The Wave Of Big Oil Write-Downs Is Far From Over
Posted 14/07/2020 11:14
BP was first. The supermajor said last month that it could book asset writedowns of up to $17.5 billion as a result of the industry crisis. Then it was Shell. The Anglo-Dutch company said earlier this week that it, too, would book sizeable writedowns on its assets, to the tune of $22 billion. It may be just the beginning. Besides writedowns on assets that will be reflected in the companies’ second-quarter reports as one-off affairs, both BP and Shell have revised down their long-term price forecast—BP to $55 per barrel of Brent crude, and Shell to $60. This revision will likely render more assets worthless, adding them to the stranded asset count. In other words, these billions in write-downs may be just the beginning.
“BP and Shell are just two of the companies that have announced recent changes. Cutting long-term price assumptions will generally result in a lower valuation for certain assets to below the accounting value held on the balance sheet. That’s what will trigger an impairment charge,” said Wood Mackenzie upstream research team director Angus Rodger in a recent update. “This process has further to run, and we expect further large impairments to occur across the sector.”
Interestingly enough, the first significant asset writedown announcement was not BP’s. Chevron said that it would write down as much as $10-11 billion in assets last December. The company said at the time that most of the writedowns would come from deepwater Gulf of Mexico projects and shale gas operations that were turning uneconomical near the end of 2019 when WTI was close to $60 a barrel and Brent was over $60 a barrel. That’s about $20 a barrel higher than what Brent and WTI are trading at now.
At the time, some analysts saw Chevron’s announcement as a harbinger for bad news for the whole industry. It made perfect sense: if Chevron could not turn in a profit from deepwater oil and shale gas at those oil prices, how likely would its peers be profitable in that environment? That question never got an answer because just three months later, the Saudi-Russian price war led to an implosion in oil prices, and then the coronavirus pandemic added its own rather hefty weight to push them further down. More assets suddenly became uneconomical.
Not everyone is ready to admit that things are not going as well for the oil industry.
Exxon, for instance, does not believe it needs to book any writedowns on its assets, at least not yet. The Wall Street Journal reported earlier this week that a group of accountants had filed a complaint against the company with the Securities and Exchange Commission claiming Exxon must write down the value of its subsidiary XTO Energy, which is focused on shale oil. According to the supermajor, the value of XTO Energy is in line with accounting regulations.
Exxon did take a write-down in its first-quarter 2020 report. That was worth $3 billion and was a result of the oil price plunge, the company said at the time.
Since then, this supermajor has been relatively silent. It has not updated its long-term oil price projections, either. But if analysts are right, Exxon will have to join the mainstream sooner or later. Because while many predict an improvement in oil prices, equally many are doubtful oil demand—and hence prices—would recover to pre-crisis levels anytime soon.
But the writedowns are just one side of the new coin that some Big Oil majors are minting for themselves. The other side is their climate change commitment. BP, Shell, and Total all have plans to become net-zero energy companies by 2050. This will require massive investments in things other than oil. Over the long term, this strategy could undermine the value of more oil and gas assets, especially if the more pessimistic global economy projections materialize and it takes longer for oil demand to recover, if it recovers fully at all.
Of course, this is not the only scenario. Exxon may be right in biding its time before it starts booking writedowns. The latest economic data from Europe and the United States suggests that economic activity is recovering—slowly, but it is recovering. Maybe OPEC+ will extend its deep production cuts for another month, and this could lead to a strong price rebound. Yet the latest on prices suggests this is unlikely.
A recent Reuters survey revealed OPEC oil output had fallen to the lowest in 20 years. Prices did not rise. Perhaps they need a stronger motivator to rise. Or perhaps the pessimists—and Chevron, BP, and Shell—are right, and it’s better to cut your losses early on.
Big Oil’s stranded assets bill is likely to swell over the near term, then. By just how much it could swell is anyone’s guess. But it may continue to swell over the medium and long term as well if the pivot to renewables materializes. On the other hand, at some point in the medium term, oil supply and demand should rebalance, driven by the combination of OPEC+ cuts and a lot lower exploration investments across the board. This should put a cap on stranded assets, for a while at least.
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