Disclosure of Financial Exposures to Climate and Other Environmental Risks

1
Disclosure of Financial Exposures to Climate and
Other Environmental Risks

• Robert Repetto
• Sr. Advisor, Stratus Consulting
• 303-381-8226
• rrepetto_at_stratusconsulting.com

2
Repetto/Austin Studies on Companies Climate and
Other Material Environmental Exposures

• Pulp Paper Pure Profit, WRI, 2000
• Oil Gas Changing Oil, WRI, 2002
• Electric Utilities The Complexities of
  Strategic Environmental Management in the
  Electric Utility Sector, Corporate Environmental
  Strategy, January, 2003
• Mining Silence is Golden, Leaden Copper
  online at www.yale.edu/environment/publications

3
Common Conclusions

• Some companies have very material financial
  exposures to climate and other impending
  environmental issues.
• Within each industry, exposures differ greatly
  among companies, creating potential winners and
  losers.
• The financial exposures are complex and difficult
  to estimate.
• Companies disclosures are inadequate, despite
  existing laws and regulations.

4
Pulp and Paper The Steps in the Analysis

• 1 Identify material environmental issues
• 2 Develop scenarios around each one
• 3 Assess each companys exposure to each issue
• 4 Estimate financial impacts of all scenarios
• 5 Weight each impact by probability of scenario
• 6 Aggregate across issues and scenarios
• 7 Compare results with companies disclosures

5
Financial exposure of major pulp and paper
companies to pending environmental issues
Expected Financial Impact (as age of market
value)
6
Sample Disclosure Statements from Pulp and Paper
Company 10K Filings

• In the opinion of ... management, environmental
  protection requirements are not likely to
  adversely affect the companys competitive
  industry position since other domestic companies
  are subject to similar requirements
• Since other paper and forest product companies
  also are subject to environmental laws and
  regulations, the company does not believe that
  compliance with such laws and regulations will
  have a material adverse effect on its competitive
  positioning

7
Climate-Related Issues Facing Oil and Gas Sector

• Scenarios included Kyoto and non-Kyoto related
  possibilities
• Estimated changes in current profits and value of
  reserves
• Related results to shareholder values

8
Companies Assessed

• Amerada Hess
• Apache
• BP
• Burlington
• ChevronTexaco
• ConocoPhillips
• Eni
• Enterprise

• ExxonMobil
• Occidental
• Repsol
• Royal Dutch Shell
• Sunoco
• TotalFinaElf
• Unocal
• Valero

9
Financial Impacts of Scenario A Adoption of
Kyoto Protocol
10
Corporate Disclosure of Climate Issue

• Only 2 companies disclosed climate change
  policies as a possible risk to future earnings in
  their SEC filings.
• 3 more mention climate change in their annual
  reports, with no mention of financial
  implications.
• 7 companies report their GHG emissions in
  supplemental reports.
• Findings have helped stimulate shareholder
  resolutions requesting greater disclosure.

11
Electric Utilities Cost Impacts of 2 Proposed
New Air Quality Laws

• Three-pollutant cap-and-trade law (Clear Skies)
• caps emissions of NOx, SOx, mercury
• allows trading
• favored by Bush administration
• Four-pollutant cap-and-trade law
• also caps CO2 emissions
• introduced by Senators McCain, Lieberman and
  others

12
Compliance Costs for 47 of the Largest US
Electric Utility Holding Companies

• Compliance cost is the least-cost mix of
  pollution controls and permit purchases (or
  sales) for each generating unit,
• Future costs are discounted at 8/yr.
• Present value costs for each company are added up
  across all its generating units.
• Present value costs are benchmarked to each
  companys 2000 total revenues.

13
(No Transcript)
14
Financial Risk vs. Indicators of Exposure The
Five Most Exposed Companies
Least-cost Compliance per of Sales (STRATUS) Emissions per KWH (CERES/NRDC) External Cost per Of Sales (TRUCOST)
Allegheny Nisource (26) Cinergy (9)
Progress Energy Vectren (15) Southern (6)
AEP Allete (32) AEP (3)
DPL TECO (10) TXU (40)
Ameren WPS Resources (17) Calpine
15
Figure 2 4-Pollutant CapTrade, Permits
Grandfathered, Regulated Market v. Deregulated
Market Merchant Plants
16
Disclosure Record of Electric Companies in SEC
(10-K) Filings

• Few companies have disclosed financial impacts of
  multi-pollutant cap-and-trade bills or carbon
  controls.
• Though they are known material uncertainties.
• Most companies confine disclosure to final
  regulations already promulgated.
• Disclosure practices of most-exposed and
  least-exposed companies dont differ
  significantly.

17
INCR Shareholder Resolutions and AEP Response

• Institutional investor network with 1 trillion
  demanded greater transparency
• AEP commissioned model for optimizing response to
  climate environmental mandates
• Set disclosure standard for other companies
• Showed complexity of understanding financial
  impacts

18
THE OVERARCHING DISCLOSURE REQUIREMENT

• The Securities and Exchange Acts lay on companies
  a general obligation to disclose promptly all
  material information needed to make required
  statements not misleading.
• Making false or misleading statements or omitting
  to disclose a material fact that is needed to
  make other statements not misleading opens a
  company and its officers to severe government
  penalties and private lawsuits.

19
What Information is Material?

• a matter is material if there is a substantial
  likelihood that a reasonable person would
  consider it important.
• There is no numerical financial threshold.
• A financially insignificant matter may be
  material if it reflects on the integrity or
  competence of management (e.g., violation of
  environmental law)

20
Specific Environmental Disclosure Requirements

• Material capital costs of compliance with
  regulations that have been enacted or adopted.
• Legal proceedings arising from environmental
  laws, if damages or claims exceed 10 of current
  assets or 100,000 in government penalties
• Contingent liabilities for site remediation
  unless the company can make a reasonable
  determination that no liability has been incurred.

21
Disclosure Requirements for the Management
Discussion and Analysis (MDA)

• A disclosure duty exists where a trend, demand,
  commitment, event or uncertainty is both
  presently known to management and reasonably
  likely to have material effects on the
  registrants financial condition or results.
• Specifically applicable to proposed government
  actions, such as proposed environmental laws or
  regulations.
• Kyoto and climate are known uncertainties

22
Are Companies Coming Clean? New Evidence from the
Hard Rock Mining Industry

• Silence is Golden, Leaden Copper Yale
  School of Forestry Environmental Studies
  downloadable at www.yale.edu/environment/publicati
  ons
• 10 case studies of financially material
  environmental risks known to management
• Nine of them werent properly disclosed.

23
The SECs Unfulfilled Commitment to Enforcement

• Where a material change in a companys financial
  condition or results appears and the likelihood
  of such change was not discussed in prior
  reports, the Commission staff will inquire as
  to the circumstances existing at the time of the
  earlier filings to determine whether the
  registrant failed to discuss a known
  uncertainty as required by Item 303d.
• SEC Release No. 33-6835, May, 1989.

24
ROYAL OAK MINING CO.

• Accumulated 240,000 tons of lethal, water-soluble
  arsenic trioxide in underground mine vaults
  leaching into water table.
• Had no plan or feasible means to remove it.
  Freezing it in place will cost more than 200
  million.
• Company had legal liability but had established
  no reserves.
• Did not disclose this problem as a contingent
  liability or material risk before declaring
  bankruptcy.

25
CAMBIOR OMAI MINE

• Knew when tailings dam was constructed that flaws
  created risk of failure.
• Nonetheless, filled it to 8 times its design
  capacity with cyanide-laden mining waste too
  concentrated for discharge.
• The mine failed, sending 4 million cubic meters
  of these wastes into a principal river running
  through the capital city.
• Companies stock price fell 25 mine closed for
  six months company was subject to lawsuits.

26
HECLA MINING, INC.

• Suffered a series of adverse legal and regulatory
  decisions over a period of years, leaving it with
  31 liability for cleaning up the huge Coeur
  dAlene Superfund site and natural resource
  damages.
• Though its potential liability ranges from 200
  to 500 million, its financial disclosure claims
  that 18 million is as likely a liability
  estimate as any other, with no supporting
  explanation.

27
New Disclosure Issues at Newmont Mining

• 2001 Report to Top Management Directors
  indicated serious environmental problems at
  several mining sites
• Problems have had repercussions, including
  canceling Peru gold mine expansion
• Results of audit report were not disclosed to
  investors at the time.
• Newmont stock downgraded and down.

28
New Legal and Regulatory Developments to Promote
Better Disclosure

• SEC will make public its comment letters on
  company filings. (GAO study result)
• Baxter Intl securities fraud case ruling
  cautionary statements are inadequate if they
  dont reflect the knowledge of the company as to
  what risks are actually likely to affect future
  results.
• Sarbanes-Oxley Section 302 404 and PCAOB
  Auditing Standard No.2.

29
Conclusion The Road Ahead

• Research will continue to uncover cases of
  inadequate disclosure of material environmental
  information
• Concerted shareholder pressure for greater
  transparency will continue.
• There will be pressure on SEC for stricter
  enforcement