The Securities and Exchange Commission (SEC) considers carefully what it says in public, so when its senior petroleum engineer makes a rare appearance in Houston to talk with oil reserves engineers – even not as an official spokesperson – his comments merit attention.
The message boils down to this: Abandonment costs have now become “a focus area for the SEC.” More to the point, disclosures must include all asset retirement obligations (AROs) reported as both discounted and undiscounted figures.
(To be clear, the discussion in Houston was not an official statement of the agency but a presentation among technical professionals. The long-time employee spent over an hour graciously sharing his personal experience and perspective with a group of nearly 60 other professionals working in his same discipline, namely quantifying reserves and related cash flows. What follows is my memory, understanding, and interpretation of the discussion. The slides for the presentation can be accessed here.)
As the SEC seeks to enforce rules and protect investors, its feedback to public companies sometimes run in themes according to the needs of the day. For example, the SEC and its petroleum engineers stepped in with more and clearer feedback when shale companies aggressively booked decades of drilling or extrapolated productivity far from existing well results. Now seems to be the time to focus on decommissioning costs.
Even if the details have often been overlooked, the relevant standards for disclosure and their application have stood for decades. The distinguished engineer, who bears responsibility for reviewing corporate disclosures, explained in detail how every level of guidance has long required inclusion and disclosure of AROs: statutes, regulations, two generations of FASB standards, public comment by the SEC and even a leading reference book. He cited chapter and verse of how decommissioning costs fall under the standardized measure of oil and gas (“SMOG”) disclosure and under FASB 932. He even quoted from SEC guidance of from twenty and more years ago.
Specifically, he asserted that financial disclosures must include undiscounted costs as well as discounted aggregates for all retirement costs. The discounted total reported in the summary of liabilities does not suffice. It is not sufficient to argue that the date of abandonment is uncertain, and it is not sufficient to assert that costs are trivial. All legal obligations of decommissioning fall within the scope of disclosure, both active and idle wells as well as surface removal and remediation of well sites, flowlines, and shared facilities.
Scheduling those costs should comport with time periods required by law or contract. If legal obligations expand, for example by boomerang liabilities from assets sold previously, then those liabilities merit disclosure. In fact, the existence of statutory residual liability may already pose enough risk that it deserves discussion with investors. Statutes in key jurisdictions like Louisiana, California, and the Gulf of Mexico make previous owners liable when subsequent operators fail, so the fact that companies like Exxon could face liability for billions of dollars of liability for assets sold decades ago may need to be discussed, even to be quantified and disclosed.
Recent comment letters by the SEC demonstrate his point about their focus on these requirements. By the engineer’s personal count, his office propounded 49 comments about abandonment costs to oil and gas filers in the last four years, 20% of FASB ASC 932 disclosure comments. This history also reinforces that the SEC has annealed their theories of disclosure and accountability in the fires of disagreements with multiple companies and their securities attorneys; the SEC’s requirements seem unlikely to change.
For instance, comment letters describe how the concepts of materiality and significance do not excuse or preclude disclosure of asset retirement obligations. Those tests apply to individual disclosures, and the existing rules require disclosure of an undiscounted total all abandonment costs. Which is to imply that the absence of an estimate for undiscounted cost, or an error of 5 or 10%, could trigger the tests of materiality and significance.
He reiterated several times and ways the potential consequences—economic, criminal, and civil—that can follow from an SEC comment. Already two filers have had to restate their undiscounted liabilities, and the SEC further admonished one of those to review its internal controls. These are the kinds of outcomes that could spawn investor defections and personal liability for executives, auditors, and even for engineers like those in his audience.
In fact, the engineer closed his 70 minutes of discussion with three slides about Sarbanes-Oxley, including a headline from the hometown newspaper and a reminder that disclosures are reviewed at least once every three years. The final slide brought it home: “The SEC staff reminds professionals engaged in the practice of reserve estimating and evaluation that the Securities Act of 1933 subjects to potential civil liability every expert who, with his or her consent, has been named as. . .having prepared or certified any report or valuation used in connection with the registration statement.”
By Dwayne Purvis for Oilprice.com
