In summary, year after year, the largest and most sophisticated energy companies in the U.S. materially understate the magnitude of their environmental debt. The companies’ own audited financial statements indisputably show that reported environmental debt estimates are inaccurate, unreliable and vastly understated.
This happens because oil companies estimate their asset retirement and cleanup liabilities using optimistic future assumptions without reference to past experience and then adjust these estimates decades later as actual costs become more certain or are incurred. Accounting estimates predictably understate actual costs because companies do not forecast adverse outcomes when it’s in their financial and legal best interests not to do so. Discounting further magnifies the problem. Management, auditors and capital markets accept debt estimates that are self-evidently unreliable because accounting standards don’t offer a readily available alternative and the perceived adverse consequences are low.
Contrary to conventional wisdom, the consequences of mispricing oil and gas environmental debt could be great if long-running historical trends continue, as illustrated by our opening example of Exxon, or if reasonably foreseeable circumstances cause the expected maturities on these obligations to abruptly accelerate, as is now happening in the coal industry.
Financial regulators and capital markets can avoid a repeat of the coal industry debacle by taking appropriate steps now to ensure that oil and gas AROs are closely monitored and properly priced. Without knowledge action is useless and knowledge without action is futile. The knowledge to re-price the industry’s environmental debt now exists. All that is lacking is action.