Small numbers can cause big losses for independent oil and gas producers, as was the case in third-quarter earnings reported last week.
In this case, the number was $2.83 -- the average price of natural gas at a benchmark pipeline hub in the past 12 months.
The decade-low gas prices seen during that period are forcing producers to write down the value of their reserves. The official term is "impairment," and it's adding up to billions of dollars in losses this year.
For example, Chesapeake Energy took a $3.3 billion charge, which also included some non-producing leases the company let expire. For Devon Energy, the largest producer in the Barnett Shale, the charge was $1.1 billion.
Fort Worth-based Quicksilver Resources took a $546.8 million charge in the quarter, raising its impairments in the first nine months of 2012 to $1.6 billion. EOG Resources has taken $250 million in impairments in those same nine months, and Fort Worth-based Range Resources has taken $105 million.
The good news: the losses don't involve cash. An impairment is just an accounting measure.
The bad news: an energy company faced with persistently low prices for its oil and gas will eventually have to write down its reserves. That move acknowledges that a certain portion of the oil and gas reserves on its books is no longer economical to produce, and that means the company isn't going to be worth what it was previously.
"A reserve write-down would be more serious, but we're going to have to wait until the end of the year for that," said Lysle Brinker, director of energy equity research at IHS, a big consultancy. Oil and gas producers are only required to disclose their estimated reserves once a year, Brinker said, although some choose to do it multiple times during the year. The deadline for the 2012 year is Feb. 28, 2013.
As far as this year's impairments go, "it's really not a secret" that the charges were coming, Brinker said. "Companies and analysts know prices were weak, and they've been anticipating those write-offs."
Price, price, price
"Price is the main driver of the impairments you are seeing. It's all pricing," said David Erdman, manager of investor relations at Quicksilver. Companies don't have much flexibility in the numbers they must use to perform what's called a "ceiling test," which in effect sets a ceiling for the value of oil and gas properties that a company can carry on its books.
Here's how the numbers work in Quicksilver's case, which is fairly typical for an independent producer.
First, Quicksilver must take the average price of oil and gas at a benchmark, in this case the Henry Hub in Louisiana, a major connection point for pipelines. It averages the price on the first day of each month for the previous 12 months, and that sets the price it must use in its calculations.
(Companies can include different prices that they have locked in using hedges, said Vince White, senior vice president of communications at Devon. But those generally cover only a portion of a company's production, and usually don't extend more than a year or two into the future.)
In this example, the average price was $2.83 per 1,000 cubic feet of natural gas. The producer then calculates today's value (called the net present value) of the company's estimated future revenues using that price and their estimated future production. That's the ceiling.
It then compares the ceiling value to the money it spent acquiring and developing those reserves and assets. If that number is above the ceiling, it must be written down to the ceiling value.
Big as the numbers are, impairments pale in comparison with the write-downs taken in the wake of the collapse of crude oil and natural gas prices in mid-2008.
In 2009, 50 big energy companies together reported $35.2 billion in impairments related to properties, according to data compiled by Ernst & Young. And that was barely more than the $34.4 billion in impairments reported the previous year. Impairments for those companies were just $4.9 billion in 2011, Ernst & Young says.
Impairments might not represent cold hard cash, but that doesn't mean they're not worth following, White said.
"Wall Street tends to dismiss these as a mechanical impact. But the impact on future revenues is real," he said. "Oil and gas reserves are sensitive to price. At some point in the future, the price you can sell oil and gas for is your cost. That is the economic cutoff" for figuring future production and reserves.
Said Brinker: "The question is, how much volume [reserves] are they writing off, too? We're going to have to wait" until the companies disclose their new estimate for reserves to see the full impact.
Jim Fuquay, 817-390-7552
Twitter: @jimfuquay
