OIL PRICE VOLATILITY – 2015 RESPONSE SERIES
March 2015
Asset impairment
Oil price decline: the impact of
impairment.
Since June 2014 we have seen oil prices dramatically
decreasing, with analysts and industry leaders forecasting
much lower oil prices than have been enjoyed in the last four
years. The days of $110 per barrel appear a distant memory
and expectations, for the medium term at least, appear to be
concentrated around a $60 - $70 level. These market dynamics
have recently been reflected in profit warnings, spending cuts,
declining share prices and decreased asset valuations.
Operating company prospective
The deteriorating economics are also reflected in financial
reporting. In the last couple of weeks we have seen
preliminary Q4 and year end announcements from various
super majors and large independents in the E&P sector.
Nearly all of them addressed impairment of assets in their
announcements and have collectively written down their
balance sheet valuations by many billions of dollars.
“In any case, the significant
impairments announced in the sector
so far indicate that management of oil
and gas companies are being
significantly more conservative about
oil prices, particularly in the longer
term’’
Our interviewees noted that although goodwill impairment
testing is relevant in assessing how well an investment has
performed, its relevance to the market is in confirming rather
than predicting value.
Between 14 January and 3 February 2015, we noted ten FTSE
350 Oil & Gas earnings announcements reported by Capital IQ.
Eight referenced specific impairment charges as a result of the oil
price decline, one referenced a non-specific impairment (under
review) and one made no reference of impairment at all.
Source: Capital IQ
Impairment describes the scenario where the recoverable
amount, of the assets of the company (either non-financial
assets or goodwill), is lower than the balance sheet carrying
values for those assets.
The general premise is that the recoverable amount is the higher
of the asset’s value in use (i.e. value to the company in its
current state / use) or fair value, less the cost to sell (i.e. the
value which could be obtained on a sale to a hypothetical third
party).
Companies are required to perform this ‘recoverability analysis’
either annually or when there is an indication of impairment,
such as when the market dynamics affecting underlying values
have substantially declined and this decline is expected to be
prolonged.
Shareholders' prospective
Early in 2014 KPMG interviewed a sample of stakeholders to find
out their views on goodwill impairment testing – its relevance, its
effectiveness, the quality of disclosure and any shortcomings
that should be addressed in future.
The market reaction as highlighted by the relative share price
movement ranged from adverse (-4.7%) to favourable (+2.8%).
Comparison of share price reaction (% gain or fall) following
impairment announcement
5%
4%
3%
2%
1%
0%
10-Jan
-1%
15-Jan
20-Jan
25-Jan
30-Jan
4-Feb
-2%
-3%
-4%
-5%
-6%
Super Majors
Large Independent E&P
Source: Capital IQ
© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity.
All rights reserved. Printed in the United Kingdom.
Other
9-Feb
Balance Sheet Impacts
From a balance sheet perspective, impairment of assets would mean that overall value of the assets recorded on the books
decreases and the change is likely to be more medium to long term in nature. In particular in relation to the impairment of long-lived
assets we note the following:
: Type of asset
Licenses
Issues to consider


Approach to impairment
In most countries, oil companies have the right to
extract hydrocarbon resources in return for paying
the government taxes, royalties or sharing the
production with the state. These rights cannot
typically be assigned or transferred without prior
governmental approval, which can be difficult to
obtain.
In the UK (and most emerging markets) lenders are
not able to directly take security over reserves and
instead seek security over contractual rights,
whether under license pursuant to the Petroleum
Act 1998, a production sharing agreement, or a joint
operating agreement.

Under current IFRS pronouncement, licenses
appear on the books at their fair value only
when they were acquired as a part of a
transaction.

The level of impairment is therefore
dependent on when the asset was acquired,
the prevailing oil price at that time and the gap
between that and the current price outlook.

It is therefore common to have different
levels of impairment across a single asset
portfolio.
In situations where a lender has taken
security over the contractual rights associated
 In the US it is legally possible for an oil company to
with the asset, a lower oil price outlook will
own the underlying reserves and so the US
(with other things being equal) in general lead
domestic lending market is one of the few where it
Source: WoodMac
to an assessment of underlying asset value
is possible to get asset-level security over the
diminution.
Note: Ratio of Upstream Enterprise Value to WM estimate of upstream NPV. Upstream Enterprise Value = Enterprise
Value x percentage of earnings in last three years
underlying oil or gas field.

from upstream sector. Enterprise Value = average of Market Capitalisation in November 2014 + Q3 2014 reported Net Debt (or last reporting period). Data not provided
for CNPC, Petronas,
Pluspetrol and
Property,
plant PetroVietnam,
 Impairment
ofSinopec.
property plant and equipment is
and equipment
usually assessed on a cash flow basis.
Goodwill

For those operating assets in a sliding spot market,
depressed day rates for equipment such as drilling
rigs or vessels could imply the presence of a
deteriorating cash flow outlook.

Goodwill on acquisitions is tested for impairment at
least annually or when there is an indication of
impairment.

Where the resulting NPV on a cash flow basis
is lower than the carrying amount of assets
then impairment is recognised.

The size and probability of impairment is likely
to be more significant on the acquisitions that
happened during the period of rising oil prices.
Financing considerations
Potential impacts of impairment
Significant value in exploration and production financing is linked
to the earnings and cash flow potential of the company and its
underlying asset base. Reserve based lending limits are derived
from the expected present value of future production from the
fields in question. These take account of factors such as:
Impairment of assets is a non-cash charge but will have an
immediate impact on the profit and loss account. That
change may impact asset based covenants or covenant
headroom. Given the long-lived nature of these assets, their
impairment may also have a longer term impact on EBITDA
and cash flow.

estimated volume of reserves

capital expenditure

expected oil price

fiscal regime

discount (risk) rate

hedging and coverage

operational expenditure

reserve tail
Lenders review the limits on a bi-annual basis taking into account
reduced price decks and factors but also risks associated with
the asset. The impact of oil price decrease will take effect
through next month when banks start in a number of cases
revising their limits based on the new price decks.
Contact for Oilfield Services
Euan Tait
Director
T: +44 (0) 1224 416 804
E: [email protected]
Contact for Exploration & Production
Lyuda Sokolova
Director
T: +44 (0)207 6944826
E: [email protected]
www.kpmg.co.uk
Companies and their stakeholders should be looking at their
P&L and cash flow as well as their balance sheet to identify
potential impairment consequences under various oil price
scenarios and start discussions early to adjust operations and
financing structures to the changing price environment.
© 2015 KPMG LLP, a UK limited liability partnership and a member firm of the KPMG network of
independent member firms affiliated with KPMG International Cooperative (“KPMG
International”), a Swiss entity. All rights reserved.
The KPMG name, logo and "cutting through complexity" are registered trademarks or trademarks
of KPMG International.
The information contained herein is of a general nature and is not intended to address the
circumstances of any particular individual or entity. Although we endeavour to provide accurate
and timely information, there can be no guarantee that such information is accurate as of the
date it is received or that it will continue to be accurate in the future. No one should act on such
information without appropriate professional advice after a thorough examination of the particular
situation.
Produced by Create Graphics | CRT035462 | March 2015