Originally posted 5 November 2018
Two major stories hit the wire this past week spotlighting the emerging realization that financial markets do care about the scale of environmental liabilities of energy companies. In this post the lawsuit filed by New York State’s Attorney General is examined. In Part 2, the story about estimated environmental liabilities reported by the Alberta Energy Regulator to industry in a private meeting in February 2018 is explored.
On 24 October the Attorney General of the State of New York, Barbara Underwood, brought a lawsuit against Exxon-Mobil. The lawsuit alleges ExxonMobil “fraudulently, systematically and repeatedly has deceived investors about the impact that future climate change regulations could have on the company’s assets and value.”New York AG News Release According to the statement, knowledge of this activity reached the highest levels of ExxonMobil including former CEO Rex Tillerson (and former U.S. Secretary of State), who “knew of misrepresentation for years.”
At issue is the reporting to investors on the company’s determination of the “proxy cost” of carbon. Since the estimation of the cost of decontaminating industrial sites is subject to a large number of factors, a methodology for costing the liabilities (proxy cost) is disclosed in periodic securities filings. Specifically Exxon-Mobil was approximating the likely effects of future events including increasingly stringent climate change regulations. Exxon, it is alleged, told investors these proxy costs were used in corporate planning, estimations of company oil and gas reserves, evaluations of whether its long-term assets remain viable, and estimations of future demand for oil and gas.”
The civil lawsuit or “complaint” states:
“that Exxon frequently did not apply the proxy costs as represented in its business activities. Instead, in many cases Exxon applied much lower proxy costs or no proxy cost at all.”
The lawsuit argues the company realized that as the company increased its internal proxy costs to conform with public representations, that by applying this methodology it would incur “massive costs and “large write-downs”.” Instead it employed an undisclosed “alternate methodology” which assumed that climate change regulations would remain static.
The motivator for this lawsuit is the New York State Common Retirement Fund (CRF) and the New York State Teachers Retirement System ownership of about $1.5 billion in Exxon stock. Given the rising risk associated with climate change, the accuracy of financial reporting on environmental liabilities (including the cost of clean-up) is incredibly important to institutional investors like the CRF.
The New York AG is seeking an order from the court to “award damages, a disgorgement of all monies obtained in connection with the alleged fraud, and restitution.” Additionally, the complaint requests the court to direct a comprehensive review of Exxon’s failure to apply a proxy cost consistent with its representations, and the economic and financial consequences of that failure. ”
Of specific interest to Alberta readers is the comments on Exxon’s (majority owned; i.e. Imperial Oil Ltd.) oilsands facilities. According to the press release:
- For 14 of Exxon’s oil sands projects in Alberta, Canada, Exxon’s failure to apply its publicly represented proxy costs resulted in undercounting of projected greenhouse-gas related expenses by more than $25 billion over the projected lifetime of the projects.
- Exxon undercounted projected greenhouse gas-related costs by as much as 94% – equal to about $11 billion – in an economic forecast for its Kearl oil sands asset in Alberta.
- Exxon failed to apply the proxy costs it represented to the public in estimating company reserves at Cold Lake, a major oil sands asset in Alberta, resulting in an overestimation of its projected economic life by 28 years, and an overestimation of company reserves volumes by more than 300 million oil-equivalent barrels, representing billions of dollars of revenues.(Emphasis added)
This investigation commenced in December 2015 when then Attorney General Eric Schneiderman subpoenaed records from Exxon Mobil. 20151104_docket-na_subpoenaNYAG to ExxonMobil
The 18 page subpoena was initiated under New York State laws which relate to “deceptive acts and practices” and “potential fraudulent practices in respect to stocks, bonds and other securities law” under two articles of New York State’s General Business Law.
The breadth of the subpoena included a 228 word definition of “document.” The lengthy definition of document appeared designed to ensure that Exxon documents could not escape scrutiny. The following definition of “entity”also was designed to leave “no stone unturned.”
“entity” means without limitation any corporation, company, limited liability company or corporation, partnership, limited partnership, association, or other firm or similar body, or any unit, division, agency, department, or similar subdivision thereof.
What does this Mean?
Institutional investors are beginning to take seriously the risk inherent in enterprises that primarily extract and refine fossil fuels. Risks include accepting at face value claims a firm’s financial disclosure of liabilities. Other risks include the management of reputational risk and regulatory risk. Reputational risk relates to the ability of the enterprise to maintain social license. Regulatory risk is the uncertainty surrounding future measures by government legislatures and regulators to price carbon and mandate environmental mitigation.
The great fear facing institutional investors and agencies that rate long-term debt obligations are “stranded assets.” The balance sheet of large integrated energy companies include the estimated value of oil, bitumen and natural gas reserves and their refining assets. On the other side of the balance sheet are easily measurable liabilities such as short-term payables and short and long-term debt. More difficult to evaluate are environmental liabilities. As environmental regulations become more stringent with higher carbon taxes and conditions of operations, the net worth of the company falls. Depending on the assumptions used, net enterprise value could in worst case scenarios be wiped out. This in turn presents challenges for a corporation’s auditors who must assess whether the company is in fact a “going concern.”
Of particular concern for governments (e.g. Alberta and Canada) is the collective capacity of Canada’s energy industry to fund the costs of remediating wells, oilsands, and tailings lakes.
In Part 2, we take a look at this issue.