The Tables Have Turned on Big Energy PlayersRobert Mcnatt
Less than a year ago, the price of oil was close to $150 per barrel and many oil and natural gas producers were riding high with strong ratings and record profits. At the same time, nations whose economies were tightly tied to energy prices saw increasingly favorable trade balances. Those inflows also fueled the growth of powerful sovereign wealth funds that became major global investors. The oilfield services companies also profited from the boom, as demand for rigs and drilling services stayed strong.
But by mid-March of 2009, oil had been knocked down to roughly one-third its 2008 peak price, with similar steep declines for natural gas. Making matters worse for oil and gas producers, the world has also now settled in for what looks to be a wide, unexpectedly deep, and possible lengthy recession.
For energy producers, the tables have clearly turned. Oil-importing nations, some energy-intensive industries, and individual consumers can expect relief while oil prices remain low, but Standard & Poor's Ratings Services believes this global economic slump will be a time of stress for oil and gas producers—especially speculative-grade exploration and production companies—and to some degree, for sovereign wealth funds. Many speculative-grade U.S. oilfield services and drilling companies are facing a severe downturn in earnings and cash flow, and in February we revised the outlook on 11 of these companies to negative and lowered the ratings on three. Moreover, we believe this downturn may cause us to revise ratings on some sovereigns themselves—although even for countries that depend most on oil, energy prices are just one factor that influences sovereign ratings.
The long-term outlook for energy is undeniably strong. The mega-economies of India and China will again start pushing forward and driving up demand. The industrialized nations will once more begin to grow, and the global economy will eventually rebound. But until that day arrives, many oil producers can expect they won't be calling the shots the way they did a year ago, as they seek to maintain liquidity and financial flexibility in an era of low prices and less certain access to credit. In our opinion, that will make 2009 a crucial year for them.
Europe May Fare Worse Than the U.S.
This year and 2010 will be difficult for major producers. We believe the ratings of the big, integrated, Western European producers—BP (BP), Royal Dutch Shell (RDSA), Total SA (TOT), and Eni SpA (ENI)—could come under pressure as a result of continuing large dividend payouts and high levels of capital expenditures. In an era of low oil prices, such spending might limit their financial flexibility to a degree we don't expect to see at their U.S. counterparts—ExxonMobil (XOM), Chevron (CVX), and ConocoPhillips (COP)—which are less generous in dividend payouts. Taken together, we expect the four European majors to pay out nearly 40% of their funds from operations in dividends this year.
The big Russian producers OAO Gazprom and LUKoil OAO could also encounter difficulty. Although we've a stable outlook on LUKoil (as we have on the European and U.S. majors), LUKoil and Gazprom will be vulnerable to steep drops in refining profits in 2009 as a result of Russia's economic weakness. Our pricing assumptions for Russian oil, at $38 per barrel (bbl), are also lower than the $40 per barrel benchmark we're using for 2009 in our analysis of European and U.S. producers.
Russian producers will have significant refinancing needs this year. Finding access to capital from international sources will generally prove more difficult than from domestic ones, and to the extent that producers can tap local capital, they will have an easier time coming through the downturn. But the potential for a negative free cash position at Gazprom is, in part, why we've already assigned it a negative outlook.
One major factor in the Russians' favor, however, is the ruble's devaluation. Along with lower industry costs, this will help see Russia's producers through the downturn. In addition, favorable tax changes, including the lowering of the Russian corporate tax rate to 20%, from 24%, will also boost cash flow at Russian companies.
Sovereign Wealth Funds Are More Cautious
Last year it seemed as if the sovereign wealth funds—nationally owned and controlled investment companies that bought stakes in both foreign and government-owned enterprises—would never stop growing. These funds, many of which are in big oil exporters such as Russia, Kuwait, Abu Dhabi, and Norway, invested in a swath of U.S. financial firms, including Merrill Lynch (MER), Citigroup (C), Morgan Stanley (MS), the Blackstone Group (BX), and Lehman Brothers.
Now that many of those investments have nose-dived in value, sovereign wealth funds are far more cautious about investing than they were a year ago—and the recession is just adding to their pullback. We expect that, because inflows from oil revenues are falling at many of these wealth funds, they'll invest more in their home countries, providing economic stimulus to the local economy or financing to state-owned industries. Such investment can reduce or even eliminate the need for companies to raise more difficult-to-find capital. These funds are also propping up deteriorating currencies, and they can help mitigate banking turmoil, as they're now doing in Russia.
Oil Prices and the Sovereign Rating
It's important to remember the price of oil has no direct link to a sovereign rating. Big oil-exporting nations have such a variety of other factors in play that we can't simply say that if the price of oil goes down, so will the sovereign rating. Nations whose economies are closely tied to oil revenues can still withstand this falloff with little to no rating damage if other important factors are in place. These factors include political stability, a nation's overall wealth, and structural fiscal and economic factors.
We can show how this works by looking at the four nations whose heavy dependence on oil production makes them most vulnerable to falling prices: Bahrain, Saudi Arabia, Azerbaijan, and Nigeria. Their sovereign ratings range from AA- (Saudi Arabia) to BB- (Nigeria). These countries are most at risk because of their relatively narrow economies, exports, and revenue streams. Yet their ratings range from investment grade to speculative grade, largely because of the other factors in the mix, including differences in geopolitical risks, overall economic development, and political stability.
A New Era for Producers and Exporters
Perhaps there is no other industrial sector as crucial to the world economy's well-being as oil and natural gas. But the global economy is weak and so is the demand for these resources. As the beneficiaries of last year's high oil prices head into a future of lower revenues and for some, possibly lower ratings, Standard & Poor's will continue to monitor how the players in the world's energy business are adapting in an economy so different than what existed a year ago.