Yesterday, I blasted Devon Energy (NYSE: DVN) for its huge $7.1 billion impairment charge, taken as a result of lower year-end oil and gas prices. I also mentioned that EOG Resources (NYSE: EOG) had reported no meaningful writedowns. This may have been an unfair comparison, but I still favor the latter firm by a mile.
Whether an E&P is forced to dramatically write down reserves today hinges on the accounting method employed. One well-informed commenter has pointed out that full cost (FC) accounting -- employed by Devon and Chesapeake Energy (NYSE: CHK), requires flat forward projections based on year-end commodity prices. Successful efforts (SE) accounting, the method favored by EOG and Anadarko (NYSE: APC), does not. This would imply that FC is more conservative.
When it comes to booking reserves, however, SE is by far the more conservative practice. As the name implies, successful efforts allows one to capitalize onl ythe costs of successful wells. Full cost allows capitalization of the dry holes as well as the gushers. That's why price-based ceiling tests are tougher on FC firms -- assets would more likely be overstated otherwise.
EOG chief Mark Papa, as a successful efforts proponent, echoed my concerns with these giant writedowns: "Asset impairments are often dismissed as noncash or nonrecurring. But these impairments do reflect cash that indeed was spent and now has to be written down because the investment value has dropped." But to be fair, Devon made some important counterpoints that I overlooked yesterday.
New SEC rules allowing average pricing rather than a single point in time for FC will help firms do a better job of approximating economic reality. Devon says it would have suffered no hit to its balance sheet with those new rules. Further, the ceiling test writedown didn't lower the firm's estimate of reserves -- just their carrying value on the balance sheet.
I hope I haven't bored you to tears. This is important stuff!
At the end of the day, the E&P business -- and any business, really -- is about generating satisfactory returns on capital employed. In this regard, EOG continues to smoke its peer group, which also includes folks like XTO Energy (NYSE: XTO) and Southwestern Energy (NYSE: SWN). With 20% average returns over the past decade, the accounting quibbles melt away, and what you're left with is one exceptional explorer.
EOG Resources is rated a formidable four stars by the Motley Fool CAPS community. Weigh in with your own thoughts on the firm's likely performance in 2009 right here.
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