Why Does This Matter?
Oil companies are generally not required to earmark dedicated funds to ensure decommissioning of their assets. Instead, the majors can usually “self bond” by showing financial responsibility based on their income and assets, while smaller companies may in some cases have to pay for a surety bond or other form of financial assurance
Historical trends in the growth of environmental debt payments are not sustainable in the long term. Nonetheless, capital markets may reason that as long as companies are able to meet their current debt payments, it doesn’t matter if the reported liabilities are understated. Indeed, in the near term, this “pay as you go” approach may continue to work reasonably well, but only if one assumes that there will be no technological, regulatory, market or catastrophic disruptions that result in the early retirement of oil and gas production assets.
The world is transitioning to a low carbon economy driven by climate change. This is causing central banks and financial regulators to envision a “Too Late Too Sudden” scenario in which vast amounts of petroleum reserves become stranded and worthless. What many have yet to recognize is that at the same time oil and gas revenues and asset values are falling, mandatory environmental debt payments will add fuel to the fire. “Stranded assets” will give birth to “orphaned liabilities” and vice versa. Debt service payments may become unsustainable. Unwary creditors and investors may be wiped out, and an unprepared public could inherit the debt. We are seeing this scenario play out before our eyes in the coal industry. Just look at the problems with reclamation liabilities in the coal industry today.
Financial regulators and capital markets can avoid a repeat of the environmental debt debacle in the coal industry by taking appropriate steps now to ensure that oil and gas AROs are closely monitored and properly priced. The knowledge and data now exist to do so.