The Elephant in the 10-K: Carbon Asset Risk
Written by Jackie Cook, Founder, Fund Votes
Large US oil and gas companies are not adequately disclosing to their investors the risk that a portion of their carbon-based assets could be left stranded.
Boston-based sustainability organization, Ceres, in collaboration with CookESG Research, recently launched a new version of its online Securities and Exchange Commission (SEC) Sustainability Disclosure Search Tool, providing users with access to new features and expanded coverage of corporate environmental sustainability disclosures.
The tool now helps users to explore narrative disclosures relevant to assessing carbon asset risk by companies in high-emitting industries. Carbon asset risk is the risk that the value of extracted and un-extracted fossil fuels, and assets for generating power from fossil fuels, will be impaired or even stranded under various carbon constrained scenarios.
A survey of the most recent disclosures by the 23 oil and gas production and extraction companies in the S&P 500 index, disclosing a collective 77 billion barrels of oil equivalent (BOE) in reserves as of the end of 2014, reveals that not one discussed the potential impact on the value of these reserves of an international agreement to limit global warming.
Market capitalizations of large oil and gas companies are nearly perfectly correlated with reserves (r=0.98). As the market value of un-extracted reserves is recalibrated in anticipation of an increasingly carbon-constrained global economy – as envisioned by the ‘The Paris Climate Agreement’ to keep global temperature rise to well below 2 degrees Celsius – shareholders’ investments face greater risks.
The International Energy Agency (IEA) estimated in 2012 that “[n]o more than one-third of proven reserves of fossil fuels can be consumed prior to 2050 if the world is to achieve the 2°C goal, unless carbon capture and storage (CCS) technology is widely deployed.” This scenario puts a large portion of the 77bn BOE at risk.
The agreement reached in Paris at COP21, while hailed as a major step forward in the fight against climate change, should not have caught oil and gas companies flat-footed.
As world leaders prepared to negotiate the climate agreement in Paris, participating countries had been submitting national pledges (Intended Nationally Determined Contributions, or INDCs) well in advance of COP21. The meeting in Paris was the culmination of a four-year round of negotiations with invitations for submission of INDCs called for two years earlier at COP19 in Warsaw. A number of other milestones had been reached by the conclusion of negotiations at COP20 in 2014 in Lima, Peru, that indicated growing international political appetite for a global agreement. 
ExxonMobil (XOM), the largest US oil and gas producing company, holds almost a third of the reserves accounted for by S&P 500 companies for the year ending 31 December 2014.  Yet, in its 2015 10-K report to shareholders, the company merely notes:
“International accords and underlying regional and national regulations covering greenhouse gas emissions are evolving with uncertain timing and outcome, making it difficult to predict their business impact.” -ExxonMobil (XOM), 10-K report, 2015.
In fact, this passage appears verbatim in Exxon’s 10-K reports from 2010 onwards.
Chevron Corporation (CVX), the next largest of the S&P 500 oil and gas companies, holding 11bn BOE in developed and undeveloped proved reserves, also uses much the same language to address the evolving risk of an international agreement over the past six years of 10-K filings.
“Continued political attention to issues concerning climate change, the role of human activity in it and potential mitigation through regulation could have a material impact on the company's operations and financial results. International agreements and national or regional legislation and regulatory measures to limit greenhouse emissions are currently in various stages of discussion or implementation.” -Chevron Corporation (CVX), 10-K report, 2015.
Investors in the Carbon Asset Risk Initiative, coordinated by Ceres and Carbon Tracker with support from the Global Investor Coalition, have been pressing fossil fuel companies to review their business models in the face of game-changing climate-related risks. In April 2015, a group of 62 investors, representing nearly $2 trillion in assets, asked the SEC to “closely scrutinize” reporting on carbon asset risks by oil and gas companies and address inadequate reporting in comment letters to issuers.
The Securities and Exchange Commission’s existing disclosure regime requires companies to address in their annual communications to shareholders the material risks to their business, including environmental risks and those related to climate change as articulated in the February 2010 SEC interpretive guidance on climate risk disclosure.
However, since 2011 the SEC has done little to monitor climate risk disclosure in securities filings, particularly by large emitters.
These securities disclosure omissions are now coming under the spotlight.
In October 2015, US Senators Jack Reed (RI) and Brian Schatz (HI), Representative Matt Cartwright (PA) and 32 additional members of Congress asked the SEC for an update on its effort to implement the “Commission Guidance Regarding Disclosure Related to Climate Change,” noting, “The effects of climate change can pose material and evolving challenges for many companies and investors deserve access to complete and accurate information.”
At the end of October 2015, several Representatives asked the SEC to investigate whether Exxon breached securities laws by failing to adequately disclose material risks to its business posed by climate change.
Independently two state-level investigations into the adequacy of ExxonMobil’s climate risk disclosures to investors have been initiated. On November 5, 2015 the New York attorney general’s office launched an investigation under state securities law which could result in civil and criminal charges if the disclosures are considered to be misleading (because material information was misrepresented or omitted). On January 20, 2016 a similar investigation was launched by the California attorney general investigating potential disclosure violations by ExxonMobil under both state securities and environmental laws.
In November the New York attorney general’s office announced a settlement with Peabody Energy (BTU), the world’s largest coal producing company, after a two-year investigation showing that the company repeatedly misled investors and the public about the risks of climate change to its business. The agreement notes in particular that Peabody denied that it was able to predict the impact that GHG emissions laws and regulations would have on its business. It requires that past disclosures need to be revised with more concrete language. This sets a precedent for holding emitters responsible for their material risk omissions.
Even before COP21, the oil and gas industry had been suffering under an historically low oil price with excess supply from OPEC, threatening the viability of capital intensive modes of extraction. For instance, investments in most of Canada’s oil sands operations, with breakeven around 44 US$ per barrel of crude oil, could be left stranded or severely impaired at recent crude oil prices.
The financial viability of other modes of extraction, such as deep and ultra-deep water drilling and prospects for drilling in the Arctic are also threatened under a combination of global carbon constraints as well as increasing competition from renewable energy sources with an acceleration of investments in this sector envisioned in INDCs.
The Paris Agreement therefore serves to formalize the risk that fossil fuel reserves exceeding the global quota for containing global warming well below two degrees will have to remain un-extracted. With oil and gas companies’ 10-K reports due out next month it will be interesting to see if the usual boilerplate, equivocal language on climate change risk that they’ve placated investors with for so many years will be replaced by more tangible and useful information that investors can actually use to assess exposure to carbon asset risk.
 A metric for accounting for fossil fuel reserves. One unit, or ‘barrel of oil equivalent’, represents the amount of energy released by burning one barrel (42 gallons) of oil. In their 10-K disclosures oil and gas companies break this figure down into fossil fuel liquids and natural gas (converted from cubic feet) and into developed and undeveloped proved reserves.
 Using reserves disclosures for the year ending 31 December 2014 and market capitalizations as at March 2015.
 International Energy Agency, World Energy Outlook 2012
 These are summarized in: OUTCOMES OF THE U.N. CLIMATE CHANGE CONFERENCE IN LIMA 20th Session of the Conference of the Parties to the United Nations Framework Convention on Climate Change (COP 20), Center for Climate and Energy Solutions (C2ES).
 A total of 25.3bn BOE, including 16.5bn in developed and 8.8bn BOE in undeveloped proved reserves.
 Investors push SEC to require stronger climate risk disclosure by fossil fuel companies, Apr 17, 2015, available at http://www.ceres.org/press/press-releases/investors-push-sec-to-require-stronger-climate-risk-disclosure-by-fossil-fuel-companies.
 Commission Guidance Regarding Disclosure Related to Climate Change (Feb. 2, 2010), 75 Fed. Reg. at 6797
 Cool Response: The SEC & Corporate Climate Change Reporting, Jim Coburn and Jackie Cook, Ceres, August 2014.
 Reed, Schatz, & Cartwright Lead Bicameral Letter Urging SEC to Enforce Climate Change Guidance, News Release, Senator Jack Reed, 20 October 2015
 Congressmen Call on SEC to Investigate Exxon's Climate Disclosures, Neela Banerjee, Inside Climate News, 2 November 2015.
 Exxon Mobil Investigated for Possible Climate Change Lies by New York Attorney General, Justin Gillis and Clifford Kraus, New York Times, 5 November 2015.
 California to investigate whether Exxon Mobil lied about climate-change risks, Ivan Penn, LA Times, 20 January 2016.
 A.G. Schneiderman Secures Unprecedented Agreement with Peabody Energy to End Misleading Statements and Disclose Risks Arising from Climate Change, Press Release, Attorney General Eric T. Schneiderman, November 9, 2015.
 Canadian Oil-Sands Producers Struggle, Chester Dawson, Wall Street Journal, August 19, 2015.
 Both key crude oil price indexes (the WTI and Brent) remained under $50 a barrel for most of the second half of 2015, down to below $40 per barrel since early December 2015 and below $30 per barrel by mid-January 2016.