Investors in the securities of oil, gas, and mining companies face a range of challenges, from volatility in commodity pricing to acute social, political, and regulatory risks related to natural resource extraction in countries with poor governance. Whether it is the threat of production disruptions in the Niger River Delta, nationalization or abrupt changes of tax policy risks in Venezuela, or tenuous license to operate in Guatemala, project-specific social and political risks are becoming more significant as companies push further into the frontiers of petroleum and mineral exploration.
For example, instability and conflict in Libya led to lengthy disruptions of oil and gas production. Between 2011 and 2014 five US-listed companies, including Marathon, Hess and Total, missed out on an estimated $17.42 billion in revenues due to halted production in Libya – a serious impact for company income statements as well as investors. Fully quantifying and accounting for social, political, and regulatory risks in investment analyses is difficult with the currently available public disclosures.
On June 27, the Securities and Exchange Commission (SEC) voted to enact a rule to implement section 1504 of the 2010 Dodd-Frank Act, which requires oil, gas, and mining companies to report their payments to governments by project in every country of operation. This rule will provide investors with the information they need to understand corporate exposure to changes in host government policies and international operating conditions. Such transparency will also strengthen governmental accountability to citizens in resource producing countries about the way that natural resource wealth is managed.
My firm, Calvert Investments, has limited holdings in these companies in part because of our concerns about their social risks and impacts. Indeed, for that very reason, we are supportive of section 1504 – it can help us understand and manage our exposure to the risks of operating in challenging social and political environments.
Regardless of a particular investor’s direct investments, oil, gas, and mining companies are a major part of the global capital markets and all investors have an interest in transparency and accountability within the natural resources sector. It is telling that there is unanimous support for section 1504 in the over two dozen letters submitted to the SEC by institutional investors representing over $9.8 trillion dollars in assets under management.
Section 1504 was a milestone, setting the baseline for mandatory disclosure requirements that have developed internationally. Parallel disclosure requirements are now on the books in the EU, Canada, and Norway. Royal Dutch Shell and Total, two of the world’s largest oil and gas companies, have reported their project-level payments to governments under EU transparency requirements. With the SEC approval of the implementing rule for Section 1504, the global transparency standard for the extractives sector extends to the United States, the world’s largest extractives market.
The project-level payments that extractive companies make to governments are material to investors. Public disclosure of royalties, taxes, production entitlements, bonuses, and other fees paid by extractive companies can provide investors the data to accurately model and analyze a company’s exposure to country-specific and project-specific risks. Project-level tax data and a clearer picture of company performance can contribute to better investment decisions.
Disclosures required through Section 1504 can reduce the information asymmetry that exists between investors and extractive companies. With this sector in particular, the gap in information can be even more pronounced due to the social, political, and regulatory risk factors described above. The information provided to investors through 1504 disclosures can lead to increased trust and willingness to invest in extractive companies, especially in difficult international operating environments, thus lowering the cost of capital to the companies.
The US will no longer lag behind the global oil, gas, and mining transparency standard. With project-level reports coming out under parallel transparency requirements, public mistrust could increase for US-listed companies if they were not subject to similar disclosure requirements. Such mistrust could lead to an increase in social and political risks affecting investments in US-listed oil, gas, and mining companies. The SEC action brings the US in line with the global transparency standard, providing a level playing field for industry, and a more stable and predictable environment for investors.
Stu Dalheim is Vice President, Governance and Advocacy at Calvert Investments.