Growing awareness about the financial impacts of climate change has drawn significant attention to how companies are addressing the risks of climate change and the impacts of climate-related regulations. The potentially significant impact of climate-related regulations on oil and gas reserves, the most valuable asset of exploration and production (E&P) companies, has raised particular concern about how oil and gas companies are calculating climate risks and costs.
Even without more stringent climate disclosure guidelines from the SEC, companies who fail to accurately address the impact of the “cost of carbon” on reserves could be violating existing disclosure guidelines. When analysts and investors evaluate E&P companies, they rely heavily on the company’s reported “proved” oil and gas reserves, i.e. reserves that are economically feasible to recover in existing economic conditions. To ensure that investors have accurate information, the SEC sets standards for proved reserves and requires all public companies engaged in significant oil and gas activities to disclose estimates of both their proved and overall oil and gas reserves to supplement their public financial statements. When conditions change and the reserves cannot be feasibly recovered, companies are required to “debook” them and disclose the revision to investors.
The SEC also requires U.S. companies to comply with U.S. generally accepted accounting principles (U.S. GAAP) when preparing and filing annual and interim financial reports. GAAP principles require companies to evaluate whether an asset is impaired at the end of each reporting period; when an asset is worth less than the amount listed on the company’s financial statements, companies are required to disclose an impairment charge against the company’s earnings.
However, without inside information, it can be difficult to determine whether companies are truly adhering to these requirements. To encourage those with inside information to step forward, the Dodd-Frank SEC Whistleblower program allows whistleblowers to confidentially report companies who are overstating their oil and gas reserves or failing to disclose impaired assets. Whistleblowers who provide original information that leads to successful SEC prosecution can receive between 10% and 30% of monetary sanctions.
Investor concern about the accuracy of this reporting has led to a new wave of litigation, including Pedro Ramirez v. Exxon Mobil Corp. et al., the first class-action climate-change related securities class action against a major oil and gas company. While the lawsuit’s allegations are specific to ExxonMobil, this case raises serious questions about how ExxonMobil and other companies are calculating “carbon costs” in their oil and gas reserve estimates and highlights the need for whistleblowers who can provide answers.
Pedro Ramirez v. Exxon Mobil Corp. et al.
Even among other oil and gas majors, Exxon has stood out for its investment in risky projects. In a study which ranked 69 of the biggest oil and gas companies by the extent of their exposure to a low-carbon transition, analysis from Carbon Tracker found that Exxon was the most at risk, with the highest percentage of its capital expenditures going to high-cost projects and the most emissions exceeding the “carbon budget.” Exxon has likewise drawn attention for its previously aggressive stance against de-booking oil and gas reserves, as well as early confident assurances that it was accounting for current or future regulations and that none of its assets would become stranded due to climate regulations.
In 2014 and 2015, global oil prices crashed, causing the industry as a whole to record hundreds of billions of dollars of asset impairment charges. In contrast to its competitors, Exxon drew attention by assuring investors that, due its superior investment processes and project management, it did not need to write down any assets. In August through September of 2016, several news sources revealed that regulators were investigating Exxon’s disclosures concerning climate costs and its refusal to disclose write-downs, leading to a significant stock price drop. In October 2016, Exxon disclosed that it might be forced to write down 3.6 billion barrels of oil sands reserves and nearly one billion other North American reserves, nearly 20% of its oil and gas assets.
Building on the impairment disclosures and federal investigations, the Greater Pennsylvania Carpenters Pension Fund and lead plaintiff Pedro Ramirez Jr. in 2017 filed a complaint as a federal securities class action on behalf of all investors who purchased Exxon stock between March 31, 2014 and January 30, 2017. In the complaint, the plaintiffs allege that, as the price of oil and gas declined in 2014, Exxon failed to properly impair its oil and gas reserves and that Exxon had avoided impairments by failing to adjust for declining prices and by failing to consider the costs associated with climate change.
To support these allegations, the plaintiff alleged that the “proxy cost” carbon that the company was using internally to estimate the future costs of climate-related regulations when valuing assets was lower than the one it had previously described to investors, and that, for some projects, the company had used no proxy cost at all. According to the complaint, until 2016, the company had not used any proxy cost in connection with the Company’s asset impairment determinations for its reserve assets. The plaintiff alleged that Exxon’s material misstatements and omissions artificially inflated Exxon’s stock price and that it influenced rating agencies to issue strong ratings on Exxon’s $20 billion of outstanding debt ahead of a $12 billion dollar public debt offering in March of 2016.
In August 2018, the federal district court for the Northern District of Texas ruled that the suit against Exxon would continue, finding that the plaintiff had sufficiently pleaded claims that Exxon and certain Exxon officials made material misstatements concerning the company’s use of proxy costs for carbon in business and investment decisions. In August 2019, a request for an evidentiary hearing on the lead plaintiff’s motion for class certification was granted.
Ramirez v. Exxon highlights the ways that companies potentially could be misleading investors about the value of oil and gas reserves by failing to account for climate-related costs. Research from Carbon Tracker has highlighted the potential for many of the key carbon assets held by oil and gas companies to become “stranded” if more stringent climate regulations were to be passed. Yet Exxon is not the only oil and gas supermajors to continue to expand and invest heavily in the exploration and production of new reserves, suggesting the need for greater scrutiny in how these companies are addressing the risk of climate-related regulations.
The plaintiffs in this case allege that Exxon used a lower proxy carbon cost in some cases and failed to include any proxy cost in other cases to avoid writing down assets during a downturn. As the pandemic creates significant financial challenges, companies facing pressure may be more tempted to engage in creative accounting; avoiding write-downs by failing to properly account for “carbon costs” could appear as an easy answer, particularly due to the opaque nature of the reserve estimate process.
In highlighting the alleged difference between Exxon’s external and internal proxy carbon costs, Ramirez v. Exxon also shows the need for inside information about how companies are addressing these costs, an area in which industry whistleblowers could play a powerful role. Using the Dodd-Frank SEC Whistleblower program, industry whistleblower could play an influential role by confidentially reporting companies who are overstating their oil and gas reserves or failing to disclose impaired assets.