In June, BP and Royal Dutch Shell announced massive write-downs on their assets – $17.5 billion in the case of BP, and $15-$22 billion for its Anglo-Dutch peer.
The impairments are enormous in size and significant in their implications. Behind the write-downs is a substantially gloomier assumption about the long-term trajectory of the oil market. The two announcements could also be the first of many.
“We basically have a crisis of uncertainty.”
Impairments point to lower prices
In April, when Shell cut its dividend, chief executive Ben van Beurden looked shaken when explaining the decision. “We basically have a crisis of uncertainty. Uncertainty about demand, about prices,” he said. “Maybe even uncertainty about the viability of some of our assets given all of the logistical issues we have.”
That was in April. Two months later, Shell offered an update – one that included the $15 to $22 billion impairment. Previously, Shell assumed Brent would average $60 per barrel each year between 2020 and 2022, and Henry Hub would average $2.75/MMBtu in 2020 and 2021, and $3/MMBtu in 2022. All of those numbers were revised sharply lower. The company also cut its forecasted assumption on refining margins. Taken together, the revisions illustrate how the value of a global network of oil and gas assets can suddenly be worth much less than previously thought.
In the wake of coronavirus pandemic and the ensuing damage to the global economy and oil demand, old assumptions about long-term oil demand were abruptly discarded. In their place, oil market analysts have drawn up a long list of projections that run the gamut. On the optimistic end, oil demand dips temporarily, but resumes its long-term growth trajectory in the next year or two. On the more pessimistic end of the spectrum, demand already peaked and will never return to previous heights.
BP and Shell have both acknowledged that the pandemic has utterly changed everything in the oil market and that there is no going back to “normal.”
The details in Shell’s numbers are revealing. An estimated $8-$9 billion of the write-down was related to the company’s Australian assets, largely concentrated in LNG. That was larger than the $4-$6 billion attributed to its upstream unit. The numbers illustrate how Shell’s very large gamble on the growth of the global natural gas trade (Shell spent over $50 billion on BG Group five years ago to become the largest LNG exporter in the world) may not be the moneymaker the company had hoped it would be. Demand for both oil and gas face an uncertain future.
The industry wrote down a combined $48 billion worth of assets in the first quarter of 2020.
The impairments are not confined to the oil majors. According to an EIA survey of 40 U.S. oil companies, the industry wrote down a combined $48 billion worth of assets in the first quarter of 2020, the largest total in years, exceeding the quarterly totals during the depths of the 2014-2016 downturn. Since the first quarter only captured the early days of the pandemic, it seems reasonable to assume that further write-downs will be forthcoming.
In fact, some of the financial pain predates the pandemic. In December 2019, Chevron announced a $10-$11 billion write down, a clear sign that the industry was facing financial trouble even before the latest downturn.
Earnings reports
On July 24, Equinor was the first of the large integrated oil companies to report second quarter earnings. The company posted a surprise profit in the second quarter, although some of its success can be chalked up to a profitable trading unit. Notably, the Norwegian oil producer did not adjust its long-term oil price assumptions – which include Brent averaging $80 per barrel in 2030 – allowing it to avoid having to report a substantial write-down on its assets. Equinor said that it would announce revisions to its long-term oil price forecast in September.
Additional second quarter earnings reports will be released in the coming days, and they will offer an updated window into the thinking of oil executives. But beyond the most recent quarter, the depressed oil market ensures that even more write-downs could be coming down the pike.
At the same time, governments around the world – especially the European Union – are engaging in green stimulus in the wake of the coronavirus-related economic wreckage. The EU is pouring hundreds of billions of dollars into renewable energy, EVs and associated infrastructure. The UK is targeting 30 million EVs over the next two decades and an electric grid that is carbon negative by 2033. In the U.S., the change of administrations could see the U.S. following suit, with potentially trillions funneled into energy transition.
Some oil majors recognize the shifting landscape. BP and Shell have committed to low-carbon transformations. The plans to transition, along with billions of dollars of write-downs, add up to an acknowledgement that some of their oil and gas assets may wind up left in the ground. ExxonMobil and Chevron, on the other hand, has stubbornly refused to shift course. But the threat of unproduced reserves is the same, even if it takes longer to acknowledge.
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