Last September, when the price of oil was well below where it had been trading for the bulk of the past several years, we reported that NY Attorney General Eric Schneiderman was probing why Exxon Mobil hasn’t written down the value of its assets, two years into a pronounced crash in oil prices. The complaint was simple: out of the 40 biggest publicly traded oil companies in the world, Exxon - then still led by now Secretary of State Rex Tillerson - was the only one that hasn’t booked any impairments in the prior 10 years.
As the WSJ wrote at the time, "since 2014, oil producers world-wide have been forced to recognize that wells they plan to drill in the future are worth $200 billion less than they once thought, according to consultancy Rystad Energy. Because the fall in prices means billions of barrels cannot be economically tapped, such revisions have become a staple of oil-patch earnings, helping to push losses to record levels in recent years." And yet, Exxon had - until the later half of 2016 - declined to take any write-downs, the only major oil producer not to do so, which has led some analysts to question its accounting practices.
Maybe the NYAG was on to something?
To be sure, the company had played down the criticism, saying it is extremely conservative in booking the value of new potential fields and wells. That reduced its exposure to write-downs if the assets later prove to be worth less than expected. Then again, not even the most "conservative" company could have factored in oil crashing from $100 to $42 without that impacting the balance sheet.
Needless to say, avoiding reality and Exxon’s "ability" to avoid write-downs, and the massive losses that come with them, had been the main factors helping the company outperform rivals since prices began falling in mid-2014. Exxon shares had fallen by about half of the average of top peers Chevron, Royal Dutch Shell, Total and BP. Since 2014, those companies have booked more than $50 billion overall in write-downs and impairments. But not Exxon.
Then-CEO Rex Tillerson has an unusual explanation why Exxon has refused to write down assets so far: Rex told trade publication Energy Intelligence in 2015 that the company has been able to avoid write-downs because it places a high burden on executives to ensure that projects can work at lower prices, and holds them accountable.
“We don’t do write-downs,” Mr. Tillerson told the publication. “We are not going to bail you out by writing it down. That is the message to our organization.”
All of that changed this afternoon, when Exxon, now ex-Tillerson, disclosed the deepest reserves cut in its history as the ongoing rout in oil prices erased the value of a $16 billion oil-sands investment and other North American assets. In a press release filed after the close, Exxon announced that "proved reserves were 20 billion oil-equivalent barrels at year-end 2016, inclusive of a net reduction of 3.3 billion oil-equivalent barrels from 2015. Reserves changes in 2016 reflect new developments as well as revisions and extensions to existing fields resulting from drilling, studies, analysis of reservoir performance and application of the methodology prescribed by the U.S. Securities and Exchange Commission."
As a result of very low prices during 2016, certain quantities of liquids and natural gas no longer qualified as proved reserves under SEC guidelines.
In other words, after years of denials, and claims that "we don't do write-down", Exxon just concluded the biggest reserve cut on record, as 3.3 billion barrels of crude was removed from the company's "proved reserves" category. The revisions were triggered when low energy prices made it mathematically impossible to profitably harvest those fields within five years. The massive 3.5-billion barrel Kearl oil-sands development in western Canada accounted for most of the hit, with another 800 million oil-equivalent barrels in North America did not qualify as proved reserves, "mainly due to the acceleration of the projected economic end-of-field life."
Following the reserve cut, the company's total reserves dropped to 20 billion, the lowest in two decades.
As Bloomberg adds, the oil-sand mines in northern Alberta are among the costliest types of petroleum projects to develop because the raw bitumen extracted from the region must be processed and converted to a thick, synthetic crude oil. As such, they have been particularly hard hit by the worst oil slump in a generation.
The reductions were partially offset by reserves additions of oil and natural gas totaling approximately 1 billion barrels of oil equivalent in the U.S., Kazakhstan, Papua New Guinea, Indonesia and Norway, which replaced 65% of production and were the result of acquisitions, improved asset performance and a decision to fund an expansion of the Tengiz project in Kazakhstan.
According to Bloomberg calculations, the 19 percent drop amounts to the largest annual cut since at least the 1999 merger that created the company in its modern form. That includes 1.5 billion barrels of reserves that were pumped from wells. The previous record cut was a 3 percent reduction taken during the height of the global financial crisis in 2008.
Proved Reserves are among the most important metrics watched by investors because they are an indicator, along with commodity prices, of future cash flow. When the 2008 reserves cut was announced in February 2009, Exxon shares lost more than 4 percent in a single day, wiping out almost $17 billion in market value.
Today, after the biggest reserve write down in history, the shares gained 0.2% to $81.08 in after-hours trading as of 5:46 p.m. in New York on Wednesday, after closing at $80.93, suggesting that either the market does not care about fundamentals, or had largely priced in the announcement. As noted above, Exxon was facing an SEC probe into how it valued its portfolion, and signaled in October and again last month that the revision was probably coming, which may explain the lack of reaction.
On Tuesday, ConocoPhillips engaged in a similar reserve reduction when it removed the equivalent of 1.15 billion barrels of oil-sands crude from its books as part of a 21 percent cut that pushed the Houston-based company’s reserves to a 15-year low.
Under SEC rules, proved reserves can only include oil fields that can be produced economically within the next half decade. Price trends from the previous 12 months are compared against the estimated cost to harvest crude and gas in determining which reserves are counted.