ACCT101-FA Project Case 2 1

Billions of barrels of oil vanish in a puff of

accounting smoke
THU, DEC 10, 2015 - 5:26 PM

[NEW YORK] In an instant, Chesapeake Energy Corp will erase the equivalent of 1.1
billion barrels of oil from its books.  Across the American shale patch, companies are
being forced to square their reported oil reserves with hard economic reality.

After lobbying for rules that let them claim their vast underground potential at the start
of the boom, they must now acknowledge what their investors already know: many
prospective wells would lose money with oil hovering below US$40 a barrel.

Companies such as Chesapeake, founded by fracking pioneer Aubrey McClendon,

pushed the Securities and Exchange Commission for an accounting change in 2009 that
made it easier to claim oil (goods) reserves from wells that wouldn't be drilled for years.
Inventories almost doubled and investors poured money into the shale boom, enticed
by near-bottomless prospects. (2009: undrilled oil will be counted in inventories too)

But the rule has a catch. It requires that the undrilled wells be profitable at a price
determined by an SEC formula, and they must be drilled within five years.

Time is up, prices are down, and the rule is about to wipe out billions of barrels of shale
drillers' reserves. The reckoning is coming in the next few months, when the companies
report 2015 figures. (5 years up but price is down means not worth it for them to drill)

"There was too much optimism built into their forecasts," said David Hughes, a fellow at
the Post Carbon Institute and formerly a scientist with the Geological Survey of Canada.

"It was a great game while it lasted."

The rule change will cut Chesapeake's inventory by 45 per cent, regulatory filings show.
Chesapeake's additional discoveries and expansions will offset some of its revisions, the
company said in a third-quarter regulatory filing. Gordon Pennoyer, a spokesman for
Oklahoma City-based Chesapeake, declined to comment further. (reserves is inventory;
earn profits from other thing to make up for their losses)

Other examples include Denver-based Bill Barrett Corp, which will lose as much as 40
per cent, and Oasis Petroleum Inc., based in Houston, which will erase 33 per cent,
according to filings. Larry Busnardo, a Bill Barrett spokesman, declined to comment.
Richard Robuck of Oasis didn't respond to questions.
ACCT101-FA Project Case 2 2

The US shale revolution, which brought the country closer to energy self-sufficiency
than at any time since the 1980s, was built on money borrowed against the promises of
future output. (all the undrilled is calculated but all ended up not being used in the
future) New wells that could be drilled when U.S. oil was selling for US$95 a barrel - last
year's price as calculated by the SEC's formula - simply don't pay at today's prices, and
the revolution has stalled.

UNDRILLED PROPERTIES

When fracking advocates lobbied (persuade) the SEC, they argued that hydraulic
fracturing was a new technology that unlocked oil and gas in vast layers of underground
rock, making drilling more predictable that it used to be. (estimated reserves are more
accurate)

Drillers met the rule's profitability provision (present liability) last year due to a quirk in
the SEC's pricing formula. The agency's yardstick is an average of the prices on the first
day of each month during the calendar year. The price came to US$95 a barrel at the
end of 2014, even though oil was trading below US$50 by the time the companies
reported reserves in February and March. The 2015 average, including the Dec 1 price,
comes out to US$51 a barrel.

"They got such a break with the price for last year, but it sure as hell isn't going to
happen this year," said Ed Hirs, a managing director at Houston-based Hillhouse
Resources, an independent energy company.

PROVEN RESERVES

The wells that exist only on paper are particularly vulnerable to revision. And thanks to
the SEC rule change, companies have a lot more undeveloped reserves on their books
than they used to.

Undeveloped reserves of oil and natural gas liquids have more than tripled to 6.1 billion
barrels since 2008, the last year before the rule went into effect, according to data
compiled by Bloomberg on 40 independent US producers. Undrilled wells account for
45 per cent of proven reserves, up from 30 per cent in 2008.

Writedowns, which are reported on a quarterly basis, point to sizable revisions. The 61
companies in the Bloomberg North American Independent Explorers and Producers
index have announced impairments of US$143.8 billion in the past year.

Some of the wells may never be drilled, while others may return to inventories if prices
rise. A company's deletions may be offset by the addition of new prospects, purchased
properties or an increase in the estimated amount of crude each well will produce.
ACCT101-FA Project Case 2 3

"The question is, how are these reserves going to come back?" said Subash Chandra, an
energy analyst with Guggenheim Securities in New York. "Because if you have to spend
within cash flow, those reserves aren't coming back. Not unless we get a spike in prices,
or we return to levered growth."

BLOOMBERG

Suggestions for report (you may add or subtract from the following):

 Brief overview of company.

 Brief overview of central issue and the circumstances that led to it.
 Discuss the impact of the write-down on current and future period financial
statements and financial ratios of the company.
 How will a write-down influence investors’ decision (existing and potential
investors)?
 How might one assess if the company has really “improved” its performance in
the future periods?
ACCT101-FA Project Case 2 4

Group Assignment:
Study and research the issue/s mentioned in the given article. Submit a report on:
 your group’s understanding and discussion of the issue/s;
 relevant accounting standard/s to which the issue/s relate to;
 your group’s conclusion as to whether the entity’s action/s were consistent
with the letter and spirit of the accounting standard.

Issues in the case studies randomly assigned may or may not be covered in
ACCT101. The objective is to:
 raise awareness of wider accounting issues that exist outside the
boundaries of a basic accounting module;
 instil the spirit of curiosity;
 build resourcefulness.

Hence, independent research is valued and will be taken into consideration. As

such, I will not be expecting many (if any) consultations on the projects 😊
otherwise I might be grading myself!!

The report submission should include:

1. A cover page, stating the company name, section and group number, and all
group members’ names.
2. The main report - 8 pages maximum.
3. Appendix: no page limitation. Assignment will be graded based on the main
report and appendix will only serve as a reference.
4. The main report should be typed within normal margins, in Arial font size
12. You may use slightly larger fonts for headings and sub-headings.

In any event, you are advised that the length of the Submission should be dictated
by whether the answer has covered all relevant issues and is well argued and
reasoned rather than whether it meets any page/word limit. Remember that it is
the quality of your answer, rather than its quantity, that is important.
Unnecessarily long submissions containing significant amounts of irrelevant
writing will result in a poorer grade.

The report must be submitted through

ELEARN by 2359hours of 16 November 2019.
Please assign one responsible group member to complete the submission of the
correct version of the report. Multiple submissions will be rejected by the system.

PLEASE NOTE THAT WRITTEN SUBMISSIONS FOUND TO BE AFFECTED BY

PLAGIARISM WILL BE GIVEN A FAIL GRADE AND A ZERO MARK.

The project grading rubric is posted on Elearn for your information. In order to
assess teamwork, you are required to complete a confidential peer evaluation due
on the same date. Failure to do so will result in a 2-point individual penalty.