By Deborah Rogers
In my last post I discussed the many mistakes of Energy in Depth (EID), an entity funded by the Oil and Gas industry, in its evaluation of shale gas economics. I should like to continue with this discussion and consider shale gas energy truly more in depth.
EID wrote “The greatest fear for a CEO, and top management in general, is the impairment charge where reserve values are written down and charges against income occur. Therefore, companies tend to be very conservative with their volume estimates to avoid such an embarrassment.”
To use a current colloquialism…really?
Unfortunately, “avoid[ing] such an embarrassment” has not happened in the least in spite of EID’s promises. In fact, shale companies are writing down assets and destroying shareholder value at alarming rates.
According to Fox Business News:
“Encana…said additional shale gas write downs are expected under US full-cost accounting rules…Encana reported a $1.7 billion aftertax impairment charge against net earnings in the second quarter resulting primarily from the decline in 12-month average trailing gas prices.”
According to Reuters:
“Natural gas-focused producer Quicksilver Resources Inc posted a second-quarter loss on a big impairment charge as weak prices for natural gas and natural gas liquids lower the value of the company’s assets…Quicksilver said its results were hurt by a $992 million non-cash impairment of oil and gas properties due to lower prices.”
According to Seeking Alpha:
“In the second quarter, Chesapeake Energy (CHK) saw losses on sales and impairments of fixed assets totaling $243 million, about thirty times the loss on this item it reported in the same quarter last year. This is discouraging as Chesapeake’s second quarter accounting did not report significant impairments to the carrying value of its natural gas an oil properties since it was not required, but based on the current market such impairment will be due in the second half of this year. Though it will be a non-cash charge, it could potentially reduce Chesapeake’s equity by a substantial amount.”
According to the Financial Times of London:
“British Petroleum (BP) said Tuesday it is taking an impairment charge of US$2.11 billion, primarily relating to its U.S. shale gas assets.”
Also according to the London Financial Times:
“BHP Billiton (BHP) blamed a glut of gas supply in the US for a US$2.84bn impairment charge against the value of its Fayetteville gas assets, which it acquired for US$4.75bn 18 months ago.”
According to the Oil and Gas Journal:
“Meanwhile, Exco Resources Inc. of Dallas reported a first-quarter $276 million non-cash write down on its assets“.
And the list goes on…and on…and on.
It is interesting to note, however, another aspect to this story. Encana’s news release made the following optimistic statement:
“The impairment charge…is not reflective of the fair value of the assets”.
And yet, they went on to say:
“Given the current pricing environment, the company expects that further declines in 12-month average trailing natural gas prices will likely result in the recognition of future ceiling test impairments.”
Let’s examine this for a moment. What is not being said here is that there is a significant difference in international accounting rules which the European companies like BP and BHP are subject to. Note that the impairment charges for these companies are typically substantially greater than those of the US companies thus far.
The WSJ explained this phenomenon quite succinctly:
“The European approach, governed by international financial reporting standards, means companies better reflect actual US gas-industry conditions. After a review in May, BG Group lowered its long-term Henry Hub natural-gas price assumption to $US4.25 a million British thermal units, from $US5. Applying the lower price to BG’s expected future discounted cash flows from its shale-gas assets resulted in a $US1.3bn impairment charge, equivalent to two-thirds of its second-quarter operating profit…By ignoring the time-value of money, the US GAAP rules make little economic sense”.
Impairment charges destroy shareholder value. They also complicate the balance sheets of companies which in many cases already have serious fiscal issues. For instance, after BP’s $2.1 B shale related impairment, their debt-to-capital ratio rose several percentage points to 21.9 per cent from 19.9 per cent.
Undoubtedly, we will see more impairments in the second half of 2012 from shale gas companies. But perhaps there is light on the horizon. In the recent above mentioned article, the Wall Street Journal concluded with the following statement:
“…the US shale boom could be over before the US and Europe agree on how to account for it.”