Oil companies are likely to impair billions in assets this year despite the latest geopolitically driven price jumps
By Rochelle Toplensky
Big-oil investors shouldn’t pay too much attention to alarming headlines from the Middle East.
The killing of Iranian general Qassem Soleimani sent oil prices up, as did Iran’s retaliatory missile attacks against U.S. bases in Iraq on Wednesday.
But geopolitical tensions probably haven’t risen far enough to shift long-term price expectations.
Big petroleum producers are still likely to write billions of dollars off the value of their oil and gas assets this year.
The five big integrated petroleum producers— BP, Chevron, Exxon Mobil, Royal Dutch Shell, and Total—are busy preparing their 2019 annual reports.
A key part of that process is assessing how much of the resources they own and what the assets are worth. At the end of 2018, the five oil supermajors had a total of $708 billion in oil and gas assets on their books.
Lower commodity-price expectations can force companies to write down these assets, which typically reflect decades of petroleum production, for two reasons: Some reserves are no longer economically viable to extract; sales from those that are worth extracting will generate lower cash flows.
Companies develop their own commodity-price outlooks using both external forecasts and management expectations. These mostly reflect long-term trends, though sometimes short-term changes can shift the numbers. Like other complex financial models, they blend science and art.
Many companies’ estimates are based on an expected oil price of $75 to $90 a barrel for the next decade, according to Barclays. It has been more than five years since the Brent oil price was consistently in that range.
While history doesn’t predict the future, by the end of last year there was a growing feeling that the price outlook was too bullish, leading to expectations that producers would be forced to impair billions of dollars in assets. Last year’s big write-downs—by Chevron (around $10 billion) Spanish giant Repsol($5 billion) and Shell ($2 billion)—seemed a sign of things to come.
The latest news out of the Middle East makes future oil prices seem less predictable. We don’t know whether the U.S. will respond with action to Iran’s missile strikes, nor the outcome of Iraqi lawmakers’ motion to expel U.S. troops from their country. The situation could yet escalate. Traders’ gut instinct has been to push prices higher.
Significant volatility in the oil price could open a path for producers to argue that big impairments aren’t required this year, but this would be a mistake. Oil prices are less influenced by geopolitics than they used to be.
The oil-price spike after the drone attack on a major Saudi production facility in September soon faded. The potential for sustained price jumps has been eroded by plentiful U.S. shale reserves, where producers can react quickly to price changes by adding or shutting down supply.
Given that the market already expects big impairments, major oil companies have an opportunity to clear the decks. They should embrace it.
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