Oil Firms’ Rising Debts Add Downward Price Pressure in BIS ViewGrant Smith
The oil and gas industry’s $2.5 trillion of debt may compound the drop in crude prices, as companies maximize output to meet their financial obligations, according to the Bank for International Settlements.
Debts owed by energy firms have more than doubled since 2006, the Basel, Switzerland-based institution said in a report on Wednesday, following similar comments last month. The need to repay those loans may keep global markets oversupplied by spurring companies to produce as much oil as possible and sell futures contracts that protect against slumping prices.
“High debt burdens may force these firms to maintain production despite the fall in prices in order to generate the cash flow necessary to service the debt,” according to the BIS report. “A sell-off of oil company debt could spill over to corporate bond markets more broadly if investors try to reduce the riskiness of their portfolios.”
Oil plunged almost 50 percent last year as members of the Organization of Petroleum Exporting Countries refused to cut production in response to the highest U.S. output in three decades. A rebound from the lowest price in almost six years has faltered this month amid speculation that supply growth will withstand the rout. West Texas Intermediate, the North American crude benchmark, is poised to return to a bear market amid a seven-day slide.
U.S. oil explorers, especially shale drillers, “borrowed heavily” in the period, accounting for about 40 percent of outstanding syndicated loans and debt securities, according to the report. The ratio of total debt to assets almost doubled for smaller companies including shale producers, while remaining stable for the larger U.S. oil firms.
Outstanding bonds issued by oil and gas companies swelled to $1.4 trillion in 2014 from $455 billion in 2006, growing at a rate of 15 percent a year, according to the BIS report. Syndicated loans to the industry increased to $1.6 trillion as of 2014, up from $600 billion in 2006.
The price slump has caused a “significant decline” in the value of assets used by energy firms to back this debt, increased financing costs and raised the risk of default, according to the report.
Oil and gas companies represent a “substantial portion” of future debt redemptions, meaning developments in the sector could have “system-wide relevance,” the report said. A selling spree of oil-producer debt could affect other bond markets, the BIS said.
The combination of cutbacks to the number of drilling rigs and increasing U.S. crude production may indicate that companies are focusing more heavily on their most productive wells in order to meet cash flow needs, according to the BIS.
Rigs targeting oil in the U.S. fell by 56 to 866, Baker Hughes Inc. said on its website on March 13, the lowest level since March 25, 2011. Production accelerated to 9.37 million barrels a day in the week to March 6, the most since at least January 1983, according to the Energy Department’s statistical arm.
Debt levels may also determine the extent that the economies of oil-producing nations are affected by the price collapse, according to the report. Countries where the national oil company is highly leveraged will face “more acute constraints on government spending.”