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Background & The Business Case
As companies navigate the energy transition, investors are looking for confidence that capital is not being wasted on assets that may become stranded and hydrocarbon reserves that may never be produced. Disclosure of assumptions that oil and gas companies use to value assets and assess future revenue hits at the core of stranded asset risk and will help investors assess long term value. For this reason, climate accounting and audit was added as an assessment indicator to the Climate Action 100+ Net Zero Company Benchmark, which measures corporate progress on achieving net zero emissions by 2050 or sooner.
More specifically, investors want oil and gas companies to disclose information for assets that they define as having “indeterminate lives” to better understand the true end-of-life costs the company might face, including legal asset retirement obligations (AROs). AROs are especially relevant as asset retirement timelines may accelerate under an economy-wide net zero by 2050 scenario.
Oil and gas companies such as Shell have taken critical first steps to recognize the impact of the energy transition on their decommissioning and restoration assumptions. This level of internal analysis and transparency is an essential action that oil and gas companies must undertake in order to present a more fulsome picture of long-term valuation and stay competitive in a low carbon economy. Not only will this type of disclosure provide investors with decision-useful information but attract additional investment to companies who provide this level of transparency.”
Currently, investors only have partial visibility into AROs. Most companies report AROs for assets with expected retirement dates, and only on a discounted basis, an accounting adjustment ultimately reliant on assumptions which may deceptively distribute the asset’s end-of-life retirement costs across a timeframe unrealistic under a net zero scenario.
There is little to no disclosure on assets with indeterminate lives. For those assets, which include pipelines and refineries, a decision-useful metric for investors is instead the undiscounted value of an ARO. In other words, undiscounted value is what the cost would be to retire these assets today. In this way, investors can assess value and costs separately from assumptions related to asset life. This allows investors to make their own assessment of the timing for when those liabilities may come due. This flexibility allows investors to better discern long-term value and understand the financial health of oil and gas companies.
Greater transparency and disclosure around asset retirement obligations are imperative for investors to better evaluate the long-term risks and economic viability of businesses in a carbon constrained future. Clarity on climate accounting is urgently needed to identify the costs associated with the impact of the energy transition – particularly for critical sectors such as oil and gas which will be central to delivering net zero.”
Historical Proxy Season Background
The first resolution on the topic of climate accounting was filed by Christian Brothers Investment Services at ExxonMobil in 2021 (Result: 48.9% FOR). It sought an audited report on whether and how a significant reduction in fossil fuel demand under the IEA Net Zero 2050 scenario would affect the company’s financial position and underlying assumptions.
During the 2022 proxy season, two similar shareholder proposals were filed at ExxonMobil (Result: 51.0% FOR) and Chevron Corp (Result: 38.7% FOR). While the Exxon vote marked a historic first majority vote for this topic, the additional result at Chevron represented notable support from the wider investment community.
Beyond shareholder resolutions, investors are beginning to hold board members and auditors accountable when there is a failure to properly incorporate material climate risk into financial reporting. In 2022, the Climate Action 100+ initiative flagged pre-declarations on management votes at four companies on accountancy grounds.
2023 Preview
As investors drill down into climate accounting, at least six resolutions were filed on the topic of Asset Retirement Obligations at Climate Action 100+ focus companies this year. The resolutions seek an audited report containing the undiscounted expected costs to settle obligations for Asset Retirement Obligations with indeterminate settlement dates.
Relevant information on flagged votes and other notable proxy season activity is updated weekly on our Proxy Season Webpage.
Further resources
- Carbon Tracker produces corporate briefs and provides analysis for the Climate Action 100+ Net-Zero Company Benchmark accounting assessment indicator.
- Ceres’ Lifting the Veil: Investor Expectations for Paris-aligned Financial Reporting at Oil and Gas Companies
- IIGCC’s Investor Expectations for Paris-aligned Accountsprovide the business case and investor expectations for climate accounting.