Impairment of oil and gas assets

What triggers an oil and gas impairment test?

IAS 36 requires a test when there is an indication of impairment at the reporting date. In oil and gas, common indicators are a fall in long-term price assumptions, a downward revision of reserves, significant increases in development or operating costs, delays, changes to fiscal terms or licences, and policies that may reduce future demand or raise the cost of carbon. A market capitalisation below net assets is also an indicator. Exploration and evaluation assets have their own triggers under IFRS 6; see IFRS 6 exploration and evaluation.

What is the cash-generating unit?

The smallest group of assets that generates largely independent cash inflows. That is usually a single field, or several fields that share a platform, pipeline or processing plant and cannot produce independently. Infrastructure that serves several fields, and whose output is not sold separately, belongs to the group of fields it serves. See cash-generating units.

Value in use or fair value less costs of disposal?

Value in use uses the company's own cash flow forecasts, excludes future spending that would enhance the asset, and is discounted at a pre-tax rate. Fair value less costs of disposal takes a market participant's view: it can include developing undeveloped reserves and other spending a buyer would undertake, and is usually measured with a post-tax discounted cash flow model, a Level 3 measurement. Because fields are long-lived and still being developed, many oil and gas companies use fair value less costs of disposal. Either way, the recoverable amount is the higher of the two. See value in use.

Oil and gas impairment: a field tested at three prices

A field is carried at CU 500 million. Its fair value less costs of disposal, from a discounted cash flow model of its remaining reserves, depends on the long-term oil price assumed.

At $70 the headroom is only 20 million, so a reasonably possible fall in the price assumption would cause an impairment. The company should disclose that sensitivity as a major source of estimation uncertainty under IAS 1, and where goodwill is allocated to the unit, IAS 36 also requires the headroom and the price at which it would be eliminated. At $60, the field is written down by 70 million, charged to profit or loss, and depleted from its new carrying amount of 430 million.

Which price assumptions are used?

Most companies use forward market prices for the first few years, where the market is liquid, and a long-term real price thereafter, drawn from their own planning assumptions and checked against external forecasts. Value in use must reflect reasonable and supportable assumptions; fair value must reflect what market participants would assume. Companies increasingly explain how their assumptions compare with scenarios consistent with international climate goals, and how carbon costs are included, as regulators and investors ask whether long-lived assets will be recovered.

How is the decommissioning provision treated in the test?

A buyer of a field would take on its decommissioning obligation, so fair value less costs of disposal is measured net of those costs. To compare like with like, IAS 36 lets the company deduct the recognised decommissioning provision from the carrying amount of the cash-generating unit, so both sides of the test exclude it, or both include it. Getting this wrong double counts the obligation. See decommissioning provisions.

Can impairments be reversed?

Yes. If the indicators reverse, for example because long-term price assumptions rise, the company retests and reverses the impairment, but only up to the carrying amount the field would have had, after depletion, had no impairment been recognised. Goodwill impairments are never reversed. See impairment reversals.

How does US GAAP differ?

Successful efforts companies apply ASC 360: a recoverability test using undiscounted cash flows, then a write-down to fair value if the test fails, with no reversal. Full cost companies apply the quarterly ceiling test instead. Because the undiscounted test is easier to pass, US GAAP impairments tend to come later and, once made, stay. See successful efforts vs full cost, IAS 36 vs US GAAP and oil and gas accounting. For mines, see mining impairment.

This guide is general information. It is not tax or legal advice for your situation.