How US fossil fuel companies could be left holding an unexpectedly large bill #NewsMarket

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If all goes to plan for the biggest US oil companies, they’ll keep enjoying robust demand and pricing for their fossil fuel products decades into the future. There’s a chance, however, that the energy transition could proceed more quickly than they hope, meaning they’ll need to decommission assets sooner than expected. In any scenario, they’ll eventually need to pay big clean-up costs around the retirement of each individual fossil fuel site.

In their annual reports, European oil companies provide extensive detail about the assumptions they make to assess these long-term liabilities, which make a meaningful impact on their balance sheets. US energy giants, in contrast, have kept these details largely behind closed doors. And according to one group of international investors, it’s time for the regulators to step in and force greater transparency around these risks.

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Investor group pushes US energy companies for transparency on clean-up liabilities

For now, the fossil fuel assets owned by listed US energy companies are generating a healthy stream of profits. But sooner or later, each of those assets will come to the end of its useful life — triggering an expensive clean-up bill that corporate owners are legally required to attend to.

These obligations are a huge financial liability hanging over US oil and gas companies — on which they are failing to provide proper transparency in their public accounts, according to a group of international investors.

The 40 investors — a group of UK, European and US institutions controlling an aggregate $3.75tn in managed assets, organised by London-based Sarasin & Partners — wrote to US regulators this week alleging that big US oil and gas companies are breaking the rules by not properly disclosing the calculations behind the environmental liabilities they report.

The investors include major UK institutions such as Legal & General and Scottish Widows, as well as continental European ones including Denmark’s AkademikerPension and a handful of smaller US institutions including the Vermont Pension Investment Commission.

The letter to the Securities and Exchange Commission — reported for the first time here — notes that, under SEC regulations, companies must give details of the estimates and “critical accounting assumptions” that they use when calculating the assets and liabilities published in their financial statements.

It focused largely on companies’ estimates of liabilities around the legally required clean-up of decommissioned fossil fuel infrastructure. A report last December by the think-tank Carbon Tracker estimated that existing fossil fuel infrastructure in the US would cost more than $1.2tn to decommission.

The investor letter warned that the six most valuable listed European oil companies, including BP and TotalEnergies, have given far more detail on this front than seven of their biggest counterparts in the US, which include ExxonMobil and Chevron.

All the companies studied, on both sides of the Atlantic, provide an estimated net present value of the liabilities that they will face around the clean-up of their fossil fuel operations. But that present-day figure gives only a partial picture of the financial risk that the companies face.

The present-day estimate of the clean-up liabilities depends to a very large degree on two numbers. One is the estimated retirement date of the asset. The other is the discount rate used to adjust the value of a future liability (on the principle that a dollar today is more valuable than a dollar years in the future).

The higher the discount rate used, and the more distant the asset’s estimated retirement date, the lower the present-day value of the clean-up liability.

All six of the European companies that were studied provided at least some details on the expected retirement dates of their assets. And all, except Norway’s Equinor, also published the discount rate that they used to work out their clean-up liabilities (Equinor pointed out to us that its annual report provided a description of its approach, without giving a numerical figure).

Among the seven US companies, only Occidental Petroleum provided even some details on the expected retirement timing. And none of them provided the discount rate they used to calculate these liabilities.

There was a similar contrast when it came to the long-term oil price assumptions that the companies used to calculate the present-day value of their assets. All the European companies published their future price assumptions; none of the US ones did.

“It’s a bit surreal,” said Natasha Landell-Mills, head of stewardship at Sarasin & Partners. “If you read the regulation, it’s very clear that there is a requirement for companies to disclose their critical forward-looking accounting assumptions, including the actual numbers used.”

Eric Rieder, a partner and securities litigator at US law firm Bryan Cave Leighton Paisner, pointed out that while securities regulations made extensive requirements around the disclosure of “critical” or “material” information, there are constant disputes over the interpretation of these terms. “Materiality depends on facts and circumstances,” he told me.

In any case, it’s worth noting that the US companies have published much lower estimates of the present-day value of their clean-up liabilities compared with their European peers. According to my analysis of their latest annual reports, the seven US companies mentioned above reported an aggregate $38.9bn in such liabilities, worth 3.8 per cent of their total assets. The figure reported by the six European companies was $90.2bn, or 6.7 per cent of assets.

This disparity alone clearly doesn’t prove that US companies have been using unduly optimistic assumptions in their calculations. There are other factors to consider, such as European environmental regulations that are in many respects stricter — and therefore potentially more expensive for companies — than in the US. But it may lend weight to the investor calls for transparency.

According to the investor group, the US companies’ current approach is inhibiting investors’ “ability to interpret and compare companies’ financial condition and operating performance, undermining our ability to allocate capital effectively”.

The US energy companies declined to comment, as did the SEC.

Every investor will have their own expectations about the pace of the world’s transition away from fossil fuels. It makes sense that those who invest in energy companies should want some sense of how far those businesses’ assumptions align with their own.

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