Posted by: bmeverett | August 2, 2012

“Private Empire” by Steve Coll (Part 4)


Let’s continue our discussion of Steve Coll’s new book “Private Empire: ExxonMobil and American Power.” As discussed in my previous posts, my basic theme is that Mr. Coll does some excellent story-telling, but much of his analysis is implicit and confused. Let’s take a look at his discussion of ExxonMobil’s reserve statements. This section of the book is perhaps the most puzzling.

Mr. Coll states (quite correctly) that “To protect stock market investors from oil operators that inflated their reserves to boost their share prices, Congress had mandated in the Securities Act of 1933 and the Securities Exchange Act of 1934 that Washington regulators oversee how publicly traded companies reported their numbers.” Mr. Coll acknowledges that ExxonMobil fully met all these legal requirements, using the definitions established by the Securities and Exchange Commission (SEC) in all the company’s reporting. He strongly objects, however, to ExxonMobil’s statements in press releases and analysts’ briefings that the company’s internal reserve assessments are higher than the SEC estimates, a practice ExxonMobil “had gotten away with for many years.” Furthermore, Mr. Coll faults the SEC for doing nothing to “force ExxonMobil to modify its public statements.”

There are two issues here. The first question is what is wrong with stating publicly that you disagree with government accounting practices? If ExxonMobil had falsified its SEC reporting, Mr. Coll would have a point, but they didn’t. Here’s an analogy. Let’s suppose you want to rent an apartment, and your landlord asks for an income statement to demonstrate that you can afford the rent. He specifically asks for your last five year’s federal tax returns. You give him the tax returns which show an annual salary of $25,000. In a cover letter, however, you point out that you also have a stock portfolio worth $200,000 which has grown consistently by 5% per year for the last 10 years. This stock appreciation will not appear on your federal Form 1040 because federal tax laws do not recognize capital gains as income until the asset has been sold. Nonetheless, the growth in your portfolio is a legitimate source of potential income for you should you need it. What could possibly be wrong with giving this information to your landlord in addition to the tax returns?

The second issue is whether the SEC rules for calculating reserves are correct. As Mr. Coll notes, under SEC rules “certain forms of oil, such as bitumen or oil sands extracted by techniques that resembled mining, could not be counted.” ExxonMobil’s internal reserve estimates include these very real and profitable types of oil production. Why does Mr. Coll assume that the SEC definition is correct? After all, the purpose of government-mandated disclosure is to give investors a clear picture of the company’s earnings, assets and operations. In 2011, ExxonMobil produced an average of 2,311 thousand barrels per days of liquids worldwide. This total is broken down in detail on page 42 of ExxonMobil’s 2011 Financial and Operating Review, which is a public document. The total includes 120 thousand barrels per day of bitumen from Canada and South America. Investors are free to consider that business segment as a positive or a negative or to ignore it altogether. Mr. Coll’s position seems to be that investors should be kept ignorant of the reserves and production potential associated with that asset. How do investors benefit from that?

Why doesn’t the SEC include bitumen and oil sands in reserve definitions? The answer is that the government is simply behind the times, using reserve definitions that were developed before the synthetic oil industry had really taken off. In this matter, ExxonMobil’s reserve accounting is clearly superior to the SEC’s accounting, and investors are better off being advised of the two different approaches.

Here, in summary, is the basic problem with Mr. Coll’s book. He makes a series of accusations of inappropriate behavior against ExxonMobil and implies that these actions demonstrate that ExxonMobil is somehow an irresponsible company. Although he never uses those words, the title of the book is telling. What he fails to do is either to establish any clear standards for corporate social responsibility or to demonstrate that ExxonMobil has behaved other than as a commercial entity following the laws, operating to the highest ethical standards and providing a legitimate return to its shareholders. Reading this book, one gets the impressions that Mr. Coll believes that a responsible corporation is essentially an arm of the state following governmental guidance and supporting government policy. That would make ExxonMobil as successful as the Post Office.

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