Trouble in the pipeline for oil companies

Oil companies cashing in on soaring oil prices and strong demand from
emerging markets could face an unexpected brake on profits because of a new
accounting standard for oil exploration.

It is expected that by next year IFRS will require companies to expense
failed prospecting attempts immediately in the P&L, known as successful
efforts accounting, instead of amortising dry fields that have always been
capitalised. The change will hurt any company that drills for oil
unsuccessfully, and lead to sizable reductions in reported profits.

The potential impact of the new accounting standard emerged last week when
FTSE250 company Premier Oil voluntarily restated its 2004 accounts under IFRS
and downgraded post-tax profits from $43.8m (£24.3m) to $22.1m.

‘The new accounting provides more transparency for oil exploration as the
performance of assets is reported directly in profit and loss,’ said Tony
Durrant, FD of Premier Oil. ‘Premier has taken a proactive decision in
anticipation of likely future changes in accounting standards for our industry.’

Other mid-cap oil and gas businesses, those likely to be most affected, have
yet to adopt the pending standard and analysts predict further profit reductions
when they do.

‘The move from full cost accounting to successful efforts is the steer we
have been given and there is going to be an impact on income statements and
write-downs,’ said Al Stanton, oil analyst at Bridgewell Securities.

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Fiona Westwood of Smith and Williamson.