The unrelenting sell-off in the price of crude oil will have a deep impact on the value of oil assets. One of the deepest impacts will come from the looming flood of asset writedowns that are expected in the industry over the next few months. Bloomberg reported that as much as $1.6 trillion in earnings could be wiped out this year as oil prices continue to weaken.
First cracks begin to emerge
We've already seen asset writedowns impact the offshore drilling sector: Transocean (NYSE:RIG) took a $2.76 billion writedown in the third quarter, with another $100 million writedown expected in the fourth quarter. However, those were related to goodwill charges from previously acquired drilling rigs and the retirement of older drilling rigs. The next wave of industry writedowns is expected to come from oil and gas explorers as reserves are written down to reflect current oil prices.
Analysts anticipate large writedowns from European energy giants, with Royal Dutch Shell (NYSE:RDS-A)(NYSE:RDS-B) and BG Group (NYSE:BG) having large portions of their capital (up to 5% and 8%, respectively, according to Citigroup analysts) tied up in what now appear to be money-losing projects.
Big problems for small shale producers
Analysts are even more concerned with the writedowns at small U.S. shale explorers. Of particular concern are Sanchez Energy (NYSE:SN), Matador Resources (NYSE:MTDR), and Clayton Williams Energy (NYSE:CWEI). These drillers didn't have the financial discipline of their larger peers as smaller drillers outspent cashflow considerably over the past few years, so they could be forced to make larger writedowns.
Matador Resources recently hinted this could be the case when it delayed its analyst day by two weeks at which time it will be prepared to report its fourth-quarter results as well as its update to proved reserves. By hosting its Analyst day after releasing this data it will have more time to go through the numbers with analysts and investors. These numbers will undoubtedly be affected by asset writedowns, as lower oil prices will almost assuredly result in a lower value for the company's oil and gas reserves.
Sanchez Energy's risk lies in its exploration program. The company is exploring the Tuscaloosa Marine shale, which has proven a tough play to crack as it requires very high oil prices for drilling to be profitable. Because of that, some of the value of the company's acreage dedicated to exploring this play could be written down. Clayton Williams, meanwhile, has acreage and reserves in Texas that might need to be written down due to the collapse of oil prices.
Broadly, it's likely that aggressive drilling plans in recent years will now force small and midsize shale drillers to make writedowns due to the current market situation.
Investors need to brace themselves as energy companies of all sizes write down the monetary worth of oil assets that continue to lose value now that petroleum prices have been cut in half. That being said, this doesn't mean these assets have disappeared -- a return to higher oil prices or improved technology could eventually allow these values to be put back on the books.