Billions in impairments, spending cuts expected in oil earnings

HOUSTON — A $32 billion operating cash shortfall and persistent low oil prices will probably force big shale drillers to announce billions in oil field impairments and spending cuts in third-quarter earnings reports this week.

“It should be a weaker quarter,” said Guy Baber, an analyst at Simmons & Company International in Houston. “Third quarter prices were the worst of the year, down 20 percent from the second quarter. It was a pretty significant fall.”

Barclays said it expects a handful of large North American oil producers including Chesapeake Energy Corp. and Apache Corp. to report in the next few weeks that they wrote off a combined $20.9 billion in oil property values in the third quarter.

That’s on top of the $40 billion in impairments the six producers, also including Devon Energy, Southwestern Energy Co., Encana Corp. and Newfield Exploration Co., posted in the first half of the year.

These six firms use a method called full-cost accounting to determine the value of their reserves, making it easier for Barclays and others to estimate their future impairments. Southwestern Energy last week reported $1.7 billion in impairments on its oil and gas fields as its chief executive kicked off the quarterly earnings season in a somber tone.

“What is understood but not said is that we also received many scars in the past tough times, and we’ll have many more before the cycle is finished,” Southwestern CEO Steven Mueller told analysts in a conference call. “And even deeper, but unspoken understanding, is that not all of our organizations will actually survive these times.”

The 10 largest American shale oil producers had an operating cash flow shortage of $32 billion in the first half of the year, according to consultancy Oliver Wyman, and they were about $20-a-barrel short of covering their funding requirements. More efficient drilling and lower prices for equipment, rigs and drilling crews have helped offset low prices but that benefit may be ending.

“The first round of operational improvements and cost reduction in shale is reaching the tail of the curve – they’re seeing smaller and smaller incremental improvements,” said Bob Peterson, a senior partner at Oliver Wyman. “They’re reaching the end of the efficiency improvements. Typically in a downturn, operators and service companies renegotiate contracts, and that wave is over as well.”

Analysts expect U.S. oil companies to trim billions from their annual budgets but most probably won’t say much about their plans until they hold key board meetings in coming months, investment banking firm Jefferies said.

But Jefferies believes U.S. oil producers are going to trim next year’s spending by an average 12 percent, slightly more than the Wall Street consensus of 10 percent. “Management discussions will likely imply significant cuts by suggesting that capex will stay close to internally generated cash flow,” Jefferies said.

In its third-quarter report last week, Houston-based Cabot Oil & Gas said it would cut its spending on drilling next year by 27.6 percent to $615 million, though it anticipates its oil and gas production will grow between 2 percent to 10 percent.

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