Oil and gas prices have been hammered over the past year. That's leading to not only weaker oil and gas cash flow for companies like BreitBurn Energy Partners (NASDAQ:BBEP), but it's also causing the asset values of oil and gas properties to fall. Because of this simple fact of G.A.A.P. accounting, investors shouldn't be surprised if the company announces that it is writing down the value of some of its assets when it reports results on May 5. Here's why a writedown might happen and how it could impact the company in going forward.
Investors have been warned
BreitBurn actually warned investors in its most recent annual report that a write down could be on the way. In the risk factors section of that report it highlighted this risk by saying, "Future oil and natural gas price declines may result in a writedown of our asset carrying values." The company then laid out why as it wrote:
Accounting rules require us to write down, as a non-cash charge to earnings, the carrying value of our oil and natural gas properties in the event we have impairments. We are required to perform impairment tests on our assets periodically and whenever events or changes in circumstances warrant a review of our assets. To the extent such tests indicate a reduction of the estimated useful life or estimated future cash flows of our assets, the carrying value may not be recoverable and therefore requires a writedown.
Obviously, a 50% drop in oil prices is a circumstance that warrants a review of its assets. It's also very possible that during this review the company will find that some of its assets won't deliver as previously expected and therefore it will writedown the value of these assets.
This wouldn't be the first time the company has written down assets as last year it recorded noncash impairment charges of about $149 million. The bulk of that charge, or $124.8 million, was related to its assets in Florida due to reserve adjustments and lower oil prices. However, the company also wrote down the value of other assets around the country. Like Florida, most of these adjustments were either due to reserve adjustments or lower crude prices, however some of these write downs were due to weaker well performance and others were due to expiring leases it chose not to renew.
Because so many issues can lead to a writedown BreitBurn warned:
We also may incur impairment charges in the future, which could have a material adverse effect on our results of operations in the period incurred and on our ability to borrow funds under our credit facility, which in turn may adversely affect our ability to make cash distributions to our unitholders.
At the moment that credit facility is safe as BreitBurn has locked in its liquidity through next April as part of its recent capital raise. That said, big writedowns in 2015 could be what leads to its borrowing base being reduced in 2016. That's why investors should at least keep an eye on any big write down it has in this, or subsequent quarters.
Following the leader?
One reason why it's not beyond the realm of possibilities that a big writedown could occur in the first-quarter is because we've already seen a number of these taken by others in the industry, including upstream MLP leader LINN Energy (NASDAQ:LINE). In LINN's first quarter report it took a $533 million, or $1.61 per unit noncash impairment charge. Most of the impairment was split between its assets in Texas and those in California, which just happen to be two areas where BreitBurn also operates. As a result of this writedown, as well as other factors, LINN Energy's borrowing base is expected to be cut this spring from $5.9 billion to around $5.2 billion and the company expects another $300 million cut to its borrowing base during the fall redetermination, unless commodity prices substantially improve.
BreitBurn investors can almost certainly expect that the company will report an asset writedown when it reports results this week. However, in the near-term the writedown won't matter much as it has already locked in its bank borrowing base through next April. The real issue is that future writedowns could lead to a credit crunch further down the road as the assets being written down are part of what factors into its overall borrowing base.
Matt DiLallo owns shares of Linn Energy, LLC. The Motley Fool recommends BreitBurn Energy Partners. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.