Asset Retirement Obligation is an accounting term. It offers a unique approach to how to quantify environmental liabilities.  

In the early years 2000, I was having a drink at a home party with friends, when I met somebody which was working at what is now SAP Ariba. They were developing online procurement services and had been able to fit all except one activity into their on-line procurement/bidding platform. When I told him I was working in Soil Remediation, he reacted with “Wow, interesting !” , “We are able to breakdown a whole offshore drilling platform, but soil remediation we have not been able to get a grip on. There are so many uncertainties that we are just not able to get it on our system.”

  That is when I realize what was really different about soil remediation and the environmental business. It is not just about engineering. It is about managing liabilities and risks.

Although I did my fair share of looking into risk-management by corporations or liabilities quantification in brownfielding. Non of these disciplines really seemed have a good answer to the question : ‘how to quantify environmental liabilities ?’

What is interesting about Asset Retirement Obligation (ARO) is, that it can be used as ‘vessel term’ for most any environmental issue or liability. It can serve as a sort of common language or maybe the idea of an ‘umbrella or container term’ to quantify environmental issues linked to operations. The accounting principle excludes covering the clean-up of divested sites, as they are no longer linked to operations, but we are not going into these details here. We will just propose to look at the general approach to cover any environmental liability.

The basis of ARO is revenue matching. Once you know you will spend money in the future to eliminate an environmental liability or issue, you can book it on an account and depreciate it over time, while at the same time you gather the funds to provide for the future expenditure.

The idea is that you want to identify the cost of doing business today, with the revenu stream of doing business today. This way assessing the future profits correctly.

The idea is that you want to identify the cost of doing business today, with the revenu stream of doing business today. This way assessing the future profits correctly.

At it’s core the Asset Retirement Obligation( ARO) breaks down into  :

1. A fair value cost assessment

2. A counter party risk.

The fair value cost assessment is an assessment of the cost for the removal or remediation of the environmental risk. The cost assessment can, but does not have to be detailed initially. It is the breakdown of the cost as the issue is understood at the time of assessment. This is meant to be a straight forward professional assessment.

And although this might include some assessment of uncertainty, like a technical uncertainty of reaching remedial standards for groundwater at a certain point in time, the bulk of uncertainty is covered by the counter party risk term.

The counter party risk takes into account probabilities of uncertain occurrences.

As the word says it, it covers the risk of a counter party not holding up to their engagements.

A counter party can be a joint venture partner, a supplier, legislative or governmental agency. A counter party is thus any party involved in an operation and transactional dealings related to this operation.

So, counter party risk covers any changes in the future, subject to external influences, which are unforeseen and thus might not align with the current view of things.

Let’s look at an example:

The failure of one of the joint venture partners to pay for The Asset Retirement Obligation can be accounted for in terms of probabilities.

  • 60 % chance – No Counterparty Default 0 €
  • 10 %  chance  – 50 % Counterparty Default : 50.000 euro legal costs + 1.000.000 ARO costs
  • 30 % chance – 100 % Counterparty Default : 50.000 euro legal costs + 2.000.000 ARO costs.

Originally the ARO costs where assessed at 3.000.000 euro for 3 joint venture partners. The probabilities are expectations on the chance of none, one or two joint venture partners failing to meet there obligations during or after operations of an asset. This can be for example the closure and remediation of an oil well.

Another issue that is covered by the couterparty risk term is the future change in legislation.

For example the change in threshold values of certain contaminants or for example new legislative frameworks for for example PFAS.  All these future risks can be covered by counterparty risk term.

Other examples are, when governments allowed to landfill waste and afterwards abolish the permits of the landfills because they are now considered to be in a flooding area. These are also risks which can be covered by the counter party risk term.

With this brief article we do not want to give a detailed explanation of what ARO is. This is just an introduction of a methodology for which an environmental professional can develop an interest.

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