The New World Champion!
I have to say there’s been a general trend in terms of the deterioration in the integrity of this companies reports. In the fourth quarter of 2016 they reported profits by booking negative depletion. Not that that’s wrong but why would you do that if you were following appropriate oil and gas capitalization policies as we spelled out last Thursday. In the first and second quarter of 2017 they’ve boosted their working capital by as much as $3.3 billion by listing their unsold properties for sale as current assets. That is certainly much better than showing a working capital deficiency of $1.3 billion isn’t it. I think we’re seeing the beginnings of a boldness and creativity that has not otherwise been shown in an industry that is all about bloating the balance sheet beyond recognition. Cenovus feel quite confident that these types of transactions are acceptable and the ability to boost earnings, as in 2016, or working capital in early 2017 shows they fear no one. As they state in their financial statements they are in compliance with all the regulations, but when did reasonableness become unreasonable?
It was in the first half of 2017 that Cenovus purchased the other 50% working interest in the FCCL Partnership from Conoco. It would appear that in that transaction Cenovus paid Conoco a market price of approximately $5 billion more than what the actual partnership had incurred in building the facility. Cenovus owning the other 50% of the partnership therefore realized a market gain of about $2.5 billion as a result of their purchase of the Conoco assets, assuming they could find another willing buyer to purchase their assets at the price they paid Conoco. If Cenovus we’re to sell their original 50% interest in the FCCL Partnership they would realize the $2.5 billion gain on the disposition. Therefore in order to realize that gain in the second quarter of 2017 they would have to, for accounting purposes, “deem” that property to be disposed. Which is what they did on the financial statements. This enabled them to increase goodwill by $1.8 billion and recognize a gain on the income of statement of $2.524 billion. Enabling Cenovus to report $2.851 in after tax profits.
Now the industry knows how to turn around this downturn! Cenovus have applied IFRS 3 to a “Joint Venture” which IFRS 3 specifically precludes Joint Ventures from this accounting treatment. Therefore I would not have done this. It also shows the world that you're willing to pay a lot for otherwise unprofitable assets. When your real working capital, adjusted for the property, plant and equipment that isn’t selling, is $5 billion less than what it was three months ago, and your debt is twice the size, the only friend you have is the Canadian government who appreciate the $700 million in taxes that were sent as a result of this transaction. I fail to understand how this accounting treatment didn’t catch on fifty years ago. This type of transaction has been conducted 50 million times in the history of oil and gas and at no time am I aware of the reclassification of assets and profit in this manner.
The rest of the industry is probably sighing with relief over these Cenovus financials. Who will the SEC set their sites on now is pretty obvious. In my opinion. There is however another definite trend occurring in 2017. The American companies are beginning to clear out their bloated balance sheets of property, plant and equipment. Of the producers that have reported in our sample of 22 companies the amount of depletion per barrel for American producers is already averaging $38.93 per boe which is materially higher than what the Canadian producers are reporting at $18.81 per boe. Maybe we’re getting through to some people.
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