Final word: Environmental disclosure must improve

In today’s environmentally conscious world, the pressure on companies to meet global standards is paramount. To this end, environmental and decommissioning provisions add up to sizable future obligations for the chemicals, oil and gas, and metals and mining industries.

Yet poor disclosure is making understanding the basis and reasons for changes in such provisions guesswork, Standard & Poors Ratings Services said in a report entitled “Poor Disclosure By Europe’s Chemicals, Oil & Gas, and Metals & Mining Companies Gives Limited Insight into Decommissioning and Environmental Provisions”.

Clearer reporting of environmental and decommissioning provisions would provide greater guidance for analysis. On this score, Standard & Poor’s calls for standard industry terminology to be used throughout disclosure, maturity profiles for operating and closed sites split by geography or other meaningful industry categories, and disclosure of the discount rates applied.

Environmental provisions are generally unconnected to current business operations and involve a cleanup of contaminated sites connected with past activities of acquired companies or due to the toughing of environmental legislation. Decommissioning provisions are connected to current operations and will require substantial funding for the dismantling and removal of production facilities and returning production sites back to an agreed environmental standard.

“Companies are setting aside provisions for those future cash outflows and the size of such provisions tends to be based on management judgment rather than third-party appraisals,” says Standard & Poor’s credit analyst Anton James. “This contrasts with pension provisions, where third parties provide significant input as to obligations for future payments.”

Standard & Poor’s typically sees high provisions for decommissioning in the metals and mining and oil and gas industries, while chemical companies tend to have mainly environmental provisions.

Standard & Poor’s treats decommissioning provisions as additions to debt. For the companies we reviewed they represent a substantial part of the overall future debt burden for metals and mining and oil and gas companies. These provisions equate to about 40 percent of a company’s reported debt. Indeed, decommissioning provisions represent a significant part of the financial risk of these companies, because the majority of cash flows occur at the end of the project’s life. In contrast, we do not adjust for environmental provisions, however, the cash costs will be funded from ongoing business operations. Chemical companies, on the other hand, tend to have no decommissioning, but instead face environmental provisions. Here, environmental provisions typically represent less than 10 percent of the companies reported debt.

“Current disclosure makes comparative assessment difficult as the details on timing and nature of the decommissioning and environmental provisions is opaque,” says James.

Specific to the companies analyzed is their high cyclicality and therefore volatility of cash flows. “Although decommissioning cash flows do not represent material cash outflows now, as companies are currently benefiting from the strong upward business cycle of recent years, they will have to ensure they have sufficient funds to deal with future decommissioning payment obligations even in a weak business environment,” said James.

Of the three industries, oil and gas companies show the highest obligations for decommissioning and environmental liabilities, equivalent to 50 percent of the companies reported debt obligations in 2006. In contrast, the chemical industry shows the most modest provisions, representing about nine percent of their reported financial debt and provisions are mainly environmental.