The slump in natural gas prices last year hit more than just producers' earnings. Because of how companies are required to record reserves, impairments due to the collapse in natural gas prices caused earnings at the top 50 oil and gas reserve holders to drop by $26.4 billion in 2012. This highlights the importance of looking beyond just the top and bottom lines to get an adequate gauge of a company's performance.
Price movements are completely out of a company's control (unless all were secretly working together, of course), so taking these impairments into consideration is a must. That's why it's important to drill down a little deeper into these charges to see if last year's could be hiding upside if natural gas prices move higher in the future. Let's look at five companies that logged large natural gas impairment charges last year which really clouded overall profitability.
If you didn't look close enough, you might miss the fact that Southwestern Energy's business isn't as bad as the numbers made it look last year. The company wrote down $2.97 billion in proved oil and gas properties due to the low price of natural gas. That caused the company to report losses per share of $14.24. However, when you strip those and other charges out, the company actually produced operating cash flow of $713 million and earnings of $2.15 per share. It goes to show you, when investing in oil and gas companies you need to look past the headline numbers before passing judgment on a company because these reserves could be added back on the books if gas prices spike.
The past few years haven't been kind to the nation's No. 2 natural gas producer. The low natural gas prices last year were especially tough as it forced the company to book a $2.022 billion impairment charge on several of its natural gas and oil properties. When you look at the company's headline financial number you'll see that it reported a loss of $940 million, however, when you back out items like these impairment charges the company actually produced operating cash flow of $1.146 billion last year. This is just one of the many cases where natural gas impairment charges made the bottom line of a producer appear to be much worse that it was in reality.
Source: Chesapeake Energy
Last year natural gas wasn't kind to EOG - the company recorded a $849.4 million impairment charge in the fourth quarter on certain of its Canadian natural gas assets. On top of that, according to the company, "total company net proved undeveloped reserves decreased 15% year-over-year due to low natural gas prices in 2012 that caused essentially all of the previously booked proved undeveloped reserves in EOG's North American dry gas properties to be written off." While this cost the company $1.27 billion in impairment charges, as these are non-cash charges it didn't affect the company's cash flow. Further, if drilling for gas at these properties proves profitable in the future, the reserves can be added back.
Pioneer Natural Resources
Earnings at Pioneer were weighed down in the fourth quarter of last year by a $101 million non-cash impairment charge relating to its natural gas assets in the Barnett Shale. Earnings for that quarter were just $29 million; however, when you strip out that impairment charge as well as other one-time items in the quarter, earnings were $107 million. As you can see, these asset impairment charges can significantly distort earnings which is why you need to look at the complete picture. Overall, the effect of impairment for the year totaled $532.6 million at Pioneer thanks to several write-downs of its Barnett dry-gas properties in Texas.
Last year LINN was able to boost its oil and gas reserves by 42% from 3.4 Tcfe to 4.8 Tcfe through a combination of savvy deals and its drilling program. Reserves, however, could have grown even more if it weren't for the 803 Bfce of proved reserves that came off the books last year. This cost the company $422 million in impairment charges and caused LINN to report a net operating loss. Only 340 Bfce of those reserves were cut from the books due to poor asset performance and are likely lost forever. The rest of the reserves were either impaired due to the SEC's five-year-development limitation on proved undeveloped reserves or came off the books due to low natural gas prices. If natural gas prices move higher these reserves could become economically viable and turn once again into assets for the company.
Final Foolish thoughts
Last year was a rough one for commodity producers as natural gas companies joined mining companies with large write-downs. What this does is highlight the fact that it's more important to watch a company's cash flow statement, which places these non-cash charges back into operating cash flow, than looking at headline losses. Sometimes you can find companies with solid operations that are hit by the headlines which can make for a great buying opportunity.
One stock that fits that description well is Chesapeake Energy. In fact, energy investors would be hard-pressed to find another company trading at a deeper discount than Chesapeake Energy. Its share price has plunged thanks to all the negative news surrounding the company's management. To learn more about Chesapeake and its enormous potential, you're invited to check out The Motley Fool's brand-new premium report on the company. Simply click here now to access your copy.
The article 1 Factor That Crushed Natural Gas Stocks in 2012 originally appeared on Fool.com.
Fool contributor Matt DiLallo owns shares of LINN Energy, LLC. The Motley Fool has the following options: Long Jan 2014 $20 Calls on Chesapeake Energy, Long Jan 2014 $30 Calls on Chesapeake Energy, and Short Jan 2014 $15 Puts on Chesapeake Energy. 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.
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