U.S. exploration and production (E&P) companies that use full-cost accounting methods could be facing sizable third quarter write-downs because of lower natural gas prices, an energy analyst said in a note to clients this week.
Robert Morris, who covers E&Ps as an energy analyst for Banc of America Securities, said quarterly earnings may be lower regardless because of lower prices compared with a year ago — but those relying on spot gas prices to calculate quarterly earnings may take the biggest hit.
“With natural gas prices ending the third quarter near four-year lows (composite spot natural gas price of $3.85/MMBtu, including $3.28/MMBtu in the Rockies), we expect some companies could report a one-time, noncash, ceiling test write-down or impairment charge when they report third quarter results,” Morris wrote.
The Securities and Exchange Commission regulates how E&Ps value their reserves for accounting purposes. Some producers use successful-efforts accounting, which values reserves using a mid-cycle price that covers the entire year. It also does not allow E&Ps to include hedging on their balance sheet.
Full-cost accounting, which allows E&Ps to use swaps and basis hedges for valuing future cash flow, marks the predicted value of reserves at end-of-quarter spot prices. If the reserves value is lower, E&Ps are required to take noncash write-downs to reduce the value of the reserves on the balance sheet for that quarter.
Morris noted the one-time charges under full-cost accounting methods would not impact the worth of the proven reserves “or even the quantity of the reserves…just the carrying value of the proven reserves on their books.”
“Ceiling impairment tests are based on a lot of detailed data, most of which is not publicly disclosed, and thus it is difficult to project which companies are likely to take ceiling/impairment test write-downs,” Morris noted. Other “key variables” also could affect write-downs — including the geographic location of the reserves. Rocky Mountain producers may be at higher risk for write-downs in the quarter if they use full-cost accounting because prices in the Rockies are consistently lower than in other U.S. basins.
E&Ps covered by Morris that he considers at risk to take quarterly write-downs are EnCana Corp. and Anadarko Petroleum Corp. — which both use full-cost accounting and which rely on the Rockies for a substantial amount of their production. Other large Rockies-weighted gas producers that also may be affected by the lower prices include Cabot Oil & Gas, Noble Energy Corp. and Pioneer Natural Resources. Even without Rockies exposure, Morris said other E&Ps could see lower earnings in the quarter if they have high gas-to-oil ratios, where oil production can’t offset weak gas prices.
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