Reserve Analysis
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 a trend exists, to learn if reserve adjustments are becoming routine, and to discover how long cleanup reserves will remain on balance sheets.
No one questions the rigor, materiality, and perpetuity of employee pensions, another type of contingent liability. 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 capitalization (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 from 2008 are generally higher than they were in 1998. 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 the 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); the three entities' historic data is combined as if they were one company.
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.
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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 Financial 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 least number of years in their environmental reserves, while BP generally maintains the most. ERCI noted that BP's ratio of environmental reserve balance to spend dropped 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 standard for the number of years of the environmental reserve balance, there seems to be a competitive range of 2 to 7 years.
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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, to 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. While comparing your own company to peers can be a useful exercise, consistent, repeatable policies and procedures need to be developed from within.