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SEC Probe of ExxonMobil's Financial Reporting Underway

ExxonMobil Corp. has confirmed that an investigation about how it values its oil and natural gas reserves has been launched by the U.S. Securities and Exchange Commission (SEC).

The SEC sought information and documents in August from ExxonMobil and auditor PricewaterhouseCoopers LLP, according to initial reporting byThe Wall Street Journal.

"We are fully complying with the SEC request for information and are confident our financial reporting meets all legal and accounting requirements," spokesman Alan T. Jeffers said. "The SEC is the appropriate entity to examine issues related to impairment, reserves and other communications important to investors."

Specific details were not released about what the SEC is looking at, but it is said to mirror requests by New York Attorney General Eric Schneiderman, who is spearheading two investigations into ExxonMobil -- one on its climate change research and the other on reserves reporting (see Daily GPISept. 16). Under New York's Martin Act, the attorney general has extraordinary powers.

ExxonMobil has not written down the value of its oil and gas assets or recorded an impairment since oil prices crashed in late 2014. The SEC requires U.S. producers to use the 12-month average trailing price for oil and natural gas to book the value of their reserves. The commission also mandates that proved undeveloped reserves, or PUDs, be developed within five years or be deleted from the reserves numbers.

ExxonMobil earned $1.7 billion (41 cents/share) in 2Q2016, versus year-ago earnings of $4.18 billion ($1.00). However, it did not appear to report any asset impairments. By contrast, Chevron Corp. recorded a $1.5 billion loss (minus 78 cents/share) in 2Q2015, with impairments and one-time charges totaling $2.8 billion. A study by Ernst & Young LLP found that 44 of the 50 largest U.S. producers in 2015 recorded property impairments, including ceiling test charges, totaling $141.8 billion (see Shale Daily, June 14).

Because it is an open investigation, the SEC had no comment about whether an investigation was underway.

House Rep. Lamar Smith (R-TX), who chairs the House Science, Space and Technology committee, has criticized inquiries into ExxonMobil and sought jurisdiction over the Schneiderman-led investigation (see Daily GPISept. 14). The GOP congressman slammed the SEC investigation as a way to prop up the state inquiries.

"With no one left to do its bidding, an SEC investigation seems like the natural, if not desperate, next step by the administration to intimidate scientific research," Smith said.

Wells Fargo Securities LLC analysts Roger Read and Lauren Hendrix don't think the SEC investigation will be a gamechanger.

"We rate the likelihood of a negative outcome from a reported SEC investigation into ExxonMobil's accounting/climate practices as very slight," the analysts said in a note. "ExxonMobil has historically avoided asset writedowns during periods of dramatic price declines and in general.

"That this fact stands out might say as much or more about its competitors/peers' willingness to over-capitalize assets as it does ExxonMobil's aversion to writing them off."

Wells Fargo analysts said they have asked ExxonMobil "on multiple occasions how it avoids the asset write-down trap. Their answer is they are conservative on when and how much is capitalized. Other parts of the answer are likely related to ExxonMobil's size (i.e., materiality), its ability to capitalize other reserves to offset losses and its practice of high-grading its operations through investments, acquisitions and dispositions. The final reason to believe ExxonMobil is not over-capitalized is that its returns on capital employed have consistently outperformed its peers -- a harder performance to deliver without write-downs..."

But the "headline risks associated with an SEC investigation create enough investor angst to damage ExxonMobil’s reputation and impact its share price performance during the investigation period," Read and Hendrix wrote. Because of that, they reduced their target price/earnings multiple on the company to 18 times from 20 times the 2018 earnings/share estimate and reduced the valuation range to $93-103 from $103-114.

Activist groups were enthused by the news of an SEC investigation, which they said was linked to Schneiderman's wide-ranging probe into ExxonMobil's climate research.

"This is a remarkably important development," said 350.org co-founder Bill McKibben. "The federal government is joining the courageous state attorneys general, and they're all following the trail of clues that began with powerful investigative journalism. Before they're done we'll understand considerably more about how the world overheated -- but in the meantime, every institution that invests in Exxon should take real note of who you're keeping company with."

Environmental advocacy group ClientEarth attorney Alice Garton said fossil fuel companies "should take this development very seriously. We've reached a tipping point on litigation risk associated with climate change...This may also signal the opening of a new front in climate-related regulation and enforcement at the SEC, against fossil fuel companies and other carbon intensive sectors."

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