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Alexander Pearson

Alexander Pearson

Alexander Pearson is an online financial journalist. He has contributed market analysis, industry news, and educational articles to a variety of sites including ETFDailyNews and…

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What Do Impairment Charges Mean For Energy Stocks?

What Do Impairment Charges Mean For Energy Stocks?

As U.S. earning season gets into full swing this week with energy companies reporting for the fourth quarter of 2015, it seems increasingly likely that we will see another bout of impairment charges from firms in the beleaguered energy sector.

Knowing how to interpret these charges is another matter, and in a market dominated by relentless supply and investor panic, it’s easy to overestimate the impact that the writing off of intangible assets can have on a company’s share price.

Small Cap Producers and Contractors

The value destruction among smaller companies with lower cash reserves has been astonishing. Last Wednesday the NYSE took to drastic step of de-listing Goodrich Petroleum Corp (NYSE:GDPM) after its shares fell to less than 20 cents. Its stock is now trading over the counter. Related: Does Buffett See A Bottom In Oil Prices

Goodrich is just one in a long line of Houston based oil and gas producers to find themselves in rocky waters; Energy XXI Ltd and Halcon Resources Corp are both trading below $1 per share while Swift Energy Co. and Magnum Hunter Resources Corp both filed for Chapter 11 bankruptcy protection at the end of last year.

Offshore driller Atwood Oceanics (NYSE:ATW) is another Houston-based company facing difficulties. The offshore contractor has taken the unusual step of forewarning investors that its Q4 revenues will show a year-on-year decline of around 12 percent, and it may take a $50-$70 million impairment on its Falcon rigs as the expiration of its contract draws near.

Nevertheless, Atwood can still be expected to beat analyst estimates, with earnings of $70-$78 million representing nearly a 70 percent improvement on the same quarter of 2014. Despite the incredibly tough climate, Atwood is one of a number of firms that have proved remarkably robust, with management employing aggressive strategies to slash costs and ensure that operations remain financially feasible.

Yet while firms may post earnings that beat estimates, the underlying problem of a surfeit of rigs and a dearth of demand remains.

The Large Cap Producers

Things are less rosy still in the shale business. With intraday crude oil prices falling below $30 several times last week, then finishing decisively lower at the close of trading on Friday, many shale projects are simply not economically viable.

Even the larger producers are suffering. Chesapeake Energy (NYSE:CHK), the U.S.’s second largest producer, already wrote off goodwill in the third quarter with a $5.4 billion impairment charge, bringing its total impairments year-to-date to a staggering $15.4 billion. Related: Oman Offers to Slash Oil Production If OPEC Follows Suit

Nevertheless, energy producers have so far demonstrated a surprising amount of resilience, and Chesapeake not only continues to pump oil and gas, but grew production by as much as 3 percent in the third quarter.

Accompanying this stream of write-offs, Chesapeake Energy’s stock price has fallen hard, down 81 percent over the course of 2015, and 19 percent already in January. But while the stock has continued to make new lows, weighed down by sector concerns and the price of oil, it is not since March of 2015 that Chesapeake has exhibited any significant negative alpha against benchmarks such as USO, OIL, and DBO.

The Catch-22 of Increased Production

This resilience, however, brings with it problems of its own, potentially reinforcing a catch-22 situation for producers; increased production aims to boost revenues for the like of Atwood or Chesapeake, but at the same time it boosts supply in a market saturated with sellers.

The OPEC members face a similar scenario. Their strategy through 2015 has been to flood the market with cheap oil, neutering any support in the market in an attempt to relegate U.S. shale supplies. This kind of price war hurts both sides, and Saudi Arabia now has an unwholesome $98 billion budget deficit to contend with.

Will low prices cause OPEC to balk and cut production in 2016? Iranian suppliers are now widely expected to return to international markets in the coming months, further increasing the pressure on oil prices. Related: Iran’s Eagerness To Export Sees Oil Tanking Again

Conclusion

In this context of rising supply, plummeting crude prices and sequential impairments for U.S. producers, is there any value left in energy stocks for investors? Would only the foolhardy contemplate purchasing Atwood or Chesapeake at this juncture?

There can be little doubt that earnings season will bring with it a slew of bad news for investors holding energy stocks, and that there is little hope in sight while ever the current climate prevails.

The impairments, of which much is being made of by the financial media, should be less of a concern. Impairments often have little or no discernible impact on stock prices. They are non-cash events, and do not directly impact on a company’s financial position, causing no material change in a firm’s cash flow, leverage, or earnings.

In other words, impairments from Atwood or Chesapeake are not going to bring any new information that the market hasn’t already priced in. If these stocks over-react to the downside during earnings season, exhibiting positive beta over a benchmark energy index such as DBE or USO, then speculators with a strong appetite for risk may even consider them as a short term value play.

By Alexander Pearson for Oilprice.com

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