Objective:
Since 1975, generally accepted accounting principles have obligated US corporations to identify, quantify and disclose environmental remediation liabilities. Since then, environmental laws and GAAP have grown both in number and complexity. What has happened to environmental reserves since then?

ERCI researched the environmental reserves of five large companies to see if there is a trend (up or down), to learn if reserve adjustments are becoming routine and how long cleanup reserves will remain on balance sheets.

No one questions the rigor, materiality and perpetuity of another type of contingent liability, employee pensions, but are environmental reserves here to stay? ERCI compiled the following results.

Process:
ERCI examined SEC filings over the past eighteen years and assembled the environmental and exploration and production (E&P) reserves for the five largest energy companies, along with their acquisitions. We did not adjust for inflation or discount rates, or bring the numbers to 2009 dollars. We simply collected the reserves as stated in the 10-K and 20-F reports, correcting for any subsequent adjustments. Wherever possible, we excluded costs which were capitalized (as part of an investment) or expensed (as part of an operating facility).

We chose the five largest energy companies by market cap (ExxonMobil, Chevron, BP, Shell, and ConocoPhillips) because they are all in the same industry, and have grown through acquisitions in the past twenty years. They also have comparable waste streams, historic waste disposal practices, capital stewardship efficiency, financial sophistication, consumer brand awareness, and large geographic footprints.

Analysis: End of Year Environmental Reserve Balances
Environmental reserve balances in 2008 are generally higher than they were 10 years ago. We believe this trend is based on a combination of factors:

• increased awareness of environmental liabilities
• new environmental regulations
• more aggressive enforcement of environmental regulations
• increased sophistication among external and internal auditors
• increased sophistication of environmental consulting professionals
• asset divestitures
• bankruptcy of smaller potentially responsible parties/acquirers of divested assets
• improved compliance with accounting procedures
• accounting standardization following mergers

To the extent that data is available, ERCI assembled the environmental reserve balances reported for each company, along with any legacy company reports. For example, BP acquired Amoco (1998) and Arco (2000), and their historic data is combined as if they were one company eighteen years ago.

ExxonMobil has periodically found that their environmental liabilities are not material, so reporting is sporadic.

We use the same x- and y-scale for all graphs.

End of Year Environmental Reserve Balance Graphs
     (Click to enlarge images.)
        
        

Analysis: Exploration & Production Restoration Balances
E&P Restoration is the obligation or liability for dismantlement, abandonment, and restoration costs of oil and gas producing properties. All of the Big Five oil companies have seen a significant increase in E&P Restoration balances since 2000. This is attributed to the issuance of Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations in 2001 and Finacial Accounting Standards Board (FASB) Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations in 2005. Before 2001, the guidance was simpler and narrower in SFAS 19; for example, dismantlement costs were often recognized as a contra-asset, instead of a liability.

Exploration & Production Restoration Balance Graphs
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Analysis: End of Year Environmental Reserve to Environmental Spend Ratio
This chart displays the ratio of a year-ending environmental reserve balance to that year’s spending off of that reserve. This ratio implies a useful life of the current reserve at the current spend rate. (Note: no spend data was found for ConocoPhillips.)

ERCI looked at this ratio to identify a competitive range, or benchmark, to see if any one company has a pattern of over- or under-reserving, relative to this peer group.

ExxonMobil maintains the fewest number of years in their environmental reserves, while BP generally maintains the most. ERCI notes that BP’s ratio of environmental reserve balance to spend drops significantly between 2007 and 2008 due to both an increase in reserve spending and a decrease in reserve additions during that period. While there is no set standard for the “correct” number of years the environmental reserve balance should last, there seems to be a competitive range of 2 to 7 years.

End of Year Environmental Reserve to Environmental Spend Ratio Graph
     (Click to enlarge image.)

Key Takeaways:
ERCI encourages you to take a look at your own company’s environmental reserves (and if relevant, E&P restoration balance), and environmental expenditure rate and see how they compare to the Big Five.

Ask yourself the following questions:

• Is your company consistently accounting for and disclosing your environmental liabilities and reserves?
• Is your company properly accounting for and disclosing your Exploration and Production balances?
• Does your company have a pattern of fluctuating spend and reserve balances that are not in sync with the project needs?
• Do environmental cleanup projects close and reopen?
• Where do new environmental liabilities come from?
• Is your environmental reserve going down only to be replenished with another year of the same or more expected spending?

If any of the above questions trigger discussion and analysis among your management teams, you are likely moving in a good direction. Environmental liability analysis and management requires time and attention and the involvement of a range of stakeholders. Comparing your own company to peers can be a useful exercise; however consistent, repeatable policies and procedures need to be developed from within.