Oil Companies Write Down Significant Assets in 3rd Quarter

Lower oil prices also contributed to a 33% decline in cash flow from operations in the 2015 third quarter from the previous year. However, companies reduced capital expenditures by 34% over the same period, and for the first time in a year the 46 firms EIA surveyed showed a surplus of cash from operations over capital spending. Large write-downs, also called impairments, as well as reduced cash flow suggest that investment spending will continue to decline absent a meaningful increase in crude oil prices.

The significant increase in impairment charges was an important factor many companies discussed in their third-quarter earnings releases. An impairment charge represents the decrease in value of assets a company owns, typically its amount of proved reserves. Proved reserves are estimated quantities of oil and natural gas that analyses of geologic and engineering data demonstrate with reasonable certainty are recoverable under existing economic and operating conditions. Because oil companies must publish the amount of proved reserves they own every year, an impairment charge reflects assets that have estimates of future net cash flows below what the company already spent to develop them. This situation could result from a combination of geologic and economic factors, but regardless lowers the value of the company.

Impairments are nonrecurring reductions in asset values reflected on a company’s income statement but do not represent cash flows. In the 2015 third quarter, impairments represented more than 40% of the $85 billion in non-cash adjustments. This is higher than in 2011-2013, when impairments averaged only 10% of all non-cash adjustments. Further, the increase in impairments contributed to negative net income for the 46 companies for the fourth consecutive quarter.

Large impairment charges acknowledge that some of a company’s projects are no longer profitable and are being discontinued. While this adjustment reduces the investment expenditures that would occur, it also reduces the future estimated cash flow from the projects. Options for conserving cash include reductions in dividends paid shareholders, elimination of share repurchase programs or increases in cash through share issuance, increasing debt, or sales of assets.

Since 2014, the 46 companies EIA tracked reduced dividends by 16% and share repurchases by 92%. Impairments make increasing debt and selling assets more difficult. Lenders may be less willing to lend if a company’s assets declined in value, or may only be willing to lend up to a certain percentage of the value of a firm’s proved reserves, which declined in value from impairments. Selling assets becomes difficult because they are typically sold at a lower valuation than when the company purchased them because of the impairment charge, therefore raising less cash than otherwise would be expected.