Why Oil and Gas Companies Should Pay Attention to CECL

FASB’s new Current Expected Credit Loss standard (Topic 326), more widely known as CECL, makes sweeping changes in accounting for credit losses of financial assets. It moves away from the traditional model of “incurred losses” and toward an “expected credit loss” model, which requires a periodic evaluation of forecasted impacts.

The new standard applies not just to businesses that provide financing or invest in debt securities, but to all industries with financial assets, including oil and gas companies. With oil demand dropping significantly from the coronavirus pandemic coupled with excess market supply from Russian and Saudi Arabia, oil producers are facing significant pressure. A number of producers have filed for bankruptcy protection and more bankruptcies are likely in the future. These market conditions have made it more important than ever for companies to evaluate the impact on expected credit losses. 

Determining the impact of CECL is subjective and requires a great deal of judgment, as assumptions and other considerations can be complex and difficult to quantify. Furthermore, while the standard specifies that loss recognition at some level will be more likely than under the incurred loss method, the factors used in determining expected losses will ultimately depend on the organization’s documented rationale.

Even though implementation for most calendar year public registrants was required beginning January 1, 2020, some companies are just beginning to evaluate CECL’s impact.

Since oil and gas companies do not typically have long-term receivables with complex financing arrangements and large credit exposure subject to long-term fluctuations in the market (e.g. reinsurance receivables or security lending agreements) the implementation of the standard will most likely not require complex financial models to estimate the expected losses. Prospective assessments for producers will likely be based on a few key variables such as commodity price. While this may be simpler, it will require additional context to communicate the organization’s position on why the selected variable is the most relevant for forecasting expected credit losses.

Companies that do not thoroughly analyze their financial asset categories could miss key considerations in adopting and evaluating the impact of the new standard. In doing so, they should either ensure that the assets are out of scope of the standard or prove that each asset has a minimal risk of loss.

For most independent oil and gas companies, the financial instruments that would be subject to the standard would be various trade receivables, producer/pipeline imbalances and revenue generating leases. 

For detailed information about considerations in preparing for the first financial reporting period under the new standard, click here for the full insights.

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