Impairment charges at record levels for North American E&P peer group (IHS Herold)

The elevated level of asset impairments in the first half of 2015 have exceeded the previous annual high of the past decade in 2008. Given continued low commodity prices, we predict continuing severe impairments for companies in our North American E&P peer group during the remainder of 2015, with companies with high DD&A expense and assets outside core areas of the best plays most at risk. With proved reserves used as collateral for debt financing, E&Ps taking major write-downs in 2015 could have difficulty obtaining financing from their banks if prices remain depressed.

• Our preliminary second-quarter 2015 data shows the North American E&P peer group (Large, Midsized, and Small) took a total of $31 billion in impairment charges during the quarter, surpassing the first-quarter total of $29 billion. This propels the first-half 2015 total to $60 billion, far exceeding the previous high of $49 billion in 2008, as well as the 10-year annual average of $18 billion.

• Updating our year-end 2015 ceiling test price projection for the current futures curve, we estimate determining prices could fall to $48.90/bbl of oil and $2.75/Mcf of gas assuming the 12 August 2015 futures price outlook. At these prices the economics of even the best North American plays would be under stress.
• The largest impairment charges in the second quarter came from three companies which reported a combined $33 billion in impairments year to date, equal to about a third of their year-end 2014 capitalized costs. Four other companies have reported the largest impairments as a percentage of year-end 2014 capitalized costs, at 46%, 40%, and 39%.
• However, many companies in the peer group have remained relatively free of impairments through the first half of 2015. However, we continue to expect that companies with a higher-cost capital base, identified as those with high-unit DD&A expense, are most at risk of impairment. Additionally, companies with assets in higher break-even plays and assets outside of the core areas of the best plays are at higher risk of impairment.
• We expect operators with high debt and a large portion of proved undeveloped reserves will be among those most at risk of reserve revisions from the proved undeveloped to probable category.
• Large reserve write-downs and revisions will reduce the borrowing ability of companies, and a tightening of bank lending could force companies to curtail drilling. Additionally, impairments and revisions will limit proved reserved growth in 2015. Following the past several years of weak returns, reductions to the capital base and DD&A rates following impairments in 2015 could lead to improved returns in the longer term, but the sector must first endure significant pain with the write-down itself.

September 1 2015 by Paul O'Donnell

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This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.