An Alternative Way to Price Environmental Debt
Actuaries will tell you that the best way to predict future outcomes is to study prior experience. Current life insurance premiums are based on historical mortality rates. Might it be possible to price AROs based on projections of past asset retirement costs and growth rates? That is not how accountants measure AROs, but it could provide a better way for capital markets to re-price them. The data to do this exists.
Accounting Standards Codification section 410-20-50-1(c)(2) requires companies to annually disclose “liabilities settled in the current period,” which is another way of saying companies must disclose annual expenditures to settle AROs. With more than a dozen years of reported cash flows, it’s now possible to use historical cash flow analysis to more accurately price the environmental debt of mature oil companies. The key variables are the time period over which accumulated AROs will be extinguished and the compounded annual growth rate of cash flows over that period.
Oil and gas exploration and production assets are long-lived. This means that oil companies are likely to be incurring costs to retire existing assets several decades into the future—even if they never put another new asset into service. The average age of active exploration and production assets operating in the Gulf of Mexico is 30 years and counting. This suggests that Exxon and Chevron, for example, which have ongoing operations in the Gulf of Mexico and an inventory of newer and older assets, can be expected to incur payments on existing environmental debts over that same period or longer.
You can use your own assumptions about the amount and timing of future debt payments with our scenario-based model to re-price the environmental debt of the largest publicly traded U.S. oil companies.