The Casper Star Tribune recently published a story on the significant impairments reported in 2015. In fact, impairments have been a major topic of discussion since commodity prices began falling.
What is impairment? My grandpa would say it is a fancy word for what could happen when you count your chickens before they hatch.
Impairment is defined by the Nasdaq Glossary as follows: "Reduction in the value of an asset because the asset no longer generates the benefits expected earlier as determined by the company through periodic assessments. This could happen because of changes in market value of the asset, business environment, government regulations, etc."
"Impairment expenses occur in the oil and gas industry when the current carrying value of a company's oil and gas properties, for any given technical or economic reason, can no longer be recovered under present conditions." Forbes recently reported that an impairment is charged against net income and is not an 'accounting trick' for oil and gas companies, but may explain how a large loss is reported with a positive free cash flow.
The Casper Star Tribune explained that impairments "represent a recognition that many wells will have shorter productive lives than initially anticipated" and that it also reflects an acknowledgement that companies may have to pay for the cost of plugging and abandoning wells sooner than expected. The article further explains that "[o]il companies essentially estimate the value of a well by multiplying known reserves by the price of oil and then subtracting the pumping cost. When prices drop to a point where it is no longer economic to pump, companies declare the well and impairment, or a loss."
The Casper Star Tribune reports that for some oil and gas companies, impairments do not necessarily reflect the health of a company or indicate that a company is not well-positioned to ride out the downturn in commodity prices; but, for other companies, it may signal growing financial stress. Thus, it remains to be seen whether impairments are an 'indicator' or provide any real insight into the health of the industry.
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