Dec2016 - Presenting and Disclosing Environmental Liabilities
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Transcript of Dec2016 - Presenting and Disclosing Environmental Liabilities
© 2017 Environmental Risk Communications, Inc.
Contact:
John Rosengard(510) 548-5570
www.erci.com
Presenting and Disclosing Environmental Liabilities
December 2016
© 2017 Environmental Risk Communications, Inc.
Elevator Speech Environmental liabilities are significant, growing
GAAP more detailed than ever More environmental regulations than ever Legacy and ongoing releases to soil, GW, sediments Raw sampling data accumulating Detection technology improving Data in public domain (aerial, scientific, property tax, financial) Counterparties defaulting regularly
Reliably stating environmental liabilities is a challenge Fair value is the trend; counterparty risks grow unchecked Legacy behaviors brought deferral, not extinguishment
© 2017 Environmental Risk Communications, Inc.
OutlineWhat Are Environmental Liabilities? GAAP References Why Do Environmental Liabilities Matter? Are the Liabilities Significant?
How Has Presentation and Disclosure Changed? Fair Value Measurement Non-Performance Risk of Counterparty Default Presenting Internally vs. Disclosing Externally
Presentation and Disclosure Examples
Q&A
© 2017 Environmental Risk Communications, Inc.
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
© 2017 Environmental Risk Communications, Inc.
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
© 2017 Environmental Risk Communications, Inc.
Environmental Remediation Obligation Examples
Contaminated soil removal
Pipeline removal
Sediment remediation
Groundwater remediation
© 2017 Environmental Risk Communications, Inc.
Asset Retirement Obligation Examples
Creosote pilings removal
© 2017 Environmental Risk Communications, Inc.
Asset Retirement Obligation Examples
Warehousedemolition
Power plant demolition
Airportdecommissioning
© 2017 Environmental Risk Communications, Inc.
Federal Environmental Legislation v. GAAP Timeline
9
© 2017 Environmental Risk Communications, Inc.
FASB Conceptual Framework
Source: FASB Statement of Financial Accounting Concepts No. 8, September 2010
Enhancing Qualitative
CharacteristicsFundamental Qualitative
Characteristics
Objective of Financial Reporting
Information
Useful to Decisions
Relevant
Predictive value
Confirmatory value
Faithful Representation
Complete
Neutral
Free from error
Elements of Financial
Statements
Comparability
Verifiability
Timeliness
Understandability
Recognition
Measurement
Presentation
Disclosure
Cost Constraint
Materiality Constraint
© 2017 Environmental Risk Communications, Inc.
Liability Estimate Purpose (□ = disclosed)Purpose 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
© 2017 Environmental Risk Communications, Inc.
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% 2028 - 2057 $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%
2018 - 2057 $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% 2018–2021 $2–$3 M
© 2017 Environmental Risk Communications, Inc.
($ millions)
Site Future Obligating Event or Recognition Benchmark
Probability of OE/RB
Timing LowValue
Expected Value
High Value
Site 1 Decision to remove building from service
100% 2028-2057 $4 $20 $50
Site 1 Decision to terminate RCRA Permitted Operations
10 – 100% 2018 -2057
$20 $30 $80
Site 1 Regulatory approvals with decision to close the facility (noted above)
95% 2020-2056 $1 $1 $1
Site 1 Soil excavation due to regulator NOV 25% 2018-2021 $2 $3 $4Site 2 Remedy selection: SVE for 10 years 100% 2018-2022 $7 $10 $15Site 3 Insurer denies coverage 50% 1/1/2019 $49 $70 $105Site 3 30% design of soil removal 20,000 MT 50% 2019-2020 $35 $50 $75Site 4 Scope of investigation 100% 1/1/2019 $3.5 $5 $7.5Site 5 NRDA claim/damages 80% 2018-2025 $7 $10 $15Site 5 25% PRP defaults by 2020 33% 7/1/2019 $21 $30 $45Site 5 Remedy selection for 195,000 MT
(solvents)100% 7/1/2020 $28 $40 $60
Site 6 Spill excavation, pipeline areas A-1 to C-10
100% 2019-2025 $14 $26 $40
… List continues…. … … $55 …Sum of Loss Contingencies $350
Portfolio Watch List ExamplePr
evio
us p
age
© 2017 Environmental Risk Communications, Inc.
Presentation and Disclosure Examples
ARO Site Population Tracking 2017 2016 2015A. ARO Sites at start of fiscal year 84 84 70B. ARO Sites added or reopened 0 4 20C. ARO Sites closed or transferred (2) (4) (6)D. ARO Sites at end of fiscal year 82 84 84
Portfolio Financial Tracking Table ($ millions) 2017 2016 2015A. Liability Value – start of fiscal year $125 $160 $150B. Liabilities incurred $10 $10 $10C. Liabilities settled (includes spending) ($15) ($30) ($30)D. Accretion expense $0 $0 $0E. Revisions in estimated cash flows (includes derecognition)
$20 ($15) $30
F. Liability Value – end of fiscal year $140 $125 $160G. Portion of Liability Value offset by deferred tax assets
$49 $44 $56
H. Corporate tax rate assumption applied 35% 35% 35%
© 2017 Environmental Risk Communications, Inc.
Portfolio Assumption Table 2017 2016 2015A. Inflation assumption (average) applied to portfolio 2% 2% 2%B. Discount assumption (average) applied to portfolio 4% 4% 4%C. Time horizon used for portfolio liability forecasting 20 yrs 20 yrs 10 yrsD. Portion of liability balance calculated using expected value
90% 85% 50%
E. Percentile we used for determining our own “ability to pay” (max = 100)
94% 90% 50%
F. Weighted average percentile of our counterparties’ abilities to pay (max = 100)
21% 17% 33%
G. Portion of liability balance concentrated in five largest environmental counterparties (or PRPs)
2% 25% 18%
H. Portion of liability balance with updated estimates 40% 0% 10%I. Date of cost index used June
2015Jan
2012Jan
2012
Presentation and Disclosure Examples
© 2017 Environmental Risk Communications, Inc.
Portfolio Metrics Tracking ($ millions unless noted) 2017 2016 2015A. Portion of liability balance in 3rd party financial assurance instrument
10% 0% 0%
B. Portion of liability balance which is self-insured 90% 100% 100%C. Approximate percentile of liability value (applied definition of expected value)
55th 55th 55th
D. Approximate percentile of “reasonably possible” value
75th 75th 75th
E. Approximate percentile of “remote” value 95th 95th 95th
F. Liability balance – end of year $140 $125 $160G. Reasonably possible increment (liability range between current liability value and remote increment, as defined by entity policy)
$20 $30 $40
H. Remote increment (liability range above reasonably possible increment, as defined by entity policy)
$105 $115 $125
Presentation and Disclosure Examples
© 2017 Environmental Risk Communications, Inc.
When Did Presentation and Disclosure Change?
1975 – FASB Statement 5 – Accounting for Contingencies Significant latitude to define a contingent liability
“Probable” that a loss has occurred Liability can be “reasonably estimated”
Outcome: divergence in practice. Examples: pensions, environmental, post-retiree medical, product warranty costs.
1996: AICPA SOP 96-1 Preference for expected value Recognition benchmarks Counterparty nonperformance risk of default (PRP “ability to pay”) Outcome: regular booking of reserves, reserve refills
2001: FASB 143 – Asset Retirement Obligations (now ASC 410)
2006: FASB 157 – Fair Value Measurement (now ASC 820)
2009: Accounting Standards Codification (ASC)
© 2017 Environmental Risk Communications, Inc.
Why is Spending Not Reducing ERLs?
18
Source: 10-K Reports, $ Billions.
Jan 1 balance
Spending
New Jan 1 balance
Year end increase
$4.0
$3.0
$2.0
$1.0
$0.0
© 2017 Environmental Risk Communications, Inc.
Why is Spending Not Reducing AROs?
19
Source: 10-K Reports, $ billions
AROs redefined
Legacy definitions
$20.0
$15.0
$10.0
$5.0
$0.0
© 2017 Environmental Risk Communications, Inc.
Detailed versus Minimal DisclosureMajor OilCompany
2014 10-KExcerpts
The company records asset retirement obligations when there is a legal obligation associated with the retirement of long-lived assets and the liability can be reasonably estimated. These asset retirement obligations include costs related to environmental issues. The liability balance of approximately $15.1 billion for asset retirement obligations at year-end 2014 related primarily to upstream properties. For the company’s other ongoing operating assets, such as refineries and chemicals facilities, no provisions are made for exit or cleanup costs that may be required when such assets reach the end of their useful lives unless a decision to sell or otherwise abandon the facility has been made, as the indeterminate settlement dates for the asset retirements prevent estimation of the fair value of the asset retirement obligation. Refer to the discussion below for additional information on environmental matters and their impact on us, and on the company's 2014 environmental expenditures. Refer to Note 23 on pages FS-57 through FS-59 for additional discussion of environmental remediation provisions and year-end reserves. Refer also to Note 24 on page FS-59 for additional discussion of the company's asset retirement obligations.
MajorIndustrial Manufacturer
2014 10-KExcerpts
Our operations, like operations of other companies engaged in similar businesses, involve the use, disposal and cleanup of substances regulated under environmental protection laws. We are involved in a number of remediation actions to clean up hazardous wastes as required by federal and state laws. Such statutes require that responsible parties fund remediation actions regardless of fault, legality of original disposal or ownership of a disposal site. Expenditures for site remediation actions amounted to approximately $0.4 billion in each of the years 2014, 2013 and 2012. We presently expect that such remediation actions will require average annual expenditures of about $0.4 billion in 2015 and $0.3 billion in 2016.
We are involved in numerous remediation actions to clean up hazardous wastes as required by federal and state laws. Liabilities for remediation costs exclude possible insurance recoveries and, when dates and amounts of such costs are not known, are not discounted. When there appears to be a range of possible costs with equal likelihood, liabilities are based on the low end of such range. It is reasonably possible that our environmental remediation exposure will exceed amounts accrued. However, due to uncertainties about the status of laws, regulations, technology and information related to individual sites, such amounts are not reasonably estimable. Total reserves related to environmental remediation and asbestos claims, were $2,182 million at Dec 31, 2014.
Asset Retirement Obligations 2014 2013 2012
Balance at January 1 $ 14,298 $ 13,271 $ 12,767
Liabilities incurred $ 133 $ 59 $ 133
Liabilities settled $ (1,291) $ (907) $ (966)
Accretion expense $ 882 $ 627 $ 629
Revisions in estimated cash f low s $ 1,031 $ 1,248 $ 708
Balance at December 31 $ 15,053 $ 14,298 $ 13,271
Environmental Remediation Reserves 2014 2013 2012
Balance at January 1 $ 1,456 $ 1,403 $ 1,404
Net Additions $ 636 $ 488 $ 428
Expenditures $ (409) $ (435) $ (429)
Balance at December 31 $ 1,683 $ 1,456 $ 1,403
© 2017 Environmental Risk Communications, Inc.
Will Presentation and Disclosure Change?
Fair Value Measurement Has been mandatory for Asset Retirement Obligations (AROs)
Why? FIN47 (2005) and ASC 410-20 make this clear (as long as you can make an estimate)
Discounted to a present value (at a current “credit adjusted risk-free rate”) Disclosures showing liabilities growing dramatically
Generally not applied to Environmental Remediation Liabilities (ERLs) Why? Wide latitude in ASC 410, 450 These liabilities don’t demonstrate spending efficiency or pace to closure
Preferred for Commitments, Guarantees
Nonperformance Risk of Counterparty Default Explicit part of determining a “fair value” Losses continue to occur, are preventable
© 2017 Environmental Risk Communications, Inc.
Does the Reserve ≈ Value of Spending Pattern?
Averages 1995–2015 2011–2015
ERL Spending/year $77 M $84M
ERL Increase/year $76 M $101M
Year End Balance $425 M $456M
❶
❷
$3.0
$2.0
$1.0
$0.0Source: 10-K Reports, $ billions.
$456 M
© 2017 Environmental Risk Communications, Inc.
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
Environmental: $0.5 B(Probable and reasonably estimable)
Dividend proxy: $1.9 B
Pension proxy: $1.4 B
Refinance proxy: $2.5 B
Market Value/Fair Value Zone
Source: 10-K Reports, $ billions.
Is “Book Value” vs. “Market Value” an Issue?
2016 data from US-based company, noting the valuation methods in place for remediation and pension liabilities; by valuing the remediation cash flows with actuarial pension or other approaches, market value would be 3x to 5x higher.
© 2017 Environmental Risk Communications, Inc.
$0.0
$0.5
$1.0
$1.5
$2.0
$2.5
$3.0
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
Source: 10-K Reports, $ billions.
Can Progress Be Monitored? ASC 410-30 Example
“likely” accounting definition
Takeaway: while a “probable and reasonably estimable” reserve policy may show spending does not impact the liability, using other metrics may show successful liability burndown.
© 2017 Environmental Risk Communications, Inc.
Fair Value Hierarchy
Level 1 (preferred): currently quoted price, active market, identical liabilities
Excavated soil “Class C waste”, trucked to landfill for $84.50/ton 500 sediment samples tested for PCBs under USEPA Method 8082A (SW-846) 80,000 kilowatt hours per year to operate groundwater pump/treat system
Level 2: some observable inputs, less-active market, similar liabilities
Site soils are 50% sand/50% gravel; lookup bulking factor is 1.15, therefore excavation will require 130 truck trips to the landfill.
Transportation costs last estimated when diesel was $3.648/gallon (7/2/2012). Peer PRP has credit score of 920; 35% probability of default in ten years.
Level 3: unobservable inputs, little (if any) market, unique liabilities
Regulatory approval of the remediation plan may take four years; during that delay, the groundwater plume may expand 0%-25%, depending on rainfall
© 2017 Environmental Risk Communications, Inc.
Fair Value Measurement Disclosure Metrics
$ millions 2017 2016 2015A. Portion at Level 1 $21 $13 $8
% of total 15% 10% 5%
B. Portion at Level 2 $28 $19 $16 % of total 20% 15% 10%
C. Portion at Level 3 $91 $94 $136 % of total 65% 75% 85%
D. Sum $140 $125 $160 % of total 100% 100% 100%
Common expectation is that Level 3 estimates will be replaced with Level 2 and Level 1 estimates over time.
© 2017 Environmental Risk Communications, Inc.
Quiz: Name the Source of This Disclosure
ARO
ERL1 ERL3
ERL2
Didn’t apply fair value Applied it
© 2017 Environmental Risk Communications, Inc.
Liabilities Repriced at Fair Value
Date Event12-31-2008 GM environmental reserve: $297 million6-01-2009 GM files Chapter 116-30-2009 GM updates their reserve to $536 million
10-20-2010 $773 million for first six settlements12-14-2010 +$25.0 million settlement = $798.0 million
3-3-2011 +$28.2 million settlement = $826.2 million3-7-2011 +$50.6 million settlement = $876.8 million
3-29-2012 +$23.8 million settlement = $900.6 million6-29-2012 +$39.2 million settlement = $939.8 million
11 settlements = 3.2x reserve, three years$297 million >>> $940 million
Source: USEPA press releases
© 2017 Environmental Risk Communications, Inc.
Why Are Liability Disclosures Necessary?
Help a reasonable investor/creditor make better decisionsHelp management allocate capital more efficientlyDisclosures demonstrate compliance with GAAP!
FASB: ASC 410-20 [ARO], 410-30 [ERL], 440, 450, 460, 820 GASB: GASB Statements 18, 49, 72, 83 IASB: IAS 37, IFRS 13 SEC Regulation S-K (17 CFR 210 to 230) Securities Act (1933); Securities Exchange Act (1934); Sarbanes-Oxley Act (2002); Dodd-Frank Act (2010) PCAOB AS 1015, 1105, 1210, 2501, 2502, 2705 (2011+) ASTM E2137-16 Standard Guide for Estimating Monetary Costs and
Liabilities for Environmental Matters ASTM E2173-16 Standard Guide for Disclosure of Environmental Liabilities
© 2017 Environmental Risk Communications, Inc.
Recognition and measurement changed Liability definitions and auditing procedures
Presentation and disclosure will follow recognition, measurement Fair value is being applied on AROs by all Fair value is being applied selectively on ERLs
Freeport-McMoran, 2007 ERLs for Phelps Dodge acquisition Republic Services, 2008 ERLs for Allied
Remediation reserves and AROs are typically replenished (annually) at rates from 80-300% of current year spending. Anecdotal justification for reserve increases:
Existing sites progressing from study to remedial design, then to remediation to OM&M (including five-year reviews)
New releases (ERLs), new capital expenditures (for AROs) Acquisitions PRPs defaulting on their allocations Changing cleanup goals
ERCI Observations
© 2017 Environmental Risk Communications, Inc.
Summing Up Presentation and Disclosure
What is at Risk Misallocating capital (people, money, reputation, attention) Not complying with GAAP
What Can Improve Is there a large gap between book and fair value? Do cost recoveries capture full life-cycle costs? Does spending match liability reductions? Are we discharging booked liabilities at the best rate? Are our asset retirement obligation forecasts appropriate given
the current size of our asset base?
© 2017 Environmental Risk Communications, Inc. 32
Next Steps
Website: www.erci.com
LinkedIn Group – webinar announcements
YouTube page – select webinar recordings
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