Dec2016 - Calculating Environmental Liabilities

© 2017 Environmental Risk Communications, Inc.

Contact:John Rosengard(510) 548-5570

www.erci.com

Calculating Environmental Liabilities

December 2016


Outline

Definitions of the Types of Liabilities

Watch Lists and Event Trees

Guidance for Calculations

Best Practices in Financial Modeling

Q&A


Speaker Background: John RosengardWrote Defender™ liability forecasting software package Environmental remediation liabilities (ASC 410-30) Asset retirement obligations (ASC 410-20) Due diligence on acquisitions and divestitures Watch list for future reserve increases (sites & portfolios) Decision analysis on individual sites Pollution remediation obligations (GASB49) Counterparty (PRP) default tracking

ERCI supports Corporate remediation teams PRP groups Port authorities The engineering/consulting and legal partners Their internal and external auditors

Member of ASTM E2137 workgroup, tech contact E2173

MBA, Northwestern; BS, Georgetown

John RosengardFounder/CEO, [email protected], CA


Five Types of Environmental Liabilities

Asset Retirement Obligations

Commitments Contingencies Guarantees

Liabilities

Your company and four others sign a consent order to complete the RI/FS for a CERCLA site

An asset sale agreement includes a buyback promise if a buyer finds contamination

Leasing property indefinitely on premise that study and possible remediation are deferred

Financial assurance to regulator

Asbestos removal

Lead-based paint removal

Mine closure

Stormwater line decommissioning

Oil well plugging and abandonment

Environmental Remediation Obligations

CERCLA past cost reimbursement to USEPA

Deminimis cash out

Outcome from Litigation

FASB: ASC 410-20GASB: GASB 83IASB: IAS 37

FASB: ASC 410-30GASB: GASB 49IASB: IAS 37

FASB: ASC 440GASB: Note disclIASB: IAS 16

FASB: ASC 450GASB: GASB 10IASB: IAS 37

FASB: ASC 460GASB: GASB 70IASB: IAS 39


Asset Retirement Obligation Examples

Creosote pilings removal


Asset Retirement Obligation Examples

Warehousedemolition

Power plant demolition

Airportdecommissioning


Asset Retirement ObligationsExample Booked

NowAnnual Duty

AROTask(s)

Buyer acquires building with asbestos and lead-based paint; purchase contract clearly transfers ARO from seller to buyer for $1 M price discount.

$1 M Reconfirm timing and amounts.

Demolition

Company leases land for 60 years, adds treatment ponds and RCRA drum storage building. The RCRA permit and the lease end in 20 years.

Demo: $0.1 MPond closure: $5 M

Reconfirm timing and amounts.

Demolition, RCRA facility investigation, corrective action

Natural gas is discovered and company is 60% owner of well royalties

60% of ARO for production assets and wells.

Determinedecommissioning date and unit costs.

Remove production equipment and plug wells.

Company builds and owns four new warehouses for new product line; 40 year life on building, 15 year life on solar panels

Per warehouse: $0.5 M for demo; $0.2 M for solar panels

Confirm ARO dates are 15 and 40 years out.

Remove old solar panels; demolish warehouse.


“Obligation” is not a “contingency”. If an ARO is an “enforceable obligation”, estimate it and book it. Enforceable, not enforced. Big difference.

Must be “fair value measurement” (three methods: income, market, or replacement cost)

Must be “expected value” (based on multiple scenarios of dates, technologies or other factors)

Must be “present value” (adjusting future spending with credit-adjusted risk free rate)

Asset Retirement Obligations – How-to

2017 2018 2019 2020 2021 2022 2023 2024 202580% primary strategy -$ -$ -$ -$ -$ -$ 50$ 50$ 2,000$ 20% backup plan -$ -$ -$ -$ -$ -$ 100$ 4,000$ 100$

current $ -$ -$ -$ -$ -$ -$ 60$ 840$ 1,620$

inflation factor (0%) 100% 100.0% 100% 100.0% 100% 100.0% 100% 100.0% 100%discount factor (4%) 100% 96.0% 92.2% 88.5% 84.9% 81.5% 78.3% 75.1% 72.1%Cash flows (PV, 4%) -$ -$ -$ -$ -$ -$ 47$ 631$ 1,169$

Present value (2017) 1,847$ ARO balance, each year 1,847$ 1,924$ 2,004$ 2,087$ 2,174$ 2,265$ 2,299$ 1,555$ -$


Environmental Remediation Obligation Examples

Contaminated soil removal

Pipeline removal

Sediment remediation

Groundwater remediation


Environmental Remediation ObligationsExample Booked

NowAnnual Duty

Future Work

USEPA sends your company a 104e information request about a CERCLA site

$0 Reconfirm allocation and amounts.

Join PRP group

Company determines a stormwater line carried contamination from a plant to anadjacent CERCLA sediment site, and decides to join an existing PRP group

TBD Determine allocation, timing of cash calls, viability of PRP group

RI/FS, RD, RA, OM&M; PRP group administration

USEPA issues a record of decision on a site where the company has a 10% allocation

10% of expectedvalue

Reconfirm dateand amount of cash calls; Determine counterparty viability.

RD, RA, OM&M; PRP group administration

RCRA facility investigation is completed just as decision to close company plant is made.

RCRA corrective action cost and ARO

Confirm end state for property, date and amount of spending.

RCRA CA, ARO work


“Obligation” vs. “contingency”. Decide if an issue has an enforceable obligation or looks like a claim (strictly financial settlement). Same property may have all types of liabilities simultaneously

“Obligation path” – use “fair value” + “expected value” + “present value” if your company policy allows

“Contingency path” – use “probable and reasonably estimable” criteria; track recognition benchmarks and obligating events via a watch list (next page!)

Environmental Remediation Obligations – How-to


Site Specific Watch List Example

Source of Risks How Risks become CostsInputs to Generate Expected

Value

Liability Type

Site-Specific Definition of

Environmental Liability

Current Obligating Event(s) or Recognition

Benchmark(s)

Future Obligating Event or

Recognition Benchmark(s)

Probability of Future Obligating

Event or Recognition

Benchmark(s)

Range of dates (current

expectations)

Range of Costs (low

to high)

Asset Retirement Obligation

UST removals (4), demolition of 800,000 SF warehouse

Purchased 1962Building in service in 1983

Decision to remove building from service

100% 11–40 years $4–$50 M

RCRA Closure Obligation

Closure of process water cooling system, 8 acres

Purchased 1962RCRA Permit 1993

Decision to terminate RCRA permit by owner or regulator

Decision to modify or sell operation 10%Decision to close 100%

1–40 years $20–$80 M

Remediation Obligation

Abandonment of groundwater well network

Purchased 19622010 Spill Response2014 Groundwater remediation system installation

Regulatory approval of the well abandonment step

Regulatory approval 100%Decision to close facility and convert use 95%

2024–2034

2020–2056

$1 M

Remediation Obligation

Soil excavation, 2 acres x depth of 6-10 feet

Purchased 19621995 Fire

Regulator issues notice of violation

25% 2017–2020 $2–$3 M


Commitments - ExamplesExample Booked

NowAnnual Duty Future

WorkYour company sells an operating plant and agrees to reimburse 50% of third-party cleanup costs for ten years

50% of expected spending

Reconfirm date and amount of cash calls; Determine counterparty viability.

Counterparty tracking

Your company donates surplus land to a nonprofit wetland bank. While no contamination is known, your company promises to buy land back if any contamination is found in the future.

None Confirm no change in land use or change in ownershipstructure.

None

Your company leases surplus land to an industrial user. Tenant plans improvements and to operate RCRA-permitted assets and promises to return land in “original condition” in 30 years.

None Determine counterparty viability.

None

Pipeline operator leases an easement from your company, with agreement to keep all assets above the groundwater table.

None Monitor groundwater table, spill reports; determine counterparty viability.

Invoke commitment


Contingencies - ExamplesExample Booked


WorkAn adjacent property owner asks your company to prevent stormwater from inundating their property

None Determine if stormwater permit is violated

TBD

USEPA invoices your PRP group for $75,000 in oversight costs five years after remedial work concluded. Your company has 50% of the PRP group allocation.

Cash call for future five year reviews

Reconfirm allocation with other PRPs (ifappropriate)

TBD

USEPA and a site’s PRP group jointly announce cash outs to deminimis parties. Your company was noticed ofa volume and range of cash out values.

Cash out value, unless due immediately

Determine date(s) of cash calls, probability of reopeners, viability of high-allocation PRPs

TBD


Guarantees - ExamplesExample Booked


WorkUSEPA requires RCRA financial assurance for a 30-year monitoring period

30-year OM&M scope

Reduce amount and duration of financial assurance instrument annually

OM&M

State requires a performance bond for asset retirement work when your company’s mining operation closes

Incremental cost of bond

Reconfirm timing and cost of ARO work is reported to financial instrument provider and State regulator

ARO work

US Interior Department requires letter of credit or bond for oil well platform decommissioning

Incremental cost of LC or bond

Reconfirm timing and cost of ARO work is reported to financial instrument provider and State regulator

ARO work

Your company breaks into two pieces; your surviving company guarantees all environmental liabilities of peer will be satisfied

Peer liability x probability of default over time

Understand if spending at peer is reducing liabilities

Take back work if needed


Comparison of Estimate PurposePurpose Time

HorizonInflation and Discounting

Fair Value

Expected Value

Present Value

Asset retirement

Life of asset

Per GAAP Mandatory Mandatory Mandatory

Remediation Reserve forecast

Company policy

Per policy Per policy Per policy Per policy

Budgeting 1-5 years No No No NoCash out Infinite Best practice Yes Yes YesInsurance claim Per policy

limitsPer policy limits

Per policy limits

Per policy limits

Per policy limits

Due diligence Infinite Best practice Yes Yes YesFinancial assurance

As required

As specified No No No

Commitment Infinite Per GAAP Yes Yes YesContingency Company

policyPer policy Per policy Per policy Per policy

Guarantee Infinite Per GAAP Yes Yes YesRemedialalternatives

30 years Per EPA guidance

No No Yes


Recognition Timeline v. Spending

$0

$5

$10

$15

$20

$25

2005 2010 2015 2020 2025 2030

Asset Retirement Obligation (FASB)Asset out of service

$0

$5

$10

$15

$20

$25

2005 2010 2015 2020 2025 2030

Asset Retirement Obligation (GASB)

GASB 83 effective

Asset out of service

Asset in service

Asset in service

$

$

$0

$5

$10

$15

$20

$25

2005 2010 2015 2020 2025 2030

Commitments & Guarantees

$0

$5

$10

$15

$20

$25

2005 2010 2015 2020 2025 2030

Probable + Reasonably Estimable

$ $ $

$

$

$

Initial Obligation New Obligating

Events or Recognition Benchmarks

Contract or Obligation

$

$ $

Cashout


Relevant Information1 Event type (for example, new air emission control requirements, leaking landfill, site PRP notice, worker exposure, site decommissioning, compliance audit findings, notice of violation, filing of a lawsuit, and recognition benchmarks and obligating events2 Number and location of affected operations/facilities, 3 Use of surrounding property, including but not limited to sewer systems, groundwater and surface waters,4 Past, current, and potential future site uses, and constraints imposed upon those future uses by AULs, including institutional controls and/or engineering controls,5 Findings from environmental and other relevant studies,6 Environmental risks posed by the event,7 Bodily injury or other claims related to the event,8 Relevant federal, state, tribal, local, or other regulatory requirements and alternatives,9 Federal, state, tribal, local, or other agency involvement, including the preferred alternatives and preferred remedies of governing agencies,10 Public involvement,11 Planned or completed remedial activities,12 Decision documents (for example, Records of Decision),13 Litigation activities related to the event (for example, claims, suits, actions, demands, requests for payment, notices),14 Resources, tasks, and deadlines,15 Available technologies and designs,16 Type and extent of contamination,17 Number of operable units (CERCLA) or solid waste management units (RCRA),18 Involvement of various parties at the event, 19 Information on prior experience with similar events,20 Experience with and expectations of enforcement actions by regulatory authorities, 21 Timeline to implementation of a given liability, through, for example, a remediation program, asset retirement plan, capital expenditure

project, claim adjudication, toxic tort investigation, arbitration proceeding, or litigation,22 Impacts to natural resources and ecological assets, and the interests of relevant natural resource trustees,23 Ecological assets and environmental projects used to offset assessment or remediation costs (Note: This may include supplementalenvironmental projects),24 Relevant tax consequences.

Guidance available from several sources:

• ASTM Standards

• Financial Accounting Standards Board

• Government Accounting Standards Board

• International Accounting Standards Board

• Public Company Accounting Oversight Board

• American Institute of CPAs


Policy Decisions1 Changes to GAAP,2 Changes to requirements of external financial auditors,3 Changes to entity policies to comply with GAAP and auditor requirements, 4 New or modified environmental laws and regulations (Note: critical habitat regulations may change over time.),5 Policy decisions or interpretations to be made by regulatory agencies,6 Compliance assurance procedures or policies adopted by the dutyholder,7 Acceptable levels of risk (for example, business risk, human health risk, ecological risk),8 The degree to which societal or external costs and benefits are considered,9 The duration of the forecast for costs and liabilities, and whether or not life cycle costs are considered, 10 The degree to which sustainability/sustainable development are considered,11 Local environmental management system criteria, including trade-off of emissions across environmental media, alternative methods and permitting options, auditability, and performance oriented metrics,12 Level of non-governmental organization involvement and scrutiny,13 The degree of communication with and cooperation of the public.

In the absence or insufficiency of such information, an assessment should be made of the applicable regulatory and industry standard requirements, and a determination made as to whether based on these requirements, significant costs and liabilities for environmental matters may be incurred that would indicate the need for further data collection and analysis in the future.

Guidance available from several sources:

• ASTM Standards

• Financial Accounting Standards Board

• Government Accounting Standards Board

• International Accounting Standards Board

• Public Company Accounting Oversight Board

• American Institute of CPAs


Fit-for-purpose: Right Tool at Right Time

Current cost-to-close ($ M)

Tools available Financial assurance <$0.1 $0.1 -

$0.5$0.5 -

$1 $1 - $5 $5 +

Detailed estimate √ √ √ √ √ √Cost bracketing √ √ √ √ √ √Event tree √ √ √ √Weighting of scenarios √ √ √ √Probabilistic modeling √ √ √ √Remedy scenarios √ √ √ √Non-remedy scenarios √ √ √Detailed decision analysis √ √ √Sensitivity analysis √ √Peer review of costs √ √Peer review of constructability √

Takeaway: higher expected cost = more cost engineering


Recognition BenchmarksRecognition Benchmarks (from ASC 410-30-25-15)• Identification and verification of an entity as a potentially responsible party• Receipt of a unilateral administrative order.• Participation, as a potentially responsible party, in the remedial investigation-

feasibility study• Completion of feasibility study.• Issuance of record of decision • Remedial design through operation and maintenance, including

postremediation monitoring.

Recognition Benchmarks (from GASB49:12)• Receipt of an administrative order.• Participation, as a responsible party or a PRP, in the site assessment or

investigation.• Completion of a corrective measures feasibility study.• Issuance of an authorization to proceed.• Remediation design and implementation, through and including operation and

maintenance, and post-remediation monitoring


Obligating EventsObligating events (from ASC 410-20-15-2)a. …acquisition, construction, or development and (or) the normal operation of a long-lived asset, including any legal obligations that require disposal of a replaced part that is a component of a tangible long-lived asset. b. An environmental remediation liability that results from the normal operation of a long-lived asset and that is associated with the retirement of that asset. ….c. A conditional obligation to perform a retirement activity. ….d. Obligations of a lessor in connection with leased property that meet the provisions in (a). ….e. The costs associated with the retirement of a specified asset that qualifies as historical waste equipment as defined by EU Directive 2002/96/EC. ….

Obligating events (from GASB49:11): • The government is compelled to take pollution remediation action because of an imminent

endangerment.• The government violates a pollution prevention–related permit or license.• The government is named, or evidence indicates that it will be named, by a regulator as a

responsible party or potentially responsible party (PRP) for remediation, or as a government responsible for sharing costs.

• The government is named, or evidence indicates that it will be named, in a lawsuit to compel participation in pollution remediation.

• The government commences or legally obligates itself to commence pollution remediation.


Variable Level 1/2/3 inputs: site-specific conditions, KPIs, unit costs

FVM Level

Income Impact

A. Lifecycle cost projection 12 years pump & treat, 10 gpm from 5 wells, three pore volumes of 19 acres

2 -$5.5 million

B. Contingencies for changes to scope, schedule and vendor

25% cost increase for fourth pore volume, doubling well count (to 10) in years 8-12

2 -$1.2 million

C. Premium for full/partial strategy failure

Additional ten years pump & treat for fifth and sixth pore volume

3 -$3.8 million

D. Premium for project management 12 years oversight, legal, contracting, cost recovery work 2 -$2.8 million

E. Premium/discount for counterparty risk

Successor owner has diesel generator onsite; credit rating 620

1 -$1.5 million

F. Premium/discount for your company’s own ability to pay

Fortune 200, credit rating 1085 1 +$0.5 million

G. Insurance for cost cap, etc Self-insuring all cost escalation, reopeners 3 +$0.0 million

H. Income for brownfield Ground lease $500K/yr to 2025 2 +$5.0 million

I. Recovery - current/future costsAsserted and unasserted claims

50% recoverable under Federal contract20% recoverable from legacy owner

2 +$7.4 million+$3.0 million

J. Recovery – sunk costsAsserted and unasserted claims

50% recoverable under Federal contract20% recoverable from legacy owner

1 +$0.5 million+$3.0 million

K. Value of deferred tax assets 30% of items A through F 1 +$4.3 million

Fair Value Components Total OutflowsInflows

Net

-$14.8 million+$23.7 million

+$8.9 million

Fair Value Term Sheet (Reserve = A to F)


Event Tree Example

24


Expanded Event Tree for Counterparty Risk

25

Takeaways • Professional judgement is essential to selecting which uncertainties,

negotiations and decisions to display• probabilities also require professional judgement; document your thinking• keep decisions separate from uncertainties and decisions you make with others

(negotiations)


Probabilistic Modeling vs. Event TreesEvent Trees Key Tasks Separates cost uncertainties from negotiations and from decisions

Uncertainties: unit prices, economies of scope / scale, counterparty risk, remedy failure Decisions: pace to closure, soil / GW cleanup goals, remedy selection, property reuse

Test and develop a range of workable alternatives Mature vs. emerging technologies Local vs. national contractors

Make timing explicit; if regulator is not enforcing timetables, be transparent about their lack of urgency (very common)

Probabilistic Modeling Key Tasks Includes all data from Event Trees, plus…. Bracketing for ten high-cost components

Widest range during investigation (-50%/+100%)

Narrower range at feasibility study stage (-30% to +50%)

Common hazard: neglecting to correlate assumptions, otherwise variables cancel out Four steps (next slides)


Financial Modeling Practice #1 – Assumption Table

27

Transparent bracketing

WBS line items, unit costs, or units

for bracketing

Calculated expected values

Cases for decisions


Financial Modeling Practice #2 – Standard WBS

28

Point estimates

Expected values from modeling

sheet

User selects subtasks from

drop-down menus

Common WBS

Takeaway: WBS separates costs for study, remediation, O&M, overhead and legal costs; recovery rates (%) apply to one or more PRPs and insurers


Distribution Type[Preferred]

When to Use Example

Normal Higher confidence estimates for minimum, likeliest and maximum costs.

Remedial study costs will be $100,000, +/-$50,000.

Triangular Higher confidence estimates for minimum, likeliest and maximum costs.

Remedial study costs will be $100,000, +/-$50,000.

Lognormal Higher confidence estimates for two points on a cost curve, such as the 10th, 50th or 90th

percentiles.

10% chance the cost will be $35,714 or less; 10% chance the cost will be $70,000 or more.p(10) = $35,714p(90) = $70,000

Uniform Only minimum and maximum are estimated.

Lab costs will be between $100,000 and $200,000.

Beta O&M duration (years only) System O&M for ten to 25 years.

Weibull Any two or more data points are known.

Match curve to any data.

Custom Either/or events 60% chance of $25,000 cost, 40% chance of $75,000 cost.

Financial Modeling Practice #3 –Proper Distribution


Financial Modeling Practice #4 –Estimate Reliability

Work through reasonable range of alternativesSplit decisions from uncertainties (risks)

Systematically work through entire WBSMake a comprehensive estimate

Be realistic about timing

Incorporate a cost loaded schedule

Add ranges for achievable outcomesMake the ranges wide enough

Incorporating cost of failure or supplementary work

Connect project risks through statistical correlation


Probabilistic Forecast


Probabilistic Forecast Comparison


Probabilistic Forecast Utilization

reserveWatch list


Starting Point – Evolving Forecasts

2012

2011

2013

2016

2015

2014

2010

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027

($ M

)

Cumulative Spending

}+23%

}+14%Lifecycle Cost to Close Forecasts

Takeaway: this graph compares a trailing indicator (spending) and a current indicator (closure forecasts)


$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027

($ M

)

Cumulative Spending

Reserve Changes and Watch List

Original Reserve

2011 Update

2014 Update

Due Diligence Reserve Add

← Watch List →

Purchase Accounting Reserve Add

Reserve increases

Takeaway: this graph compares a current indicator (reserve increases) and a leading indicator (the watch list)


Original Reserve

Purchase Accounting Reserve Add

2011 Update

2014 Update

Due Diligence Reserve Add

Reserve Estimates vs. Spending vs. Liability

2012

2011

2013

2016

2015

2014

2010

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027

($ M

)

Cumulative Spending

Takeaway: this graph compares trailing, current and leading indicators- Reserve increases lead spending by several years- Watch list leads reserve increases and generally trends down

← Watch List →


cost

un

certa

inty

Probabilistic Reserves Increase Forecast

$0

$10

$20

$30

$40

$50

$60

$70

$80

$90

$100

$110

$120

$130

1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027

($ M

)

timinguncertainty

Commitment to Full Soil Remedy Commitment to

Redevelop Site

Commitment to Sell Site


Summing Up

What is at Risk Misallocating capital (people, money, reputation, attention) Not complying with GAAP

What Can Improve Does spending match liability reductions? Are we discharging booked liabilities at the best rate? Is there a large gap between book and fair value? Do cost recoveries capture full life-cycle costs? Are our asset retirement obligation forecasts appropriate given

the current size of our asset base?

© 2017 Environmental Risk Communications, Inc. 39

Next Steps

Website: www.erci.com

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Email [email protected] or call (510) 548-5570 PDF of this presentation (original PPTX format on request)

December 2016 webinars on Calculating Environmental Liabilities Calculating and Managing Environmental Counterparty Risk Presenting and Disclosing Environmental Liabilities Fair Value Measurement for Environmental Liabilities

Dec2016 - Calculating Environmental Liabilities

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