Asset Retirement Obligations

An asset retirement obligation (ARO) is an obligation associated with the retirement of a tangible, long-lived asset.  In the oil and gas industry, AROs include the legal obligation to decommission platforms, pipelines and other facilities and permanently plug all wells.  For example, U.S. Outer Continental Shelf decommissioning regulations are set forth at 30 CFR Part 250, Subpart Q. Department of Energy and Climate Change (DECC) Guidance summarizes United Kingdom Continental Shelf (UKCS) decommissioning regulations.  BP’s Decommissioning Programme for the North Sea Miller Platform exemplifies the extensive scope of work required to meet decommissioning requirements.

Actual cost data in the oil and gas industry are proprietary and obtaining them is challenging.  Decommissioning cost estimates for offshore facilities, both individually and in aggregate, are available from government and academic sources.  See, for example, Oil & Gas UK Decommissioning Insights and U.S. Department of Interior Decommissioning Cost Update for Removing Pacific OCS Region.  However, these estimates, which are derived from work decomposition algorithms performed using engineering time and cost estimates, do not fully account for the “fat tails” in the cost distributions.  Offshore decommissioning costs, in particular, are subject to significant estimation uncertainty, as illustrated by Apache’s per well decommissioning cost analysis.

Limitations on actual and estimated cost data have led analysts such as ourselves and others to focus on financial accounting data reported by public corporations to securities regulators.  Our Scenario-Based Environmental Debt Pricing Model and related analyses rely on audited financial data reported to the U.S. Securities Exchange Commission by U.S. GAAP registrants pursuant to Paragraph 22.c of Statement of Financial Accounting Standards No. 143 , Accounting for Asset Retirement Obligations.  Using this data, we are able to assess the accuracy of reported ARO estimates, back-calculate discount rates, forecast future ARO expenditures, and calculate adjusted discounted and undiscounted ARO estimates.

What happens in the event of wide scale default on these environmental debts?  Oil and gas corporate revenues are falling, stranded assets are rising, environmental debts are largely unsecured, and governments are over committed.

Large companies such as Exxon are able to “self-bond”.  As a result, oil and gas decommissioning obligations are not 100% secured.  For example, last year the U.S. Government Accountability Office reported that only $2.9 billion in bonds were in place to secure an estimated $38.2 billion in decommissioning liabilities in the Gulf of Mexico.  The rest was self-bonded.  The problem of insufficient collateral to meet environmental debt obligations is much worse if the $38.2B government estimate far understates the magnitude of the actual obligation.

In October 2015 Exxon announced that it may be forced to recognize that as much as 4.6 billion barrels of its reserves are no longer profitable to produce.  The disclosure came as the oil producer reported a 38% decline in quarterly profit.  The announcement adds to concerns that ARO payments are on track to surpass net income in the next 10 to 20 years.  If corporates cannot pay, the debt reverts to corporate shareholders and creditors.  See Accounting for Environmental Liabilities in Bankruptcy, American Bankruptcy Institute (July 2016).

If AROs cannot be funded out of the bankruptcy estate, the debt reverts to governments, which reduces funds available for public  investment in climate-related programs.  If governments cannot pay to properly plug, abandon and monitor oil and gas wells, fugitive CO2 and CH4 emissions from onshore and offshore systems will continue to contribute to global warming.  See Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990 – 2014, reporting that natural gas systems were the largest anthropogenic source category of CH4 emissions in the United States in 2014 with 176.1 MMT CO2 Eq. of CH4 emitted into the atmosphere.  Petroleum systems are the fourth anthropogenic source of CH4 emissions in the United States (68.1 MMT CO2 Eq.), accounting for 9.3 percent of total CH4 emissions in 2014.  These analyses of producing natural gas systems do not include analysis of “orphan wells,” but studies by researchers at Cornell, Princeton, Stanford and Durham (UK) have documented the impact of these orphan wells in certain regions of the United States, the UK and other areas