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Generally speaking, accounting is blind to the destruction of nature that can result from corporate activity. There is, however, an interesting and little-known tool that could be put to greater use, namely decommissioning provisions. This mechanism requires a company to set aside financial reserves to repair the environmental damage caused by its activities on a site.
What is a provision for site dismantling and restoration?
While all economic activities cause damage or alteration to the environment, some are much more impactful and directly visible than others.
This is particularly true in the energy and industrial sectors, where immediate damage can be caused by the construction of buildings or infrastructure (e.g. factories, oil rigs, nuclear power plants, gas pipelines), or gradual damage (accumulation of nuclear or chemical waste, quarrying, mining, etc.). These two types of damage are often combined.
The aim here is not to make good any pollution caused by the company’s activities (such as the discharge or leakage of toxic products), since the company must comply with discharge or emission standards: if it fails to do so, or if the pollution is the result of an accident, the company will have to pay a fine or make good any damage. This is a different type of logic from provisions for dismantling.
In many countries, at the end of the economic life of a site or facility, the companies concerned are obliged to dismantle (i.e. deconstruct) the buildings and infrastructures that have caused environmental damage, and to restore degraded sites (restoring their natural appearance, making the site safe, depolluting or decontaminating the soil). This obligation may be legal, regulatory or contractual, or even result from a public commitment made by the company.
In accounting terms, this obligation translates into the establishment of decommissioning and restoration provisions, i.e. the creation of financial reserves to cover the costs of dismantling and restoring a site when it reaches the end of its economic life.
This could be a mine that has run out of ore, or a power plant that has been closed because it has become too old, or as a result of an administrative decision motivated by climate policies. Facilities that are closed before the end of their economic life as a result of political decisions are known as
The accounting mechanism for decommissioning provisions
When the deterioration is gradual (a mine, for example), the provision is built up progressively according to the damage caused.
When deterioration is immediate (e.g. plant construction), the provision is recorded on the liabilities side of the balance sheet. At the same time, a “dismantling asset” is recorded as an asset alongside the tangible fixed asset representing the plant built (or purchased). Future dismantling and restoration costs are then expensed in the income statement through depreciation of this asset over the life of the site.
These mechanisms ensure that the provision is set aside and available for use on the day when dismantling operations need to be carried out.
Given their long-term nature, the costs provided for are discounted. 1 At the start of a plant’s life, therefore, they will be relatively low (in absolute terms) compared with what will be required at the end of the plant’s life.
For more details on the provision for dismantling under French GAAP, see the Bulletin officiel des finances publiques.
The impact of decommissioning provisions in the energy industry
With regard to energy-related infrastructures, provisions for dismantling and site restoration are a sensitive issue.
On the one hand, the amounts involved are often significant. At the end of 2020, decommissioning provisions amounted to 28 billion euros for EDF, 15.3 billion dollars for TotalEnergies and 7.8 billion euros for ENGIE. 2
On the other hand, these provisions oblige the company to determine at the time of construction when a plant will no longer be used, for reasons either internal to the company (such as the expected end of its useful life) or external (such as the end of fossil fuel reserves or a ban on their use).
However, the expected lifespan of the installation is not guaranteed, which may mean higher or lower costs in a given year.
The impact of governments’ environmental decisions on decommissioning provisions
States can adopt regulations forcing the cessation of the use of certain infrastructures by a specific deadline, before they reach the end of their economic life. France, for example, has announced the phase-out of coal by 2023, while Germany has announced the phase-out of nuclear power by 2022. More generally, the goal of carbon neutrality by 2050 should lead to the gradual closure of most fossil fuel industry sites.
From an accounting point of view, this type of decision leads the companies concerned to immediately trigger provisions for refurbishment, thus potentially reducing the depreciation time of the dismantling asset. This can result in very substantial increases in costs (see example in the box). Of course, this early end-of-life of a plant has other economic consequences (cessation of resources derived from the activity, change in the value of the plant in question to zero – see the passage on stranded assets in the module on corporate accounting), and it also has social consequences in the form of job cuts.
An example of the impact of early end-of-life on decommissioning provisions (excluding the effect of discounting)
In year 1, a company builds a fixed asset (a coal-fired power plant, for example) at a cost of €1,000 million. Its lifespan is estimated at 40 years, and dismantling costs at 60 M€.
In accounting terms, a provision of 60 M€ is recorded on the liabilities side, and a dismantling asset of the same amount is recorded on the assets side. Subsequently, a depreciation charge of 1.5 M€ (60/40) will be recorded each year, gradually spreading the expense over the 40 years. This accounting mechanism means that, instead of “setting aside” €60 million in year 1, this amount will be built up from the company’s earnings over the plant’s 40-year lifespan.
If, in year 18, the government decides to ban coal-fired power generation two years later, the plant will also have to close at that time. In total, the plant’s lifespan will have been 20 years, not 40. The remaining depreciation of the decommissioning asset (60-18*1.5=33M€), which was to be carried out over 22 years, will now be carried out over two years, i.e. 16.5M€ per year.
Clearly, the impact on the company’s bottom line is massive.
The impact of shale gas on provisions for decommissioning gas infrastructures
Conversely, following the massive influx of American shale gas in 2010, proven reserves 3 suddenly took a fantastic leap forward. They have risen from 60 to over 250 years (of the year’s consumption). 4 ) !
This phenomenon has led to the virtual cancellation of provisions for dismantling gas infrastructures over this time horizon, due to the discounting mechanism (see box). This is how, for example, income of 1.1 billion euros was recorded in ENGIE’s accounts at the time. 5 (formerly GDF Suez) by cancelling the dismantling provisions initially recognized.
The discounting mechanism
Discounting consists in bringing an amount that will be spent or received in the future down to today’s value. Let’s imagine that dismantling gas infrastructures costs 100 million euros today. How can we evaluate in today’s accounts this sum to be spent in the future? To do this, economists use the discount rate. When the discount rate is zero, this means that the present value and the future value are equivalent. Conversely, if the rate is high, it means that more value is placed on the present. As the calculation below illustrates, the time over which the sum is discounted is also important.
If the company has to spend 100 million euros in 250 years’ time, discounting it at a rate of 5% gives a value of 504 euros (yes, euros, not millions of euros!). On the other hand, if the company has to discount these 100 million euros over 25 years at the same rate, it must immediately recognize 29.5 million euros as a provision for dismantling.
What would happen if this 250-year horizon were suddenly shortened to 25 (or 30) years? And for all fossil fuels? The amounts to be provisioned would increase dramatically.
Awareness of this issue is reflected in ENGIE’s published financial statements: in 2020, the paragraph dedicated to the decommissioning of gas assets still referred to probable and proven gas reserves up to 2260. 6
This argument has completely disappeared from the 2021 accounts, which now include carbon neutrality in 2050 and rely on the French energy mix and the rise of green gases to push back the decommissioning horizon. 7
- Discounting consists of converting an amount that will be spent or received in the future into today’s value. For example, we use the discount rate to give a present value to the sum we plan to spend in 30 years’ time to dismantle a coal-fired plant built today. A zero discount rate means that these values are equivalent, and therefore that the present and the future are equally valuable. Behind this technical indicator lies a profoundly ethical debate: what place should be given to the well-being of future generations? ↩︎
- See the 2020 financial reports ofEDF (note 15), TotalEnergies (note 12.1) andENGIE (note 19). ↩︎
- The term “proved reserves” does not refer to all the resources estimated to be still available on earth, but rather to the quantity of resources that operators can guarantee will be extracted in the future, under current technical and economic conditions, from producing fields. See definition of resources, ultimate reserves and proved reserves. ↩︎
- This way of counting proven reserves by projecting future reserves on the basis of consumption in the current year is very conventional. But it can be misleading, as consumption can vary from one year to the next. What’s important here is the fact that proven resources have been multiplied by more than 4, potentially changing the usage horizon of the assets under consideration. ↩︎
- GDF Suez, Document de référence 2010, note 6.1.3 ↩︎
- ENGIE, Annual Report and Consolidated Financial Statements 2020, note 19.3.1 ↩︎
- ENGIE, Annual Report and Consolidated Financial Statements 2021, note 20.3.1 ↩︎