Society is always pushing for more consideration and accountability from corporations and the impact their activities have on the environment and local communities. Many companies, especially oil and gas companies, are realizing it is more profitable to be proactive on possible liabilities rather than ignoring what could be a very real and financially devastating event. It also provides companies a way to account for assets that otherwise might not have been considered and by doing so entice new investors and higher stock prices.
Whelan and Fink explained that “…executives are often reluctant to place sustainability core to their company’s business strategy in the mistaken belief that the costs outweigh the benefits. On the contrary, academic research and business experience point to quite the opposite.” People are more interested than ever in sustainability and corporate governance. An investor’s decision-making process involves not only the profitability of the company but also its potential; longevity; and attainment of environmental, social and governance (ESG) goals. In the current exceedingly competitive market for new investors and financial backing, the days of ignoring sustainability are limited.
Sustainability accounting overview
The Brundtland Report (Our Common Future) defined sustainability as “…development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” The purpose of sustainability accounting is to evaluate the ESG performance of companies through an account of their management of various forms of nonfinancial capital associated with sustainability—environmental, human and social—and corporate governance issues that they rely upon for sustained long-term value creation. The Sustainability Accounting Standards Board (SASB) has developed standards that allow companies to account for material issues that do not have an exact numeric value. In effect, materiality is the “ante” for companies to publish credible nonfinancial reports and related extra-financial information. Sustainability accounting adds detail in a narrative format to accompany the federally required financial reporting for publicly traded companies. This detailed reporting can include nonfinancial assets, potential liabilities, ESG achievements, expected upcoming trends and their overall plans for the current and future handling of the above mentioned.
The SASB addresses issues that are classified into five categories: environmental, social capital, human capital, business model and innovation, and leadership and governance. The purpose of establishing these standards was to assist investors and the public so that they can better compare companies in the same industry.
Understanding how companies plan to mitigate their risks and what assets they value as critical to their business model will ultimately help investors better diversify their portfolios. The SASB provides guidance in certain areas that can help investors decide this. These areas include attention to the management of critical capitals, vulnerability to depletion or misuse of these capitals, scenario planning regarding alternative resources, risks associated with mismanagement of certain environmental or social issues and opportunities related to global or industry sustainability challenges. There are many areas in the oil and gas industry that are direct material sustainability issues, but for the sake of this discussion we will only focus on solid drilling waste.
Liability of solid drilling waste
Waste is a leading concern in the industry and includes oil-based and water-based drill cuttings. It is common practice in the industry to dispose of cuttings in a landfill, by soil farming or land spreading or even placing them on top of or underneath roads. If these companies use the standards set forth by the SASB, it would not be a very flattering picture of the liability they created for themselves using these methods. The sheer volume of drilling waste makes it clear the liability of not disposing of the waste responsibly could be devastatingly exponential. This is the type of information that is not currently captured using standard financial statements, directly leading to the development of the SASB.
Society in general is taking a stronger stance on sustainability and corporate governance. This trend is only going to increase. Public pressure is causing regulatory agencies to take a much closer look at drilling waste and its disposal practices. Regulators will continue to crack down on the oil and gas industry and the way it manages its waste. Companies can be proactive and initiate a conversion to improve waste practices on their terms. Transitions and changes to business models are always more fluid and economical when willingly initiated and well planned by the company. Being forced to change by laws, regulations and public pressure is a much more painful and traumatic experience.
Turning liabilities into assets
In addition to the financial benefits that accrue from increased competitive advantage and innovation, companies are realizing significant cost savings through environmental sustainability-related operational efficiencies. Moreover, investors are now able to track the high performance on ESG goals and are correlating better financial performance with better ESG performance. Some oil and gas companies already use sustainability accounting to report nonfinancial assets and liabilities in regard to drill cuttings and waste management. These companies have taken an in-depth look at their waste and are no longer fearful of what it might contain or of future liabilities that might arise from it.
The common mentality of whisking the drilling waste offsite in the cover of night because no one wants to acknowledge it, let alone answer questions about it, is no longer an issue. Companies have evolved, taken ownership of their waste rather than avoiding the issue and have acknowledged that drill cuttings are an unavoidable part of the oil and gas industry, and they are handling them responsibly.
These companies have scientific test results showing exactly what is in their waste. They treat the cuttings and use processes to encapsulate the waste followed by additional scientific testing to confirm that the waste is fully contained. They are confident that it is never comingled with anyone else’s waste; they know its exact location, and their footprint is exceptionally small. By addressing proper waste management of their drill cuttings, they have been able to significantly reduce a future liability that has the potential to be a fatal blow to the business.
Investors are getting a full snapshot of their current business activities, not just profit and loss. In addition, there is the impressive sustainability reporting of the company’s ESG performance that speaks more to investors interested in long-term returns. Investors are paying attention. According to the 2015 EY Global Institutional Investor Survey, investors are increasingly using companies’ nonfinancial disclosures to inform their investment decisions. In its survey of more than 200 institutional investors, 59.1% of respondents view nonfinancial disclosures as “essential” or “important” to investment decisions, up from 34.8% in 2014.
The oil and gas industry is being forced to become more competitive to survive the cyclical peaks and valleys that are a natural part of capitalism. Very soon the most fiscally strong companies will be ones that embrace their waste and properly manage the corresponding liabilities. The use of sustainability accounting and providing transparency to investors is the new game changer in the industry and the key for future success.