Oil companies at risk of stranded assets without better financial reporting

U.S. oil and gas companies, along with their investors, may be facing the risk of significant stranded assets because they aren’t doing enough to reflect the impacts of the climate crisis in their financial reports.

A report released last Thursday by the sustainability nonprofit Ceres analyzed how the oil and gas industry should address climate change to comply with existing U.S. financial disclosure standards and meet investor expectations for transparency.

The report’s release comes at a time when countries responsible for nearly two-thirds of the world’s greenhouse gas emissions have committed to reach an overall goal of net zero emissions by 2050 or sooner, but many U.S. oil and gas companies haven’t yet set targets or fully acknowledged the financial implications of a clean energy transition. A recent shakeup on the board of ExxonMobil to include more outside directors could force the oil giant to move toward greater emphasis on renewable energy. A worldwide drop in demand for fossil fuels, accelerated by regulation and affordable renewables, would likely slash overall demand and affect companies’ positions, depending on how they approach the transition.

The Ceres report includes details on investor expectations on reporting in line with the goals of Climate Action 100+, an investor initiative on climate change. It discusses the steps that companies and their boards, audit committees and auditors can take to align financial reporting with the Paris Agreement goal to limit global temperature rise to no more than 1.5 degrees Celsius while staying consistent with the U.S. GAAP rules.

“Financial accounting requires numerous estimates about the future,” said Samantha Ross, the report’s author and a former Securities and Exchange Commission staffer and the chief of staff of the Public Company Accounting Oversight Board, who now leads AssuranceMark, an initiative to help investors get the most out of audits, in a statement. “Existing accounting standards are designed to give investors fair warning when it looks like assets may become stranded, as can happen in any period of disruption and transition. If companies don’t disclose the assumptions they use to set and test asset values, it is very difficult for investors to understand the extent of the value at risk of future stranding.”

The report provides four investor expectations for financial reporting in the U.S. oil and gas sector:

• Companies should explicitly and consistently discuss climate-related impacts in all financial statements. They should also disclose future asset retirement obligations, including plugging wells, decommissioning infrastructure and reclaiming land. They should disclose long-term pricing assumptions, all carbon offset and carbon capture assumptions, and total greenhouse gas emissions, as high emissions can pose a greater future financial risk due to regulations.
• The narrative portion of oil and gas companies’ financial reports should include robust discussion of a company’s climate strategy in line with the SEC guidance and should disclose limits on access to capital. Assumptions should be consistent with financial statements.
• Corporate audit committees should reinforce rigorous consideration of climate-related impacts on financial statements and set expectations with external auditors.
• External auditors should demonstrate that they have taken climate impacts and the energy transition into account.

Low oil and gas future prices could result in lower cash flows, potentially impairing assets, triggering writedowns, and accelerating asset retirements, according to the report. There are more than 3 million active and idle oil and gas wells that operators are legally required to plug and reclaim in the U.S. Investors expect companies to disclose the full undiscounted amount of their asset retirement obligations. Wells in the U.S. are bonded at a fraction of their true clean-up cost. If companies are unprepared, the impact is likely to hit local communities and state budgets.

“Investors felt that we needed this foundational material in the U.S.,” said Tracey Cameron, senior manager of corporate climate engagement at Ceres, in a statement. “Companies have begun to disclose climate impacts in some places, but not in their financials — and that is what really matters to investors. Failure to do so puts investors at risk. We are at a moment where investors have recognized that a climate risk is a financial risk and they are acting on that reality through their investment and voting decisions.”

During the 2021 proxy season, shareholders handed climate-related proposals majority votes at Phillips 66, ConocoPhillips, Exxon and Chevron, and three Exxon board directors were replaced by candidates with experience in energy transitions and clean energy. First-time proposals recommending that Exxon and Chevron report on financial risks associated with climate change received 48% and 47% of shareholder votes, respectively.

Some oil and gas companies have disclosed the financial impact of the clean energy transition, resulting in write-downs. The report calls for more consistent transparency of assumptions, stronger board oversight over climate reporting, and independent, third-party assurance over climate disclosures.