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


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


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


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


Environmental Remediation Obligation Examples

Contaminated soil removal

Pipeline removal

Sediment remediation

Groundwater remediation


Asset Retirement Obligation Examples

Creosote pilings removal


Asset Retirement Obligation Examples

Warehousedemolition

Power plant demolition

Airportdecommissioning


Federal Environmental Legislation v. GAAP Timeline

9


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


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


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


($ 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



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%


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



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



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)


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


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


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


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


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


$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.


$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.


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


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.


Quiz: Name the Source of This Disclosure

ARO

ERL1 ERL3

ERL2

Didn’t apply fair value Applied it


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


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


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


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

Documents

Dec2016 - Presenting and Disclosing Environmental Liabilities