BP's reduction in its oil and gas price assumptions - could this set off a chain reaction that puts us on a path to Paris?
BP has today announced that it will lower the long-term oil and gas price assumptions used in its financial statements by roughly 20% and 28% respectively, resulting in estimated impairments of between $13 and $17.5bn. This is equivalent to 13% to 17% of 2019 net assets. This move – which follows an engagement Sarasin & Partners has led with BP’s Audit Committee and lead audit partner – is hugely important, not just to BP shareholders, but to the world as it seeks to deliver on its commitment to the Paris Agreement. This is because until we get Paris-aligned numbers, promises to align business strategies and capital expenditure with a goal of keeping temperature increases well below 2⁰C will be questionable.
Take a simple example. If oil and gas companies are using $70/bbl for valuing their oil assets on their balance sheet, clearly these assets will be more valuable than if they use $50/bbl. This impacts not just plants, property and equipment, but also exploration assets, goodwill, joint venture valuations, and even deferred tax assets. In other words, almost the entire balance sheet embeds this assumption in some form. It also impacts how soon liabilities, such as asset retirement obligations need to be paid. The lower the price, the sooner these liabilities will be incurred as operations are wound down earlier, and the bigger the liability in present value terms.
Taken together over-stated oil and gas prices therefore underpin reported capital and performance, and thus what money is available to reinvest. The numbers also tell executives whether it is profitable to put more money into fossil fuels. The lower the expected price, the less new capital will go towards oil and gas. Paris-aligned accounts, thus, give Paris alignment promises teeth.
BP should be commended for showing leadership; other fossil fuel dependent companies need to sit up and take note. Based on our detailed analysis of major European fossil fuel companies’ financial statements released this spring, it is clear that almost none have aligned their critical accounting assumptions with the Paris Agreement. The level of BP’s impairments demonstrates the materiality of this risk hidden in companies’ balance sheets.
The question company directors and their shareholders now need urgently answered is where else might company positions be overstated? And this question is not only pertinent to oil and gas companies, but any company that depends on fossil fuels to deliver future profits.
Sarasin & Partners has been at the forefront of calling for Paris-aligned accounts and audit since 2018. We released a paper “Are oil and gas companies overstating their positions?” in 2018, and worked with the Institutional Investor Group on Climate Change to publish a discussion paper on the topic later that year.
In 2019, Sarasin brought together roughly 30 institutional investors to write to the Big Four audit firms (PWC, KPMG, EY and Deloitte) to set out investor expectation for Paris-aligned audits. Letters followed to audit committees as specific companies, including BP, Shell and Total in November 2019. A broader effort is currently being rolled out to a range of fossil fuel exposed companies.