In December 2023 Alberta’s Auditor General, Doug Wylie produced a report on his opinion on the Government of Alberta’s Consolidated Financial Statements, The report identifies in the matters which, in the professional judgment of the Auditor General and his staff (OAG), were the most significant matters raised during their audit work.
These matters were the
- Accounting for environmental liabilities
- Implementation of the new public sector accounting standards related to asset retirement obligations,
- financial instruments, and
- foreign currency. (OAG, December 2023, p. 15).
This post focusses on environmental liabilities.
Background
Alberta’s financial statements are released by the end of June each year by the Finance Minister and the OAG’s audit objective is “to provide reasonable assurance that the consolidated financial statements are free of material misstatement and are presented fairly in accordance with PSAS” (Public Sector Accounting Standards). The unqualified opinion means that the financial statements are free of material misstatement and presented fairly in accordance with PSAS (OAG, December 2023, p. 18).
This new report is the result of requirements for the OAG to report Key Audit Matters (KAM). KAMs are matters of “most significance” in the audit of the financial statements. The purpose of KAMs is to “enhance the communicative value of the auditor’s report by providing greater transparency about the audit that was performed” (OAG, December 2023, p. 18).
At the end of March, the Government of Alberta (GOA) recorded $117-million in environmental liabilities a rounding error in terms of the province’s financial operations. According to the OAG, the nature of the risk to the financial statements includes:
- a significant number of sites where responsibility for who will do the work and/or costs of required work to protect people and the environment have not been established;
- weaknesses in GOA’s processes to provide information about environmental liabilities; and
- significant interpretation of environmental law and standards to determine who is responsible to do the work when private operators will not do the work or no longer exist; and
- it requires significant expertise to assess the nature and extent of contamination ((OAG, December 2023, p. 20).
The first risk, in my judgment, is the most problematic. As it has become evident, smaller producers’ liabilities are larger than the economic value of their producing wells (e.g. Trident, Redwater, Sequoia bankruptcies). The GOA and the Alberta Regulator (AER) have taken a hands-off approach to forcing companies, of all sizes, to set aside realistic amounts of money to provide for end of life remediation.
In a recent paper by Drew Yewchuk, Shaun Fluker, and Martin Olszynski from The University of Calgary’s School of Public Policy, the co-authors examine the 2020 environmental liability management framework for addressing inactive and orphan wells.
This question goes directly to the heart of the OAG’s concern over who is responsible for environmental clean-up. The AER assesses the liability for these wells and associated infrastructure at $58-billion, $30-billion of which is conventional oil and gas assets.
In 2018 internal AER documents leaked to the media showed estimated existing closure liabilities for the conventional oil and gas sector alone of $130-billion including collector pipelines (Yewchuk et al, p. 6). These numbers, even the official, lower estimates are not rounding numbers for the province. Over the past decade the OAG has been increasingly persistent in highlighting this problem including the requirements for financial security pledged by oilsands operators.
Reliance on judgment and expertise can be subjective
Doug Wylie’s analysis of this subject relies, in many respects, on his 2021 report to the Legislative Assembly. In this report,
Wylie observes:
Accounting for environmental liabilities is complex and requires significant judgements on experts and the province’s environmental regulatory system (OAG, December 2023, p. 21- emphasis added).
Judgment and reliance on expertise means that officials have discretion, perhaps wide discretion, as Yewchuk et al say about the AER, to determine an appropriate number. As shown below one of the concerns of the OAG is having sufficient information to make these judgments. Relying on expertise is also a challenge because all expertise is ultimately subjective with bias creeping in. Expertise also heavily depends upon measurement but there may be debates in the scientific community about what measures are appropriate and the best way to achieve accurate measurements. Standards for measurement are increasingly being set either in accounting or engineering and the independence from corporate interests of standards setters is often up for debate.
The Government of Alberta’s (GOA) public servants are required to “prepare a best estimate of the costs necessary to remediate and reclaim a site to an appropriate level for its specific use as well as the costs for any post-remediation operations, maintenance, and monitoring activities.” Sites where the GOA is directly accountable for remediation include the Swan Hills and gravel and sand pits. This is where the rounding error $117 million figure in the unqualified financial statements comes in.
The Auditor General notes that the polluter pay principle places the onus on private operators and the industry-funded Orphan Well Association Fund to clean up their sites. In recent years, most of the money that has been used to clean up the industry’s mess has come from the federal government ($1-billion as part of a COVID-19 employment program) and over $500-million in loans from the the federal government and provincial government (both the Notley and Kenney governments loaned funds).
In fiscal 2017-18, the OWA entered into an interest-free loan with the GOA allowing the OWA may borrow from the Province to a maximum aggregate amount of $235-million. The outstanding balance of this Provincial loan is repayable in quarterly instalments of $7.55-million through to January 1, 2027.
In fiscal 2020-21, the loan agreement was amended to allow the OWA to borrow an additional $100-million interest-free. This $100-million loan is repayable in quarterly instalments of $6.25-million commencing on January 1, 2028 until October 1, 2031.
In fiscal 2020-2021 an interest-free loan arrangement with the Government of Canada allowed the OWA to borrow $200-million. This loan is repayable in quarterly instalments of $12.5 -million from January 2032 until October 1, 2035. (Orphan Well Association, Annual Report, 2021-22, pp. 33-4).
This loan program is another subsidy to the fossil fuel industry since the province and federal governments have had to borrow the money and pay interest at market rates for this debt. It remains to be seen how much the OWA will pay back to the government.
At the crux of the problem is the interpretation of environmental law and standards to determine who is responsible to do the work when private operators will not do the work or no longer exist. This issue is not just a problem with oil and gas sites and pipelines but includes legacy sites from coal mines, wood treatment facilities, and sand and gravels pit where operators no longer exist and where there is no backup agency like the OWA to remediate at industry, and increasingly government, expense.
Public Sector Accounting Standards requires the province, where it has not reported a liability, to disclose if the responsible party is unknown or a reasonable cost estimate cannot be made.
Note 8(e) of the consolidated financial statements reads in part
CONTINGENT ENVIRONMENTAL LIABILITIES
The Province recognizes liabilities for contaminated sites (Schedule 12) when the Province is responsible or has accepted responsibility for remediation of the sites and the cost of remediation can be reasonably estimated…. This includes determining the nature and extent of contamination, who is responsible to clean up the sites, if needed, and still developing remediation plans with reasonable costs estimates to complete any required work. The Province’s ongoing efforts to assess contaminated sites may result in additional environmental remediation liabilities related to newly identified sites, or changes in the assessments or intended use of existing sites. Any changes to the environmental liabilities will be accrued in the year in which they are assessed as likely and measurable (GOA, Consolidated Financial Statement, 2022-23, p. 52- emphasis added).
Credit rating agencies must be vigilant
But what the note does not give is any estimate of the dollar range of the liabilities or the magnitude of the buildup of the problem which has sped up in the past decade. Readers of these statements, like the credit rating agencies and investment professionals probably would like to know as well as students of public finance. For example, it might be useful to know if there any GOA database which identifies wells and sites where legal responsibility has not been sorted out.
This is why it is so important for credit ratings agencies to do their homework on this subject because as noted these liabilities are potentially greater than the province’s outstanding direct debt of nearly $94-billion as at the end of last March. Indeed, the liabilities of the conventional industry are nearly matched by the oilsands which was internally estimated to be around $130-billion, a figure that was quickly disavowed by the AER.The date after the disavowal, AER Chair Jim Ellis had resigned.
Further muddying the effort has been the controversy over Premier Danielle Smith’s promotion of an “R-Star” program which would have funded remediation by foregone royalties. This lobby effort occurred when she was the CEO for the Alberta Enterprise Group.
Alberta has been fortunate to Auditors General who have become increasingly strategic in identifying matters of fundamental importance to the province. Although most Albertans would be hard-pressed to say who the auditor general is and what the OAG does, the office plays a vital role for all Albertans.
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