The SEC is suddenly interested in carbon.
Not all giants are slain by sword. A mirror petrified Medusa. Tax evasion (and a case of syphilis) brought down Al Capone. And if oil monolith ExxonMobil’s stock price ever takes a major plummet, it will probably come from failing to tell its investors how climate change would wreck its business model.
On September 20, the Wall Street Journal broke news that the US Securities and Exchange Commission—the highest federal financial regulator—is formally investigating Exxon’s accounting. The company stands accused of ignoring and possibly even lying about how market fluctuations affect its profits. Some, but not all, of those fluctuations come from government regulations targeting climate change. Environmental law wonks are watching that last bit closely, because the company stands accused of knowingly pushing an anti-climate agenda. If the SEC gets the goods on Exxon, it could drop some serious sanctions on the company, and that could affect the way publicly-traded companies account for the costs of climate change.
Climate change causes temperatures to rise, seas to heave, storms to surge. It leads to longer droughts, wilder wildfires, wetter deluges. Political, military, and economic experts have linked climate change to rise of ISIS and the Syrian refugee crisis, and promise more upheavals.
If the world’s economy is weaned off oil by 2050, what happens to the value of those reserves you spent all that money accumulating? Do they have any value anymore>
Former SEC commissioner Bevis Longstreth
Those costs have led governments to react with emissions regulations. Regulations basically put a price on emitting carbon, making it more expensive to burn fossil fuels. “The question to ask is, in a world where climate change is leading regulations, what happens to the estimated value of the company’s assets, and therefore the worth of that company,” says Bevis Longstreth, a former SEC commissioner. This is especially important for companies who rely on public investors.
Since at least the late 1980s, Exxon has sold its stock based on two claims: 1) Climate change is not real; and, 2) Even if it were, governments would balk at the huge costs associated with transitioning to clean energy economies. But in 2015, Inside Climate News reported that Exxon didn’t actually believe that first claim. That investigation showed how the company’s own research established the links between greenhouse gas emissions and climate change back in the 1970s. Then, beginning in the late 1980s, Exxon actively worked against domestic and international efforts to introduce climate change-fighting regulations. By extension, it was—allegedly—misleading its own investors about how climate change would affect their returns.
The SEC is just the latest government agency to target Exxon for investor fraud. New York’s attorney general launched an investigation last September, and has since been joined by 19 other attorneys general. In March, the Department of Justice referred a congressional request for an investigation into Exxon to the FBI.
So what are they all looking for? Well, first of all, this is more broad than just climate investigations. Exxon does not publicly record how it values its own oil reserves during market fluctuations. The current oil market, for instance, is oh-so-timidly rebounding from a historic bottoming out, which was driven largely by a natural gas boom. But through that dip, Exxon has continued to invest in high-cost oil exploration.
“Then the question arises of corporate waste. This becomes of paramount interest to your investors, if you are spending $80 or so per barrel to explore for new oil, and the market is only paying $40 per barrel. In short, your stock is overvalued,” says Longstreth. Especially if the oil price is not expected to recover—which is a reasonable assumption, given that last year 185 countries agreed to emit net zero carbon emissions by 2050. “If the world’s economy is weaned off oil by 2050, what happens to the value of those reserves you spent all that money accumulating? Do they have any value anymore” says Longstreth.
To figure that out, the SEC will dive into Exxon’s accounting records, looking for evidence that it was overvaluing its oil reserves. The investigators will also likely try to figure out how Exxon calculated the effects of various government emissions regulations on its profits. “They will probably ask the following questions: What would be the impact on Exxon’s assets if emissions were priced at $20 a ton, $40 a ton, $60 a ton,” says Bob Litterman, former head of risk management for Goldman Sachs. “That’s the kind of information any investor would want to learn about a company operating in the fossil fuel industry.”
The mere fact that the normally pussyfooted SEC is doing a formal investigation is big news. Launching one requires a majority vote from the SEC commissioners. “They wouldn’t launch a formal investigation without something close to probable cause that these rules had been violated, and if Exxon violated them the SEC has no option but to proceed with some form of enforcement,” says Longstreth. In the most extreme circumstance, Longstreth says the SEC could make Exxon liable for paying out damages to anyone who overbought, or undersold, stock during whatever time frame the SEC deems the company culpable.
But that’s not likely, given Exxon’s litigious nature, and the SEC’s track record with bringing corporate mustache-twirlers to justice. More realistically, they might send an impartial accountant to monitor Exxon’s books for a few years. That alone would probably force more active climate change disclosures from other fossil fuel companies (most of whom are doing much better in that regard than Exxon). “But the fact that the SEC is raising the carbon cost question is deeply significant,” says Longstreth. Other companies could be driven to release more accurate accounts of how climate change affects their business, and that cost would become transparent in their stock prices. And that’s how you slay a giant.