Moody’s Investors Service has changed its outlook of the independent exploration and production industry to negative, citing the “precipitous decline” in oil and natural gas prices to levels that are likely to result in abnormally low cash margins and fundamental credit deterioration.
“This increased likelihood of fundamental credit deterioration beyond our normal cyclical expectations is a key driver for our negative outlook,” said Peter Speer, Moody’s vice-president and senior analyst.
“In addition, the potential reduction in credit availability to the speculative grade companies also weighed heavily in our forward view,” Speer said.
According to Moody’s, there is significant risk that E&Ps have entered a prolonged period of abnormally low cash margins and returns due to persistent demand-driven price declines’ outpacing cost reductions and supply response.
“Many E&Ps had fully ramped up capital spending and were increasing leverage just as the market turned,” said Speer, “as a result, some companies are ill-prepared for a downturn.”
Moody’s noted the roller coaster ride oil and gas prices were on in 2008. “Our long-term fundamental ratings for these E&P companies are driven by their scale, cost competitiveness, capital productivity, and leverage profiles—not by commodity prices,” said Speer.
However, the extreme reversal in prices over the past 6 months followed an enormous ramp up in E&P capital spending that could not be throttled back as fast as prices declined.
Speer noted that, overall, most investment-grade E&Ps have sufficient cash resources, committed credit availability, and flexibility in their capital expenditures to manage through current low commodity prices.
However speculative-grade E&Ps are at great risk of bank borrowing base reductions.
According to Moody’s, key issues in the coming year include the cost of oil field services, the impact that global macroeconomic fundamentals have on oil demand and prices, and the expected adjustment in response to lower E&P activity.