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Stock Strategist Industry Reports

A Tough Start for Oil and Gas in 2009

Weak year-end prices and high costs suggest poor reserve growth and write-offs.

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This past Friday,  ConocoPhillips (COP) kicked off what will likely be a spell of large write-offs and weak proved reserve growth for oil and gas producers (see our note). When reading and interpreting this wave of negative news flow, we suggest keeping a couple points in mind. Like any balance sheet measure, these reports represent a snapshot of an object in motion. Although the current snapshot is very, very ugly--thus inducing goodwill and property, plant, and equipment (PP&E) write-offs and proved reserves write-downs--it is likely to change as the year progresses.

When computing present value measures (used to weigh against PP&E and goodwill values) companies look at current prices and costs. At year-end 2008, prices were roughly $45 for WTI oil and $5.50 for Henry Hub natural gas, well off their midyear highs and well below the figures for year-end 2007 (which were roughly $90 and $6.50, respectively). Oilfield services and drilling costs had not yet fallen considerably from where they stood at midyear. Given the low oil and gas selling price assumptions and the high cost assumptions used in the year-end snapshot, oil and gas producers' present profitability and economics aren't pretty. In addition to oilfield drilling and services costs, many host governments increased taxes when prices were high (Russia, U.K. North Sea, Alberta, etc.), further reducing the value of these oil and gas assets by adding additional taxes.

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Eric Chenoweth has a position in the following securities mentioned above: CVX, XOM, RRC, RDS.A. Find out about Morningstar’s editorial policies.