The headlines in and of themselves are alarming — Exxon Mobil Corporation (NYSE:XOM) is being investigated by New York State’s Attorney General Eric Schneiderman, who has concerns about the company’s accounting statements. It’s how far too many deceptive-accounting scandals began to unravel.
Current and would-be owners of XOM stock don’t have nearly as much to worry about in this particular instance, however. For better or worse, in the oil business much of the balance sheet is as much of an opinion as it is fact, and as long as Exxon Mobil can reasonably justify its opinion, the probe isn’t going to get very far.
Exxon Mobil Under the Microscope
Of particular interest to New York Attorney General Schneiderman is XOM’s valuation of its reserves.
For oil drillers and explorers, reserves represent a known oil or natural gas asset that could be feasibly tapped into to produce crude or gas. Since it’s an asset — purchased with cash or another asset — it must be accounted for on a balance sheet. The value of that reserve, however, would theoretically rise and fall with the rise and fall in the value of crude oil’s market price, or the market price of natural gas.
To that end (as much as one can determine the value of a reserve anyway), Schneiderman wants to know why Exxon Mobil hasn’t taken a write-down on the value of reserves, even though the price of crude is still less than half of its peak price seen in 2014, and peers like BP plc (ADR) (NYSE:BP) and Chevron Corporation (NYSE:CVX) have. Indeed, XOM hasn’t booked an impairment charge or asset write-down in over a decade.
There’s a perfectly good explanation, according to the company. That is, Exxon Mobil has historically been conservative in its valuation of its reserves, so it can be similarly conservative with devaluing them.
The arbitrary nature of reserve accounting is difficult to digest. Most other industries are more cut-and-dry in terms of fiscal data, making oil an uncomfortable outlier to those — like attorney generals and the SEC — who oversee such matters. But, it’s nothing new. And, there’s a reason such investigations of oil companies are ever made, and there’s a reason most of those investigations never get far.
That reason? Arbitrary valuations are a two-way street. An investigator is no better equipped to determine the book value of an asset than the asset’s owner is, and that investigator is even worse equipped to prove it to a judge, jury or regulator.
As The Accounting Onion’s chief blogger Tom Selling explained it, “This is an extremely subjective area. Everyone will have a different pattern of writedowns depending on how old their fields are and how much they cost to develop.”
Attorney Robert McTamaney, who’s with law firm Carter, Ledyard & Milburn, commented “From glancing at it, I think Exxon has substantial arguments that their accounting is correct.”
In fact, given that once the value of a reserve is written down it can be raised again, one could argue that a write-down followed by a rebound in the price of oil and natural gas would still paint a misleading picture of the value of an oil company’s reserves. Further obfuscating is the reality that even if reserves are overvalued, much of an oil company’s equipment is apt to be undervalued on the books … particularly if it has been owned for a while and completely depreciated.
McTamaney and other accounting experts further conclude that the matter is so clouded, it’s likely not worth pursuing.
That doesn’t necessarily make rivals like BP or Chevron wrong for taking impairment charges on the heels of falling oil prices. It simply points to the relatively meaningless nature of reserve values for most of the energy sector’s companies.
Bottom Line for XOM Stock
Will Eric Schneiderman find something wrong? Probably. Will it matter? Probably not.
The crux of Schneiderman’s argument is that Exxon Mobil ultimately misled owners of XOM stock because its balance sheet made the organization look healthier than it really is. It’s difficult to accept, however, that anyone — even the newest and greenest of investors — truly believes an oil company can reasonably surmise what oil prices are going to look like in the near or distant future. Ergo, there’s no reasonable way of knowing exactly how those companies should value their reserves.
It has always been a best guess, and it has always been an acceptable reality. It has also rarely mattered to investors, who are far more interested in the income statement.
In other words, this looks more like political grandstanding than a genuine investor-protection effort. It’s also a bit of a non-starter.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
