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Lower Oil Prices Could Blow a $300 Billion Hole in the Balance Sheets of U.S. Oil Companies

By Matthew DiLallo – Jun 27, 2020 at 9:15AM

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Investors can expect a gusher of asset writedowns in the coming quarter due to this year's plunge in crude prices.

Lower oil prices have a significant effect on the financials of oil companies. Not only do weaker prices cut into their cash flows, but they also impact asset values. Because of that, companies need to write down the value of their assets, which puts a lot of stress on their balance sheet.

With crude prices plunging earlier this year, oil companies in the U.S. will likely write down a substantial amount of assets in the coming quarters. According to an estimate by auditor Deloitte, the sector might need to write off as much as $300 billion in assets, with a sizable portion of that likely coming when oil companies report their second-quarter results. Those write-offs could have a significant impact on the sector's access to credit, which might force more drillers to file for bankruptcy. 

Oil pumps with a downward sloping chart in the background.

Image source: Getty Images.

A dour view of the oil market

As a leading auditor, Deloitte has its fingers on the financial pulse of most industries. Unfortunately, it detects an extremely weak one for the U.S. oil patch. In the firm's view, the sector could write down as much as $300 billion of oil and gas assets as a result of this year's market downturn because they're no longer profitable to develop. A large portion of those impairment charges could come during the second quarter.

Because of that, Deloitte foresees a wave of bankruptcies hitting the sector. In its view, 30% of U.S. oil and gas producers are technically insolvent at $35 oil because their assets (once written down to reflect that price point) will be less than their liabilities. Meanwhile, another 20% have "stressed financials," meaning that they're on the road to insolvency if prices take another dive. Though on a positive note, crude prices have recently bounced above $40, which does ease those concerns somewhat.

Once this industry wash-out occurs, Deloitte expects a mass consolidation wave. The sector will likely see financially stronger players scoop up assets on the cheap while weaker producers will combine in deals designed to increase scale and reduce costs.

Starting to unleash the gusher

Oil companies have already begun writing down asset values. ExxonMobil (XOM -0.20%) recorded a sizable $2.9 billion impairment charge during the first quarter. As a result, it reported a $610 million loss during that period, its first one in 32 years. Meanwhile, Occidental Petroleum (OXY 1.14%) booked roughly $2 billion of impairment charges during the first quarter, causing it to report a large loss. These included a $1.4 billion impairment of its stake in Western Midstream Partners' (WES -1.30%) pipeline assets and $580 million of oil and gas property writedowns. 

Those were just the tip of the iceberg as oil companies have already started warning investors that they should brace themselves for massive writedowns in the coming quarter. Oil giant BP (BP 0.67%) got the ball rolling in mid-June. It provided investors with an estimate of its upcoming asset impairment charges after it revisited its long-term oil price assumption. BP will likely take between $13 billion and $17.5 billion of impairment charges during the second quarter. While the company didn't specify the regions these writedowns will come from, it undoubtedly will have some in the U.S., especially after making a huge $10.5 billion bet on U.S. shale in 2018 when it bought BHP Group's (BHP 0.58%) assets in the region. Those assets aren't as valuable as they were when BP made the deal, which it based on oil averaging $55 a barrel. 

Several other producers will likely record sizable impairment charges during the second quarter, including many that already started taking them during the first quarter. One name to watch is Occidental Petroleum. The company paid a stunning $55 billion to buy Anadarko Petroleum last year, outbidding a rival offer from Chevron (CVX -0.69%) by $5 billion. It could end up writing down a significant portion of those assets this year, given the collapse of oil prices and the value of the acquired assets.

Expect a sea of red in the second quarter

Oil producers will undoubtedly record substantial impairment charges during the second quarter as they revalue their assets in light of sinking crude prices. Some of the biggest ones will likely come from producers that paid big bucks to buy oil assets over the last couple of years, since they're no longer worth their original purchase price.

This value wipeout could cause a cascading effect by forcing more producers to restructure in bankruptcy, while others might turn to mergers and acquisitions to avoid that fate or go dumpster diving. The result could be a dramatic reshaping of the oil industry's makeup in the coming years.

Matthew DiLallo owns shares of BHP Group Ltd. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Exxon Mobil Corporation Stock Quote
Exxon Mobil Corporation
$88.68 (-0.20%) $0.18
BP p.l.c. Stock Quote
BP p.l.c.
$28.75 (0.67%) $0.19
Occidental Petroleum Corporation Stock Quote
Occidental Petroleum Corporation
$62.11 (1.14%) $0.70
Chevron Corporation Stock Quote
Chevron Corporation
$144.77 (-0.69%) $-1.01
BHP Group Stock Quote
BHP Group
$50.42 (0.58%) $0.29
Western Midstream Partners, LP Stock Quote
Western Midstream Partners, LP
$25.02 (-1.30%) $0.33

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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