Opinion, exclusive IASB interview by Mathew Carr
Jan. 13-16, 2023 — If 2022 was the year of massive oil, natural gas and coal profit amid war, 2023 could shape up as a year for even bigger writedowns in the value of assets not needed so much, any more.
Oil company profits alone will exceed $200 billion (see the Reuters chart below from October), yet chief financial officers will be obligated starting this year to perhaps write off even more than that from exploration and production equipment that won’t be needed so much, anymore, and reserves that won’t need to be tapped, after all.
While many smart people are betting the fossil-fuel era will last a lot longer yet, the International Accounting Standards Board (IASB) is beginning a new project by June that will check whether companies are properly measuring and accounting for the value of assets and liabilities related to the climate transition.
The board has received feedback that companies may be inconsistently applying some accounting standards, according to a board member, in an interview below. The IASB covers more than 140 countries. It’s not a regulator but an independent group of experts responsible for the development and publication of International Financial Reporting Standards (IFRS) Foundation accounting standards. As a result of the work, it could recommend a tightening of those standards.
On social media (LinkedIn):
As business transitions to cleaner systems, fossil fuel production and gasoline automakers for instance, will probably see the value of their factories and equipment fall because electric vehicles are less complicated to produce. Untapped oil reserves may not be able to be exploited. The value of equipment used for exploration or extraction may plunge.
The IASB work this year should allow investors to better understand whether a company’s assessment of its assets is correct – whether the value of assets listed is the right value. Is there enough consistency in the information being provided by companies at the moment? the board will ask.
Oil and gas companies are spending vast sums on new production that will tip the world towards climate catastrophe, revealed a report from the financial think tank Carbon Tracker released last month.
It found that in the year to March Chevron, Eni, Shell, TotalEnergies and other companies “approved a total $58bn of investment that will only be needed if oil and gas demand grows to the point where it pushes global temperatures beyond 2.5°C.”
The Paris climate deal has a target to keep temperatures from rising more than 1.5C.
The difference suggests company assets may need to be downgraded, liabilities boosted.
Under the International Energy Agency’s Net Zero Emissions by 2050 scenario (NZE), the most widely cited pathway to limit warming to 1.5°C, there is no need for new conventional oil & gas development – production falls by 22% by 2030 and 44% by 2035 compared to 2019, Climate Tracker said.
The implication of this is that for all of the largest listed companies, to be aligned with 1.5°C, production needs to fall over the coming decades.
That means lower revenues and potentially lower profit as companies compete to fill demand in a shrinking market.
Other accounting bodies may need to make assessments similar to the IASB.
With approximately 2.1 million abandoned wells across the U.S., there is growing concern about unfunded asset retirement obligations (AROs) to decommission oil and gas wells, for instance, Climate Tracker says.
This is true for all production basins.
Fueling the rise in abandoned and orphan wells are the perverse regulatory incentives for operators in the US to strip the last remaining resources from mature wells before defaulting on AROs and filing bankruptcy.
A recent class action lawsuit on behalf of West Virginia landowners offers a potential judicial solution to this regulatory failure, Climate Tracker said.
I interviewed Nick Anderson, IASB member, by phone.
“The critical piece” is how assets and liabilities are measured and accounted for, Anderson said.
Exploration assets, for instance, may come under scrutiny.
On the new project:
We have a project that “will go live during the first half of this year asking the question …is enough information being provided about climate-related risks in the context of the financial statements? Is there enough consistency in the information being provided by companies at the moment in relation to their climate-related risk.
“A lot of this will be around the asset side. Some of our stakeholders tell us there isn’t enough being done. Hence the response to investigate this further.”
So the project will look at how companies are meeting the IASB rules, whether assets and liabilities are taking account of the range of potential oil and carbon prices, levels of oil exploration allowed by governments, and recommended disclosures, for instance, I infer from what Mr Anderson said.
“We published educational material back in 2020,” in terms of climate-related risk, he said.
“We’ve been following stakeholders views on how well that has been followed.” The views are mixed, Anderson said, citing Carbon Tracker as an example.
On whether companies should be flagging future liabilities as contingent (not clear what they will be in total, but coming):
“There isn’t certainty” about how much a company will emit in the next five years, so there has not been a past event that would require the disclosure of a contingent liability, Anderson said.
On whether the Paris climate deal was an event that should have required a stronger reaction by the board (IASB):
“Financial statements have a role to play to bring transparency to this, but governments have a role to play here, as well. We are not a substitute for government action. We’ll be complementary. We’ll shine a light on what’s going on.”
There’s another piece that goes alongside …that is where two sets of sustainability standards come into place potentially this year, covering more forward-looking disclosures. “These, we see as being complementary,” Anderson said.
From May, The Conversation:
Who really owns the oil industry’s future stranded assets? If you own investment funds or expect a pension, it might be you
When an oil company invests in an expensive new drilling project today, it’s taking a gamble. Even if the new well is a success, future government policies designed to slow climate change could make the project unprofitable or force it to shut down years earlier than planned.
When that happens, the well and the oil become what’s known as stranded assets. That might sound like the oil company’s problem, but the company isn’t the only one taking that risk.
In a study published May 26, 2022, in the journal Nature Climate Change, we traced the ownership of over 43,000 oil and gas assets to reveal who ultimately loses from misguided investments that become stranded.
It turns out, private individuals own over half the assets at risk, and ordinary people with pensions and savings that are invested in managed funds shoulder a surprisingly large part, which could exceed a quarter of all losses.
More climate regulations are coming
In 2015, almost every country worldwide signed the Paris climate agreement, committing to try to hold global warming to well under 2 degrees Celsius (3.6 F) compared to pre-industrial averages. Rising global temperatures were already contributing to deadly heat waves and worsening wildfires. Studies showed the hazards would increase as greenhouse gas emissions, primarily from fossil fuel use, continue to rise.
It’s clear that meeting the Paris goals will require a global energy transition away from fossil fuels. And many countries are developing climate policies designed to encourage that shift to cleaner energy.
But the oil industry is still launching new fossil fuel projects, which suggests that it doesn’t think it will be on the hook for future stranded assets. U.N. Secretary-General António Guterres called a recent wave of new oil and gas projects “moral and economic madness.”
How risk flows from oil field to small investor
When an asset becomes stranded, the owner’s anticipated payoff won’t materialize.
For example, say an oil company buys drilling rights, does the exploration work and builds an offshore oil platform. Then it discovers that demand for its product has declined so much because of climate change policies that it would cost more to extract the oil than the oil could be sold for.
The oil company is owned by shareholders. Some of those shareholders are individuals. Others are companies that are in turn owned by their own shareholders. The lost profits are ultimately felt by those remote owners.
In the study, we modeled how demand for fossil fuels could decline if governments make good on their recent emissions reduction pledges and what that would mean for stranded assets. We found that $1.4 trillion in oil and gas assets globally would be at risk of becoming stranded.
Stranded assets mean a wealth loss for the owners of the assets. We traced the losses from the oil and gas fields, through the extraction companies, on to those companies’ immediate shareholders and fundholders, and again their shareholders and fundholders if the immediate shareholders are companies, and all the way to people and governments that own stock in the companies in this chain of ownership.
[Weirdly, my software messed up these charts, so I snipped and pasted good versions of them]
It’s a complex network.
On their way to ultimate owners, much of the loss passes through financial firms, including pension funds. Globally, pension funds that invest their members’ savings directly into other companies own a sizable amount of those future stranded assets. In addition, many defined contribution pensions have investments through fund managers, such as BlackRock or Vanguard, that invest on their behalf.
We estimate that total global losses hitting the financial sector – including through cross-ownership of one financial firm by another – from stranded assets in oil and gas production could be as high as $681 billion. Of this, about $371 billion would be held by fund managers, $146 billion by other financial firms and $164 billion could even affect bondholders, often pension funds, whose collateral would be diminished.
U.S. owners have by far the largest exposure. Ultimately, we found that losses of up to $362 billion could be distributed through the financial system to U.S. investors.
Some of the assets and companies in an ownership chain are also overseas, which can make the exposure to risk for a fund owner even more difficult to track.
Someone will get stuck with those assets
Our estimates are based on a snapshot of recent global share ownership. At the moment, with oil and gas prices near record highs due to supply chain problems and the Russian war in Ukraine, oil and gas companies are paying splendid dividends. And in principle, every shareholder could sell off their holdings in the near future.
But that does not mean the risk disappears: Someone else buys that stock.
Ultimately, it’s like a game of musical chairs. When the music stops, someone will be left with the stranded asset. And since the most affluent investors have sophisticated investment teams, they may be best placed to get out in time, leaving less sophisticated investors and defined contribution pension plans to join the oil and gas field workers as losers, while the managers of the oil companies unfold their golden parachutes.
Alternatively, powerful investors could successfully lobby for compensation, as has happened repeatedly in the U.S. and Germany. One argument would be that they couldn’t have anticipated the stricter climate laws when they invested, or they could point to governments asking companies to produce more in the short-term, as happened recently in the U.S. to substitute for Russian supplies.
However, divesting right away or hoping for compensation aren’t the only options. Investors – the owners of the company – can also pressure companies to shift from fossil fuels to renewable energy generation or another choice with growth potential for the future.
Investors not only may have the financial risk, but also the related financial responsibility, and ethical choices may help preserve both the value of their investments and the climate.