Investors for Paris Compliance recently issued the report Accounting for the Canadian Oil & Gas Liabilities Gap.

The organization is “a shareholder advocacy organization that works to hold Canadian publicly-listed companies accountable to their net zero commitments.” The report concludes:

• Canadian oil and gas investors face significant uncertainty regarding the decommissioning liabilities that appear on the financial statements of major companies. Both the overall scale of those liabilities and how they are portrayed on balance sheets are subject to differences in interpretation that have significant impacts on shareholder equity. The industry has a financial incentive to downplay such liabilities. Auditors are supposed to stress test significant material assumptions on behalf of investors, but there is no evidence they do so on this matter.

The report examined the 15 largest Canadian oil and gas producers in this respect, finding:

• A widespread failure to disclose material factors, such as timelines for cleanup and sensitivity analyses of key factors such as estimated costs, inflation, and discount rates.
• Accounting judgments that minimize liabilities in their financials, such as overly long timelines for remediation, high discount rates, and rosy assumptions regarding future commodity prices that ignore the energy transition.
• A potential massive overall liability gap based on a leaked Alberta Energy Regulator (AER) estimate of liabilities. The 15 companies report about $67 billion of liabilities in today’s market prices vs. their share of the AER estimate of $180 billion, a $113 billion gap, or 2.7 times what appears in their financials.
• An across the board failure of auditors to publicly assess decommissioning liabilities assumptions, despite this significant impact on shareholder equity. The AER estimate of $180 billion is more than half the total market capitalization of the 15 companies.

The report observes: “As the energy transition takes hold and the markets for fossil fuels plateau or begin to contract, the retirement of decommissioning liabilities comes into sharper focus since this is predicated on future cash flow. Investors therefore have a growing interest in an accurate portrayal of such liabilities on financial statements so that they feel secure about company valuations.”

Digging a bit more into the disclosure point, the report says “while all 15 assessed companies report the present value of their decommissioning liabilities and the discount rate used in their estimate, only some report other material information, like the timeline over which these costs are spread. None provide energy transition related sensitivities around key inputs like estimated decommissioning costs, timelines, inflation rates and the discount rate. This means that investors cannot assess the credibility of, or effectively stress test, this major balance sheet liability.” It provides a table summarizing the key information provided for each of the fifteen, illustrating for instance that the applied discount rate ranged from 3.3% (seven of the companies used either 3.3% or 3.33%) to 10%. That last one was by Strathcona Resources (up from 8% applied in the previous year), and one might indeed have thought that its outlier status warranted some specific explanation. But there’s nothing beyond the generic: “Assumptions, based on current economic factors, have been made to estimate the future liability. However, the actual cost of decommissioning is uncertain and cost estimates may change in response to numerous factors including changes in legal requirements, technological advances, inflation and the timing of expected decommissioning and restoration.” On the other hand, Strathcona does at least disclose an estimate of the uninflated and undiscounted estimated cash flows required to settle the obligation, which is more than eight of the others did.

The report refers, seemingly with some optimism, to the IASB’s “new guidance illustrating how companies with even ‘immaterial’ decommissioning liabilities should consider including a description of the obligations, the timing of expected payment of the liabilities, and an indication of any uncertainties about the amount or timing of the liabilities. This guidance clarifies standards that already existed under the IFRS, but are not being consistently applied.” That’s a reference to the illustrative examples on Disclosures about uncertainties in the financial statements, which we looked at here. On that topic, the IASB’s guidance addresses a situation in which “although some of (an entity’s) plant decommissioning and site-restoration obligations have an immaterial effect on the carrying amount of its plant decommissioning and site-restoration provision, information about these obligations is material.” It reaches that conclusion after considering, among other factors, the size of the costs required to settle the obligations (that is, they’re high); the risk of early settlement; and external climate-related qualitative factors—”the industry and jurisdictions in which the entity operates (including the entity’s market, economic, regulatory and legal environments) make the information about the obligations more likely to influence the decisions that primary users of the entity’s financial statements make on the basis of the financial statements.” But if any of the companies covered by the report are steadfast, for whatever unwelcome reason, in their reluctance to disclose some of the items highlighted, it’s questionable whether the IASB’s additional nudges will be sufficient to force them to change. Anyway, we’ll look at other aspects of the report in the future.

The opinions expressed are solely those of the author.