A recent study by BNP Paribas Asset Management suggests that decommissioning redundant and end-of-life energy, mining, industrial, waste management and shipping assets could cost at least USD 8.0 trillion over the coming decades. Pre-funding such future layouts now can offer benefits to the companies involved – and to investors.
Companies and governments often overlook or underestimate decommissioning since they consider it to be a problem to be addressed long into the future.
However, with the energy transition fast gathering pace in recent years, many such costs may become due far earlier than expected.
The increasing focus on the need for activities that are responsible from an environmental, social and governance perspective and on the energy transition mean decommissioning obligations are becoming more significant for companies and investors alike.
Companies failing to account for these exposures may face reputational damage and financial losses, especially as many have endorsed the pledges of the Paris Agreement and have started to implement sustainability and energy transition policies.
Adequate funding is essential
Mothballing assets can be costly and complex: they often require specialised skills, technologies and equipment. Outdated facilities left unattended can lead to major environmental and health risks.
Beyond the reputational risk, sub-standard decommissioning can have adverse environmental impacts, so it is vital that there are adequate financial resources for the decommissioning phase.
This means companies should set aside enough funds during their facilities’ operational life to cover all future decommissioning costs.
BNPP AM’s study shows that nuclear, renewable energy and mining assets are the most expensive to decommission. Regionally, costs are highest in Asia, Europe and North America (see Exhibit 1).
Decommissioning is crucial to the energy transition
The shift in energy sources from fossil fuels to renewables is paramount if the world is to reduce greenhouse gas emisisons to zero by 2050 to manage global warming successfully. One way to cut GHG emissions is closing and disposing of outdated, polluting infrastructure at the same time as the world develops new, cleaner infrastructure.
Decommissioning is part of the new energy system and can be seen as a genuinely ‘green’ investment. It enables the reuse and recycling of materials and components, reducing waste and promoting circular economy principles.
The definitive scale of the problem is hard to gauge…
With companies acknowledging the acceleration of the energy transition, decommissioning work is brought forward, raising the current estimates of the associated costs. Costs also often rise significantly over time. For example, one mining company saw its closure provision rise almost fivefold amid cost revisions – from AUD 169 million in 2008 to AUD 805 million in 2015.
Should decommissioning programmes be sped up for strategic purposes or because of strong market or societal pressures, actual decommissioning costs could increase substantially. A ‘run for the green door’ could have dire financial consequences for companies laden with decommissioning liabilities.
The BNPP AM report suggests that the current total estimate of around USD 8.0 trillion is likely lower than the costs that companies, governments and taxpayers may incur when the bill comes due.
…so, the risks should not be underestimated
The risks surrounding decommissioning are varied and can be substantial:
- Shortfall risk: Oil & gas, mining, power and other companies may not be able to meet their decommissioning costs with free cash flows due to revenue volatility
- Financial risks: Assets not properly decommissioned may generate significant costs such as maintenance or insurance that could impact the financial health of the owner or operator
- Legal risks: Failure to fully decommission an oil rig, for example, may result in fines or legal action from government agencies or local communities
- Reputational risks: Not decommissioning an asset correctly may damage the owner or operator’s reputation, leading to loss of business or a negative public perception.
In summary, failing to adequately prepare for the retiring of old, polluting assets may significantly impact the environment, safety, legal liability, financial health and reputation of companies.
Benefits of pre-funding decommissioning liabilities
Pre-funded reserves – monies set aside over a facility’s operating life to cover expected decommissioning costs – can be a reliable and predictable source of funds to meet such long-term liabilities.
As with employee pension funds, pre-funding can limit the risk of financial shortfall and the need to rely on government support and help companies fulfil their environmental and financial obligations.
The benefits of pre-funding investment include:
- Increased cash flow: Investment returns can provide some financing of the liabilities and can improve risk management
- Enhanced efficiency of matching liabilities: Pre-funding allows for long-term investment that can generate returns to match future liabilities
- Lower financing costs: Pre-funding can improve a company’s standing with banks and help lower the costs of letters of credit and loans. It can also improve ESG and debt ratings
- Flexibility: It leaves companies with options in an uncertain future and the flexibility of risk transfer
- Better relationship with stakeholder: It can lead to an improved standing with regulators and investors and reinforce a company’s sustainable values.
A diversified approach to investing in the ongoing transition
Companies have begun to shift their business models to maintain viability and relevance in the net zero economy and preserve access to shareholder capital and capital markets. However, it is not obvious which technologies will become dominant or how best to access them.
A diversified portfolio of energy and sustainability transition themed exposures developed by BNPP AM allows companies to invest in early-stage technologies that may ultimately lead to mergers & acquisitions as government regulations and technologies mature.
In the meantime, we believe that pre-funding decommissioning liabilities is a prudent approach that can develop over time in the strategic review of business models.