Disclosure of Financial Exposures to Climate and Other Environmental Risks

Robert Repetto

Sr. Advisor, Stratus Consulting

303-381-8226

rrepetto@stratusconsulting.com

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

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.

Pulp and Paper: The Steps in the Analysis

• 1: Identify material environmental issues*

• 2: Develop scenarios around each one*

• 3: Assess each company’s 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

Financial exposure of major pulp and paper companies to pending

environmental issues

-15%

-10%

-5%

0%

5%

M B H D C J L I E G A K F

Exp

ecte

d F

inan

cial

Im

pac

t

(as

%ag

e of

mar

ket

val

ue)

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 company’s 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”

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

Companies Assessed

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

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

Financial Impacts of Scenario A: Adoption of Kyoto Protocol

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

6%

8%

AHCAPA BP BR

CVXCOP E

ETPXOM

OXYREP

RDSSUN

TOTVLO

UCL

Ch

ange

in S

har

ehol

der

Val

ue

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.

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

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 company’s 2000 total revenues.

Figure 3: 4 Pollutant Cap & Trade, Announced Carbon, Permits Grandfathered

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47

Utilities from Most to Least Exposed

Com

plia

nce

Cos

ts a

s %

of 2

000

Rev

enue

s

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

Figure 2: 4-Pollutant Cap&Trade, Permits Grandfathered, Regulated Market v. Deregulated

Market & Merchant Plants

-10%

-5%

0%

5%

10%

15%

20%

25%

30%

35%1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47

Utilities from Most to Least Exposed

Com

plia

nce

Cos

t as

a %

of 2

000

Rev

enue

s

Dereg & Merch Regulated

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 don’t differ significantly.

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

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.

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)

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.

Disclosure Requirements for the Management Discussion and Analysis

(MD&A):

• “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 registrant’s financial condition or results.”

• Specifically applicable to proposed government actions, such as proposed environmental laws or regulations.

• Kyoto and climate are known uncertainties

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/publications

• 10 case studies of financially material environmental risks known to management

• Nine of them weren’t properly disclosed.

The SEC’s Unfulfilled Commitment to Enforcement

• “Where a material change in a company’s 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.

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.

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.

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 d’Alene 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.

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.

New Legal and Regulatory Developments to Promote Better Disclosure

• SEC will make public its comment letters on company filings. (GAO study result)

• Baxter Int’l securities fraud case ruling: “cautionary statements are inadequate if they don’t 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.

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