Time for an audit?

Along with Dan Woynillowicz of Pembina (Twitter @danwoy), I had a very interesting discussion/debate with David Sands, (Twitter, @DSandsGovAb) on the new reclamation standards proposed by the Government of Alberta. Now, I think David has just about the worst job in the world (although he seems to enjoy it most days) because he has to argue with people like me all day long, and not just about energy policy, but about health, education, and everything else the Alberta Government is perceived to have done badly in the eyes of someone in the Twitter-sphere.  I do not envy him, but I think he does a very good job and does the Province a wonderful service.

The exchange began as David suggested that he had been working on sourcing a reply to some comments I had made in this space last night in my admittedly wonkish blog entry on the reclamation protocols, which I greatly appreciate. “FYI, trying to find an answer for you for a comment (on your blog). Interesting post, but I think you put too much in the royalty/fiscal angle. Motivation to change on both sides was increasing reclamation, not dealing with who holds the buck$.”  I replied that I was also sourcing additional info, and that I agreed that the royalty angle was likely over-played in last night’s post and that the new system was indeed an improvement in terms of the total expected reclamation payments.  We then got on to the question of risk aversion, where I asked David, “do you agree that value of asset is exposed to commodity (and regulatory) risk while the value of the liability is not?”

The risk associated with the unfunded reclamation liability remains the key issue for me, and one which I did not do a sufficiently good job at getting across in my post last night. In the new regime, the Government of Alberta is collecting a far greater total reclamation escrow, which is great, but it is counting on the future value of the mine, which is determined by oil prices and regulations around oil sands, as collateral against reclamation expenses which will need to be incurred as the mines are abandoned.  If the oilsands business carries on as is, then I agree that there is little worry, since firms will pay to reclaim old sites as the open new sites.  However, while it seems hardly likely today, there are many events which could change the economics of oil sands mines and make the on-going business model in Northern Alberta a thing of the past.  If anything, the past week should give our governments pause to think about small probabilities of unlikely events and perhaps more importantly, unknown probabilities of unknown potential future events – Andy Revkin’s don’t know squared, if you will. As owners of the resource, it is not clear to me why we should also be holding the reclamation liability on our balance sheets at all.

So, my question out of all this is, if the deferred payments are not a means to improve the investment environment in Alberta by limiting up-front expenditures, and there are no fiscal advantages from collecting later versus now, why not collect security letters-of-credit or escrow deposits to match the on-going incurred liability?  David’s response (albeit to Dan, not to me) was that we should, “let the Auditor General have a look at this model,” and I could not agree more.  From an auditor’s perspective, the current system amounts to an unfunded liability on the Province’s books for many years before the accrued payments catch up in the last expected years of the mine’s operation. In this graph, the payments under the old system and the new system of reclamation payments required are shown.  Obviously the new system requires greater security, which is exactly what it should do, but I expect that the Auditor General might also question why the payments are back-loaded while the incurred liabilities are accrued from day 1.  If the graph were re-drawn, and I invite the Government to provide such a consideration, with the incurred liabilities (i.e. expected reclamation expenses if the mine were shut down and had to be reclaimed at each date, or bullet 3 on slide 10 here) versus cumulative payments received to cover these expenditures to date, you would see a bigger gap for at least the first 20 years of mine operations under the new system versus the old. Again, if there is no advantage to deferring these payments, why not benchmark the payments to the incurred liability?

The Office of the Auditor General has examined issues of unfunded liabilities under the responsibility of the Province in the past, including in the 2008 report on the Alberta Universities’ Pension Plan (UAPP) in a systems audit.  The report suggested that the Universities needed to implement consistent, actuarial assessment of the unfunded liability based on, “reasonable assumptions,” so that, “financial-statement users may not fully understand the universities’ liabilities.” This is quite similar to what I think both Dan and I were asking be addressed today.  At a minimum, I expect that the Auditor General would agree that the Province should clearly assess, under reasonable assumptions, the unfunded liabilities likely to be associated with the new regime, and provide some sense of how the size of the unfunded liability might be altered by changes in these underlying assumptions.  David was quick to point out to both Dan and I that the Alberta Government is risk-averse, and I would hope that they would be in this case.  While I know that David was frustrated with our discussion, his comment that, “there’s operators on second mines, 4th decade (and) they haven’t run away,” doesn’t cut it in terms of risk analysis for a multi-billion dollar unfunded liability.

I would very much like to see the GoA modify their analysis to provide estimates of the size of the unfunded liability for a prototypical site over time, as I expect would be requested by the Auditor General.  This graph would, undoubtedly, be initially increasing and eventually, we hope, decreasing back to zero.  The unfunded liability would likely be positive for each year but that last 5 (correction inserted at the request of the Government of Alberta) in which the mine is in operation. I would also like to understand why, when we were re-working the system (and again, the new system is certainly an improvement), why we chose not to have a system based on the incurred liabilities so that, as Albertans and owners of both the land and the resource, we are not incurring the incremental risk of unfunded environmental liabilities for which we seem to be getting little added value in return.