Impairment in Oil and Gas Accounting: Important Considerations

Public companies become very busy preparing SEC filings and there is no doubt that discussions of impairments of oil and gas assets will occur in the coming months. In most cases, privately held companies do not have to report to the SEC but are finding that it is becoming increasingly important to pay close attention to their impaired assets when putting together their financial reports so that they comply with debt covenants and investor reporting requirements.

For a quick refresher, an asset is deemed to be impaired when the market value is less than the value listed on the company’s balance sheet. Assets should be tested for impairment on a regular basis to prevent overstatement on the balance sheet.

Below, we will discuss impairment considerations relating to oil and gas accounting to take into 2021. We hope that this article will help you and your team be prepared to put together accurate financial statements when the time comes. 

Proved and Unproved Property Testing

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Proved Property Testing

Accounting Standards Codification (ASC 360), Property, Plant and Equipment (“PP&E”) provides information on impairment testing for a company’s long-lived assets. 

The test for impairment under ASC 360 consists of:

  1. Assess Impairment Indicators i.e. triggering events
  2. Test for Recoverability
  3. Measure the Impairment

Note: How these steps are carried out will differ based on the accounting method used (see below).

Unproved Property Testing

Unproved property is required to be tested at least annually for impairment to determine whether the book value is greater than the current assessed value either at an individual property basis or a group basis, and an impairment should be taken. With decreased commodity pricing, private and public companies need to evaluate whether their unproved property is recoverable. 

Here is a quick list of other items that should be evaluated when assessing impairment for unproved properties:

  • Lease renewals and extensions
  • Wells drilled in the corresponding area or on neighboring operator’s lease
  • Economics
  • Exploratory drilling in the area
  • Changes in capital deployment planning
  • Ability to access capital to develop and extend current leases 

 Unproved properties are evaluated under ASC 932-360-35.

Accounting Methodology Can Impact Impairments

The methodology used to calculate impairments can impact the results and timing. Postponing or avoiding impairment calculations can result in questions from the SEC for public companies and concern from investors for private firms.

Oil and gas companies use either Successful Efforts or Full Cost methodologies to account for their oil and gas properties. Variables that may seem insignificant such as the price, discount rate, and type of reserves can be taken into account when assessing impairment and are different under each methodology.

For example, when looking at how each impairment is measured, successful efforts use the book value by lease or by trade minus the pre-tax discounted cash flows (“fair value”). Full cost is calculated by looking at the excess of “Full Cost Pool” book value by country over the ceiling. 

In Statement of Financial Accounting Standards No. 19, the FASB requires that oil & gas companies use the successful efforts method. However, the SEC allows companies to use the full cost method. 

Crude Oil and Natural Gas Current and Forecasted Pricing

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Brent Crude Oil Price for 2020 and 2021

In doing impairment analysis, oil companies had to provide an impairment forecast in disclosing major oil price adjustments. In 2020 financials, oil companies estimated long-term price for Brent crude in the range of $70–$80 per barrel and did not adjust these estimates for the crisis. The EIA forecasts monthly Brent crude oil prices will average $42 per barrel during the fourth quarter of 2020 and will rise to an average of $47 per barrel in 2021.

Energy executives believe that the pandemic will hold oil and gas prices low for a prolonged period, while the global shift towards cleaner fuels will be accelerating. The EIA expects that high inventory levels and a surplus in crude oil production capacity will limit upward movement when it comes to oil prices.

Although we all want the price per barrel to rise to pre-pandemic projections, it does not look like that will be the case this year. 

Henry Hub Natural Gas Spot Price for 2020 and 2021

There is some good news to keep in mind as your team discusses impairments. Henry Hub natural gas spot price averaged $1.92 per million British thermal units (MMBtu) in September, down from an average of $2.30/MMBtu in August. 

Okay, so where is the good news? Although prices are trending downward, the EIA expects to see a rising domestic demand for natural gas heading into winter. This, combined with reduced production, to could or will cause Henry Hub spot prices to rise to a monthly average of $3.38/MMBtu in January 2021. Monthly average spot prices are expected to remain higher than $3.00/MMBtu throughout 2021 at an average of $3.13/MMBtu for the year. An increase from a forecast average of $2.07/MMBtu in 2020. 

Many in the industry believe that impairments will continue to be an important topic of conversation over the next few years. Ensuring that your firm – no matter what size – understands impairments and what affects them will affect the financial health of your company. 

As the source for oil and gas accounting, the Council of Petroleum Accountants Societies® (COPAS®) is here to keep you informed on the latest changes and processes in oil and gas accounting. We have a variety of resources available to oil and gas accountants including valuable webinars.

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