The CERCLA of life

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Like all mining and natural resource extraction companies, Teck can take a bad rap for their actual or perceived damage to the environment.  I will be a realist and admit that some damage is going to be incurred whether we are talking about the oil sands in Fort McMurray or Teck’s lead/zinc smelter in Trail, BC.  Of course I am still very concerned about the extent of the damage and companies must be doing all they can to minimize the impact on the earth and the people affected.  The smelter in Trail BC is currently owned by Teck, but some of what I’ll mention here preceded their ownership.  Historically the Trail, BC smelter has not been the cleanest enterprise in the world.  In fact the city of Trail was ranked as the second most polluted city in North America.  As early as 1925, nearby settlers sued the smelter for damages to crops and forests. The real push to clean up their act started in 1975 when a study of the lead levels in young children were well above any reasonable safe level.

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Teck has recently been in the news for some pollution that they have admitted they dumped into the Columbia river that flows past the smelter.  Trail, BC is a stones throw away from the US border and the Columbia river flows south so the pollution has ended up in the US.  I’d been reading the recent news stories and then bumped into the Teck controller the other day.  I asked him how the lawsuit was affecting their financial reporting, expecting him to say that they were accruing millions of dollars for the potential costs.  Nope.  It turns out that while everyone knows what was dumped in the river, no one is all that clear on how much damage has occurred.  Some people (mostly Teck employees) claim very little damage has occurred.  So they’re paying for a bunch of environmental studies but no accrual beyond the costs of those studies has happened.

Then the controller mentioned to me that their bigger concern is selenium.  What?  I’ve studied Teck for years and never heard of selenium, how bad could it be?  It turns out its not good news.

Ok, so Teck has some trouble with pollution of the Columbia river and then this selenium problem.  How do these impact their financial statements?  I was expecting the Columbia river lawsuit to show as an accrual which is a liability.  Check out the balance sheet (the December 2012 financial statements have not yet been released).  First, note that Teck is financially very healthy: total debt ($16 Billion) is less than 50% of the total assets ($34 Billion) and the current assets ($7.4 Billion) far exceed the current liabilities ($2.1 Billion).  Next, realize that to find out very much about the accruals we’ll need to dive into the financial statement notes, particularly note 20 for “Other liabilities and provisions”. Also, notice at the bottom of the balance sheet, that contingencies are discussed in note 22, that will be interesting to read as well.  Access the full financial statements and notes from the left hand side, “Consolidated Financial Statements (PDF)”.

Here is a portion of note 20:

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This is a complex financial reporting topic but notice that selenium is mentioned in the second paragraph.  Accounting for these types of costs requires a lot of estimation: how much the remediation may cost, when it will occur, an appropriate inflation rate, and an appropriate discount rate.  Be very clear that the number shown in the financial statements is an estimate.  I look forward to seeing how they adjust the December 2012 financial statements, I suspect the remediation costs will be dramatically higher.

Now let’s turn to note 22, the contingencies:

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The important paragraph to read is that last one, “until the studies … are completed, it is not possible to estimate the extent and cost …”  What that means is that Teck has not recorded any liability yet for the Columbia river pollution.  They simply have no idea how much they may be on the hook for, if any amount, so have not recorded anything.  This isn’t devious or wrong, its in accordance with generally accepted accounting principles (IFRS) and highlights again how estimation and judgement are a huge part of the financial reporting.

Now back to the title, “CERCLA of life” – yes its a bad pun, my apologies to Simba et al.  CERCLA is the US Comprehensive Environmental Response, Compensation and Liability Act, otherwise known as Superfund.  It does affect Teck, it has no impact on the Lion King.

 Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)

Oiling (or soiling) the wheels of justice

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Many of you will remember the tragic events in April 2010 of the BP Deepwater Horizon drilling disaster.  The fire on the drilling rig resulted in multiple deaths and untold environmental damage.  The drilling rig was operated by BP who rightly took a lot of the heat for the disaster.  You may not have been aware that the actual drilling platform was not owned by BP but was owned by a separate company, Transocean Ltd.  BP, Transocean and many other companies associated with the disaster are involved in multiple lawsuits resulting from the disaster.  This article is an excellent summary of the events, particularly the lawsuits.  BP was the main player and has paid or will pay at least $40 Billion due to the disaster.

Recently, Transocean settled the bulk of their lawsuits with the US Justice Department for $1.4 Billion.  Interestingly, the very same day Transocean’s stock price (NYSE:RIG) rose dramatically (~ 6.3%):

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A very interesting situation … a huge payout which is seemingly bad news for Transocean but the investors react positively.  What’s going on?  Well it turns out that paying just $1.4 Billion was seen as good news by the shareholders.  As large as that figure is, it was less than they were expecting to pay out.  It’s worth looking at Transocean’s financial statements in a bit more detail to see how the Deepwater Horizon disaster impacted the accounting.  Transocean’s financial statements can be found here, we’re going to look at their 2011 annual report (December 31, 2011) and their 3rd quarter report (nine months ended September 30, 2012).

The first significant impact on Transocean’s financial statements is the goodwill (and other intangibles) impairment charge they took in 2011.  This impairment charge was $5.2 Billion dollars and resulted in a net loss for the year of $4.8 Billion (on revenue of $8.3 Billion).  The goodwill impairment charge was directly related to the Deepwater Horizon disaster and note 5 of the financial statements discusses it in more detail:

Goodwill and other indefinite-lived intangible assets—As a result of our annual impairment test, performed as of October 1, 2011, we determined that the goodwill associated with our contract drilling services reporting unit was impaired due to a decline in projected cash flows and the market valuations for this reporting unit, and we recognized our best estimate of the loss on impairment in the amount of $5.2 billion ($16.15 per diluted share from continuing operations), which had no tax effect.

Essentially, the Deepwater Horizon disaster permanently damaged Transocean’s drilling service reputation and they are doubtful that they will get as much business as they previously expected.  That seems reasonable to me and its a very good example of the cost of repetitional damage.  $5.2 Billion.  Wow.

The second significant impact on Transocean’s financial statements was accruing a liability for the lawsuits they are expecting.  In their September 30, 2012 financial statements the note disclosure related to the disaster is in Note 15 (pages 26-31).  Its an interesting discussion that includes a lot of legalese around multi-party lawsuits and counter lawsuits and potential insurance proceeds.  As at September 30, 2012 they had accrued a total of $1.9 Billion related to lawsuits and potential payouts.  While the $1.4 Billion payment to the Justice Department is not the only lawsuit that Transocean will have to pay, it will be the largest.  The $1.4 Billion settlement removed some of the uncertainty about how fault would be spread between Transocean and BP and will likely be reflected in any further settlements.  So the positive share price bump of +6.3% is really a case where the bad news is just not as bad as it could have been.

Now hopefully those fines and settlements can be put to good use providing partial compensation to the victims and cleaning the environment.

Note: this blog was originally posted on my site hosted by Pearson Education(http://php2.pearsoncanada.ca/highered/inthenews/accounting_in_the_news/)