Big Oil Faces More Calls for Stranded Asset Disclosure

By Elisabeth Jeffries
Had ExxonMobil reported its reserves differently in 2016, investors might have taken another view of the company’s future. It reported its Kearl oil sands as reserves, effectively as cash in the ground. In 2016 it was ordered to take these assets of its books by the Securities and Exchange Commission. A major shift in its disclosures ensued in March 2017, with proved reserves cut by 3.3 billion oil-equivalent barrels. If it costs too much to get that oil out of the ground, it doesn't count as an asset.

According to Tarek Soliman, senior analyst at the CDP, if climate-related risk were considered systematically, there would have been a different disclosure in the first place. “If the company were to integrate climate risk into its assessments, it would highlight that these assets show a high propensity to become impaired. They would have been downgraded to a resource rather than a reserve, and this problem would have been foreseen,” notes Soliman. Valuations across the whole hydrocarbons sector could be impacted.

A redirection of energy pathway, not just for ExxonMobil but for all its competitors, might follow if they acted this way, as recommended in the final report of the Task Force on Climate-Related Financial Disclosures (TCFD) presented to the G20. Reporting financial activity using the lens of climate-related risk would, according to the TCFD, help more appropriately price risks and allocate capital in the context of climate change. The initiative is voluntary, would help speed the transition to a low-carbon economy, and would shift the corporate perspective beyond immediate concerns.

Most industries are not reporting on this values-based assumption. Oil and gas companies are understandably among the least likely to report through a channel that undermines their very raison d’etre. Their disclosure of historic greenhouse gas emissions (usually in corporate responsibility statements) has certainly improved since the last decade. But now the pressure, as expressed by the TCFD, is to disclose for the first time in financial filings and to look much further into the future.

This is not about innovative accounting but more in-depth information. “It would change what the directors are telling us in the strategic report but wouldn’t change [the structure of] the balance sheet and profit and loss account,” explains Russell Picot, special advisor to the TCFD and former chief accounting officer at HSBC. For hydrocarbons, categories such as reserves and resources in strategic reports would be the numbers most likely to change.

Leaders have already emerged, and the picture is mixed. In its 2016 study, In the Pipeline CDP finds Norwegian company Statoil the best hydrocarbons performer on carbon disclosure for the longer-term horizon, with Canadian company Suncor listed as the poorest, and ExxonMobil second to last. “Statoil is the only company that quantifies what a world with a 2 degree Celsius [°C] temperature increase would do to its worth,” says Soliman. Indeed, in its 2016 annual report, Statoil states that the International Energy Agency’s ‘450 ppm scenario,’ compatible with that temperature increase, “could have a positive impact of approximately 6 percent on Statoil’s net present value compared to Statoil’s internal planning assumptions as of December 2016.”

While most companies employ conventional economic metrics to justify decisions in financial filings, CDP finds they also increasingly publish carbon pricing. This can be perceived as another way to express the risk of regulation on carbon emissions and to test the company’s resilience in that light. Eight out of the 11 companies studied use an internal carbon price, ranging from USD 22/tonne to USD 57/tonne. Three (Chevron, Occidental and Petrobras) are silent on the matter. Some apply a carbon price to projects under assessment, but there is no evidence they screen out projects on this basis. “I have not seen a case where the company has said: The project makes sense but we are going to veto it because the carbon price is too high,” says Soliman.

The TCFD report thus comes at a time of transition. Some oil and gas majors are talking about climate risk, others are not. Some are acting accordingly, others paying lip service. An obvious example of directional shift is Italian company Eni, which is increasing the share of gas in its portfolio. In its 2015 annual report, it states: “Companies operating in energy business have to face with challenges…such as climate change and a gradual decarbonization process. In this context, natural gas represents an opportunity for a strategic repositioning, thanks to gas low carbon intensity.”

But the task force wants more. If the corporate community systematically adopted its recommendations, balance sheet, income statements and strategic reports would need modifications, as Picot points out: “including climate risk would sharpen disclosures on the impairment of cash flows arising from assets.”

Investors would be able to access a set of comparable sector scenario analysis relating at least to a 2°C scenario as well as, for instance, scenarios related to Nationally Determined Contributions and business-as-usual (greater than 2°C) scenarios. But the actual frameworks have yet to be shaped. “We need to see a period of experimentation. Three or four years down the road we could potentially be assessing what is useful in the voluntary disclosures, and see it codified by institutions through, for example, stock exchange guidelines,” says Picot.

However, he suggested the most significant progression would be found in strategic discussions in financial statements. “This is not going to result in a huge data drop by companies but rather a thoughtful narrative description from board directors. It will hopefully be used as an engagement tool as well as a divestment tool,” he says. A move towards less carbon-intensive business models could result. However, says Picot: “we’re not saying they should alter their business model but that the information needs to get out there so that the market can decide.”

Disclosures on climate-related risk have been improving, but as the Statoil case demonstrates, the view of risk is always subjective. “The company had the previous year assessed a 5% loss in NPV, so the 6% improvement estimated in 2016 was an interesting flip,” points out Soliman. Arguably, the risks to financial performance are considerable if a company moves away from its traditional business model or abandons its store of expertise.

This piece originally appeared on Ethical Performance and is republished here with permission

Image credit: Dru Oja Jay, Dominion, Flickr