenditures of $100m, that the oil may be extracted for a cost of $30 per barrel and that oil prices will increase steadily with inflation from their value today.
When those assumptions embody uncertainty, as here, tribunals often seek guidance from expert opinion. Often, an expert will consider, first, the range of potential outcomes and then seek to adopt the most likely outcome, or a probability-weighted-average outcome, as their assumption. When one or more “best estimate” assumptions are adopted, the result is a single, “deterministic” set of cash flows that reflect their influence.
In principle, the degree of uncertainty surrounding the assumptions underpinning a set of cash flows might be reflected in the choice of discount rate. All else equal, a higher discount rate is associated with greater uncertainty and a lower present value for a given set of cash flows.