Moody’s Ponders Credit Downgrades for 120 Energy Companies
Despite the nascent oil price rally that started to take hold at the end of last week, there is a broad swathe of financial distress that continues to engulf more players in the energy sector.
The descent of oil prices down below $30 per barrel was once unthinkable. Price forecasters have had to continuously revise their projections for 2016, with investment banks and energy agencies steadily publishing lower and lower predictions for where they think oil prices will bottom out.
Oil prices received a jolt on January 21 and 22, as a cavalcade of bullish news conspired to push oil prices back into the $30s per barrel. The markets got excited at the possibility of more aggressive action from the European Central Bank on Thursday after comments from Mario Draghi, the bank’s president.
Also, several voices weighed on oil prices, raising the questions about the unreasonable decline below $30 per barrel. The head of state-owned Saudi Aramco said that oil prices below $30 per barrel was “irrational,” and that he expected prices to rebound this year. Separately, Citigroup said that oil could be “the trade of the year,” because a price increase is nearly assured. After all, prices cannot go much lower, can they?
Meanwhile, even if prices rebound, the financial damage of $30 oil continues to impact energy companies around the world. Moody’s Investors Service, in several separate moves, put 175 oil, gas, and mining companies up for review for possible credit downgrades. 120 of them are in energy and 55 are mining companies.
On January 21, Moody’s issued notices on 69 E&P companies. Included in the long list of companies were important names like Transocean, Schlumberger and Chesapeake Energy. “Even under a scenario with a modest recovery from current prices, producing companies and the drillers and service companies that support them will experience rising financial stress with much lower cash flows,” Moody’s wrote in a press release.
Some companies are a lot worse off than others. In fact, Moody’s said that it will be looking at “multi-notch” downgrades in some credit ratings. “Multi-notch downgrades are particularly likely among issuers whose activities are centered in North America, where natural gas prices have declined dramatically along with oil prices,” Moody’s wrote.
That is a pretty dire warning for shale companies in Texas, North Dakota, and the Marcellus Shale. In fact, the day after Moody’s issued the press release, Chesapeake Energy, the nation’s second largest natural gas producer, suspended its dividend to its preferred shares. The move will save $170 million, which Chesapeake will use to pay down debt. The company’s stock price is down more than 80 percent over the past year.
On January 22, Moody’s put four additional companies up for review for a downgrade, three of which are much more notable: Royal Dutch Shell, Total, and Statoil, plus all of their subsidiaries.
Behind the credit reviews is a rather dim view of the state of oversupply. Moody’s wrote that “production now exceeds demand by about 2 million barrels per day,” which led the ratings agency to conclude that there is a “substantial risk that prices may recover much more slowly over the medium term than many companies expect, as well as a risk that prices might fall further.” And of course, if prices are lower for longer, it will “cause further deterioration in financial ratios, including deeper negative free cash flow.”
But, of course, prices around $30 are wholly unsustainable. A comment in the Moody’s press release highlights this fact. Moody’s wrote that “most companies are unable to internally fund sustaining levels of capital spending at current market prices.” The only way to fund operations is through more debt or asset sales. But debt markets have largely closed to drillers, and asset sales are probably not an answer either because valuations have declined by so much. It’s rather difficult to sell assets into a depressed market, at least at prices that one might want. In any event, companies are not going to sell their way to growth.
In short, that means that production has to fall and prices will go back up. That has been the script that everyone has expected, but the adjustment period has simply taken a lot longer than anticipated. But the financial distress washing over the industry could hasten the rebalancing.
By Nick Cunningham of Oilprice.com
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